Auditing Assignment Question

Question 2 [20 marks]

Part A

Delta audit firm was planning the audit for its existing client, Apple and Banana Corp. Which is a small retailing company that does not have any warehousing facilities as all stock is kept on the premises and they only have a small team of staff, which makes the separation of duties principle difficult. The preliminary tests of controls found that the internal control procedures are well designed, but not always observed due to the small number of staff. Previous experience with this client also showed that controls were not always observed. Despite this, Delta has never discovered a material misstatement in the accounts.

Required:

Determine and justify what audit strategy should be used?

Part B

FUN Limited is a large public company whose year-end is 30 June 20X0. FUN operates 3 divisions: entertainment, hospitality, and tourism & leisure. Each division is run as a separate business, with its own accounting system and management team. While planning the audit of FUN, you become aware of the following independent and material situations.

Entertainment division

The entertainment division owns the largest chain of cinemas in Fiji. Owing to changes in technology in the USA, movie distributors will shortly begin releasing films using a recording that is incompatible with the movie projectors used by FUN. Approximately 70% of the movies the entertainment division screens are sourced from the USA. The movie projectors currently have an estimated useful life of 4 years. FUN has sufficient financial resources to purchase and install new movie projectors without interpreting cinema operations.

In March 20X0 the entertainment division introduced a new general ledger system. Apart from a few teething problems the systems seems to be functioning well and now produces a range of management reports that were not previously available. Owing to an oversight by your firms computer audit division, no audit staff were present during the conversion process.

Hospitality division

The Hospitality division is involved in a luxury hotel development on an island in Indonesia. The project is currently around 60% complete, and FUN is carrying around $70m of work-in- progress related to the project in its balance sheet. The Asian economic crisis has cast doubts on the future of the project, with estimates of hotel patronage and revenue falling on a weekly basis.

Under the terms of its bank loan the hospitality division must maintain 3 key financial ratios at set levels or risk the loan being immediately recalled. Owing to the downturn in the hospitality industry, the division is currently in breach of 2 of these ratios. The directors are currently negotiating the loan terms with the bank, arguing that although the hospitality division is in breach, overall FUNs ratios are within set limits.

Tourism & Leisure division

The tourism & leisure division manages 3 ski lodges in Nadi on behalf of the private investor. In March 20X0 unusually heavy rains caused land slippage, which badly affected the foundations of these lodges. Preliminary reports suggest that the lodges will have to be demolished and rebuilt. The private investor is taking legal action against FUN, claiming that a lack of proper maintenance work caused the slippage.

Approximately 30% of the divisions revenue comes from organizing and selling tour packages to travel agents. The tour packages are tailored to the needs of tourists from Korea, Japan and Thailand. Selected travel agents are given a certain number of packages, which they allocate to customers once a deposit is paid. On account of the economic downturn in Asia, travel agencies are experiencing late cancellation rates of around 50%. Although the customers are liable for the full cost of the tour for cancelling on short notice, FUN has found it is unable to collect most of the money owing as the customers simply lack the capacity to pay.

Required:

For each of the situations (i ) to (vi):

a.) How will the situation affect your audit plan? (5 marks)

b.) What further information would you seek prior to finalising your audit program? (5 marks)

c.) According to ISA 315, an auditor needs to take certain steps to understand the entity and its environment. Outline these key steps. ( 5 marks)