Preparing an Audit Working Paper in a Memo format Background and Context:

You are the audit senior of ABC Pty Limited (ABC), a company involved in the assembly, distribution. and servicing of mobile phones and electronic tablets. ABC is a wholly owned subsidiary of a publicly listed company in the United Kingdom and has been operational in Australia for five years. Although ABC has been profitable for the last three years, and the growth in the company's revenue has been substantial, liquidity has been a major problem. This has been countered by the non-repayment of intercompany debt to the parent entity which is the major supplier of the components which are used in mobile phones. Due to the rapid growth of ABC, there has been a great deal of pressure put upon the company's staff and IT systems. Temporary staff are often used in the accounting department to ensure the dayto-day processing is kept up to date, while full-time employees work on special projects required to ensure that the accounting systems keep pace with the growth in the business. The turnover of staff has been very high in the accounting department in the last two years due to the pressure and long working hours associated with a rapidly expanding business. At present there are eight full-time accounting department employees, with the financial controller and management accountant being the only two who have been in the company for longer than two years. The audited income statement and balance sheet for the two years (2015 and 2016), together with management's estimates for the year (2017) are attached in Moodle. You are in the process of planning the 30 September 2017 year-end audit and have recently had a planning meeting with the financial controller. At this meeting you were informed of the following:

A. Sales are expected to be $40 million. The increase from last year is mainly due to a large order from the Queensland Government.

B. Gross margin is expected to be 31%. The decrease is due to production problems experienced during the year which led to a substantial number of components having to be air-freighted at short notice from the parent company.

C. From discussions with the credit manager you have ascertained that debtors are running at 94 days against industry practice of 90 days, while most third-party creditors are being paid at 45 days.

D. Year-end inventory is expected to be $12-4 million. Management has decided to continue production at full capacity even though the order book has fallen away in the last few months. The reason given for this was that management did not want to retrench manufacturing staff as the lull in orders is expected to be only temporary. In addition, another major order from the Queensland Government is expected shortly after year end for which management wishes to exceed delivery time expectations and outperform competitors.

E. The parent entity has given verbal assurances to Australian management that no remittances to the United Kingdom will be required within the next 12 months and that it will continue to support the Australian operations.

F. New inventory, trade receivables and trade payables software was installed during the year but is yet to be integrated with the general ledger system. Reconciliations are being performed monthly between the subsidiary ledgers and the general ledger control accounts. Problems have been experienced in reconciling inventory, which the financial controller believes has something to do with differences in exchange rates used when converting overseas purchases between the subsidiary and general ledgers. Last month's unreconciled difference was $468,000.

G. A 100% physical stocktake is not going to take place at this year end as cyclical stocktaking was introduced earlier in the year and has not indicated any problems in the recording of physical inventory. You were not aware of this until the planning meeting.

H. A number of debtors complained to ABC salespeople last year after receiving debtor confirmation requests. The sales manager has therefore requested that he dictate to the auditors which debtors can be selected for confirmation at the forthcoming year end.

I. An employee was recently dismissed when it was found that he had been forging casual employee timesheets and having money paid directly into his own bank account. The amount taken from the company was $9,000 over a period of 14 months. The financial controller was very upset that you had not identified the weakness in payroll authorisation procedures which led to this event. Although you examined the payroll system during last year's audit, you did not look at this specific aspect of the system. You are required:

1. How would you answer the client's concerns that you did not identify the payroll fraud or even advise him of the internal control weakness?

2. (a) How would you deal with the sales manager's request concerning the debtors' confirmation?

(b) What alternative audit procedures could you perform to verify the existence of debtors?