PawLow Inc. is a private manufacturer of specialized lubricants for the space industry. Its lubricants are used to cover moving mechanical parts inside rocket ships, the Space Station, and the Mars Rover. Its year-end was February 28, 2018, and the unaudited net income before tax is $4 million. You are an audit manager who is responsible for reviewing PawLow’s yearend

audit file. The audit file contains the following information:

• In 2019, PawLow will be expanding its business and establishing operations in Russia and China. These two countries have their own space programs and PawLow sees great opportunities there. To fund the expansion, in November 2017 the company obtained a loan from a bank. As part of the loan agreement, the bank requires PawLow to provide audited financial statements and to maintain a specific debt ratio (Debt Ratio = Total Debt/Total Assets) loan covenant.

• In 2017, management undertook an extensive review of PawLow’s non-current asset valuations and as a result decided to update the carrying value of all property, plant, and equipment. The VP of finance, Thomas Wolanski, contacted his brother, Joseph who is a valuer, and requested that Joseph’s firm undertake the valuation, which took place in September 2017.

AUDIT WORK PERFORMED
• Enquired Thomas Wolanski about the competence and capability of the valuer, Joseph Wolanski.

• Verbally confirmed with Thomas that Joseph has proper qualification as a valuer and that Joseph is a member of a professional body and has experience in valuing the type of assets that are at PawLow.

• Obtained a schedule of all PPE revalued during the year. Reviewed the formulas used in the Excel calculation sheet and manually recalculated all the totals.

• To confirm completeness and accuracy of the revaluation adjustment traced all totals from the schedule to the trial balance and financial statements.

PawLow’s main customer, the National Aeronautics and Space Administration (NASA), has had its space exploration budget significantly reduced. As a result NASA has been late paying PawLow for some of its largest orders. This had a significant impact on PawLow’s cashflow and the company had to miss its January and February 2018 monthly bank loan repayments.

AUDIT WORK PERFORMED

• Obtained PawLow’s cash flow forecast and reviewed the cash in and out flows. Assessed the assumptions for reasonableness and discussed the findings with management to determine whether the company will have sufficient cash flows to meet liabilities as they fall due.

• Discussed with management the current bank agreement and inquired whether any key ratios or covenants have been breached with regard to the bank loan.

QUESTIONS

1. Review the audit procedures and discuss the method and reliability of the gathered audit evidence in relation to the risks discussed in the case.

2. What other procedures could the auditor have used to gather evidence?

3. What more reliable evidence would you suggest the auditor gather in order to adequately address the risks?