You are an audit assistant in a small audit firm, Prudential Partners, where the seniors saw it as important for the juniors to be an integral part of engaging and auditing the client.

Prudential Partners is engaging a new client called Gizmo Ltd, which is operating in the technology industry for many year; however, this is the first time that Prudential Partners is working with a client from this industry, hence no prior experience. The audit team is intrigued by this new audit. Talks were finalized and the partners accepted the engagement without doing any background information on the client. You noticed this and began your own individual investigation in the firm and the industry it operates in. during the audit, the team have noticed the following trends

Company Industry

2011 2012 2011 2012

Current ratio 3 6 3.1 3.5

Debt Ratio 40% 41% 30% 29%

Acid Test Ratio 2 5 2 2.5

Gizmo Ltd has not been producing any new devices and as such revenue has declined by 10% and performing below industry level, there were no sale of fixed asset during the financial year. It was discovered that one of Gizmo Ltd, major competitor has filed a patent for an improved version of the current product selling on the market, which could prove to be a game changer for the competitor's position in the industry.

It was also observe at Gizmo that the same person who collects the cash post the entries in the journal, no vault is there to store cash overnight hence cash are kept in the registers. Journal entries are not authorized by management before posting it to the relevant books and ledgers. Audit schedules of the account that were requested are not being submitted to the auditors on time; cheques are only authorized by one person, which is the financial controller. While perusing the accounts, you have found that suppliers accounts have not being updated frequently; the same is for bank reconciliation. During the investigation it was revealed that there were an unusual amount of intangible assets that are unusual to the industry that the client operated in, no proper fixed asset registry was kept and as such, the auditor notice a machinery that represent 45% of the balance sheet of the client.While assessing the control environment, auditors noticed that management overrides controls easily and that there is no internal audit department for a company that had multiple branches.

Required:

1.Briefly discuss two critical steps of financial statement audit that Prudential Partners must do before commencing the audit. Make specific reference or contrast to what was done initially in the audit by the seniors.

(6 marks)

2.Assess the client's business risk. Additionally, from your professional skepticism, does the likelihood of material misstatement exist?

(6 marks)

3.Identify four (4) weaknesses in the case study(7 Marks)

4.Use the analytical procedures (ratio analysis) to evaluate the clients performance with the industry

(4 Marks)

5.From the comparisons made with the industry and the client, develop audit procedures to test specific balances that are associated with financial ratios of the client and the weaknesses identified. The audit procedures must also relate to the testing of inventories, fixed asset, cash, accounts payables and revenue (2 audit procedures each for the areas highlighted)

Show the balance related objective you may want to achieve from conducting the procedure and the types of audit evidence that may be necessary to achieve each objective.

(12 Marks)

6.From the weaknesses identified, what is the likelihood of an audit failure or in other words, is there a high level of audit risk? Explain your answer.

(2 Marks)

7.You have done your testing based on the audit procedures done, you found that there were material misstatements in the balance sheet and that machinery of significant value did not exist contrary to the claims of the directors.Your audit have outline this in a management letter and in several meetings but the directors were adamant that they were not going to make any changes to the financial statements.

Required:

a)Define materiality(2 marks)

b)What audit opinion would be suitable based on the findings and the action of the directors.(6 marks)