Question

You have obtained the following information:

STATEMENT OF COMPREHENSIVE INCOME FOR THE YEAR TO 31 DECEMBER

			20X8	20X7
		Note	Draft ($m)	Actual ($m)
Revenue		(1)	645.5	606.5
Other income		(2)	15.6	14.4
Changes in inventories			3.8	(16.4)
Cost of materials			(334.1)	(286.8)
Employee benefits expense			(91.0)	(83.9)
Depreciation		(3)	(29.8)	(23.6)
Other expenses		(4)	(116.3)	(100.6)
Interest income, net		(5)	12.3	(20.9)
Profit before tax			106.0	130.5
Income tax expense			(44.4)	(47.7)
Profit for the year			61.6	82.8

STATEMENT OF FINANCIAL POSITION AT 31 DECEMBER

			20X8	20X7
		Note	Draft ($m)	Actual ($m)
Assets
Non-current assets
Intangible assets		(6)	47.8	40.5
Property, plant and equipment		(7)	124.5	102.5
			172.3	143.0
Current assets
Inventories		(8)	30.3	27.9
Trade receivables			73.1	50.3
Cash and cash equivalents			111.4	86.0
Total assets			387.1	307.2
Equity and liabilities
Equity			5.8	5.8
Share capital			15.3	15.3
Share premium			112.1	80.1
Retained earnings			133.2	101.2
Non-current liabilities
Provisions		(9)	160.1	121.4
Current liabilities
Trade payables			33.5	31.8
Tax			50.4	44.3
Other liabilities			9.9	8.5
Total equity and liabilities			387.1	307.2

Notes

(1)Revenue from business activities:

Revenue from business activities
	20X8 ($M)	20X7 ($M)
Vehicles	588.0	526.0
Parts and accessories	39.6	36.8
Other	17.9	43.7
	645.5	606.5

(2)Other income includes gains on the disposals of tangible assets and income from the reversal of provisions.

(3)Average number of employees:

	20X8 (Draft)	20X7 (Actual)
Wage earners	484	499
Salaried employees	483	477
Apprentices and trainees	36	37
	1,003	1,013

(4)Other expenses include costs for warranties, administration and distribution, maintenance and insurance.

(5)Interest income, net:

	20X8 (Draft ($m)	20X7 (Actual $m)
Interest and similar income	16.8	25.1
Interest and similar expenses	(4.5)	(4.2)
	12.3	20.9

(6)Intangible assets include development costs, also franchises and industrial rights and licenses. During the year, $12.7 million (20X7 - $6.3 million) was spent on developing a new sports model, the Fox.

(7)Property, plant and equipment:

	Land and Buildings	Equipment	Assets under construction	Total
	$m	$m	$m	$m
Cost
1 January 20X8	61.8	212.1	19.0	292.9
Additions	5.0	28.9	9.4	43.3
Disposals	0.0	(4.5)	0.0	(4.5)
Reclassification	3.0	8.9	(11.9)	0.0
31 December 20X8	69.8	245.4	16.5	331.7
Depreciation
Current year	1.9	18.4	0.0	20.3
Accumulated	28.7	178.5	0.0	207.2
Net book value
31 December 20X8	41.1	66.9	16.5	124.5
31 December 20X7	34.9	48.6	19.0	102.5

(8)Inventories comprise:

	20X8 (Draft $m)	20X7 (Draft $m)
Raw materials, consumables and supplies	8.3	7.3
Work-in-progress	6.8	4.8
Finished goods	15.2	15.8
	30.3	27.9

(9) Provisions mainly cover manufacturing warranty, product liability and litigation risks. Also, provisions have been established for deferred maintenance and IT reorganisation

The following additional information is available:

(i) Pavia has achieved record sales in 20X8 with the delivery of 10,153 vehicles (20X7 – 7,642 vehicles).

(ii) Although some sales are direct to individual customers the majority are ordered through dealers who take new vehicles on consignment.

(iii) Since 1 January 20X8 Pavia has offered 0% finance for three years on new vehicle sales in its most competitive markets.

(iv) The launch of the Fox has been postponed from late 20X8 to early 20X9 as internal trials have revealed that the doors are not sufficiently secure at high speeds.

(v) A car part required for the Cipeta model is bought-in exclusively from an overseas manufacturer. Deliveries of supplies have been unpredictable in 20X7 causing disruption to the Cipeta model assembly schedules.

Given all of the information above you are required to do the following:

In respect of the financial statements audit of Pavia Co for the year ending 31 December 20X8:

(a) Identify and explain the risks of material misstatement to be taken into account in planning the final audit.

(b) Evaluate how you might use analytical procedures to provide audit evidence and reduce the level of detailed substantive procedures.

(c) Briefly describe the principal audit work to be performed in respect of the carrying amount of the following items in the statement of financial position.

(i)   Inventories

(ii) Cash and cash equivalents

(iii) Receivables

Answer 1

For Pavia Co.

(a) Various risks that can result in material misstatement include:-

1. The highest risk factor is of fraud, which can take place in any area of reporting. Observation of any deviations can help in identification of fraud.

2. One more risk can be due to unintentional error, which may or may not have sugnificant impact on financial statements.

3. Control risks that internal control would not be able to mitigate entirely.

4. Residual risks exist, which can be monitored during the audit and hence can be reduced.

(b) Analytical procedure to provide audit evidence and reduce the level of detailed substantive procedures include:-

1. Comparing financial statements to previous year for identifying significant difference in volume and value.

2. Analysis of various ratios and their relationships.

3. Documentation of reporting requirements and actual level of compliance.

4. Level of manual intervention - as there higher risks wherein manual intervention is more.

(c)

(i) Inventories

1. Physical stock must be audited to match with units mentioned in stock register.

2. Method of stock valuation must be evaluated.

3. Costs attributable to stock must be analysed.

4, Market value or net realisable value of the stock must be evaluated.

(ii) Cash and Cash equivalent

1. Daily, weekly, monthly cash reconciliation signoffs must be verified.

2. Bank statements and reconciliation must be verified.

3. Leave records and authority of person responsible for managing cash must be verified.

(iii) Receivables.

1. Invoices of Sales must be audited on sampling basis.

2. Credit period for customers must be checked and interest if any must be verified.

3. Balances of recceivables must be reconciled with ledger confirmations received from customers.

4. Receivable written off, if any must be checked for recovery efforts.