Topic: Client evaluation

Question 1

You are the audit manager of a medium-sized firm and have just received a package from Rachel Jones, the financial controller of Telechubbies Ltd, a toy manufacturer. This is your firm's first year as auditor of Telechubbies. The information contained in the statement of financial position and income statement was prepared for a board meeting and Rachel felt it might be useful to you in preparation of the forthcoming audit for the year ended 31 December 2021.

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. The loan is reviewed each year on 31 December.
2. Provision against inventory obsolescence 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 5% is a more realistic level, given the nature of its products.
3. 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.
4. Additional Financial Information are linked in png File.
   

2021 2020 2019 Statement of financial position $'000 $'000 $'000 Current assets Cash 1 586 1743 830 Inventory 16 498 11 731 7197 Trade receivables 12 134 10 700 9323 Total current assets 30218 24 174 17 350 Non-current assets Property, plant and equipment 14606 12 840 9572 Long-term loan receivable 5200 3 600 3 300 Total non-current assets 19 806 16 440 12 872 Total assets 50 024 40 614 30 222 Current liabilities Trade payables 9012 6288 2021 Provisions 1 875 3 821 4 577 Total current liabilities 13 887 10109 6598 Non-current liabilities Long-term loan payable 20 000 16 000 12 000 Total liabilities 33 887 26 109 18 598 Net assets 16 137 14 505 11 624 Shareholders' equity Share capital 2000 2000 2000 Retained earnings 14137 12 505 9 624 Total shareholders' equity 16 137 14505 11 624 2021 2020 2019 Income statement $'000 $'000 $'000 Sales 72 945 74927 89 735 Cost of sales (51 840) (51 765) (63 066) Gross profit 21 105 23 162 26 669 Depreciation (5 595) (4 332) (2 796) Inventory obsolescence (1 650) (2 346) (1 439) Marketing expense (1 345) (1 980) (2548) Administration expense (8 925) (8727) (11 516) Interest expense (1 040) 1 275) (1 140) Total expenses (18555) (18 660) (19 439) Profit before tax 2550 4 502 7230 Tax expense (918) (1 621 (2 386) Profit after tax 1 632 2 881 4 844