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ACT504 Auditing

Published : 16-Oct,2021  |  Views : 10

Question:

In March 2016, Barbra Ma, an audit partner at XYZ Chartered Accountants (XYZ), a mid-tier, Melbourne based accounting firm, evaluated and recommended accepting a new audit client, MGC Ltd (MGC). MGC is a medium sized unlisted retail trading company operating in several parts of Victoria. Barbra evaluated the audit client and assessed XYZ’s independence as well as competence to properly complete the audit. XYZ issued an engagement letter and started the MGC’s audit for the year 2016. Alex Jones was assigned as an audit manager in charge of planning and supervising the conduct of the MGC audit.  

MGC is a retailer of skin care products. It operates with seven warehouses all over Victoria. The company was established as a small family business in 1991 and has since grown in size. MGC has a large amount of long-term loan from Westpak Bank. The loan agreement puts certain restrictions on further borrowing possibilities of MGC. It also requires MGC to submit its audited financial statements to Westpak Bank by January 31 of every year until the loan is fully paid.  

MGC has a board of directors comprising five members. Two of the members of the board of directors were newly assigned to replace two former directors who resigned during the current financial year. The company does not have an audit committee. MGC’s internal audit director reports to the board of directors. MGC has a clear and detailed organizational structure for its size and all major transaction classes, i.e., sales, purchases, payroll, etc. are supported by of-the-shelf software packages that have been sufficiently tested in the market. MGC employees receive necessary training on the computer systems before being assigned to duty.

MGC markets its products by emphasizing that it is a socially responsible organisation and highlighting its moral commitment to sell only products not tested on animals. This policy was introduced largely because a major shareholder with a controlling vote has advocated for it. This shareholder also contributes major input on all policy decisions of MGC.

MGC has two major product lines: (a) makeup, which includes a range of cosmetics and (b) gifts, including handmade soaps, shampoos and a range of other handmade products produced in developing countries from recycled materials. MGC sells its products through mail-order catalogue, retail stores, personal selling and online via its website. In recent years, MGC experienced a trend of decreasing sales through mail-order and personal selling whereas online sales has been on the rise.

MGC pays higher prices for some of its products for which alternative products with better value-for-money could be found in the market. MGC pursues this strategy in order to maintain its commitment with its suppliers who also depend on MGC. With this spirit, the company also pays to its suppliers in advance of placing purchase orders. This business practice has resulted in a large amount of advance payments to increasing number of suppliers worldwide.

Alex and his team of three staff auditors formulated the audit plan during the first half of November 2016. This task involved conducting risk assessment, determination of the overall audit strategy, and identification of key areas of audit attention. The audit team updated the audit plan as additional information was obtained during the audit. Exhibits 1 and 2 below present information extracted from the working paper for MGC audit.

Statement of financial position as at 30 June

 

Current Assets

2016

$’000

2015

$’000

2014

$’000

Cash in hand

1920

1488

1855

Payments in advance

3428

2380

1882

Accounts Receivables

3804

2822

1704

Inventory

17894

13476

9876

Total current assets

27047

20166

15317

Property, plant and equipment net of depreciation

17407

4944

4164

Long-term receivable

4104

5483

6540

Total non-current assets

21511

10427

10704

Total assets

48558

30593

26021

Accounts Payables

7866

6558

5465

Other current liabilities

9025

7523

5400

Total current liabilities

16891

14081

10865

Long-term loan payable

18827

6102

4901

Total liabilities

35718

20183

15766

Net assets

12840

10410

10255

Share capital

3000

3000

3000

Retained earnings

9840

7410

7255

Total Shareholders' equity

12840

10410

10255

Income statement For the Year ended 30 June

 Items

2016 $'000

2015 $'000

2014 $'000

Sales

35239

30726

24088

Cost of sales

27985

26303

19116

Gross profit

7254

4423

4972

Depreciation

2906

1825

1451

Inventory obsolescence

581

637

199

Marketing expenses

30

96

42

Administrative expenses

1721

1363

1601

Interest expense

678

264

180

Total expenses

5916

4186

3473

Profit before tax

1338

238

1499

Tax expense

468

83

524

Profit after tax

870

155

974

Required to:

  1. Identify the risk factors present in this audit engagement. Justify your answer.
  2. Conduct the analytical review with key financial ratios and identify the key areas that merit special audit attention.
  3. Recommend the overall audit strategy appropriate for this engagement. Justify your answer.

Answer:

Particulars 2016 2015 2014
$’000 $’000 $’000
Cash in hand 1920 1488 1855
Payments in advance 3428 2380 1882
Accounts Receivables 3804 2822 1704
Inventory 17894 13476 9876
Total current assets 27047 20166 15317
Property, plant and equipment net of depreciation 17407 4944 4164
Long-term receivable 4104 5483 6540
Total assets 48558 30593 26021
Accounts Payables 7866 6558 5465
Other current liabilities 9025 7523 5400
Total current liabilities 16891 14081 10865
Long-term loan payable 18827 6102 4901
Total liabilities 35718 20183 15766
Net assets 12840 10410 10255
Share capital 3000 3000 3000
Retained earnings 9840 7410 7255
Total Shareholders' equity 12840 10410 10255

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