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HI6026 Audit Procedure and Going Concern Tutorial Questions 2 Answer

    Assessment Task – Tutorial Questions

    Unit Code: HI6026

    Unit Name: Audit, Assurance and Compliance Assignment: Tutorial Questions 2

    Weighting: 25%

    Purpose: This assignment is designed to assess your level of knowledge of the key topics covered in this unit

    Unit Learning Outcomes Assessed:

    1. Understand the audit planning procedures, evaluate the business risk and assess the internal control
    2. Prepare auditing procedures for transactions and balances by conducting control and substantive
    tests
    3. Understand the auditor’s reporting obligations and events after the balance date.

    Description: Each week students were provided with three tutorial questions of varying degrees of difficulty. These tutorial questions are available in the Tutorial Folder for each week on Blackboard. The Interactive Tutorials are designed to assist students with the process, skills and knowledge to answer the provided tutorial questions. Your task is to answer a selection of tutorial questions for weeks 6 to 10 inclusive and submit these answers in a single document.

    The questions to be answered are:

    Q1 - Week 6

    As the auditor of Komsu Air Limited (KAL) that manufactures and installs large commercial air- conditioning systems. KAL typically has two or three large contracts (ranging from $6 million to $10 million each) in progress at any one time. The contracts usually take up to six months to complete, although unexpected on-site difficulties can result in lengthy delays in completion (of up to 12 months). KAL finances its operations with a mixture of equity, long-term debt (secured by fixed assets) and short-term bank loans.

    It is now May 2017 and your planning of the audit of KAL for the year ended 30 June 2017 is nearing completion. You have met with the management of KAL and, from those discussions and a review of the preliminary information provided by KAL, you have identified several issues that may have implications for the company’s ability to continue as a going concern. The relevant issues are as follows:

    • Competition in the industry is becoming more intense, with some customers now installing their own systems.
    • KAL’s bank has requested cash flow forecasts for the coming year to support the short-term loans. It has indicated that it may need to withdraw funding or restructure debt if the forecasts are not adequate. The review of work-in-progress indicates that all the contracts in progress at year end are due for completion within six months of the balance date. There are no new contracts in place for the coming year, although management has indicated that there are orders currently being negotiated. The nature of the business is such that sales will fluctuate considerably from year to year depending on the timing of one or two large contracts.
    • Assets consist chiefly of plant and equipment, some of which is specialised to the industry. Debtors are significant, but recoverability is not considered an issue as the ongoing projects are with reputable customers and management is not aware of any problems. Creditor balances are at normal levels, and the company is in a positive working capital position.
    • Included in provisions is a large provision for warranty for one of KAL’s jobs completed at a hotel two years ago. It appears that the air-conditioning system is still not working and the hotel is now requesting a substantial refund of the contract price.

    Required:

    Explain whether you believe the area of going concern should be assessed as high risk and mitigating factors for KAL’s audit for the year ended 30 June 2017. (10 marks, maximum 300 words)

    Q2- Week 7

    Wares king supplies custom-fitted curtains and blinds to retail customers. It has recently expanded to offer a wide variety of home decorating products through its six stores across the state. After some initial problems with stock control it installed a new automated inventory system in April this year. The system replaced another automated system that had been modified so often over the years that the auditor had advised Wares’s management that they did not regard it as reliable. That is, the auditor was unable to rely on the old system sufficiently to assess control risk for inventory as anything less than high.

    Required:

    1. Explain the normal process an auditor would expect to find in the client’s systems governing changes to computer programs. Why is an auditor concerned about program changes? (3 marks, maximum 100 words)
    2. Wares kings’ financial year-end is 31 December. Does the auditor need to obtain evidence about the performance of the inventory control system from every month in the year or from a sample of months? Explain. (3 marks, maximum 100 words)
    3. If the auditor conducts test of the inventory controls at an interim date, is it appropriate to conclude that the controls also relate to the end of period date? Why? (4 marks, maximum 150 words)

    No Table is required

    Q3- Week 8

    You are the audit manager at KPMG & Coopers a medium-sized audit firm undertaking the audit for the year ended 30 June 2018 of Vesta Tech Ltd, an electronic component manufacturer located in Sydney. During the planning stage of the audit you discovered that one of Vesta Tech Ltd’s major suppliers went bankrupt one month ago, causing major product shortages. To overcome the problem, Jonathon Marshall, the husband of the finance director, Nimat Marshall provided electronic components to Vesta Tech Ltd through his private company. There is no formal agreement in place with Jonathon Marshall, however, the goods are being provided at competitive prices. You are concerned about the electronic components that Jonathon Marshall’s company is supplying, because his products are new to the market and you have heard some of Vesta Tech Ltd’s staff complaining that they are of poor quality.

    The board has informed you that although sales have been strong this year, Vesta Tech Ltd has suffered significant cash flow problems because a major debtor, Mimosa Ltd, is experiencing financial difficulties. As a result, Mimosa Ltd is taking well over 120 days to pay outstanding amounts, despite Mimosa Ltd’s terms of trade being payment within 30 days. Mimosa Ltd makes up 40 per cent of Vesta Tech Ltd’s sales and the board has been reluctant to take any action that might adversely affect those sales. As a result, Vesta 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 WestPac Bank Ltd.

    The management of CGL is currently reviewing the structure of its audit committee to ensure that it complies with the requirements of the ASX Corporate Governance Principles and Recommendations.

    However, the board is confused by the reference in the ASX Corporate Governance Principles and Recommendations to both independent directors and non-executive directors, as they thought that they were the same thing. As a result, they have sought your advice concerning the structure of their audit committee.

    Required:

    1. Identify two key account balances at risk of material misstatement. (2 marks)
    2. For each account balance identify the key assertion at risk. (2 marks)
    3. Explain why the account balance and assertion are at risk. (2 marks, maximum 100

    Answer

    Question 1: Audit procedure and going concern:

    The concept of going concerned: 

    The going concern is a fundamental principle of the business organization in accounting. The continuation of the business or entity and existence of business in the future is referred to as going concerned. In the business organization, many circumstances may have an impact on the going concern of the business. The auditors can identify these circumstances by auditing the operating activities, major suppliers detail, major debtors, sale of fixed assets of the company (McNamee, & Selim, 2018).

    KAL's audit and the impact ongoing concern of the company:

    Appropriateness of Going Concern
    		Mitigating factors
    Financial indicators: As per details given in the question, KAL's company does not have future contracts after completion of present contracts. Banks have doubts about the future profitability of the business organization and banks' demand from KAL ltd for the forecast income statement of the company. In the current situation, the company has only a few contracts left with the company and as per management representation, some contracts are pending under negotiation. This is an indicator of risk ongoing concern of the business.
    The company has good and recoverable debtors as the client of the company is reputed and has good credibility. Therefore the company has no issue on cash flows of the company and the company also has adequate assets specifically for the commercial conditioning system (Lobwo, Davis, & Anthony, 2020).
    To improve the financial position of the company, management needs to a final contract that is pending in negotiation.
    Management needs to increase business in other areas like personal AC facility (Lobwo, Davis, & Anthony, 2020).
    Operational Indicators: The competitions in the industry increase as the client are moving from a personal AC system in place of complete building AC contracts.
    		KAL limited is required to change its working process and improve the production process as per the need of customers as the market is based on the demand of customers (McNamee, & Selim, 2018).
    Other indicators: KAL ltd has performed work for a hotel that is demanding a refund due to the inappropriateness of services.
    		The management needs to do the negotiation for a refund with the hotel's management and offer other alternatives like rework, free services, etc. that will reduce the cash flow burden of the company.

    Question 2: Inventory management system and its audit:

    a) Auditors’ concern about program changes:

    Inventory is a major asset of the company as a whole business operating activity depends on inventory. If there is a change in management of inventory then there is a need to do a proper check of the new inventory management system and also understand the need for a new system. The change in the program is the main concern of the auditors as it is an indication that the previous program may be inaccurate and reports from the previous program are incorrect. Also due to change in the system, auditors are not able to do comparison analysis and not able to find variations in previous and current information (Lobwo, Davis, & Anthony, 2020).

    Auditors should check the documentation of the change in the inventory management system and check whether proper authorization has been taken at each level of management. Auditors also check the impact of the new inventory management system in books of accounts and valuation of the stock (McNamee, & Selim, 2018).

    b) Evidence about the performance of the inventory control system:

    To understand the impact of an inventory control system, auditors are required to collect evidence of inventory. Auditors are not required to collect evidence in every month to identify the performance of the new inventory control system. Auditors are required to collect evidence before and after the implementation of a new inventory control system (McNamee, & Selim, 2018).

    In the given case, the inventory control system is implemented in April, therefore the auditor may collect evidence during April before and after implementing the new inventory control system (Lobwo, Davis, & Anthony, 2020).

    c) Inventory control test:

    As the auditors need to verify the internal control system of inventory management, in that case, auditors can test the inventory control at any time during the financial year. However, in the given case, the system of inventory management is changed during April. The auditor should test inventory control before and after installing a new inventory management system. There is no need to conduct a test at the end of the financial year (McNamee, & Selim, 2018).

    Question 3: Material account balance and its audit:

    a) Key account balances at risk of material misstatement:

    In the given case, the following are key account balances that are at risk of material misstatement:

    1. Major supplier went bankrupt: The major supplier of Vesta ltd went bankrupt due to there is a shortage of inventory supply and to fulfill the current demand company taken supply from Jonathon Marshall who is a related party as he is the husband of director of the company. He is providing low quality of inventory and it is a non-reportable related party transaction. 
    2. Major debtors of the company: The major debtor of company i.e. Mimosa Ltd who is having credit period of 30 days and has 40% part of sales of Vesta Ltd has not paid amount since 120 days that is the cause of the shortage of cash inflow of the company and this result in liquidity problem for the company. 

    b) Risk key assertion: 

    The major key assertion in which company has risk are:

    • Obligation and right of the company
    • Completeness of the records of the company
    • Valuations of assets of the company
    • Complete information in financial statements

    c) Reasons for the risk of account balances and assertions:

    As the information is given in the question, the company facing a problem of cash inflow and shortage of liquidity due to non-payment by the major debtor of the company. There is a risk of lower quality product supply from a related party that is not reported in the books of accounts and no proper authorization is taken in respect of supply from Jonathan Marshall (Salih, & Hla, 2016). There is a risk in the manipulation in sales data by finance directors to hide the complaints of lower quality products of the workers.

    There is also a risk of decline in market price as a company is not able to maintain a proper debt-equity ratio due to a shortage of funds.

    d) Substantive tests:

    Auditors should perform the audit process with due diligence and take substantive tests of material account balance and key assertions. The auditor should instruct the management to take the proper authorization of related party transactions. Auditors should check the procedure used by the company for recovery of the amount from the major debtors. Auditors should check the impact of the transaction ongoing concern of the business organization (McNamee, & Selim, 2018).

    Question 4: Key audit matters and Subsequent events:

    a) Key audit matters and effect on the audit report

    Key audit matters are those matters that are reportable in the audit reports as per the professional judgment of the auditors. Key audit matter is chosen by the auditors based on financial statement analysis, an audit of internal control, information acquired from management and internal staff, etc (Fukukawa, & Kim, 2017).

    The audit report consist of the following information about key audit matters:

    • The reason for key audit matters
    • The process to deal with key audit matters during the audit
    • Reference is taken for the process of audit

    b) Subsequent events and effect on the audit report

    1. The issue of new shares through private placement as on 15 August have a material impact on financial statement therefore it is reportable in the audit report.
    2. The company has taken a 60% stake of other company and the contract will complete as on 15 August that has a material impact on financial statements therefore it is required to report in the audit report (McNamee, & Selim, 2018)
    3. There are chances of loss of case due to the availability of scientific tests therefore auditors should instruct management to identify contingent liability and auditors must report in the audit report.
    4. The major supplier of the company went bankrupt as of July 2020 that has a material impact on the liquidity of the company. Therefore, the company needs to disclose this subsequent event in the audit report (McNamee, & Selim, 2018).

    Question 5: Opinion of auditors in the audit report:

    1. Qualified opinion: 

    In the given case, the expenses incurred by the company are not supportable with payment vouchers or receipts. The auditors are not able to check the authenticity of these expenses. Therefore auditors must provide a qualified opinion in the audit report.

    2. Disclaimer opinion:

    In the given case, the valuation method used by JJ king ltd is incorrect and not as per accounting standards for the valuation of houses constructed by JJ king ltd. The auditors should provide a disclaimer opinion on the valuation of inventory and also intimate to the management for correcting the valuation of houses (McNamee, & Selim, 2018).

    3. An unqualified opinion with emphasis of matter paragraph:

    In the given case, Grand Resort ltd has overvalued assets and issue revised valuation report to the auditors. As the issue is corrected by the management, the auditor should provide an unqualified opinion and to disclose the overvaluation of property is shown under the emphasis of matter paragraph (Marais, 2014).

    4. An unqualified opinion with other matter paragraphs:

    In the given case, Band Eclipse is facing the problem of contingent liability due to the cancellation of the event. The company already disclose these contingent liabilities in the books of accounts under the working notes. Therefore auditors should provide unqualified opinion and disclose information of contingent liability under other matter paragraphs (McNamee, & Selim, 2018).

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