In: Accounting
Nicolas Drinks Inc. (Nicolas) manufactures fizzy drinks such as
cola and lemonade as
well as other soft drinks and its year end is 31 December 2017. You
are the audit
manager of B&J CPAs LL.P. and are currently planning the audit
of Nicolas.
You attended the planning meeting with the engagement partner and
finance director
last week and recorded the minutes from the meeting shown below.
You are reviewing
these as part of the process of preparing the audit strategy.
Minutes of planning meeting for Nicolas
Nicolas’ sales results have been strong this year and the company
is forecasting
revenue of $85 million, which is an increase from the previous
year. The company has
invested significantly in the cola and fizzy drinks production
process at the factory. This
resulted in expenditure of $5 million on updating, repairing and
replacing a significant
amount of the machinery used in the production process.
As the level of production has increased, the company has expanded
the number of
warehouses it uses to store inventory. It now utilises 15
warehouses; some are owned
by Nicolas and some are rented from third parties. There will be
inventory counts taking
place at all 15 of these sites at the year end.
A new accounting general ledger has been introduced at the
beginning of the year, with
the old and new systems being run in parallel for a period of two
months.
As a result of the increase in revenue, Nicolas has recently
recruited a new credit
controller to chase outstanding receivables. The finance director
thinks it is not
necessary to continue to maintain an allowance for receivables and
so has released the
opening allowance of $1·5 million.
In addition, Nicolas has incurred expenditure of $4·5 million on
developing a new brand
of fizzy soft drinks. The company started this process in January
2017 and is close to
launching their new product into the market place. The finance
director stated that there
was a problem in November in the mixing of raw materials within the
production process
which resulted in a large batch of cola products tasting different.
A number of these
products were sold; however, due to complaints by customers about
the flavour, no
further sales of these goods have been made. No adjustment has been
made to the
valuation of the damaged inventory, which will still be held at
cost of $1 million at the
year end.
As in previous years, the management of Nicolas is due to be paid a
significant annual
bonus based on the value of year-end total assets.
Required:
1. Using the minutes provided, identify and describe SIX audit
risks, and explain the
auditor’s response to each risk, in planning the audit of Nicolas
Drinks Inc. (12
marks)
2. Describe substantive procedures the audit team should perform to
obtain
sufficient and appropriate audit evidence in relation to the
following three matters:
(i) The treatment of the $5 million expenditure incurred on
improving the
factory production process;
(ii) The release of the $1·5 million allowance for receivables;
and
(iii) The damaged inventory.