Part C

Background

You are the senior auditor on the audit of Amistad Furniture Manufacturers Pty Ltd (Amistad). Your firm has recently been appointed as the first auditors of the company. You interview the managing director of the company to obtain background information on Amistad and to understand its business operations, its environment and system of internal control. Amistad was founded 30 years ago and makes grandfather clocks (freestanding, weightdriven, pendulum clocks). The clocks are made in one factory (situated in the Blue Mountains) and are distributed through boutique homeware and antique furniture stores. The clocks are advertised mainly in local newspapers and through pamphlet drops. In order to promote longer production runs and minimise finished goods stocks, Amistads retail distributors are offered stock on a sale or return basis. This means that the homeware and antique furniture stores are invoiced immediately, subject to a 90-day term of payment, but are allowed to return the stock up to 30 days before payment is due. Only the marketing manager has been given the authority to make these offers. All of Amistads timber is obtained from offshore sources. Timber prices, which are denominated in US dollars, have risen substantially over the past two years and the recent drop in the value of the Australian dollar has caused them to rise even further. Timber purchases are secured by providing Amistads suppliers with letters of credit which become due when the container shipment of timber arrives in Australia. Labour costs are high due to the craftsmanship and quality required for the production of the grandfather clocks. Skilled labour is not easy to obtain and wage rates have recently risen. Amistad has found it difficult to pass on these timber and labour price increases to customers.

An analysis of costs indicates that there have been material negative purchase price variances in purchases of timber over the course of the year. You have compiled the following information from

Amistads financials:

the current ratio as at 30 June 2016 is 1.24

on an annualised basis, net sales are $350,000

the shareholders funds to total assets ratio is 30%

gross profit margins and net profit margins for the year ended 30 June 2016 have dropped to the level where losses are being incurred.

Amistads bank finances the companys timber purchases using bills of exchange drawn at 90 days from the date of payment of the shipment. It has also extended loan finance to Amistad. The bank covenant, which is due for review shortly, requires Amistad to:

maintain a current ratio of 1.2

maintain a shareholders funds to total assets ratio of at least 30%

maintain net sales of a minimum of $100,000 per quarter

prepare a general purpose financial report for the year ended 30 June 2016 and have it audited according to Australian Auditing Standards. (Note that this is a requirement of the bank covenant as Amistad is not required to produce a general purpose financial report under the Corporations Act 2001.)

Part C.1 Required:

For parts (a), (b) and (c) of this question, please disregard all going concern considerations. Based on the background information above and your use of preliminary analytical procedures, answer the following questions:

Identify and explain two (2) asset accounts at risk of material misstatement. (4 marks)

Describe one (1) issue regarding the prior years figures. (1 mark)

Describe three (3) factors that may bring into question the going concern assumption for Amistad. (3 marks)

Disregarding the evaluation of managements assessment of the going concern assumption, briefly describe the effect of the facts on your audit planning. (3 marks)

Part C.2

After examining Amistads detailed trial balance, you notice that one of the expenses of the sales and marketing department is sales bonuses. You question this expense and the companys accountant informs you that a monthly bonus of 10% of salary is paid to all sales and marketing staff if sales for the month exceed the budgeted target. The marketing manager is entitled to a 20% bonus if the targets are achieved. This incentive was implemented during the previous financial year and was in place for the last six months of the year. You note that the bonus has been paid every month since the incentive was implemented (except for the previous month, when sales were much lower than expected). This seems a little unusual because Amistad had only achieved its budgeted sales targets in two out of the six months prior to the start of the scheme. You investigate results for the last six months of the year and find that:

sales were above the monthly budget figure when bonuses were paid

there was no significant change in gross margins

returns of stock sold on the sale or return basis were well below those in the first six months except in the final month of the year

debtors levels (measured in days outstanding) were above their budgeted levels but returned to a more normal level at year end.

On further enquiry, the accountant advises that the marketing manager is authorised to do the following with regard to the stock sold on a sale or return basis:

offer customers a sale or return deal as long as the deal is within the companys pricing structures and the terms of the scheme

initiate and approve the invoicing of customers when a sale is made (i.e. if the stock is not returned within 60 days)

initiate and approve the issue of credit notes for these customers when returns are made within 60 days or when pricing or quality issues arise.

Part C.2 Required:

Based on the information to Part C.2, answer the following questions:

Explain one (1) internal control issue at Amistad. (

Identify two (2) fraud risk factors at Amistad.

Identify one (1) account balance at risk and its two (2) assertions at risk as a result of the fraud risk factors identified in (b) above. Justify your answer with reference to the background scenario.

Describe two (2) audit procedures that would address potential misstatements arising from fraudulent financial reporting. Ensure that your procedures are specific to the scenario and the fraud risk factors identified in (b) above.