Question

Bruny Island Dairy is a boutique cheese maker on Bruny Island. Over the years, the business has grown firstly by supplying local retailers, and then through exports. In addition, there is a ‘farm-gate’ shop and café located next to the main processing plant on Bruny Island, serving tourists who also visit the other specialist food and wine businesses in the region. Quality control over the cheese manufacturing process and storage of raw materials and finished products at Bruny Island Dairy is extremely high. All members of the business are committed to high product quality because any poor food handling practices which could result in a drop in cheese quality, failed health and safety inspections, or contamination of the products which would ruin the business very quickly. The company has managed to maintain export sales throughout the COVID-19 pandemic. However, revenue from tourists visiting the island has dropped off dramatically. The company has secured government assistance.

The export arm has been built up to become the largest revenue earner for the business by the younger of the two sisters who have run Bruny Island Dairy since it was established. Jane Langley has a natural flair for sales and marketing, but is not so good at completing the associated detailed paperwork. Some of the export deals have been poorly documented and Jane often gives discounts to some customers without consulting her older sister, Melinda, or informing the sales department. Consequently, there are often disputes about invoices and Jane makes frequent adjustments to debtor accounts using credit notes when clients complain about their statements. Jane sometimes falls behind in responding to customer complaints because she is very busy juggling the demands of making export sales and running her other business, Café Consulting, which manages casual staff working at the café business at Bruny Island Dairy.

Required
a. Identify the factors that would affect the preliminary assessment of inherent risk and control risk at Bruny Island Dairy.
b. Explain how these factors would influence your choice between the predominantly substantive approach (where planned detection risk is set at low-medium) and the lower assessed level of control risk approach (where planned detection risk is set at medium -high) for sales, inventory and debtors.

Answer 1

This Case requires Application some of Audit Terminology before proceeding lets Understand what we mean by :

Inherent Risk: Untreated Or natural level of Risk which is inherent in a process or activity and nothing has been done to reduce it.

Control Risk- Risk that occur due to absence of adequate internal control to prevent and detect instances of fraud or error.

Therefore as per the requirements Of Case

a) Factors affecting preliminary assessment of inherent risk include:

• Deterioration and Inventory Valuation Storage conditions (temperature) Required to store Cheese are risky as poor storage could lead to contamination. Hence high risk of spoilage is possible and it might affect valuation of inventory.
• Complex Transaction-As Transaction involve Export sales, foreign exchange transactions hence complexity of such transaction poses risk of incorrect pricing, risk assessment.
• Unstable demand-Due to tourism sales the demand is not stable but fluctuating.
• Availability of Skilled staff-highly skilled processes requires skilled staff, therefore continuity of the business might get affected if such skilled staff is not available
• Major Revenue from export sales- increases business risk to this source of revenue, (i.e export)and meet demand requirements coming from export(though during covid19 company has been able to maintain sales however pressure of demand through this source would be high.)       Factors affecting preliminary assessment of control risk include:
• Quality Control-It is important to evaluate effectiveness of quality control over cheese production and storage, affecting revenue and sales of product (although quality control is apparently high as stated in case).
• Controls over sales made by Jane, documentation, pricing, sales allowances should be effective.
• Management Efficiency-Lack of Communication between Jane and sister Melinda and other staff can affect efficiency and effectiveness of the management.

b) Lower assessed level of control risk approach is appropriate when control is highly effective and control risk is assessed as low while predominantly substantive approach is appropriate when control risk is assessed as high, hence don't rely on controls due to low efficiency

For Sales:

Due to communication barriers between Jane and other management and staff, also her competing incentives and the lack of control over her actions raise the possibility of control risk in these areas to be considered high. There is also a risk that sales made to customers are incorrectly entered. The validity of sales transactions, including the amounts and terms of the sale, is at risk .Approach Adopted is predominantly Substantive-Because High Control Risk is there for debtors and sales

For Inventory:

Production quality seems to be good hence control over production appears good , and inventory quality seems to be high. However, the inherent risk of inventory spoilage or contamination of cheese is reasonably high. This suggests that a lower level of control risk would be appropriate for inventory. Less Substantive testing is required due to Satisfactory Results on the inventory as control seems to be efficient.

For Debtors:

Debtor accounts do not appear to be adequately controlled. Rather than developing and implementing a policy and procedures on credit notes, Jane frequently issues credit notes to clients who complain about their statement without investigating it. Also the Indication of customer complaints and Jane being busy with her other businesses poses a limitation over resource to follow the company’s protocol therefore this increases the control risk. Therefore approach adopted a predominantly substantive approach is more appropriate.

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