Question

You are an Audit Senior currently planning the 30 June 20X9 audits of Comp Limited (Comp), Health Limited (Health) and News Limited (News). At recently scheduled planning meetings with Comp, Health and News, you obtain the following overview of this year’s operations for each of the three client companies:

Comp is a manufacturer of computer hardware. The old costing system that was developed in- house, could no longer keep up with the complex and detailed manufacturing costing process that provides tender/bid submission costings and the company’s comprehensive reporting requirements. As a result, Comp purchased and installed a popular off the shelf (not customized) costing system to support the highly sophisticated and cost sensitive nature of its product designs. Since this system had been utilised by many other firms in the industry, Comp has not thoroughly tested the adequacy of the features and controls inherent within the system. At the same time, the staffs are not feeling confident with the new system due to lack of training and supervision. Staff are also concerned that data might be lost when converting to the new system.

Health operates chemist shops in Perth. A large proportion of the sales transactions are conducted in cash. Health claims on having strong control policies and procedures in place to monitor the employees handling cash transactions and safeguarding the cash. However, the proper implementation of those policies had been questioned by the previous auditor. As Health is planning to expand to Mandurah and Busselton, it is applying for a bank loan to obtain additional funding for the expansion. Before approving the loan, the bank requires Health to provide them with an audited financial statement. The unaudited figures of current year suggest Health’s revenue to have increased significantly by 25 percent from last year while the gross profit appears to have increased marginally by 5 percent.

News has been in the paper manufacturing business for the last 17 years. It manufactures and distributes paper throughout the Australian continent. During the last five years, News opened four new factories in three different locations, financed mainly from bank loans. Due to rapid growth in the company, the financial director John Brown is keen to set up an internal audit department. Currently the project appears to have stalled, as some of the senior executives do not foresee the benefit of setting up such a department and are unwilling to commit any additional fund or resources on this plan. The senior executives argue that they are competent enough to monitor the internal controls of News.

Required:

Prepare a memorandum to the audit manager, outlining your risk assessments relating to Comp, Health and News. When making your risk assessments:

(a) Identify and discuss the risks that may arise from each of the above companies. In your explanation, please mention the components of the audit risk model affected.

(b) Identify how the audit plan will be affected and recommend specific audit procedures to address these risks.

Answer 1

ISA 200 sets out the overall objectives of the auditor, and the standard explains the nature and scope of an audit designed to enable an auditor to meet those objectives. The standard also requires that the auditor shall plan and perform an audit with professional scepticism, recognising that circumstances might exist that may cause the financial statements to be materially misstated.

ISA 315 deals with the auditor’s responsibility to identify and assess the risks of material misstatement in the financial statements through an understanding of the entity and its environment, including the entity’s internal controls and risk assessment process. Standard provides following requirements-

i The auditor shall perform risk assessment procedures in order to provide a basis for the identification and assessment of the risks of material misstatement.

ii. The auditor is required to obtain an understanding of the entity and its environment, including the entity’s internal control systems.

iii. The auditor shall identify and assess the risks of material misstatement, and determine whether any of the risks identified are, in the auditor’s judgement, significant risks. This is in order to provide a basis for designing and performing further audit procedures.

ISA 315 gives an overview of the procedures that the auditor should follow in order to obtain an understanding sufficient to assess audit risks, and these risks must then be considered when designing the audit plan. ISA 315 goes on to require that the auditor shall perform risk assessment procedures to provide a basis for the identification and assessment of risks of material misstatement at the financial statement and assertion levels. ISA 315 goes on to identify the following three risk assessment procedures:

i. Making Enquiries

ii. Analytical procedures

iii. Observation and inspection.

Following is risk assessment and plan procedure for each of the 3 Companies-

	Audit Risk	Audit Plan Response
i	For Comp-
(a)	Lack of control around Business Continuity and System Change could lead to wrong IPO (input-processing-output) and hence, misstated trial balance being generated by the system.	- Testing the system's IPO (input-process-output) involving System Expert as part of audit team -Observing live transactions recording and output being generated
(b)	Non availability of accurate, fair financials
(c)	Lack of control around system change
ii	For Health-
(a)	Increase in revenue does not commensurate with increase in profit. hence, risk of misstatement.	- Testing should be increased for more coverage - Analytical procedures should be increased - Observing live sales transactions and recording
(b)	Misappropriation of fund and bogus sales being recorded due to lack of system control
(c)	Bank loans may be mis-appropriated
iii	For News-
(a)	Internal audit is important function and lack of support to set the internal audit system leads to question over management functioning	- Discuss with management and understand rationale for not setting the internal audit - Understand legal law and requirements to set new Internal Audit function -Increase the sampling being done for each of these location - Perform Analytical procedures - Verify and test spending of Bank loan and verify whether fund has been spent for the purpose loan was taken
(b)	Impact on the entity level control functioning