Q16

This scenario relates to four requirements.

It is 1 July 20X5. You are an audit supervisor with Teal & Co, which has recently been appointed as
auditor to Green Co, and you are planning your first audit which will be for the year ending 31 July
20X5. Green Co sells a variety of plants, garden equipment and garden furniture to wholesale
customers and to retail customers via a network of stores. The company was formed 13 years ago
by Aidan White who is the Chief Executive Officer (CEO) and is the company's only shareholder.
Aidan is planning to retire within the next year and is intending to sell his shares in the company.
The audit engagement partner had a meeting with Aidan White and has advised you of the following:
In August 20X4, the company began to refurbish the retail stores in order to incorporate cafes into
each one. Refurbishment costs of $14.2m were recognised within property, plant and equipment
and this was partly financed by a loan of $10m, which is to be repaid in five annual instalments
commencing in September 20X5. In November 20X4, Green Co spent $400,000 on an advertising
campaign and the cafes were opened in December 20X4. The advertising expenditure has been
included within intangible assets and is being amortised over 24 months as Aidan White expects
the advertising to generate additional revenue for that period of time. In May 20X5, Green Co
received notification that the building authority had received a complaint that the refurbishments had
not been performed in accordance with building regulations. The building authority is currently
investigating and, if found to be in breach of the regulations, Green Co would be required to remedy
any deficiencies in addition to paying a fine.
Green Co sells a range of tropical plants. In August 20X4, Green Co began a project to develop new
technology for maintaining the correct temperature and humidity in its greenhouses. The project is
expected to be completed in August 20X5 and Green Co has incurred costs of $350,000 which are
recognised within intangible assets.
In May 20X5, a flood caused water damage to inventories of plants which had cost $425,000. The
company believes that the plants can still be sold but at a reduced selling price.
The financial statements for the year ending 31 July 20X5 are expected to show revenue of $88.2m
(20X4: $85.1m), gross profit of $23.3m (20X4: $16.9m) and operating profit of $6.3m (20X4: $9.4m).
As part of your planning you have calculated the following ratios:
Forecast 20X5 Actual 20X4
Gross Profit Margin 26% 20%
Operating Profit Margin 7% 11%
Receivables collection period 67 days 40 days

Aidan White has attributed the increase in the receivables collection period to the absence of the
credit controller, who has been on long-term sick leave since April 20X5.
(a) Describe EIGHT audit risks and explain the auditor’s response to each risk in planning
the audit of Green Co.
(16 marks
(b) Explain the responsibility of Teal & Co under ISA 250 Consideration of Laws and
Regulations in an Audit of Financial Statements.
Note: You do not need to refer to the scenario to answer this requirement.
(4 marks)
(c) Describe substantive procedures which Teal & Co should perform in order to obtain
sufficient and appropriate audit evidence in respect of ADDITIONS to Green Co's property,
plant and equipment.
 (4 marks)

It is now 2 November 20X5 and the audit of Green Co has been completed. The auditor’s report
was signed in October and, in line with Teal & Co’s quality management procedures for new
clients, a post-issuance review has been carried out. During the review of Green Co’s audit files,
the engagement quality reviewer noted the following:

The members of the audit engagement team who carried out the audit of Green Co had previously
audited educational organisations, not retail or manufacturing companies.

The audit engagement partner held a planning meeting with the engagement team. However,
several junior team members were unable to attend due to a training course which was held on
the same day. No additional briefing on key audit risks associated with Green Co was held for
these team members.

The audit supervisor was absent due to illness during the last two weeks of the final audit. The
audit assistants continued their work but no other senior team members were assigned to Green
Co’s audit.

Due to the audit supervisor’s illness and absence, the audit of intangible assets was reallocated
from the audit supervisor to a junior member of the team who had never audited intangible assets
before.

(d) Identify and explain THREE quality management deficiencies in the approach adopted
by Teal & Co and provide a recommendation which would have addressed each deficiency
to ensure compliance with quality management requirements.
(6 marks)
Q17
It is 1 July 20X5. You are an audit supervisor with Canyon & Co, preparing the draft audit
programmes and reviewing extracts from the internal control documentation in preparation for the
audit of your client, Francisco Co. The company’s year-end is 30 September 20X5, and it is a
wholesale food operator with 18 distribution depots and one central warehouse.

Payroll
Francisco Co employs distribution depot staff who are paid monthly based on the number of hours
worked. Each employee has a staff identity card which they use to sign in and out of the depot at
the beginning and end of each shift to record their hours worked, and this process is supervised by
security staff as well as CCTV cameras. The hours worked per employee are automatically
transferred from the signing-in system into the payroll system. The hourly wage rate is pre-set, and
the payroll system automatically calculates the gross and net pay along with relevant statutory
deductions and produces pay slips which are immediately emailed to employees.

Access to employees' standing data in the payroll system is restricted to payroll managers through
the use of a password, which the system requires to be changed on a monthly basis.

Distribution depot employees are paid by bank transfer on a monthly basis. The senior payroll
manager reviews the list of bank payments and agrees this to the payroll records. If any
discrepancies are noted, these are investigated by the senior payroll manager who then makes the
required adjustment in the payroll records.

Purchases
Francisco Co has a central purchasing department based at its head office. When goods are
required, a production supervisor submits a request to the purchasing department. A multi-part
purchase order is then generated. The purchasing manager authorises all orders below $3,000 and
the purchasing director authorises orders of $3,000 and above.

On receipt of goods, the quality and quantities received are checked by a warehouse team member
against the supplier's delivery note, and a goods received note (GRN) is produced. A copy of the
GRN is sent to both the finance and purchasing departments.

When purchase invoices are received from the suppliers, they are logged into an invoices received
file and the accounting system assigns each invoice a unique number based on the supplier’s code
and date of input. The finance clerk then matches the invoices to a copy of the relevant purchase
order and passes those two documents to the finance director for authorisation prior to the invoice
being input into payables.

Non-current assets
Francisco Co owns approximately 55% of its distribution depots and the remainder are leased
premises, which have been confirmed as correctly capitalised in line with relevant accounting
standards. The lease agreements and ownership documents are held in the finance department.
Earlier in the year, members of the company’s internal audit department undertook a review of the
lease agreements and ownership documents but were unable to locate a number of the relevant
documents.

Each distribution depot is set up as a separate cost centre and is given an annual capital expenditure
budget, but some cost centres have already significantly exceeded their annual budgets. When new
equipment is purchased, the finance manager classifies the purchase order as capital or revenue
expenditure. The classification is made with reference to formal company policy established by the
finance director, who sample checks that the capital or revenue expenditure allocation has been
correctly applied and then evidences this review by way of signature.
ISA 265 Communicating Deficiencies in Internal Control to Those Charged with Governance and
Management, provides guidance on communicating significant deficiencies in internal control.

(a)(i) Define a significant deficiency in internal control; and

(ii) Describe THREE matters the auditor may consider in determining whether a deficiency
in internal control is significant.

Note: You do not need to refer to the scenario to answer this requirement.
(4 marks
(b) In respect of the system of internal control of Francisco Co:

(i) Identify and explain THREE DIRECT CONTROLS which the auditor may seek to place
reliance on; and

(ii) Describe a TEST OF CONTROL the auditor should perform to assess if each of these
direct controls is operating effectively.

Note: The marks will be split equally between each part.

(6 marks
(c) Identify and explain FIVE DEFICIENCIES in Francisco Co’s system of internal control
and provide a control recommendation to address each of these deficiencies.
(10 marks
Q18
It is 1 July 20X5. Cookit Co owns ten shops selling kitchen equipment. Your firm, Beeny & Co, is
about to commence the final audit for the year ended 31 May 20X5. Draft profit before tax is
$22.8m (20X4: $19.7m) and net assets are $84.3m (20X4: $77.7m). The following matters have
been brought to your attention:

Inventory
Cookit Co sells a range of cookery products endorsed by a famous TV chef, Remy Gusteau. In
February 20X5, the TV company that produced his show cancelled the programme which led to a
reduction in demand for Remy Gusteau products. Cookit Co stopped purchasing these goods in
March 20X5. Total inventory in the draft financial statements for the year ended 31 May 20X5 is
$4.25m. Cookit Co's system-generated inventory valuation report shows that this includes Remy
Gusteau products at a cost of $1.7m. A member of the audit team attended the year-end inventory
count of Cookit Co.

Decrease in trade payables

The accounts payable clerk left the company in January 20X5 and no replacement has yet been
hired. The following information has been provided by the finance director of Cookit Co:

31 May 20X5 31 May 20X4

Trade payables $2.8 m $3.5m
Payables payment period 53 days 72 days

The finance director also mentioned that no reconciliations of supplier statements had been
performed since December 20X4. The audit team has decided not to perform a year-end payables
circularisation as response rates in previous years were low.

Redundancy provision
In May 20X5, the management of Cookit Co decided to close down one of the shops as it is
unprofitable. An announcement of this decision was made on the company’s website on 28 May
20X5 and staff informed of the timetable for closure. All 32 staff employed in the shop are to be
made redundant and a redundancy provision of $1.8m is included in the draft financial statements
for the year ended 31 May 20X5. The closure is expected to take place in September 20X5.

(a) Describe substantive procedures the auditor should perform to obtain sufficient and
appropriate audit evidence in relation to the VALUATION of Cookit Co’s inventory.
(5 marks
(b) Describe substantive procedures the auditor should perform to obtain sufficient and
appropriate audit evidence in relation to the COMPLETENESS of Cookit Co's trade
payables.
(5 marks
(c) Describe substantive procedures the auditor should perform to obtain sufficient and
appropriate audit evidence in relation to Cookit Co’s redundancy provision.
(5 marks)
The final audit is now nearing completion and you are reviewing the financial statements. The
directors have told you that they have decided against including the redundancy provision of
$1.8m in the financial statements for the year ended 31 May 20X5 as the closure of the shop will
not take place until September 20X5.

(d) Discuss the issue and describe the impact on the auditor’s report, if any, should this
issue remain unresolved.
(5 marks)