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Question 1 (40 marks) You are the audit manager of a medium-sized firm and have just received a package from Rachel Jones, the financial controller

Question 1 (40 marks)

You are the audit manager of a medium-sized firm and have just received a package from Rachel Jones, the financial controller of KidSpace Ltd., an electronic toy manufacturer. This is your firms first year as auditor of KidSpace Ltd. The information below was prepared for a board meeting and Rachel, the acting Chief Financial Officer, felt it might be useful to you in preparation of the forthcoming audit for the year ended 30 June 2017.

KidSpace Ltd.

Statement of Financial Position $'000s

Current assets 2017 2016 2015
Cash

1,586

1,743

830

Accounts receivable and other receivables

13,734

11,200

9,623

Inventory

16,498

11,731

7,197

Total current assets

31,818

24,674

17,650

Non-current assets
Property, plant and equipment

14,606

12,840

9,572

Long-term loan receivable

5,200

3,600

3,300

Intangible assets

1,400

Total non-current assets

21,206

16,440

12,872

Total assets

53,024

41,114

30,222

Current liabilities
Trade payables and other payables

9,012

6,288

2,021

Provisions

4,875

3821

4577

Total current liabilities

13,887

10,109

6,598

Non-current liabilities
Long-term loan

20,000

16,000

12,000

Total liabilities

33,887

26,109

18,598

Net assets

19,137

15,505

11,624

Shareholder's equity
Share capital

2,000

2,000

2,000

Retained earnings

17,137

12,505

9,624

Total shareholder's equity

19,137

14,505

11,624

KidSpace Ltd.

Income Statement $'000s

2017 2016 2015
Sales revenue

76,945

74,927

89,735

Cost of sales

51,840

51,765

63,066

Gross profit

25,105

23,162

26,669

Depreciation

5,595

4,332

2,796

Inventory obsolescence

990

1,173

670

Selling expenses

2,405

3,153

3,317

Administrative expenses

8,925

8,727

11,516

Finance costs

1,040

1,275

1,140

Total expenses

18,955

18,660

19,439

Profit before tax

6,150

4,502

7,230

Tax expense

1,518

1,621

2,386

Profit after tax

4,632

2,881

4,844

Notes:

Trade Receivables

12,034

10,655

9,300

Pre-paids

1,600

500

300

Other receivables

100

45

23

Total Trade & other receivables

13,734

11,200

9,623

Inventory

Raw Materials

6,599

5,866

3,845

WIP

4,333

2,588

1,550

Inventory held for sale

6,699

3,520

1,972

17,631

11,974

7,367

Provision for Inventory obsolescence

(1,133)

(243)

(270)

Total inventory

16,498

11,731

7,197

Ratios

2017

2016

2015

Profit ratio

7.99%

6.01%

8.06%

Return on shareholder equity

24.20%

19.86%

41.67%

Quick Ratio

0.99

1.18

1.54

Times Interest Earned

6.91

4.53

7.34

Accounts Receivable Turnover (times)

6.78

7.51

9.33

Asset Turnover

1.45

1.84

2.94

Inventory Turnover (times)

3.50

5.35

8.76

During a brief telephone call with Rachel, you made the following notes:

1. One of the conditions of the long-term loan is that the company is not to exceed a debt-to equity ratio of 2:1 at any time and they must maintain a current ratio of 2:1. The loan is reviewed each year on 31 July. 2. Provision for obsolescence of finished inventory held for sale and work-in-progress is provided for at a flat rate of 10%. The amount provided in previous years was 20%. Rachel said that the company believes it has been overly conservative in previous years and 10% is a more realistic level, given the nature of its products. 3. To combat declining sales a senior management incentive scheme based on sales and profit levels was introduced in July 2016. 4. The long-term loan receivable is from a company involved in the development and production of computer software. It is owned by one of the directors.

Required:

a) Identify and explain what the inherent risks for KidSpace Ltd. that you will need to consider. (6 marks) b) From the information provided, perform additional preliminary analytical procedures: i) Simple comparison (3 marks) ii) Current ratio (1 mark) iii) Return on assets (1 mark) iv) Gross profit ratio (1 mark) v) Debt-to-equity ratio. (1 mark)

c) Drawing on information from a) & b), identify and justify:

i) Three key account areas that would require special attention during the audit of the 30 June 2017 financial statements. Also, indicate if those accounts are likely to be over or understated. (12 marks) ii) Two key assertions at risk for each of those account areas. (12 marks)

d) Identify and discuss any going concern issues to be considered at this stage?. (3 marks)

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