Question

Designing Audit Procedures and Preparing Audit Workpapers

Consider the following scenario and design the audit procedures for gathering, documenting and analyzing information on the client.

ABC Ltd is an established private company incorporated in Jamaica. It manufactures rubber flipflops for both the local and Caricom markets. Its operations include a factory, an administrative offce and two sale depots. It obtains its supply of rubber from RubberR-Us Ltd located in the United States. The company was started ten years ago when its primary shareholder, Mr. Jones saw a need for durable rubber slippers for both domestic and sporting wear. His idea took off and the business has been performing well but in recent times there have been some challenges. Mr. Jones has watched with great concern the development of Crosses Ltd which imports rubber shoes from China in bulk. Although he is aware that Crosses Ltd costs are less than his operations, he is relieved that there is no price war as they sell at basically the same price for similar products. Mr. Jones however boasts that the quality of his slippers is far superior to that of this main competitor.

Additionally, the recent episodes of economic down turns has been felt by ABC Ltd as business sales have slowed and the increasing rate of depreciation of the local currency has increased the costs of production. Mr. Jones has been considering merging his operations with Crosses Ltd but these discussions are still at an early stage.

XY and Associates have been their auditors for the past 3 years. You are the Senior Auditor assigned to the audit. The following is a draft of the fnancial statements for the current year with the prior year audited fgures.

ABC Limited

Income Statement for the year ended December 31,

	2012	2011
	Draft	Audited
Sales	787,000	625,000
cost of Sales	(701,000)	(478,000)
Gross Profit	86,000	147,000
Other Expenses	(86,000)	(88,000)
Interest	(9,000)	(6,000)
Net Profit	(9,000)	53,000

ABC LImited

Balance Sheet as at December 31,

	2012	2011
	Draft	Audited
ASSETS
Current Assets Inventory Trade Accounts Receivable	133,000 240,000	67,000 91,000
	373,000	158,000
Net Current Assets	161,000	89,000
TOTAL ASSETS	534,000	247,000
LIABILILTIES & SHAREHOLDERS FUNDS
Current Liabilities	317,000	90,000
Trade Accounts payable	65,000	10,000
Bank Overdraft	28,000	14,000
	410,000	114,000
Shareholders' Funds
Share Capital	17,000	17,000
Reserves	107,000	116,000
	124,000	133,000
TOTAL LIABILITIES & SHAREHOLDERS' FUNDS	534,000	247,000

Required:

i) Prepare the section of the Planning Memorandum for information on the client, including data provided above and using fctitious data based on assumptions you have made.

ii) Perform the analytical review and explain any risks of misstatements that you consider signifcant (hint: signifcant changes in ratios)

Answer 1

Requirement (i):

Planning memorandum:

To: ABC Ltd.

From: Auditors of the company.

Subject: Planning memorandum for the audit of the company.

This memorandum is in relation to the above subject matter. Let us take a look at the planning and strategy for conducting the audit effectively.

1. Analytical audit procedures shall be conducted on the financial information to ascertain the changes in profitability, liquidity, efficiency and capital gearing ratios. Abnormal changes in these ratios shall indicate possible area of misstatement.
2. Substantive procedures shall be determined after completion of analytical procedures.
3. The internal controls shall be tested to check whether these have worked efficiently throughout the period.
4. Whether there have been proper segregation of duties and responsibilities within the organization.
5. Collection of evidences on the basis management representation, confirmation letters, documents, vouchers, supporting documents, books of accounts to provide appropriate opinion on the financial statements of the company.

  

Requirement (ii):

	2012	2011
Sale	787,000.00	625,000.00
Cost of sales	(701,000.00)	(478,000.00)
Gross profit	86,000.00	147,000.00
Gross profit ratio (%)	10.93	23.52
Net profit	(9,000.00)	53,000.00
Net profit ratio	(1.14)	8.48
Current ratio
Current asset	373,000.00	158,000.00
Current liabilities	317,000.00	90,000.00
Current ratio	1.18	1.76

  

As can be seen that the changes in gross profit and net profit margin is quite abnormal thus, revenue and cost of revenue have to be checked thoroughly while conducting the audit. Hence, substantive audit procedures shall be directed towards the revenue and cost of revenue items.