Question
Q.Preliminary assessment of materiality helps the auditor to plan the audit and to carry out the audit testing. Based on your understanding of the entity
Q.Preliminary assessment of materiality helps the auditor to plan the audit and to carry out the audit testing.
Based on your understanding of the entity from the case data provided below, calculate the overall planning materiality. Justify the choice of the appropriate base and the materiality amount.
Rules of thumb for planning materiality:
Base
Ranges of percentages applied to base
Profit before tax
5 - 10%
Total Revenue
0.5 - 1%
Total Assets
0.5 - 1%
Equity
1 - 2%
(3 Marks)
Case Data: Morris Ltd
You are the audit manager planning for an audit of your client Morris Ltd (Morris).Morris has been recently listed on the Australian Securities Exchange (ASX). Morris sells herbal medicines to customers based in Australia, New Zealand and has plans to expand to USA, Canada as well as to the smaller Pacific markets. The sales channel includes in-store sales, on line and direct to wholesalers.
The herbal medicines are manufactured by a pharmaceutical company based in Malaysia under an agreement with the manufacturer.The company's key product is a root-based product grown in the South Pacific countries and is aimed at reducing anxiety levels for individuals who suffer from the condition.
Currently, the company has 90 capsules per bottle product, but the CEO informs you that the company aims to have 60, 30 and 20 capsules per bottle products in the future.The company is also investigating the use of different varieties of this root and their effect on anxiety level for future development.
Morris expects that the demand for the products will increase over time so during the year Morris made the following key appointments:
Fran Walker as Chief Marketing Officer who has over 20 years' experience in the consumer sector.
Michael Lee as General Manager of sales (International Markets).
To cope with the expected increase in demand a new web-based system was implemented for online sales.The accounting information system was also changed to cope with the different sales channels.The Information technology manager told you that "as usually is the case when companies change their IT systems, we also had some initial teething problems, but they seem to have been ironed out as I haven't heard anyone complaining about it recently".
Reading the minutes of a recent board meeting, you discover that the board has indicated its strong intention to raise additional capital to fund ongoing operations together with its initiatives to drive revenue with new product in new market segments in 2020. Some of the funds would also be used to reduce the debt level. The board minutes also indicate that a customer is taking legal action against Morris because she claims to have suffered severe adverse reactions after taking the capsules. No provision for has been made for any penalties that Morris may have to pay.
As part of your planning you have made enquiries of management and other personnel. From your enquiries you have gathered the following additional information:
The loan was obtained from Bank of Burwood. There is a loan covenant requiring Morris to maintain a current ratio greater than 1.3.
Some of the inventory was sent by the Manufacturer was shipped FOB meaning that the ownership of the goods was transferred to Morris when the goods were loaded in Malaysia.However, it appears that the goods may have been damaged, and the shipping company is still investigating the case. These goods worth AUD 200,000 is included in the balance sheet.
Morris pays the manufacturer in Malaysian currency (Malaysian Ringgit).
During the financial year, a bonus scheme was introduced for senior managers. To increase sales revenue, this bonus is based on a percentage of gross profit.
Recent tropical cyclones in the South Pacific countries that supply the raw materials has damaged the plantations from which the medicines are derived. This increased the price of raw materials and it is expected that the manufacturer will pass this increase on to the client.
Due to the size of the board, the company does not have a separate audit committee. You have been informed that the full board carries out the duties that would normally be assigned to the audit committee.
Morris Ltd
Income Statement for Year Ended 31 December 2019
2019
(Draft)
'000
Revenue
Sales Revenue
18,325
Cost of Goods Sold
14,811
Gross Profit
3,514
Other Income
26
Less: Expenses
Shipping
1,866
Employee Benefit
2,974
Share Based Payments
52
Depreciation & Amortisation
692
Selling & Marketing
1,500
General & Admin
1,183
Other Expenses
1,537
Total Expenses
(9,804)
Operating Loss
(6,264)
Less: Finance Cost
(923)
Loss Before Income Tax
(7,187)
Less: Income tax Expense
-
Loss After Income tax
(7,187)
Morris Ltd
Statement of Financial Position as at 31 December 2019
2019
(Draft)
'000
Assets
Current assets
Cash and cash equivalents
2,376
Trade receivables
1,697
Inventories
2,067
Other
646
Total current assets
6,786
Non-current assets
Plant & Equipment
10,604
Intangibles
1,729
Total non-current assets
12,333
Total Assets
19,119
Liabilities
Current liabilities
Trade Payables
3,464
Loans
1,144
Employee benefits
273
Total current liabilities
4,881
Non-current liabilities
Loans
7,816
Other non-current liabilities
1,982
Total non-current liabilities
9,798
Total Liabilities
14,679
Net Assets
4,440
Equity
Issued capital
63,200
Reserves
15,551
Accumulated losses
(74,311)
Total Equity
4,440
Number of shares outstanding
1,000,000
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