Question

You are an Audit Senior currently planning the 30 June 20X9 audit of Technology Limited, an Australian-owned company that produces and exports computer chips to China. At a recent planning meeting with Technology Limited’s senior staff, you obtained the following overview of this year’s operations: Tight checks by Australian custom officials have delayed several shipments of computer chips. These delays have angered Chinese customers who are threatening to deduct 20% from the amounts owing as compensation for lost production time. One of Technology Limited’s customers, Blue Chip Limited, is claiming that the latest batch of computer chips it received was found to be faulty. Blue Chip Limited is refusing to pay its account, which is allegedly seven months overdue. Technology Limited has claimed to have launched an investigation into the allegations, but as yet not been able to substantiate them. Technology Limited has suffered significant cash flow problems because another major customer, Creative Limited (Creative), 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 Technology Limited’s sales and the board has been reluctant to take any action that might adversely affect those sales. Consequently, Technology Limited 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. One of Technology Limited’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 used in the production of computer chips to Technology Limited through his private company Norton Limited. Norton Limited demands payment in $US prior to the electronic components being supplied. 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 Technology Limited’s staff complaining that they are of poor quality. Due to increased competitive pressure, Technology Limited has recently moved the manufacture of some of its computer chips to Bangladesh. Technology Limited saves around 25 per cent in costs compared to the equivalent Australian made items. However, the manufacturing process takes longer and on a few occasions late delivery from Bangladesh has resulted in lost sales. Last month, a protester suffered a broken leg, allegedly because he was hit by a company truck. The protester is now suing Technology Limited for damages, claiming the contractor was in fact an employee of Technology Limited at the time of the accident, and was acting on Technology Limited’s instructions. Technology Limited is fighting the case and appears to have a reasonable chance of winning; however, the adverse publicity being generated is making the company nervous about its sales in the future. During the period, the Australian dollar has remained steady against the Chinese Yuan, although it fell by about 3% against the US dollar. Debtors are invoiced in $US at the time of shipment, and payment is received in $US one month after the shipment is delivered. It takes around six weeks for the charter vessels to travel from Technology Limited’s shipyard at Bigmantle Bay to China. A recent downturn in the Chinese economy is affecting forward orders, which have fallen by 15%. Required: Prepare a memorandum to the audit manager, outlining your risk assessment relating to Technology Limited. When making your risk assessment: (a) Identify two (2) balance sheet accounts from the information provided that are subjected to an increase in audit risk. Briefly explain what factors increase the audit risk associated with the two (2) account balances identified. In your explanation, please mention the key assertion(s) at risk of material misstatement and the components of the audit risk model affected for each account balance identified. (b) Identify how the audit plan will be affected and recommend specific audit procedures to address the risks associated with each account balance identified.

Answer 1

AUDIT PLANNING MEMORANDUM

(a)Based on the discussions with the management for reviewing its operations and for the purpose of assessing and significant changes in the operations, the following would be the two key Balance Sheet items  that would need to be covered in greater details to address Audit Risks:-

1)TRADE RECEIVABLES

Recoverability of some of the high value Trade Debtors

"One of Technology Limited’s customers, Blue Chip Limited, is claiming that the latest batch of computer chips it received was found to be faulty. Blue Chip Limited is refusing to pay its account, which is allegedly seven months overdue.  

This would mean AUDIT PROCEDURES be extended ot assess accuracy of provisioning for bad and Doubtful debts for such similar customer dues having long overdue days. Audit Procedures must include Balance Confirmation procedures to be done by the Audit procedures so that reasonable efforts are made to arrive at reasonably accurate receivable balances

"Tight checks by Australian custom officials have delayed several shipments of computer chips. These delays have angered Chinese customers who are threatening to deduct 20% from the amounts owing as compensation for lost production time."

Audit Procedures to ensure suitable Letter of Representation from Management to minimise Audit Risks while assessing reasonable accuracy of Trade Receivables Figures

2) CURRENT LIABILITIES

"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 Technology Limited’s staff complaining that they are of poor quality"

Due to competitive pressures and the aggressive efforts to drive down costs , there are risk of post shipment order cancellations either in part or in full. The company needs to have a robust QC system in place to ensure that goods purchased are as per the QC norms to avoid claims by customers against delivery of poor quality of chips.'

Audit Procedures to be extended to cover the system of Acceptance of Supplies and  Payment made for purchases are validated against well defined policy to insulate the company from claims from customers.

(b) ADDITIONAL AUDIT PROCEDURES FOR RECEIVABLES

1) Cover all Trade Receivables having old balances more than 60 days.

2) Seek Balance confirmation from such debtors to ensure no deductions are missed out.

3) Get Management Letter of Representation to cover specifically values shown as receivable are accurate

(b) ADDITIONAL AUDIT PROCEDURES FOR CURRENT LIABILITIES ( Customer claims)

1) Client has a system in place for confirmtion of quality of goods received by the Customer

2) Client has system in place for assessing quality of shipments from suppliers for recovering from their payments defective shipments.

3) Get Management Letter of Representation to cover specifically completeness of Liabilities as reflected in the BS .