Question 1 ((this question consists of 2 parts (a) and (b))

(a)Discuss whether there are any threats which affect the independence of Sarah and Zi.(8 marks)

Sarah

Zi

(b)For the key threats you identified above, what actions should the audit partner take to remove the threats?

(2 marks)

Key threats identified per (a) above

Actions partner should take

Question 2(this question consists of 3 parts, (a), (b), and (c))

a) Identify and explain three (3) inherent risk factors which exist for SYL.(6 marks)

Inherent risk and explanation

1.

2.

3.

b) Identify and explain two (2) control risk factors which exist for SYL.(4 marks)

Control risk and explanation

1.

2.

Question 2 continued

c) Assess inherent risk for SYL. Justify your assessment.(2 marks)

Question 3(this question consists of 2 parts, (a) and (b))

a) Identify two (2) weaknesses in internal control in the payroll cycle.(4 marks)

b)Identify an error or fraud which could occur as a result of each of the internal control weaknesses you identified in part (a).(4 marks)

Weaknesses

Potential error or fraud that could occur

1.

2.

Question 4(this question consists of 3 parts (a), (b) and (c))

a) Assuming that Control Risk is HIGH for the Payroll cycle, what audit strategy should be adopted for the audit of the Payroll cycle and related Payroll accounts.(2 marks)

b) Assuming that the auditors require Detection Risk to be LOW in order to reduce Audit Risk to an acceptably LOW level overall, what impact would this have on the determination of the materiality figure?(2 marks)

c) Explain whether the subsequentevents should be recognised in the financial statements or disclosed in the notes to the financial statements.(6 marks)

Subsequent event 1

Subsequent event 2

Question 5(this question consists of 2 parts (a) and (b))

a)On the last page of the case there are details surrounding the Accounts Receivable audit tests

i) What assertion is most at risk in the Accounts Receivable balance?(1 mark)

ii) Did Nisa's substantive test provide evidence on the assertion mentioned? Justify your response

(2 marks)

iii) What audit procedure would you recommend Nisa performs to provide evidence on the accounts receivable balance.(2 marks)

Question 5 continued

b) Based on the Financial Reports, identify three (3) accounts, other than accounts receivable that require further investigation. Explain whyeachof these accounts require further investigation.(9 marks)

Account

Why further investigation is required

1

2

3

Question 6(this question consists of 2 parts)

a) With regards to the misstatements identified, state the audit opinion that would need to be provided in the Audit Report. Justify your answer.(3 marks)

b) Identify three (3) factors which indicate that the going concern assumption is appropriate for SYL.(3 marks)

1

2

3

END OF EXAMINATION

DEAKIN UNIVERSITY

MAA303

AUDIT and Assurance

Case Study related to Examination

Trimester 1, 2020

Sanitise Yourself Limited

Financial year end 31 March 2020

Sanitise Yourself Limited (SYL) is an Australian public company. The company is not listed. It manufactures high-quality hand sanitiser lotion in two states, Victoria and Western Australia. SYL commenced operations in 2002 and maintained slow but steady growth over the years. Its major customers are the large supermarkets: Coles, Woolworths, IGA and Aldi. It also sells to smaller outlets, such as pharmacy stores.

In March 2020, sales for the company increased exponentially due to increased demand and stockpiling associated with COVID-19.

The company initially responded to its increased orders by extending its manufacturing hours by 2 hours a day and offering overtime to its fulltime staff and additional hours to its casual staff. However, this was not sufficient to meet demand, and the company doubled its normal employee numbers by hiring more casual staff and operating its manufacturing processes 24 hours, 7 days a week for 6 weeks from the middle of March to the end of April. Manufacturing was then decreased to 24 hours for 5 days a week. Unlike the normal 2 week induction period for new staff that the company had previously offered, the new workers hired at this time were provided with a one-day induction and then went straight on to the production line.

The company has two delivery drivers who normally deliver to the supermarkets' large central warehouses and pharmacies. The drivers worked extensive overtime during this period. However, due to the inability to meet demand, SYL ceased deliveries to small pharmacies, forcing them to find other suppliers.

As a result of the huge surge in demand for hand sanitiser lotion, other companies have entered this market. To establish themselves these companies have offered their products at a discounted rate. They have become the preferred suppliers to the pharmacies where SYL ceased deliveries.

The company is audited by Smit, Perera and Chandra (SPC), a mid-tier audit firm located in Melbourne. SPC has audited SYL since its incorporation.

The Audit Team

The audit team consists of 4 people. The partner is Sarah. She has been involved in the SYL audit for over 20 years and partner on the engagement for the last 15 years. The chairman of the board has asked whether Sarah can be appointed as a non-executive director. The board lacks a financial reporting expert, and the appointment of an audit partner would bring much needed knowledge and experience. Sarah has agreed to attend meetings from time to time and provide financial reporting guidance and advice to the board.

The audit manager is Tim. This is Tim's first time on the SYL audit. Nisa is the audit senior and is responsible for the initial audit planning. Nisa has recently completed the Graduate Diploma of Chartered Accounting. The graduate on the audit is Zi. While a student, Zi worked part-time in the accounting department at SYL undertaking basic processing tasks. Zi's friend is the receptionist at SYL. The receptionist has no accounting knowledge and has no involvement with the recording or processing of accounting transactions

The audit team commenced planning the audit on SYL in the middle of March 2020. The auditors were delighted to be able to buy hand sanitiser lotion from the SYL warehouse under the same pricing arrangement available to SYL's staff. The interim work on SYL was undertaken at the end of March and early April and the final work is scheduled for early July 2020.

Corporate Governance and the accounting department

The company's Board of Directors consists of 5 directors. Due to the small size of the board, there is no separate audit committee. SYL also does not have an internal audit division. The Board of Directors consists of an independent and non-executive Chairman, the CEO who has been with the company for 2 years, the CFO who has been with the company for 3 years, an independent lawyer and another independent non-executive director. Up until December 2019, the CFO previously worked as an auditor with CPC and was involved on the audit of SYL. The CFO is great friends with Tim (the audit manager) and prior to the current season often went to the football games each Saturday.

Shareholders are expecting to see a large increase in profit this year as they are aware of the significant increase in hand sanitiser products.

The accounting department is of a reasonable size and has the ability to segregate duties, although this is not something the company focuses on. The increased manufacturing has placed the current accounting staff under extreme stress as the number of staff on the payroll has increased significantly and there has been a large increase in the numbers of suppliers' invoices received and associated goods received notes. In addition, the number of sales orders have doubled. The company chose not to increase the number of accounting staff despite the large increase in manufacturing and processing.

The financial reports

Sanitise Yourself Limited

Statement of Comprehensive Income for the year ended 31 March 2020

unaudited

Audited

Audited

2020

2019

2018

$

$

$

Revenue from sale of goods

9,576,890

6,384,593

5,980,976

Cost of sales

5,363,058

3,192,297

2,990,488

Operating gross profit

4,213,832

3,192,297

2,990,488

Selling expenses

957,689

638,459

598,098

Administration expenses

1,149,227

766,151

717,717

Earnings before interest and tax

2,106,916

1,787,686

1,674,673

Finance Costs

72,810

96,019

100,514

Profit before income tax

2,034,106

1,691,667

1,574,159

Income tax expense

517,126

404,533

368,395

Profit for the period attributable to owners of Sanitise Yourself Limited

1,516,979

1,287,134

1,205,765

Sanitise Yourself Limited

Statement of Financial Position as at 31 March 2020

unaudited

Audited

audited

2020

2019

2018

$

$

$

ASSETS

Current Assets

Cash and cash equivalents

195,000

55,000

58,000

Trade and other receivables

1,230,986

859,000

845,634

Inventories*

1,346,000

925,000

876,234

Total current assets

2,771,986

1,839,000

1,779,868

Non-current assets

Property, Plant and Equipment

4,302,431

4,340,000

4,200,000

Deferred tax assets

11,000

13,200

12,200

Other non-current assets

1,000

990

890

Total non-current assets

4,314,431

4,354,190

4,213,090

Total Assets

7,086,417

6,193,190

5,992,958

LIABILITIES

Current liabilities

Trade and other payables

932,451

764,509

690,567

Provisions

56,879

120,456

132,476

Current Tax Liabilities

294,968

250,276

234,454

Other liabilities

4,340

3,287

4,572

Total current liabilities

1,288,638

1,138,528

1,062,069

Non-current liabilities

Borrowings (due 2025)**

2,427,000

2,486,809

2,645,108

Provisions

56,700

205,400

149,000

Total non-current liabilities

2,483,700

2,692,209

2,794,108

Total Liabilities

3,772,338

3,830,737

3,856,177

Net Assets

3,314,079

2,362,453

2,136,781

Equity

Contributed Capital

2,300,000

1,900,000

1,800,000

Reserves

100,000

100,000

100,000

Retained Earnings

914,079

362,453

236,781

Total equity

3,314,079

2,362,453

2,136,781

*SYL has warehouses in both Melbourne and Perth. The inventory level at Melbourne is $846,000 and in Perth $500,000.

** there are debt covenants associated with the long-term borrowings.

Subsequent events:

A court case began in October 2019 involving an ex-employee who is suing SYL for unfair dismissal. A confirmation letter was received from the company's lawyers on 10 May 2020, which estimates that damages of $150,000 are probable to be paid (i.e. highly likely). The amount is material. As it stands, the amount has not been recognised and recorded in the unaudited financial statements for the year ending 31 March 2020. Management has informed the auditors that at best, they will include some disclosure surrounding the event in the notes to the financial statements.

In early June 2020, SYL decided to proceed with the acquisition of "Toilet Paper For Us Pty Ltd". Negotiations with the Directors of "Toilet Paper for Us Pty Ltd" began in early April as a result of the increased demand for toilet paper in Australia. The Directors of SYL decided that they wanted to capitalise on this demand and therefore decided to acquire the company.

Extracts of SPC Working Papers for the year ended 31 March 2020.

Planning Materiality was set at $115,000

Payroll Accounting and Internal Control System

There have been no significant changes in the payroll processing cycle since the previous audit. The company usually employs approximately 50 employees butfrom January to the end of March, this number increased to 80. The additional staff were casual workers. There are two staff members in the payroll department who add new employees to the payroll with no further authorisation required, and who process the payroll.

Staff recruitment

When staff are hired, all their details are entered on the computerised payroll system by the staff in the payroll department. All staff are paid award wages as per the relevant award. All award rates are in the payroll master file and do not need to be entered for each employee. The entering of staff details is not checked or authorised by a supervisor.

Processing of pays

All staff working in the production and warehouse areas are required to clock-on using time-cards. They are forbidden to clock-on for their colleagues. All timecards are authorised by the production manager who signs the cards as evidence. The time-cards are then sent to the payroll office. Payroll staff enter the hours from the timesheets into the payroll system. While there is no double-checking of data entry, the system has data entry checks to ensure that hours over 60 hours cannot be entered and that only numeric data has been entered.

Whilst performing an observation of the payroll processes and in particular observing the clock-on procedures of factory staff on four mornings, the audit team noted that two workers were clocking on more than one time-card at a time. The foreman was queried about this and he told Zi that the workers do sometimes clock-on for their friends if they know they are going to be late for work. The foreman thanked us for bringing the matter to his attention and said that he will remind workers of the rules about not clocking-on for others.

Accounts Receivable & Sales Accounting and Internal Control System

At the end of each month, the sales manager determines the amount of products required to meet sales demand for the following month based on sales orders received. He reviews the sales orders received from customers and then prepares the inventory requisition form, which he then sends to the warehouse managers so that they can prepare the goods for delivery. One copy of the sales order and inventory requisition form is sent to the warehouse, one copy is sent to the accounts receivable department and one copy is filed in the sales department.

The warehouse prepares the goods for delivery to the customers and generates the delivery document. When the goods have been delivered, the signed delivery document, which includes the delivery details, is forwarded to the accounts receivable department. The other copy is filed in the warehouse. The accounts receivable clerk matches the signed delivery document with the sales order and inventory requisition form. Once satisfied that all of the details agree, the clerk generates the sales invoice. Once generated, the clerk does another check to ensure that all details per the sales invoice agrees to the delivery document and sales order. Once satisfied, she writes "checked" on the sales invoice and sends it to the customer. At the end of every week, a different clerk in the Accounts Receivable team reviews the bank statements for receipt of payments from customers and performs a reconciliation against the sales invoices. Once a customer has paid the sales invoice, the clerk stamps "received" on the sales invoice and files that along with all the other documents.

The walk-through of the accounts receivable/sales cycle confirmed that the accounting and internal control system was working as documented above.

Test of control:

As part of the audit, Nisa tested the controls over the accounts receivable system. She selected a sample of twenty sales transactions and tested the control that all details had been checked. All sales invoices in the sample had "checked" written on them, indicating that the accounts receivable clerk had carried out the control. Nisa also checked the details herself to verify the effectiveness of the control, finding no discrepancies. Nisa has therefore determined that the internal control operated effectively and consistently throughout the year.

Substantive test

In order to test the occurrence and validity of sales transactions, Nisa selected a sample of sales invoices and traced them through to the General Ledger to test that they were properly recorded.

Misstatements identified

Description

Amount

Management Action

One of SYL's pharmaceutical customers is experiencing severe cash flow difficulties and is unable to pay the amount owing to SYL.There has been no provision/allowance for doubtful debts raised for this debtor in the financial statements for the year ended 31 March 2020. SYL's legal adviser stated in a telephone call that that the probability of any funds being received from the debtor is remote.

$50,000

Management disagreed with the advice from the legal adviser and believe that they will be able to receive the money from the customer. As such, they have not corrected the accounts in the final Financial Statements.

One supplier's invoice was not recorded in accounts payable, understating inventory and accounts payable.

$3,669

None