Question

You are the audit manager at Price & Coopers a medium-sized audit firm undertaking the audit for the
year ended 30 June 2018 of Sera Ve Tech Ltd, an electronic component manufacturer located in
Sydney. During the planning stage of the audit you discovered that one of Sera Ve Tech Ltd’s major
suppliers went bankrupt one month ago, causing major product shortages. To overcome the problem,
James Marshall, the husband of the finance director, Norita James, provided electronic components
to Sera Ve Tech Ltd through his private company. There is no formal agreement in place with James
Marshall, however, the goods are being provided at competitive prices. You are concerned about the
electronic components that James Marshall, company is supplying, because his products are new to
the market and you have heard some of Sera Ve Tech Ltd’s staff complaining that they are of poor
quality.

The board has informed you that although sales have been strong this year, Sera Ve Tech Ltd has
suffered significant cash flow problems because a major debtor, Merrinda Ltd, is experiencing financial
difficulties. As a result, Merrinda Ltd is taking well over 120 days to pay outstanding amounts, despite
Merrinda Ltd’s terms of trade being payment within 30 days. Merrinda Ltd makes up 40 per cent of
Sera Ve Tech Ltd’s sales and the board has been reluctant to take any action that might adversely
affect those sales. As a result, Sera Ve Tech Ltd has had to increase its dependency on its line of credit,
and this has caused it to temporarily breach the debt to equity ratio required in its loan covenant with
Commonwealth Bank Ltd.


Required:

(a) Identify two (2) key account balances at risk of material misstatement.
(b) For each account balance identify the key assertion at risk.
(c) Explain why the account balance and assertion are at risk.

(d) Describe one (1) substantive test of detail that you would undertake for each account to address the assertion and risk identified.

Answer 1

(a) The two key account balances at risk of material misstatements are 1. Financial and 2. Stock assertions.

(b) Before discussing how auditors should assess the risk of material misstatement, it is important to consider what is meant by 'misstatement'. The term 'misstatement' is not defined in ISA 315, but in ISA 450, Evaluation of Misstatements Identified During the Audit, which contains this definition: 'a difference between the amount, classification, presentation or disclosure of a reported financial statement item and the amount, classification, presentation or disclosure that is required for the item to be in accordance with the applicable financial reporting framework. Misstatements can arise from fraud or error.'

(c) Audit Assertions are the implicit or explicit claims and representations made by the management responsible for the preparation of financial statements regarding the appropriateness of the various elements of financial statements and disclosures.Audit Assertions are also known as Management Assertions and Financial Statement Assertions.Topic Contents 1. Definition 2. Explanation 3. Types & Examples 4. Use and Application 5. Purpose & Importance.

(d) Financial statement assertions, or management assertions, are a company's official statement that the figures the company is reporting are accurate.

• Investors and analysts rely on accurate statements to evaluate a company's stock; otherwise, metrics such as the price-to-book ratio and earnings per share would be misleading.
• The Financial Accounting Standards Board requires publicly traded companies to prepare financial statements following the Generally Accepted Accounting Principles (GAAP).
• Companies must attest to assertions of existence, completeness, rights and obligations, accuracy and valuation, and presentation and disclosure.

The different financial statement assertions attested to by a company's statement preparer include assertions of existence, completeness, rights and obligations, accuracy and valuation, and presentation and disclosure.