Question

You are the audit manager of Chestnut & Co and are reviewing the key issues identified in the files of two audit clients.

Palm Industries Co (Palm)

Palm’s year-end was 31 March 2015 and the draft financial statements show revenue of $28·2 million, receivables of $5·6 million and profit before tax of $4·8 million. The fieldwork stage for this audit has been completed.

A customer of Palm owed an amount of $350,000 at the year-end. Testing of receivables in April highlighted that no amounts had been paid to Palm from this customer as they were disputing the quality of certain goods received from Palm. The finance director is confident the issue will be resolved and no allowance for receivables was made with regards to this balance.

Ash Trading Co (Ash)

Ash is a new client of Chestnut & Co, its year-end was 31 January 2015 and the firm was only appointed auditors in February 2015, as the previous auditors were suddenly unable to undertake the audit. The fieldwork stage for this audit is currently ongoing.

The inventory count at Ash’s warehouse was undertaken on 31 January 2015 and was overseen by the company’s internal audit department. Neither Chestnut & Co nor the previous auditors attended the count. Detailed inventory records were maintained but it was not possible to undertake another full inventory count subsequent to the year-end.

The draft financial statements show a profit before tax of $2·4 million, revenue of $10·1 million and inventory of $510,000.

Required:

For each of the two issues:

(i) Discuss the issue, including an assessment of whether it is material;

(ii) Recommend ONE procedure the audit team should undertake to try to resolve the issue; and

(iii) Describe the impact on the audit report if the issue remains UNRESOLVED.

Answer 1

(i) In Palm Industries Co case, the issue is sensitive but the finance director is confident that the issue will be resolved. So, it can be ignored. Moreover, the amount receivable is approx. 6.25% of the total receivables.
In Ash Trading Co case, Inventory count has not been carried out by the external auditors but it has been done by the Internal Audit department of the company. So as an auditor we should have to undertake the stock count as the value of inventory is approx. 28% of the profit and 5% of the revenue which means if there will be some fraud in the stock management, then the stakeholders will have to bear a heavy losses in terms of revenue and profits.

(ii) In Palm case, the auditor should go for external confirmation directly from the party and check whether the quality of goods sold was up to the mark or not. If good quality goods were sold, then there is no need for further action as in that case Palm can recover its amount by filing a case. Otherwise, auditor should ask management to provide for the expected loss by making a provisio.
In Ash Trading case, auditor can physically verify the high value inventory himself or with the help of his team.

(iii) If the issue remains unresolved, then the auditor should provide a comment in his report regarding the dispute between the company and the its customer.
And in case of Ash Trading, auditor can go for qualified report as the value of inventoy involved is material in all respect as explained in (i).