Question

You are the audit manager at Black Blue. a medium-sized audit firm undertaking the audit for the year ended 30 June 20X8 of High Tech Limited (High Tech), an electronic component manufacturer located in Sydney. During the planning stage of the audit you discovered that one of High Tech'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 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's staff complaining that they are of poor quality The board has informed you that although sales have been strong this year. High Tech has suffered significant cash flow problems because a major debtor. Creative Limited is experiencing financial difficulties. As a result. Creative is taking well over 120 days to pay outstanding amounts. despite Creative's terms of trade being payment within 30 days. Creative makes up 40 per cent of High Tech sales and the board has been reluctant to take any action that might adversely affect those sales. As a result. High Tech 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 Limited. a. Based on the required Considering the information provided. determine the two key account balances at risk of material misstatement. Briefly justify your answer. b. For each account balance identify the key assertion at risk. Briefly justify your answer. c. Recommend two substantive audit procedures you could perform in response to each risk identified above

Answer 1

a.

Above case is an example of critical business situation where an entity faces/enters into:

a) shortage of Raw Material from major Vendor;

b) high probability of Bad Debts of one of the major Customer;

c) Related Party transaction such as one with Relative of one of the Director.

Auditor here needs to include substantive procedures at the planning stage for specially verifying true and fairness of these type of accounts and transactions with them as it may involve Fraud or Financial Misrepresentation.

b. Key Assertion at Risk:

1. For Major Debtor ,there is risk of Non Recovery of Financial Dues.

2. For Related Party dealings, there is risk of Purchasing Components at Overvalued Prices and indirectly benefiting the Director.

c. Substantive Procedures could be:

-Obtaining balance confirmation from customer and vendor

-Vouching Sales Vouchers

-Verifying the Purchase Process and comparing prices with Prices of other vendors.