19) OLIVE CO.
You are a manager in Olive & Co, a firm of Chartered Certified Accountants. You have been temporarily assigned as audit manager to the audit of Kiwi Co, because the engagement manager has been taken ill. The final audit of Kiwi Co for the year ended 28 February 20X5 is nearing completion, and you are now reviewing the audit files and discussing the audit with the junior members of the audit team.
Kiwi Co is a private company which designs and manufactures equipment such as cranes and scaffolding, which is used in the construction industry. The equipment usually follows a standard design, but sometimes Kiwi Co designs specific items for customers according to contractually agreed specifications. The draft financial statements show revenue of $12.5 million, net profit of $400,000, and total assets of $78 million.
The following information has come to your attention during your review of the audit files.
During the year, a new range of manufacturing plant was introduced to the factories operated by Kiwi Co. All factory employees received training from an external training firm on how to safely operate the machinery, at a total cost of $150,000. The training costs have been capitalised into the cost of the new machinery, as the finance director argues that the training is necessary in order for the machinery to generate an economic benefit. After the year end, Carrot Co, a major customer with whom Kiwi Co has several significant contracts, announced its insolvency, and that procedures to shut down the company had commenced. The administrators of Carrot Co have suggested that the company may be able to pay approximately 25% of the amounts owed to its trade payables (creditors). A trade receivable of $120,000 is recognised on Kiwi Co’s statement of financial position in respect of this customer.
In addition, one of the junior members of the audit team voiced concerns over how the audit had been managed. The junior said the following.
‘I have only worked on two audits prior to being assigned to the audit team of Kiwi Co. I was expecting to attend a meeting at the start of the audit, in which the partner and other senior members of the audit team would discuss the audit, but no meeting was held. In addition, the audit manager has been away on holiday for three weeks, and left a senior in charge. However, the senior was busy with other assignments, so was not always available.
‘I was given the task of auditing the goodwill which arose on an acquisition made during the year. I also worked on the audit of inventory, and attended the inventory count, which was quite complicated, as Kiwi Co has a lot of work-in-progress. I tried to be as useful as possible during the count, and helped the client’s staff count some of the raw materials. As I had been to the inventory count, I was asked by the audit senior to challenge the finance director regarding the adequacy of the provision against inventory, which the senior felt was significantly understated.
‘Lastly, we found that we were running out of time to complete our audit procedures. The audit senior advised that we should reduce the sample sizes used in our tests as a way of saving time. He also suggested that if we picked an item as part of our sample for which it would be time consuming to find the relevant evidence, then we should pick a different item which would be quicker to audit.’
Required
In respect of the specific information provided:
(a) Comment on the matters to be considered, and explain the audit evidence you should expect to find during your file review in respect of:
(i) The training costs that have been capitalised into the cost of the new machinery; and
(ii) The trade receivable recognised in relation to Carrot Co.