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.

1. (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.

2. (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.

3. (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.

Qusetion

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

Answer 1

Follow up audit procedures refer to the approach which is used for disposition of audit results and making sure that action plans have been implemented effectively. These are done to report on results on a timely basis.

A) In this case, the auditor has found out that SP has an obsolete inventory of HK$ 400,000 as indicated by the sales reports, therefore, as a follow up procedure, it needs to be seen whether the company has made an appropriate provision out of profits for the value of such obsolete inventory in its income statement or not. The auditor should also check if the value of the inventory of SP appearing in the balance sheet is reduced or not by the amount of such obsolete inventory because its demand is not very much in the market.

B) As a follow up procedure, the auditor should make sure that the sales transaction pertaining to next year is not included in the income statement of the current year, as its inclusion would result in increase in profits for the current year by HK$0.5 million, thus distorting the financial performance and position of the current year.

C) In this case, the auditor should himself check the correct value at which the Japanese supplier would appear under the heading of sundry creditors in the balance sheet by using the correct exchange rate of 0.085 instead of 0.075.This would result in an increase of value of sundry creditors as on year end by HK$0.2 million.