THE CASE: Adelaide Manufacturing (AM) is a suburban metal manufacturer that is operated by the Carter family and is constituted as a small proprietary limited company. Helen Grant is the firm's senior accountant. AM is currently negotiating with seven other small metal manufacturing firms to combine as a new entity that will undertake advanced manufacturing of metalworking tools for the national market. Over time, it is expected that the new entity will become a leader in the Fabricated Metal Product Manufacturing industry. The new entity will be constituted as a proprietary limited company, with each of the new owners (15 in total) holding one share each, and each having one seat on the board of directors. No further equity investment is envisaged in the short term, but the new entity will require significant borrowings to fund the expansion, and to purchase some existing ancillary services. The new entity will be called Advanced Machine Tooling Pty Ltd (AMT). Helen Grant will be employed as the Chief Financial Officer of AMT. It is expected that, at inception, AMT will have a staff of 40, assets of $80m and annual revenue of $100m.

AMT will consolidate its management, accounting, sales and warehousing functions in the Adelaide central business district, but manufacturing will be undertaken at two suburban and two regional factories. Each of the four factories will have an administration officer and an accounts clerk. A new purpose designed information system for managing records, payroll and personnel, inventory, and accounting will be purchased. The owners expect that such a change will provide for significant economies of scale and efficiencies. If all goes well, AMT will expand interstate over the next few years by purchasing other small firms. Helen Grant believes that it will be good for her career to take the appointment as Chief Financial Officer (CFO), even though it will mean a significant increase in her workload, since the owners have made it clear that they wish to focus on market development and leave her to manage the finances.

Helen believes that the new entity will require an external audit. However, one of the owners suggested that this would result in unnecessary costs, and that an annual review would suffice. Furthermore, he added, none of the firms that were coming together to form AMT had found it necessary to have an external audit in the past. Helen Grant decided to send a letter to all the owners explaining why she believes that AMT would benefit more form an audit than from a review.

Assume that the new entity, AMT, was established, that the board accepted Helen Grant's recommendation of an annual audit for the company, and that after

conducting a tender for the audit, AMT selected ABC Auditors (ABCA) to conduct the audit. Unfortunately, Helen Grant found that, for personal reasons, she was unable to continue in the new role as CFO. The case continues...

ABCA was selected to conduct the audit because one of the board members of AMT was aware of its reputation as an auditor in the wine industry where he was involved in a joint venture (a small winery) with one of the partners of AMT.

In the year first year of operation AMT made large investments in state-of-the-art computer aided manufacturing equipment, obtained licenses to use the latest software programs, and significantly increased its research and development capability. It funded this expansion through a number of bank loans and a bank overdraft. In order to minimise risk, the board of AMT accepted a proposal from one of its major customers for a seat on the board in return for signing a 5 year contract to purchase one of AMT's main products a set price. As well, AMT sought to optimise operating cash flow by reducing executives' base salaries and increasing the amount of bonuses that they could earn. The key performance indicator on which bonuses are to be calculated is accounting profit.

AMT has 3,600 active customers located across Australia. All sales are on credit, with outstanding accounts due within 30 days. Customers who pay within 7 days are given a

2% discount. Approximately 30% of customers represent 70% of the accounts receivable balance at year end.

In recent months, the Australian Dollar depreciated 35 % against the $US, which has made some of, AMT's inputs more expensive. Furthermore, rising interest rates in the Australian economy are putting pressure on some of AMT's major customers. Consequently, the new CFO, who joined AMT after many years in the building industry, is closely monitoring receivables.

The total balance of outstanding amounts owing from customers at balance date is $90m, for which the new CFO made a provision for doubtful debts of $450,000. She based this figure based on her reading of the records that Helen Grant kept while she was the senior accountant at AM.

Customers make purchases from AMT by emailing their purchase orders. On receipt of a customer's purchase order, a Sales Clerk prepares a Sales Order. In doing so, he accesses an authorised price list to determine the price that is to be charged, and inputs the quantities, product descriptions, product codes and delivery requirements. Sales Orders are prenumbered and in triplicate. The Sales Clerk then performs a credit check by comparing the value of the sale with the customer's credit limit, which is recorded on the customer database. Once the purchase is accepted, Copy 1 of the Sales Order is

sent to the Warehouse, Copy 2 is sent to the Accounting Department, while Copy 3 is filed in the Sales Department. The information system also generates an Aged Open Order Report [1]. Periodically, an Administration Clerk inspects this file to ensure that it is cleared.

In the Warehouse a Warehouse Clerk uses the information of Copy 1 of the Sales Order to pick the goods, prepare them for shipping and pass them to the Shipping Clerk, who is responsible for sending the goods to customers. The Shipping Clerk prepares a Shipping Note. Shipping Notes are prenumbered and in quadruplicate. Once per month a Clerk from the Administration Department performs a sequence check on a sample of Shipping Notes.

Before the goods are shipped to the customer, a Second Shipping Clerk checks the consignment to ensure that the goods match the information (item number and quantity) on the Shipping Note. This Shipping Clerk initials all Copies of the Shipping Note to indicate that he has performed the check. Copy 1 of the Shipping Note is returned to the Sales Clerk, who uses it to clear the open order file. That copy is filed with the Copy 3 of the Sales Order in the Sales Department, and stamped "cleared". Copy 2 of the Shipping Note is attached to the goods for delivery to the customer. Copy 3 of the Shipping Note is sent to the Accounting Department, while Copy 4 is filed in the warehouse by the Shipping Clerk.

In the Accounting Department, an Accounts Clerk matches the information on the Sales Order with that on the Shipping Order, and, on that basis, prepares a Sales Invoice. The Accounts Clerk takes great care to ensure that the extensions on the Sales Invoice (quantity order x price) are correct. Sales Invoices are prenumbered and in duplicate. Copy 1 of the Sales Invoice is sent to the customer. Copy 2 of the Sales Invoice is stapled to Copy 2 of the Sales Order and Copy 3 of the Shipping Note and is used by the Accounts Clerk to record the transaction in the Sales Journal. The stapled documents are then filed by customer name in the Accounts Department.

Note: [1] An aged open order report is a list of sales orders that is sorted by the date on which the order was generated by the sales clerk. It provides clerical staff with the opportunity to periodically review its orders to make sure that orders have not been lost, or that difficult orders receive special attention.

QUESTIONS

QUESTION 1: The benefits of an audit (15 Marks)

With reference to the facts of the case, explain what Helen Grant could have said to support her view that AMT would benefit more from an audit than from a review.

QUESTION 2: Client acceptance (14 Marks)

With reference to facts of the case, and the appropriate auditing standards and the code of ethics, outline the main issues that ABCA to have had to consider when accepting the audit of AMT, and explain why such issues are important.

QUESTION 3: Understanding the client and its environment (32 Marks)

(a) Outline the main requirements of ASA 315 with respect to understanding the client and its environment (6 Marks)

(b) State two internal and two external sources of sources of information that will provide relevant information to ABCA when gaining an understanding of AMT and its environment, and identify the nature of the information that each source could provide (8 Marks)

(c) Access the IBISWorld database to research AMT's industry and answer the following questions: (28 Marks)

(i) What is the expected annual growth in revenue for the industry for the period 2020-2025? (1 Mark)

(ii) Is the number of businesses in the industry expected to increase or decrease in the period 2020-2025? (1 Mark)

(iii) What is the outlook for employment in the industry for the period 2020-2025 compared with the period 2015-2020? (1 Mark)

(iv) Identify the external driver with the most positive impact, and the external driver with the most negative impact on the industry over the period 2015-2020. (2 Marks)

(v) Consider the Operating Conditions of AMT's industry and briefly comment on the following issues: (1) the level of capital intensity; (2) technology and systems; and (3) regulation and policy.(12 Marks)

(vi) What is the average figure for depreciation charges as a percentage of revenue for the period 2015-2020? (1 Mark)

QUESTION 4: Understanding Inherent Risk (27 Marks)

(a) With reference to the facts of the case, identify three inherent risk factors that may because concern when planning the audit of AMT. Ensure these risks are specific to AMT and classify them as either a financial report level risk or an assertion level risk. (6 Marks)

(b) Explain why the risk factors in (a) above are potential problems for the audit. That is, why could these factors increase the risk of misstatement in the financial statements of AMT? (9 Marks)

(c) For each of the three risks you have identified, state one significant Balance Sheet account that could at risk of material misstatement because of risk. For each account you have identified, provide a brief explanation of why it is a risk and identify the key assertions affected. (12 Marks)