Question

Sweaty Passion Limited (“SP”) is a listed company in Hong Kong engaging in trading of sportswear and sports equipment.

You are the auditor of SP. At the beginning of the audit, the audit partner determines the materiality for the financial statements as a whole at HK$1 million and the threshold for clearly trivial misstatements at HK$50,000. The annual audit is substantially completed. During the course of the audit, the following audit findings are identified.

(i) Some aged inventories that amounted to HK$0.4 million are identified through the review of the inventory ageing report. The sales reports indicated that there were no sales of these inventory items in the past 12 months. The management of SP considers that no inventory provision is necessary.

(ii) A sales cut-off error that amounted to HK$5 million is identified in one of the sales cut-off test samples. Transaction of next year is misrecognised as current year transaction. It is uncertain whether the sales cut-off error is an exceptional one. The profit margin ratio of SP’s products is 10%. The total revenue of SP is HK$600 million.

(iii) The outstanding balance of a Japanese supplier is found to be converted into Hong Kong Dollars by using a wrong exchange rate. The purchase transaction is denominated in Japanese Yen, with the outstanding balance of ¥20 million. The balance is stated at the book at HK$1.5 million, with exchange rate at 0.075. The closing exchange rate as at the year-end should be 0.085. It is uncertain whether the exchange error is an exceptional one.

Required:

(a) In view of the audit findings presented above, propose follow up audit procedures on each findings.

(b) Assume the audit findings presented above are all misstatements identified in the audit, with no repeating occurrence in other transactions and balances, evaluate these misstatements, individually and aggregately, whether these are material misstatements.

Answer 1

In view of the audit findings, substantive audit procedure shall be increased to cover more samples and population for sufficiency of audit evidence and hence following procedures shall be performed additionally-

1. Review the ageing of the inventory of entire population to ensure no other obsolete inventory exists

2. Increase the cut-off testing to cover more number of days and more number of samples.

3. Re-compute all the foreign payable and receivable balance at closing rate & compare with the stated balances

Evaluation of Individual materiality-

1. Inventory aged more than 12 months of 0.4 million. This item is above materiality individually and hence, should be aggregated

2. Sales cut-off of 5 million is misstated which is above individual materiality. Hence, should be aggregated

3. The error in conversion is appx. HK Dollar 0.15 million which is above individual materiality and hence should be assessed.

At finance statement level

a. Sales and cost of goods sold is misstated by 5 million and 4.5 million respectively which is above financial statement materiality, Hence, should be adjusted.

b. Item no. 1 and 3 together has impact on profit is decrease by 0.55 million which appx 55% of financial statement materiality. These 2 items together can be considered as summary of unadjusted differences which management has to sign as part of Management Representatin Letter to auditors certifying that these two entries will not have material impact on financial statements.