Case Study

Lemoco Co (Lemoco) manufactures fizzy drinks such as cola and lemonade as well as other soft drinks and its year-end is 31 December 20XX. You are the audit manager of Diet & Co and are currently planning the audit of Lemoco. You attended the planning meeting with the engagement partner and finance director last week and recorded the minutes from the meeting shown below. You are reviewing these as part of the process of preparing the audit strategy.

Minutes of planning meeting for Lemoco

Lemocos trading results have been strong this year and the company is forecasting revenue of $85 million, which is an increase from the previous year. The company has invested significantly in the cola and fizzy drinks production process at the factory. This resulted in expenditure of $5 million on updating, repairing and replacing a significant amount of the machinery used in the production process.

As the level of production has increased, the company has expanded the number of warehouses it uses to store inventory. It now utilizes 15 warehouses; some are owned by Lemoco and some are rented from third parties. There will be inventory counts taking place at all 15 of these sites at the year-end.

A new accounting general ledger has been introduced at the beginning of the year, with the old and new systems being run in parallel for a period of two months.

As a result of the increase in revenue, Lemoco has recently recruited a new credit controller to chase outstanding receivables. The Finance Director thinks it is not necessary to continue to maintain an allowance for receivables and so has released the opening allowance of $1.5 million.

In addition, Lemoco has incurred expenditure of $4.5 million on developing a new brand of fizzy soft drinks. The company started this process in January 20XX and is close to launching their new product into the market place.

The finance director stated that there was a problem in November in the mixing of raw materials within the production process, which resulted in a large batch of cola products tasting different. A number of these products were sold; however, due to complaints by customers about the flavor, no further sales of these goods have been made. No adjustment has been made to the valuation of the damaged inventory, which will still be held at cost of $1 million at the year-end.

As in previous years, the management of Lemoco is due to be paid a significant annual bonus based on the value of year-end total assets.

Required:

(a) Explain audit risk and the components of audit risk.

(b) Using the minutes provided, identify and describe SIX audit risks, and explain the auditors response to each risk, in planning the audit of Lemoco Co.

(c) Identify the main areas, other than audit risks, that should be included within the audit strategy document for Lemoco Co; and for each area provide an example relevant to the audit.

(d) ISA 300 Planning an Audit of Financial Statements provides guidance to assist auditors in planning an audit.

Required:

Explain the benefits of audit planning.

(e) ISA 700 Forming an Opinion and Reporting on Financial Statements requires auditors to produce an audit report. This report should contain a number of consistent elements so that users are able to understand what the audit report means.

Required:

Describe FOUR elements of an unmodified auditors report and for each explain why they are included.