Question

You are an audit supervisor of Pluto & Co and are currently planning the audit of your client, Venus Magnets Co (Venus) which manufactures decorative magnets. Its year end is 31 December 20155 and the forecast profit before tax is $9·6 million.

During the year, the directors reviewed the useful lives and depreciation rates of all classes of plant and machinery. This resulted in an overall increase in the asset lives and a reduction in the depreciation charge for the year.

Inventory is held in five warehouses and on 28 and 29 December a full inventory count will be held with adjustments for movements to the year end. This is due to a lack of available staff on 31 December. In October, there was a fire in one of the warehouses; inventory of $0·9 million was damaged and this has been written down to its scrap value of $0·2 million. An insurance claim has been submitted for the difference of $0·7 million. Venus is still waiting to hear from the insurance company with regards to this claim, but has included the insurance proceeds within the statement of profit or loss and the statement of financial position.

The finance director has informed the audit manager that the October and November bank reconciliations each contained unreconciled differences; however, he considers the overall differences involved to be immaterial.

     A directors’ bonus scheme was introduced during the year which is based on achieving a target profit before tax. In order to finalize the bonus figures, the finance director of Venus would like the audit to commence earlier so that the final results are available earlier this year.

Required:

Based on the above describe FIVE audit risks, and explain the auditor’s response to each risk, in planning the audit of Venus Magnets Co

Answer 1

The first issue is about reviewing the useful lives and depreciation rates of the asset, which resulted in increase in useful life and reduction in depreciation which will also lead to an increase in profits ultimately. Since such changes have a persuasive effect on the financial statements, the auditor shall obtain a valid technical advice about such an increase in life of assets and reduced depreciation rates. He can also consult an expert to ensure that the changes are appropriate.

The second issue is about inventory taking at five different branches on two days. There is a risk that the auditor may not observe such inventory taking procedures. Hence the auditor shall plan to attend the inventory taking to the possible extent and for the remaining branches, he shall perform test counts and make reconciliations of stock to ensure that the closing balance of the inventory is not materially misstated.

The third issue was not writing down the inventory to it's full value when it was damaged. The auditor shall make sure that such damaged inventory shall be written down to 0.

The fourth issue was that insurance proceeds have been recognised in its financial statements. But such insurance proceeds shall not be recognised unless such claim have actually received by the company.

The fifth issue was that the bank statements have not been reconciled and they have been ignored since such differences are not material. However the auditor shall obtain balance confirmations from the bank to ensure correct balance and he shall also observe, if there are any material transactions included.