Question

Auditing case 2:

audit planning and risk assessment of a scooter trader

Ivy Bishnoi is preparing a report for the engagement partner of an existing client, Scooter Ltd., an importer of scooters and other low-powered motorcycles. Ivy has been investigating certain aspects of Scooter Ltd.’s business given the change in economic conditions over the past 12 months. She has found that Scooter Ltd.’s business, which experienced rapid growth over its first five years in operation, has slowed significantly during the last year. Initially, sales of scooters were boosted by good economic conditions and solid employment growth, coupled with rising gas prices. Consumers needed transport to get to work and the high gas prices made the relatively cheap running costs of scooters seem very attractive. In addition, the low purchase price of a small motorcycle or scooter, at between $3,000 and $8,000, meant that almost anyone who had a job could obtain a loan to buy one.

However, Ivy has found that the sales of small motorcycles and scooters have slowed significantly and that all importers of these products, not just Scooter Ltd., are being adversely affected. The onset of an economic recession has restricted employment growth, and those people who still have jobs are less certain of continued employment. In addition, the slowdown in the world economy has caused oil prices to fall, further reducing demand for this type of economical transport. Ivy has also discovered that, due to the global financial crisis, the finance company used by Scooter Ltd.’s customers to finance. the purchase of scooters and motorcycles has announced that it will not be continuing to provide loans for any type of vehicle with a purchase price of less than $10,000.

Required:

(a) Identify the issues that potentially have an impact on the audit of Scooter Ltd.

(b) Explain how each issue affects the audit plan by identifying the risks and the financial statement accounts that require closer examination

Source: Campbell et. al (2013), Cloud 9 Pty Ltd: An Audit Case Study, Canada:

Answer 1

Facts of the given case and Analysis:

We understand the following facts from the given case:

• Scooter Limited’s business has suffered a significant decline in the last year
• All importers in the industry are being adversely affected
• Economic recession has affected employment growth
• Slowdown in the economy has caused oil prices to fall, further reducing demand or this type of transport
• Due to the global financial crisis, the finance company used by Scooter Ltd.’s customers to finance the purchase of scooters and motorcycles has announced that it will not be continuing to provide loans for any type of vehicle with a purchase price of less than $10,000.

The above facts regarding the economic circumstances makes it clear that, the entity id facing more business risks and therefore increased risks of going concern problems which must be addressed by auditors.

Requirements of ISA 315

As per ISA 315, “Understanding the Entity and its Environment and Assessing the Risks of Material Misstatement”, or its local equivalents to assess and develop responses to risks.

This process requires that auditors:

• To understand the company's business and the environment in which it operates.
• Identify the business risks facing their clients.
• Assess the risks of material misstatement arising from the business risks.
• Design suitable responses to the risks of material misstatement

Meaning of Business Risks & their impact

Business risks are risks that could affect an entity's ability to achieve its objectives and execute its strategies.

The objective of every business is to increase profits, business risks are essentially risks which if, if left unmanaged, could reduce the company's profits and eventually could mean that the company is not a going concern.

Effects of these Business Risks on Financial Statements Risks of Material Misstatements (ROMM)/Audit Planning:

1. RoMM in Debtors/Receivables/Revenue: Business risk may cause misstatement in Debtors/Revenue. For example, poor economic conditions in an industry could increase the risk that customers will not be able to pay their debts. This means that for the supplier there is a risk that receivables are overstated.
2. RoMM on Profits: Business risks significantly affect the profits. For example, the management of a company may face pressure to report higher earnings which may lead to manipulation of accounts.
3. Assessment of Going Concern Assumption: If the company is facing going concern problems that require disclosure or adjustments in the financial statements but the company fails to do so, this will result in misstatements. A thorough risk analysis is obviously a crucial part of the audit process in the current economic circumstances, focusing particularly on risks relating to going concern.

Following aspects needs to be considered:

• Entity has had past difficulties in obtaining external finance and/or complying with the related terms and covenants
• A company which may run out of cash within the foreseeable future may not be able to keep trading and will not be a going concern.
• The terms of debt covenants have been changed, making it more difficult for the entity to comply, or the company may already have breached such conditions.
• Management has plans to sell assets to overcome financing difficulties, but the values included in the plans may not be realised at present.
• Future cash flows are uncertain or volatile
• Customers taking longer or unable to pay.
• Entity dependent on key suppliers.

4. Valuation of Assets:

• Due to reduced or suspended trading in particular asset classes, assets may have become illiquid.
• Impairment of non-current assets.
• Impairment of the carrying value of purchased goodwill

5. Internal Controls:

• As part of his or her risk assessment, the auditor should consider the design and operational effectiveness of any controls the company has undertaken to address the identified risks.
• The auditor should also ensure that the controls stated within the company's systems documentation are actually being performed. Since companies will be trying to cut costs, there may be fewer staff employed within the accounting department and so some controls may not be performed due to time pressures.

Thus, the above aspects are to considered in planning of the audit of Scooters Limited.