Part B - Report

Background

CurtainsMaster is a large proprietary company established in North Queensland in the 1990s, selling a wide range of high-quality fabric curtains for household decoration. The company purchases products from manufactures in Vietnam, Bangladesh, and China, and then sells its products to wholesales customers in Australia, Germany, and the United States. The company also places its products on consignment in various small retail stores in Queensland. Sales mainly peak from the second half of the financial year, generating an average of 60% of revenue for the whole year. In past years the company has performed well, with its profit rate at around 12% and an average increase in annual revenues of 5%.

In the last two years, the company has extended its marketing from Germany to other countries in Europe. As a result of this, in the budget for the year 2019-2020, the company while aiming to maintain its profit rate, plans to increase its revenues by 8%. The company uses USD to pay its suppliers and EUR or USD in its dealings with customers.

While the business is expanding in Europe, sales in Australia and US are struggling to reach their targets. These markets are quite competitive, providing more affordable products with a large range of designs and choices. Further, in recent years, countries like Vietnam and China have become more eco-conscious, attempting to reduce their industrial impact on the environment. As such, textile manufacturing has been discouraged with strict regulations. Some of CurtainsMaster's suppliers have reduced their production capacity and have experienced an increase in production costs.

Managing inventory on consignment has been an issue for CurtainsMaster in the past 12 months. On several occasions, the company lost track of their inventory movements and status at the various retail premises. To support the business expansion and strengthen internal controls for inventory, in January 2020 the company installed a new inventory management system on the cloud, which allows inventory movements to be followed up, from production to end-users. The system will also help to follow up and calculate inventory ageing from the day the inventory was entered into the system. In the past five years, old and work-in-progress inventory has piled up due to new designs, orders cancelled by customers, or specification problems. When the new system was implemented these stock items, together with others, were entered into the system as the beginning balance for the inventory.

Since January 2020, CurtainsMaster has also experienced significant impact due to the COVID-19 pandemic. Approximately 50% of customer orders due to be delivered in May, June and July have been cancelled. Payments from customers have been delayed as they have also been impacted by the situation. Since the middle of February the company's sales at small retail stores have decreased dramatically, by approximately 70%. From the middle of March, 60% of staff (both casual and full-time) were made redundant. For the last three months of the current financial year, the company is expecting to have no sales but still pay another 10% of the current total expenses. To minimise the impact of a tight cashflow, in February, when the financial market was peak, the company sold all its financial investments and generated some extra cash for the business before the market dived in March. However, things can get worse; there is much uncertainty and no clear indication of when the pandemic will end.

Financial Information:

Requirements

Assume you are one of the audit team members who will conduct the financial report audit - year ending 30 June 2020 - for CurtainsMaster. Using the company's information given above, prepare a report dated June 10, 2020 for the audit manager outlining the audit plan. As it is the beginning of the audit do not prepare a final audit report/opinion. The report should cover the following areas under the suggested headings:

1. Risk Assessment

From the background and financial information given above:

• list six (6) potential significant risks, including both inherent risk and control risk,
• for each risk listed, identify the type of risk (inherent risk or control risk) and its level ('high', 'medium', or 'low' in relation to the likelihood and materiality of the risk occurring), the associated financial accounts, and key assertions that would be affected. (A risk should be classified as 'high', 'medium', or 'low' if it is 'highly likely', 'maybe', or 'unlikely' respectively to be present and material.)

Please use the following table to present your answers:

Potential risk - type of risk, description

Accounts

Assertions

Level of risk

1. Planning Materiality

The audit firm dictates that one planning materiality amount is to be used for the financial statement as a whole. The planning materiality bases are as follows:

Base

Threshold (%)

Profit before tax

5-10

Turnover

0.5-1

Gross profit

2.0-5

Total assets

0.5-1

Based on the information given and your risk assessment,

• select the base for planning materiality that you believe is most appropriate, and provide three reasons justifying the base you have chosen,
• calculate the planning materiality.

(You can refer to Cloud 9 case and textbook pages 123-125 and other resources for further understanding.)

1. Analytical Procedures

As part of the risk assessment phase, you conducted analytical procedures and the results are as below:

Interim

Budget

Actual

Actual

Account

30-Jun

2019-2020

30-Jun

30-Jun

2020

2019

2018

Total revenue

100%

100%

100%

100%

COS

55%

54%

56%

58%

Salaries expenses

28%

15%

14%

13%

Administration expenses

14%

8%

7%

6%

Selling expenses

8%

5%

4%

4%

Borrowing Costs

5%

2%

2%

2%

Ratios

Interim

Budget

Actual

Actual

30-Jun

2019-2020

30-Jun

30-Jun

2020

2019

2018

Liquidity ratios

Current ratio

1.4

-

2.0

2.3

Quick ratio

0.3

-

0.9

1.0

Inventory turnover

1.3

-

4.3

4.9

Accounts receivable

2.6

6.5

6.8

Solvency ratios

Debt to equity

1.4

-

0.9

0.8

Times interest earned

-1.0

7.0

6.1

6.2

Profitability ratios

Gross profit ratio

0.362

0.46

0.44

0.42

Net profit ratio

-0.102

0.12

0.12

0.13

ROA

-0.054

0.12

0.13

Return on Sh funds

-0.116

0.23

0.23

Using the above analysis and financial information given, discuss the results of the analytical procedures outlining six (6) potential problem areas (that is, where possible material misstatements in the financial reports exist) and any other special concerns (for example, going concern). Specify the account balances and related assertions that would require particular attention in the audit.