(a) Explain what is meant by the following:

1. Overall materiality for an audit; and

2. Performance materiality for an audit.

2. (b) Your audit firm, DK LLP, has a new client, Healthy Meals Ltd (HM). HM is a food manufacturer whose customers are major supermarkets and other retailers. As part of the audit team you have found out the following information in your discussions with the client:

   • Most of HMs ingredients are imported from overseas suppliers who invoice HM in their

     local currencies.

   • HMs major customers have experienced a slowdown in trade over the past few years and

     are often late in paying their invoices.

   • One large customer, Star Shops (SS), is a large chain of smaller shops which went into

     liquidation before the year end and HM are not sure if they will receive the 200,000

     which they are owed by SS.

   • In order to cover any short term cashflow difficulties, the directors have decided to ask

     the bank for an increase in their Overdraft facility. Overall Materiality for the audit has been set at 175,000.

     REQUIRED:

     Explain the risks of material misstatement likely to affect HMs financial statements based on the information given above.

     (12 Marks)

3. (c) The audit partner has reminded the audit team working on the HM audit that they should

   use their professional scepticism when they are carrying out their audit procedures.

   REQUIRED:

   Explain the meaning of professional scepticism and the reasons why it is fundamental in audit work.