Question 1 (40 marks)

Case: Sassoon Ltd

As the audit manager of Lum & Lo Ltd, CPAs, you are in charge of the annual audit of Sassoon Ltd for the year ended 30 August 2018. Your firm has been the auditor of Sassoon Ltd since it was incorporated in Hong Kong in 2013. In the past, your CPA firm has been satisfied with the internal controls of Sassoon Ltd and has given unmodified audit reports.

Sassoon Ltd is a manufacturer of cosmetic products with sales mainly to department stores and pharmacies in the Asia-Pacific region. Sassoon Ltd is owned by the Li family and has a simple management structure with the managers of the respective departments reporting directly to the Managing Director, Mr Paul Li.

During the course of the audit, you have noted the following matters.

1)Due to a recovery in the economy, Sassoon Ltd has seen a high turnover of accounting staff during the year. In particular, Mr Wong, the manager of the Accounts Department, has left early in the year for a better position elsewhere.

2)The position vacated by Mr Wong has been taken over by Mr Ho,who was previously the company's Human Resource Department manager. Mr Ho has worked for the company since its incorporation and is the nephew of Mr Li. He is considered to be trustworthy by the Li family. When Mr Ho took over the supervision work after Mr Wong's sudden resignation, his appointment was supposed to be temporary. However, the financial controller has advised that due to the shortage of good candidates it is unlikely that Sassoon Ltd will be able to recruit a suitable accounting manager before theyear-end financial statements are finalized.

3 ) Sassoon Ltd uses a perpetual inventory system with a policy of conducting a physical count of 20% of stock items every month on a rotation basis. Any unreconciled differences between the book and the physical stock-take will be adjusted in the accounts.

4) A 100% inventory count was conducted on 31 August 2018. Inventory with a book value of approximately HK$900,000 was written off as a result of this exercise. The audit senior in charge of the observation of the inventory count concluded that the count was properly conducted. However, you subsequently found that it was Mr Ho that had supervised the count teams and he is the husband of the warehouse manager, Mrs Ho.

5) This year, Sassoon Ltd has started to explore the mainland market by sending goods on a consignment basis to a number of pharmacies in Shenzhen. The respective pharmacies produce a monthly sales report for Sassoon Ltd which uses the information to recognize monthly revenue as well as the basis for invoicing the pharmacies. The industry standard credit period of 60 days from the invoicedate is given to the pharmacies. The consignment inventoryof HK$2,000,000 is included in the year-end inventory which represents about 10% of the total inventory. Sassoon Ltd recognizes $6,000,000 of revenue from consignment sales for the year which represents about 10% of the sales revenue for the same period.

Required

a) Assess the risk of material misstatements at the financial statement level. You should discuss the specific circumstances of Sassoon Ltd that you have considered and your judgement on the level of risk (i.e. low, medium or high). (16 marks)

b) Discuss possible causes of the write-off of HK$900,000 of Sassoon Ltd's inventory and the assertion(s) affected by it. (12 marks)

c) Regarding the consignment sales of Sassoon Ltd, identify the majoraudit issues in the company's consignment sales recognition forthe purpose of assessing the risk of material misstatement at the assertion level. (12 marks)