You are a new staff member of Monet & Associates, a mid-sized accounting firm and have been assigned to an engagement team that is conducting the financial report audit for Harrisons Ltd (Harrisons). The engagement team, under the guidance of the engagement partner, Vince Mater, is currently performing a preliminary risk assessment of the audit client. The following documents have been provided to you: 1. Memo from audit partner, Vince Mater, dated 6th January 2020 which includes a summary of the initial audit procedures undertaken by the engagement partner for the 31 December 2019 audit. 2. A relevant industry outlook report provided by the Australian Construction Industry Forum published on 7 November 2019. REQUIRED: You have been asked to assess the inherent risk of the client and perform preliminary analytical procedures as part of the audit planning process in obtaining an understanding about the client's business and indicate where there is an increased likelihood of misstatements. Refer to the information provided and answer the following questions: (1) Assess overall inherent risk at the financial report level of Harrisons Ltd. In your answer you should discuss, based on the materials provided in the memo from the audit partner (excluding Appendix A and B) and the industry outlook report, the factors that would increase and decrease the inherent risk of material misstatements for Harrisons at the financial report level. (i.e. For this part of the question, you are to ignore the ratios provided in the appendix to the Partner's Memo). Conclude with an overall assessment of the qualitative level (high/medium/low) of inherent risk for Harrisons Ltd at the financial statement level. (Hint: This conclusion only needs to be one sentence that states your overall assessment based on the balance of factors discussed). (9 marks) 2 (2) Examine the year-to-year changes and the common ratios documented in Appendix A to the Partner Memo, and provide the following analysis from an audit perspective: a. Use the case information and the ratios provided to evaluate the risk of material misstatement for Harrison's completeness assertion for cost of goods sold. (3 marks) b. Assume that you have established that the client has the following control in place that is designed to prevent fictitious sales from being recorded: Customers are required to sign the delivery documents on receipt of merchandise. Suggest an appropriate test of this control. (1 mark) c. Describe any observations about accounts payable and inventory and discuss any areas that you believe warrant further investigation during the current year audit. (3 marks) d. Describe your observations around interest expense. Indicate whether the results are unexpected or not within the context of the case information, and whether they require further investigation. (2 marks) (3) Refer to Harrisons' Income Statement data which is located in Appendix B to the Partner's Memo and record your answers to the following questions: a. Perform analytical procedures for the completeness assertion of advertising expense, security expense and bad debts expense and indicate whether you believe that there is a concern about material misstatements in each account. (6 marks) b. Suggest an appropriate substantive procedure to test the completeness of security expense. (1 mark

To: Dean Smith (Audit Senior) From: Vince Mater (Audit Partner) Date: 6 th January 2020 Re: Harrisons Ltd Audit for 31 December 2019 I just wanted to fill you in briefly on our client, Harrisons Ltd, as you are just joining the audit team and it is your first year on the audit. I have been out to visit the client in order to get some information which will help us with planning this year's audit for their financial year ending 31 December 2019. I have conducted some initial audit procedures for the upcoming audit and have included these in the current audit file for the client. Harrisons Ltd is a publicly traded company that is listed on the ASX. This will be the second year that we have audited the company (and I was the engagement partner last year). In last year's audit we found no material misstatements. Harrisons Ltd is an Australian manufacturer of building materials and cement, founded in 1948 in NSW. Their operations include both manufacturing plants and wholesale distribution centers in 68 locations across Australia. They have developed a good reputation with their clients and employees and maintained strong relationships with their suppliers, who are all Australian owned and operated companies. However, there has been some recent lobbying activity by environmental groups who have expressed concerns regarding the pollution levels at their Coffs Harbour manufacturing plant. The CFO indicated to me that they do have some concerns about how this may affect their relationship with stakeholders in the community and their social licence to operate in the region. While revenues have grown year on year, and profit growth has been above 5% between 2016 and 2018, the CFO noted that inventory turnover had slowed in 2019, partly due to increased competition in the domestic market. The company operates a results-oriented work environment that holds employees as well as managers accountable for success and utilizes systems that reward employee and group output. Notably, senior managers and sales staff were advised that they are to be rewarded with a bonus if the firm achieves profit growth of 5% in 2019. The CEO and two Directors of Harrisons have spent some time over the last few months engaging with industry counterparts and attending conferences in the UK and have recognized the need for innovation in fire retardant building materials. Consequently, the Board of Directors has approved the establishment of a $20 million dollar Research Centre, which they envisage will become the leading edge for research in the building industry in Australia. The company took out a loan with a local bank for $12 million in August 2019 to purchase a property in Brisbane that will house the Research Centre. The debt contract requires the audit client's interest coverage ratio to be above 3, and the debt to assets ratio is required to be below 50%. The balance of the capital required to set up the Research Centre will be obtained through the issue of additional shares. The prospectus for the share issue has already been published and the applications for the share issue closes on 15 January 2020. The CEO has been anxious to ensure that the financial results will present the company in the best possible light for the share issue and has been asking staff over the last several months to focus on cost cutting. Yesterday the client sent through a copy of their draft financial information for the year. I have calculated some ratios based on this information and included in the attached Appendix A. I also attach an extract of income statement data for the last four years in Appendix B. You might find this information useful for planning the audit. 2 APPENDIX A - FINANCIAL DATA YEAR TO YEAR CHANGES % Change % Change % Change Account Balance 2018-2019 2017-2018 2016-2017 Net sales 3.72% 2.98% 1.54% Cost of goods sold -0.63% 3.79% 2.11% Operating expenses 3.25% 0.94% -0.02% Operating Income 3.43% 2.13% 1.76% Interest Expense -2.32% -5.62% -6.41% Net receivables 51.30% 8.61% 11.11% Inventory 12.78% -0.93% 3.60% Accounts Payable 22.42% 18.12% 14.46% Current portion of long-term debt -40.51% 0.00% 11.11% Long-term debt 24.72% -1.37% 1.35% Common Ratios of Harrisons Ltd 2019 2018 2017 Gross margin % 33.98% 30.03% 30.57% Net Inc. bef tax/sales 0.04 0.04 0.04 Profit growth 5.01% 5.98% 5.98% Days Sales Outstanding 25.20 19.97 18.73 Bad Debt Expense as percentage of gross sales: 0.47% 0.62% 0.67% Days Inventory Outstanding 88.40 86.73 88.87 Accounts payable turnover rate 12.1 15.4 15.2 Payables turnover in days 30.17 23.70 24.01 Debt to assets 0.49 0.46 0.46 Interest coverage 3.01 2.81 2.50 These are the formulae I have used in the calculations: Gross margin % = Gross profit divided by net sales. Net income before tax/sales = net income before tax divided by gross sales. Profit growth = the difference between current period profit and prior period profit divided by prior period profit, i.e., (Profit t - Profit t-1) / Profit t-1. Accounts receivable turnover = Net sales divided by average net accounts receivables Days sales outstanding = 365 divided by accounts receivable turnover, where accounts receivable turnover = Net sales divided by average net accounts receivables Days inventory outstanding = 365 divided by inventory turnover, where Inventory turnover = cost of goods sold for year t divided by average inventory (i.e., the average of beginning and ending inventory balances for year t). Debt to assets ratio = Total liabilities divided by total assets. Interest coverage ratio = Net profit divided by interest expense. APPENDIX B Harrisons Ltd Extract from Income Statement for the Year Ended December 31 (draft) 2019 2018 2017 2016 $ $ $ $ Sales 196,423,03 9 189,318,978 183,841,948 181,049,153 Sales Returns and Allowances 301,379 223,148 217,290 215,670 Cost of goods sold 131,480,97 5 132,319,374 127,485,206 124,846,646 Accounting fees 379,945 386,221 374,736 370,971 Advertising 203,140 222,511 205,098 205,406 Bad debts 927,124 1,167,575 1,240,118 1,235,095 Business publications 6,736 6,944 968 1,021 Cleaning service 102,250 104,986 95,910 97,610 Depreciation expense 4,460,910 4,927,478 4,480,887 4,986,278 Fuel 496,184 486,490 351,090 349,390 Garbage collection 49,061 48,214 47,961 47,461 Insurance 116,496 135,803 135,614 135,006 Legal service 225,020 213,175 192,298 190,298 Licensing and certification fees 224,313 216,104 200,849 197,298 Linen service 21,603 21,438 20,004 20,104 Office supplies 187,285 225,425 215,386 213,886 Postage 112,204 166,898 180,998 189,098 Property taxes 153,231 160,011 157,115 218,328 Rent 1,003,569 965,433 949,131 947,931 Repairs and maintenance 332,481 710,506 723,266 722,766 Salaries & Wages 38,363,208 35,545,259 35,687,531 35,146,601 Security 688,254 796,975 787,941 785,570 Telephone 40,503 56,466 74,834 72,334 Travel and entertainment 129,236 129,803 123,599 125,599 Utilities 327,991 333,756 344,656 342,956

Extract from Construction Industry Forecast provided by the Australian Construction Industry Forum (ACIF) ACIF Forecasts Market Dragged Down by Residential Construction but Not Out 7 November 2019 ACIF Forecasts Market Dragged Down by Residential Construction but Not Out The Australian Construction Industry Forum (ACIF) forecasts that the decline in Residential Building will be so deep that it will dominate the outlook for building and construction, dragging down economic growth and employment. The outlook has been detailed in the latest Australian Construction Market Report, released today. ACIF indicates there have been recent signs of improvement in some markets, but it will take time for the impact to be felt throughout all building and construction markets. "The lowest interest rates on record have been reduced even more, despite this access to finance and credit has presented a significant hurdle to developers, builders, investors and owner occupiers. Market adversity has encouraged builders to withdraw from development of new projects; we witnessed new dwelling approvals plummet last year and commencements have also fallen. A fall in residential building activity is locked into the pipeline and this will take a while for this to be put into reverse," said ACIF Construction Forecasting Council Chair Bob Richardson. Residential Building Activity Residential Building work fell 0.4% last year (2018-19). A much deeper contraction of 8.4% is expected this year (2019-20), dragging the value of work done down to $96 billion. The rebound in building activity is expected to be delayed until 2021-22. The drop in activity will be difficult to avoid despite recent improvements in house prices because it will take time to restore approval numbers, secure land and commence new projects and address other 'lags'. Building and Construction Work Done ($ billion) 1 Non-Residential Building Activity In marked contrast to Residential Building, Non-Residential Building activity is midway through a growth phase. Expanded business investment in Accommodation, Industrial and Offices, and Public sector investment, especially in Education and Defence. Growth is expected to continue through the remainder of this year and into 2020-21. This will raise activity to peak at $45 billion. Infrastructure Construction Activity Work done in Infrastructure Construction contracted by 5.5% last year to $62 billion. This reflected the completion of large projects, and delays in shifting to new projects which are often in different sectors and geographies. Infrastructure construction activity is expected to return to growth in line with expanded plans and programs, raising work done to $66 billion in 2019-20 and $68 billion in 2020-21. Total Building and Construction Activity While the downturn in Residential Building activity is expected to deepen this year, the depth of the decline will be offset by increases in other building and construction activities. The expected rebound in Infrastructure Construction spending will be too little too late to prevent a fall in total building and construction activity this year. Growing Infrastructure Construction spending will be sufficient to stabilise the amount of building and construction work to be done in 2020-21 and lead to a return to growth in 2021-22. Building and Construction Activity in Summary Industry Outlook Total building and construction work fell 8.2% last year to $233 billion. A further fall of 1.7% is expected this year (2019-20). Most, oof the large losses in Residential Building activity are expected to be offset by increases in Infrastructure Construction and NonResidential Building. (Source: ACIF website