You are an audit senior of Berry Fruit & Co and are planning the audit of Star Fruit Co for the year ending 31 March 20X8. The company is a manufacturer of portable music players and your audit manager has already had a planning meeting with the finance director. Forecast revenue is $68.6m and profit before tax is $4.2m.
She has provided you with the following notes of the meeting:
Planning meeting notes
Inventory is valued at the lower of cost and net realizable value. Cost is made up of the purchase price of raw materials and costs of conversion, including labour, production and general overheads. Inventory is held in three warehouses across the country.
The company plans to conduct full inventory counts at the warehouses on 2, 3 and 4 April, and any necessary adjustments will be made to reflect post year‐end movements of inventory. The internal audit team will attend the counts.
During the year, Star Fruit Co paid $1.1m to purchase a patent which allows the company the exclusive right for three years to customize their portable music players to gain a competitive advantage in their industry. The $1.1m has been expensed in the current year statement of profit or loss. In order to finance this purchase, Star Fruit Co raised $1.2m through issuing shares at a premium.
In November 20X7, it was discovered that a significant teeming and lading fraud had been carried out by four members of the receivables ledger department who had colluded. They had stolen funds from wholesale customer receipts and then to cover this, they allocated later customer receipts against the older receivables. These employees were all reported to the police and subsequently dismissed. As a result of the vacancies in the receivables ledger department, Star Fruit Co decided to outsource its receivables ledger processing to an external service organization. This service organization handles all elements of the receivables ledger cycle, including sales invoicing and chasing of receivables balances and sends monthly reports to Star Fruit Co detailing the sales and receivable amounts.
Star Fruit Co ran its own receivables ledger until 31 January 20X8, at which point the records were transferred to the service organization.
In December 20X7, the financial accountant of Star Fruit Co was dismissed. He had been employed by the company for nine years, and he has threatened to sue the company for unfair dismissal. As a result of this dismissal, and until his replacement commences work in April, the financial accountant’s responsibilities have been adequately allocated to other members of the finance department. However, for this period no supplier statement reconciliations or payables ledger control account reconciliations have been performed.
In January 20X7, a receivable balance of $0.9m was written off by Star Fruit Co as it was deemed irrecoverable as the customer had declared itself bankrupt. In February 20X8, the liquidators handling the bankruptcy of the company publicly announced that it was likely that most of its creditors would receive a pay‐out of 40% of the balance owed. As a result, Star Fruit Co has included a current asset of $360,000 within the statement of financial position and other income in the statement of profit or loss.
(a) Describe Berry Fruit & Co’s responsibilities in relation to the prevention and detection of fraud and error.
(b) Describe EIGHT audit risks and explain the auditor’s response to each risk in planning the audit of Star Fruit Co.
Note: Prepare your answer using two columns headed Audit risk and Auditor’s response respectively.