Question

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: 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. (2 marks, maximum 100 words) d) Describe one (1) substantive test of detail that you would undertake for each account to address the assertion and risk identified. (4 marks, maximum 200 words)

(a) Key account balance at risk: (b) Key assertion at risk:

(c) Explanation:

(d) Substantive test of detail/ Audit Process

In table format.

Answer 1

Answer

a) The two main accounts that may be affected with a risk of significant misstatements include the following:

1. Sales account: The sales of the company may be affected by the inappropriate estimate of the revenue and the poor quality of the products being experienced by the staff of Vesta Tech Ltd. There may be misstatements related to the correct valuation of the sales revenue and completeness of the sales records.

2. Receivables account: The Company may suffer heavy losses because of the possibilities of the receivables turning to bad debts as a result of excessive delay in collecting receipts. One of the company's customers named Mimosa Ltd who is facing a financial crisis may get failed in paying the dues.

b) The assertions which are at risk related to the above-mentioned accounts are as follows:

1. Sales account: Valuation of the expected revenue and completeness of the records of events or transactions related to the sales.

2. Receivables account: The key assertions include proper disclosure, completeness of the records, and correct estimation.

c) The reasons for the assertions and balances at risk, include the following:

1. The financial crisis being faced by one of the major customers that may restrict the recovery of receipts by the company.

2. In the case, if there will be uncertainty related to the correct and complete valuation of sales revenue, then the company will not be able to follow GAAP for accounting transactions.

d) substantive test of detail that i would undertake for each account to address the assertion and risk identified are as follows

		substantive test of detail
a)	Key account balance at risk	Related to the account at risk, the test that may be performed is the collection of information from the debt holder as an independent assurance.
b)	Key assertion at risk	Related to the assertion at risk, the test that may be performed is to conduct an inquiry related to the proper accounting of provisions.
c)	Explanation	The collection of information from debtor will assist the auditor in understanding the actual financial position of the debtor and in measuring the degree of actual financial risk.
d)	Substantive test of detail/ Audit Process	Substantive test that should be conducted includes the cross verification of evidence with the figures reported on the company's financials.