AF304 Auditing

Final Exam Revision Questions

Question 1

Everyday Supplies Pty Ltd is a single-store retailer that sells a variety of tools, garden
supplies, lumber, small appliances, and electrical fixtures to the public, although about half of
Everyday Supplies’ sales are to construction contractors on account.

Retail customers pay for merchandise by cash or credit card at cash registers when
merchandise is purchased. A contractor may purchase merchandise on account, if approved
by the credit manager based only on the manager’s familiarity with the contractor’s
reputation. After credit is approved, the sales associate files a prenumbered charge form with
the accounts receivable supervisor to set up the receivable.

The accounts receivable supervisor independently verifies the pricing and other details on the
charge form by reference to a management-authorised price list, corrects any errors, prepares
the invoice, and supervises a part-time employee who mails the invoice to the contractor. The
accounts receivable supervisor electronically posts the details of the invoice in the accounts
receivable subsidiary ledger; simultaneously, the transaction’s details are transmitted to the
bookkeeper. The accounts receivable supervisor also prepares a monthly computer-generated
accounts receivable subsidiary ledger without a reconciliation with the accounts receivable
control account, and a monthly report of overdue accounts.

The cash receipts functions are performed by the cashier, who also supervises the cash register
clerks. The cashier opens the mail, compares each cheque with the enclosed remittance advice,
stamps each cheque “for deposit only”, and lists cheques for deposit. The cashier then gives
the remittance advices to the bookkeeper for recording. The cashier deposits the cheques daily,
separate from the daily deposit of cash register receipts. The cashier retains the verified deposit
slips to assist in reconciling the monthly bank statements, but forwards to the bookkeeper a
copy of the daily cash register summary. The cashier does not have access to the journals or
ledgers.

The bookkeeper receives the details of transactions from the accounts receivable supervisor
and the cashier for journalising and positing to the general ledger. After recording the
remittance advices received from the cashier, the bookkeeper electronically transmits the
remittance information to the accounts receivable supervisor for subsidiary ledger updating.
The bookkeeper sends monthly statements to contractors with unpaid balances upon receipt
of the monthly report of overdue balances from the accounts receivable supervisor. The
bookkeeper authorises the accounts receivable supervisor to write off accounts as
uncollectible when six months have passed since the initial overdue notice was sent. At this
time, the credit manager is notified by the bookkeeper not to grant additional credit to that
contractor.

Required:

1
Describe five internal control weaknesses in Everyday Supplies’ internal control for the cash
receipts and billing functions. Explain why each is a weakness.

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Question 2
You are the audit manager at Black & Blue, a medium-sized audit firm undertaking the audit
for the year ended 30 June 2013 of High Tech Ltd, an electronic component manufacturer
located in Sydney. During the planning stage of the audit you discovered that one of High Tech
Ltd’s major suppliers went bankrupt one month ago, causing major product shortages. To
overcome the problem, Peter James, the husband of the finance director, Natalie James,
provided electronic components to High Tech Ltd through his private company. There is no
formal agreement in place with Peter James, however, the goods are being provided at
competitive prices. You are concerned about the electronic components that Peter James’
company is supplying, because his products are new to the market and you have heard some
of High Tech Ltd’s staff complaining that they are of poor quality.

The board has informed you that although sales have been strong this year, High Tech Ltd has
suffered significant cash flow problems because a major debtor, Creative Ltd, is experiencing
financial difficulties. As a result, Creative Ltd is taking well over 120 days to pay outstanding
amounts, despite Creative Ltd’s terms of trade being payment within 30 days. Creative Ltd
makes up 40 per cent of High Tech Ltd’s sales and the board has been reluctant to take any
action that might adversely affect those sales. As a result, High Tech Ltd has had to increase
its dependency on its line of credit, and this has caused it to temporarily breach the debt to
equity ratio required in its loan covenant with Big Bank Ltd.

Required:
(a) Identify two key account balances at risk of material misstatement.
(b) For each account balance identify the key assertion at risk.
(c) Explain why the account balance and assertion are at risk.
(d) Describe one (1) substantive test of detail that you would undertake for each account to
address the assertion and risk identified.

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Question 3
Tanners Ltd is a wholesaler of packaging products and you are about to complete the financial
report audit for the year end 30 June 2015. Before you finalise your audit opinion you are
considering some significant events that have recently occurred in Tanners Ltd.
Denners Ltd and Minners Ltd
Denners Ltd, a customer of Tanners, is suing the company due to being sold faulty packaging.
Denners is a food manufacturer and has claimed that as a result of unhygienic packaging
supplied by Tanners it had to re-supply some products to its customers, pay them compensation
for their losses and dispose of other products that were now unfit for sale. Denners has made a
claim against Tanners for $450 000, which Tanners is disputing because the fault lay with a
new machine recently purchased from Minners Ltd. The board of Tanners have indicated they
do not intend to provide for any amounts payable to Denners as these will be recouped from
Minners.
Factory fire
There was a fire at one of Tanners’ factories in late July 2015. Some machinery, raw materials
and finished products were damaged in the fire. The insurance company was informed and an
investigation showed that the factory supervisor was at fault by not following safety
procedures, as a result the insurance company have refused to accept the claim.
Jonners Ltd
In August 2015, Tanners was informed by one of its long-standing customers, Jonners Ltd, that
it was having going concern problems and that paying the amount owed to Tanners was going
to be difficult. No amount has been received from Jonners since June. The directors of Tanners
believe that it is not necessary to adjust the receivable balance at 30 June 2015 as Jonners has
always paid them in the past.

Required
For each of the issues above describe how they should be treated in the financial report and
identify any further information you required to arrive at a conclusion as to the appropriate
treatment.

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Question 4
Consider the following independent situations found during audit testing of CD Ltd, which
has a balance date of 30 June 20X7. Assume that all the situations are material.

(i) Recent industrial action has seen trade unions win a pay increase of 4% for all their
members. Under the terms of the agreement, the pay increase will be backdated to 1
January 20X7, resulting in a charge equal to 10 % of profit. Management have agreed
to the pay increase, however, they have not made any adjustments to the 30 June
20X7 financial report.

(ii) A large order from an overseas supplier was shipped FOB (free on board) from its
port of origin on 1 June 20X7. The order arrived on 20 July 20X7. The purchase is not
reflected in the 30 June 20X7 financial report.

(iii) The draft chairman’s report to go with the financial report states that the profits of a
particular segment of the company’s operations increased by 70% during the period.
On checking the figures, you found profits increased by only 4%.

(iv) Your New Zealand branch office disclaimed responsibility for the inventory figures in
the New Zealand division’s reporting package. This is because sudden flooding
prevented the auditors from attending the stocktake, and destroyed documentation
which would have enabled them to substantiate inventory by other means. The New
Zealand division represents about 10% of CD Ltd’s operations.

(v) The entire Queensland operations of the company are under investigation by the Tax
Office for alleged failure to pay the appropriate amount of PAYG tax. Your
preliminary investigations reveal that the Tax Office has a strong case against the
company. No mention of the dispute is made in the financial report.

Required:

Assume that no adjustments are made. For each situation, identify the type of audit opinion
required and explain the basis of your answers.