You are an audit manager working on the external audit of Empire Ltd (‘Empire’), a company that supplies stationery and paper to other businesses. Your firm has audited Empire for the last three years. Empire’s year-end was 31st March 20x1.

You are currently planning the substantive tests required on Empire’s receivables balance, which is material. Your firm’s tests of control have concluded that Empire has weak internal controls in the receivables area, for the following reasons:

1) Empire’s credit controller, who managed the receivables accounts, left the company three months before the year-end and a permanent replacement has not yet been found. The role is currently being filled by a temporary member of staff from an agency;

2) The debtor days ratio (calculated by your firm during your risk assessment procedures) indicates that debtor days, which averaged 40 for the last three years, have recently increased to 55.

For the last three years, Empire has made a provision of 10% of the total receivables balance as an allowance for ‘bad and doubtful debts. However, during discussions with management, you discover that for the year ended 31st March 20x1 the provision has been increased to 15%. The reason you have been given is ‘because of the recession’.

Empire’s year-end inventory count is carried out over a number of different locations. Empire’s Finance Director (who used to be an auditor) has suggested that, as the number of locations will make it difficult for you to visit them all, you could use analytical review instead to test the inventory. The inventory balance is of material value to the financial statements

(a) Indicate the steps you would take when weak internal controls are found at Empire.

(b) Describe the substantive tests you would carry out on the receivables balance to reduce the audit risk to an acceptable level. For each test, indicate the key assertion/s to be addressed. 

(c) Explain, with reasons, whether or not the increase in the bad debt provision at Empire increases audit risk and describe appropriate tests you would carry out on the provision.

(d) In note form, prepare an answer to the Finance Director explaining whether or not analytical review procedures would be sufficient for your audit of the inventory.