Question

You are the audit manager at Black & Blue, a medium-sized audit firm undertaking the audit for the year ended 30 June 2018 of High Tech Ltd, an electronic component manufacturer located in Sydney. During the planning stage of the audit you discovered that one of High Tech Ltd’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 to High Tech Ltd through his private company. 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 High Tech Ltd’s staff complaining that they are of poor quality.

The board has informed you that although sales have been strong this year, High Tech Ltd has suffered significant cash flow problems because a major debtor, Creative Ltd, is experiencing financial difficulties. As a result, Creative Ltd is taking well over 120 days to pay outstanding amounts, despite Creative Ltd’s terms of trade being payment within 30 days. Creative Ltd makes up 40 per cent of High Tech Ltd’s sales and the board has been reluctant to take any action that might adversely affect those sales. As a result, High 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 Big Bank Ltd.

Required:

1. Identify two key account balances at risk of material misstatement.
2. For each account balance identify the key assertion at risk.
3. Explain why the account balance and assertion are at risk.
4. Describe one (1) substantive test of detail that you would undertake for each account to address the assertion and risk identified.
5. Identify and explain two key going concern factors that would place the going concern assumption at risk in relation to High Tech Ltd’s financial report for the year ended 30 June 2018.
6. Describe one (1) substantive test of detail that you would undertake to address the going concern risk.
7. Identify and explain one key related party transaction factor that would increase the risk of material misstatement.

Answer 1

a. Identify two key account balances at risk of material misstatement.

Trade Payables account of Peter James as there is no formal agreement regarding the Price. It is provided that the price will be based on competitive prices.

Trade Receivables account of Creative Limited because of higher debt coolection period of 180 days which contradicts organisational Debt Coolection Policy of 30 days.

b. For each account balance identify the key assertion at risk.

Trade Payables account of Peter James :

1. Valuation:

Trade Receivables account of Creative Limited:

1. Completeness.
2. Valuations
3. Rights and Obligations

c. Explain why the account balance and assertion are at risk.

Trade Payables account of Peter James :

At first lack of Formal Agreement poses a threat to the Price at which the product is acquired as there is a Related Party Transaction.

Secondly, the quality risk as the Products which are offered by Peter James are not of the grade as being complained by High Tech Ltd. Staf.

1. Valuation: The account balace of Peter James might not be properly valued as the there is no formal agreement as well as the quality of products is also inferior posing an issue whether the inventory can be used or not.

Trade Receivables account of Creative Limited:

Firstly, financial instability of Creative Limited surrounds it with the threat of repayment default.
Secondly, Negligence of Managemnet in not assessing the Debt Paying Capacityof Creative Limited.
Instead of searching for substitues to effect the sales that will be lost , Management is continuing effecting sale sto Creative limited and also increased the Debt Collection Period to days.

1. Completeness. ; Because the Debtor Creative Limited is suffering from financial difficulties and the board has not yet classified the Recoverable and Non-Recoverable Portion of its Debt as they fear of losing 40% sales.
2. Valuations: SInce creative Limited has been offered 120 days against 30 days , Interest for delay in Payment . Late Payment Charges has been properly accounted for and shown in account balances.
3. Rights and Obligations: As creative limited is facing Financial Crisis there might be chances that portion of debt is unrecoverable.  Therefore adequate Allowance for Doubtful Debts needs to be provided so record the correct expected amount that that managament has a Right over.

d. Describe one (1) substantive test of detail that you would undertake for each account to address the assertion and risk identified.

Trade Payables account of Peter James:

1. Examination

Trade Receivables account of Creative Limited:

1. Third-party confirmation

e. Identify and explain two key going concern factors that would place the going concern assumption at risk in relation to High Tech Ltd’s financial report for the year ended 30 June 2018.

1. Adverse key financial ratios : Being Debt-Equity Ration breached Bank's Covenant

2. Chances of Losing Key Customer: SInce Credtive Limited is suffering from Financial Crisis

f. Describe one (1) substantive test of detail that you would undertake to address the going concern risk.

By reasssing the Debt Paying Capacity of Creative Limited to address the Cash Flow issues which eventually lead to lower down Debt Equity ratio.

g. Identify and explain one key related party transaction factor that would increase the risk of material misstatement.

1. Dealing at prices or quality which is not done with Unrelated Parties:

Generally the terms of transcations with realted Parties are endered by keeping at stake the Orgaisation POlicy and Objectives to provide Benefit . For Example , by Buying at High Prices and Selling at lower prices, Compromising Quality of Material, Relaxing Credit Terms , Providing with unncessary or excessive Rebates or Discounts etc.