ECOCHEMICALS

LTD

SECTION I PLANNING

THE AUDIT

Your audit firm has been successful in a recent tender for the audit of Ecochemicals

Ltd (

ECL

).

ECL

is a closely held company that has existed since 1960. The tendering process was very

aggressive,

and the previous auditors have so far not allowed you access to their working papers

for last year. The previous years audit report gave an unqualified opinion.

Your team has been

assigned to the 30 June 2018 aud

it of ECL

and ha

s gathered the following

information:

ECL

operates in a highly regulated and competitive industry

and

is a small

manufacturer of

chemical products.

Its

head office and factory

are in

Queensland, but

it has sales branches and warehouse facilities all over Australia

.

The companys five principal officers (the managing director, the chief financial

officer, the sales manager, the product development manager,

and the factory manager)

own substantial

ly all its shares and manage the company in a highly individualistic

manner.

The company products are divided into two

categories

- Type X

and

Type Y

. The

products compete with several locally produced and imported products.

Due to

extensive

competition, t

he products are subject to a substantial obsolescence risk. If a

product becomes obsolete, the company is often able to offload the chemicals to other

manufacturers for reprocessing; however, they will generally only receive 30c in the

dollar

for the product.

The companys accounting functions are concentrated at the head office

; the sales

branches and warehouses maintain only payroll, petty cash,

and inventory records,

which are subject to review by the head office.

ECL

is currently under investigation by the Environmental Protection Agency for a

significant spill of toxic chemicals into the nearby river. The media have also reported

that senior employees were allegedly responsible for this large spill.

Management informs you that during the

year the internal auditors discovered that a

substantial amount of stock had disappeared from a small warehouse

of your client.

A number of local managers have subsequently resigned, although there were no

prosecutions. The losses equalled 2 per cent of ECL

's operating profit.

A new bank loan of ECL for $50 million is contingent on it producing at least break-

even results.

Financial

statements

for the years ended 30 June 2018,

2017

and

2016. (The

2017

and

2016

figures were those reported in the audited financial report, but the 2018

figures

were as prepared by the chief accountant prior to the audit.)

( ECL

_FinST.xls)

You are required to

:

a)

Draft an audit planning memorandum highlighting

:

i)

the legal and other considerations that need to be considered by your firm as the new

auditor of ECL

;

ii)

the major risk areas to be addressed in the audit of ECL

for the year ended 3

0 June

2018. Give reasons why the identified areas are considered to be high

risk.

Support

your answer by calculation of appropriate ratios and/or comparisons. The use of

Microsoft Excel to calculate ratios is encouraged.

(7 marks

)

SECTION

II PURCHASES AND PAYMENTS SYSTEM

( Please refer to the information provided above

)

As p

art of your interim review of

ECL

you have completed a walk

-through of the procedures

involved in the purchases and payments cycle. The following is a summary of the procedures

you have documented on your file:

1

The warehouse manager is responsible for placing orders for chemical

ingredients. Because of the bulk quantity discounts, he will usually place an order

for three months ingredients when there is one month of ingredients left. He is

able to determine how much the company uses in manufacture ea

ch month by

reviewing the inventory records held at the warehouse.

2

To order, the warehouse manager contacts any of the approved suppliers and places

an order over the phone. No record is kept of the conversation, nor does the

warehouse manager require an

y approval. To make sure he doesnt reorder in error

he ticks the inventory ledger and writes the date of order next to the product

number.

3

When goods are received the warehouse assistants check the delivery note against

the ingredient coming in and then let the deliverer pump the ingredient into the

companys storage tank. At no point do they check the actual quantity received.

The warehouse assistant then gives the delivery note to the warehouse manager.

The warehouse manager will then post a journa

l entry to the inventory system by

keying the entry to the terminal.

4

When the journal is accepted, the computer will generate a journal number. (Note:

the journal posted by the system is Dr Raw materials inventory; Cr Creditor.) The

warehouse manager wri

tes the journal number onto the delivery note and sends it

to the accounts payable clerk at head office. The accounts payable clerk files the

note by supplier.

5

The accounts payable clerk at head office receives all supplier invoices. On receipt

of the invoice the clerk checks the details to the delivery note received from the

warehouse. If there are no discrepancies she will prepare a cheque requisition for

the invoice and forward the cheque requisition, with the invoice and delivery note

attached, to the financial controller for authorisation. If the payment is over $20

000 the financial controller must forward the requisition to the MD for

authorisation.

6

The financial controller and/or MD signs the cheque requisition to indicate

authorisa

tion and forwards the documentation to the banking clerk who keys the

payment into the general ledger (the journal posted by the system is Dr Creditor;

Cr Bank). Once the journal is accepted by the system, the system generates a

journal number which the ba

nking clerk writes on the cheque requisition. She then

files the cheque requisition together with supporting documentation by cheque

requisition number.

7

All cheques are printed and signed (counter stamped) by the computer. When they

have been printed the

y are returned to the banking clerk who checks the details and

then sends them to the supplier.

You are required to:

b)

Discuss the strengths and weaknesses of the pur

chases and payments system

of ECL

.

c)

For each strength

identified in (b)

, indicate test

s to be performed to test the controls.

d)

For each weakness

identified in (b)

, indicate the likely impact of th

e weakness on the audit

risk and test

(s) which can be used to minimise this risk.

I just need answer for section 2