You are required to audit Fashion Designers Limited, a subsidiary company of Las Vegas Group Corporation (USA) Limited. Fashion Designers Ltd is a large multi-national manufacturer and distributor of fashion accessories. The company is listed on the New York Stock Exchange and its major shareholder (51%) is the US Company which controls the use of the accessory brand names throughout the world. Fashion Designers Ltd operates predominantly out of Australia but is rapidly expanding into Asia and Eastern Europe. In 1992 overseas operations accounted for 15% of the group turnover and 10% of the Group profit. In 1993 this is expected to increase to 23% of turnover and 18% of profit. As the American market is considered to be stagnant, future growth is expected to come from the Asian and European markets. The audit structure is such that all overseas operations are audited by the same international audit firm, XYZ & Co, who were the auditors of the major US shareholder. Your audit firm, DisneyLand Audit & Co, is responsible for the audit of all the American branches. The consolidated Statement of Financial Performance and Statement of Financial Position for Fashion Designers Ltd for the year ended 31 December 1992 and the estimate for the coming year ending 31 December 1993 are as follows: Statement of Financial Performance Estimate 31/12/93 $000 Audited 31/12/92 $000 Operating profit before abnormal items 113220 86974 Abnormal items (17050) - Operating profit before income tax 96170 86974 Income tax expense (25970) (24720) Operating profit after income tax 70200 62254 Retained profits at the beginning of the year 114257 52003 Dividends paid (53274) - Retained profits at the end of the year 131183 114257 Statement of Financial Position Current Assets Cash 21720 24915 Receivables 391278 352307 Inventories 189702 153978 Total Current Assets 602700 531200 Non-Current assets Property, plant & equipment 573291 495973 Investments 8357 21952 Brand names 474852 398115 Total Non-current Assets 1056500 916040 Total Assets 1659200 1447240 Current Liabilities Creditors & borrowings 587294 401253 Provisions 170446 219077 Total Non-current Liabilities 757740 620330 Non-current Liabilities Creditors and borrowings 392877 360112 Provisions 79803 68328 Total Non-current Liabilities 472680 428440 Total Liabilities 1230420 1048770 Net Assets 428780 398470 Shareholders Equity Share Capital 101908 101563 Reserves 195689 182650 Retained Profits 131183 114257 Total Shareholders Equity 428780 398470 The abnormal item relates to the loss made on the sale of an investment during the year. Brand names relates to the price paid for the brand names purchased from the major shareholder. The asset is not being amortised as the company believes that asset to be a tangible asset with a value which will never decrease below that paid due to the proven success of the brand names worldwide for over half a century. The stock valuation system used by Fashion Designers is an average costing system. Each time a delivery is entered into the stock system, the system automatically uses the new cost and the current average cost in the computer to calculate a new average cost. All stock is physically counted at balance date and then the average cost in the computer is applied to the units on hand to calculate the year end inventory valuation. Fashion Designers also runs several fashion accessory stores. The inventory in the stores is valued using the retail inventory method. You are required to complete the following: A) Set a group materiality level based upon the estimated 31 December 1993 figures. B) Prepare a memorandum to the audit partner detailing the procedures required regarding reliance on the audit work performed by XYZ & Co. on the overseas operations. C) What audit procedures would you adopt to verify the carrying value of the brand names? D) Assuming you disagree with the non-amortisation of the brand names to the extent that a qualified audit opinion is required, what type of qualification would you issue? E) Prepare an audit strategy document outlining the audit procedures which should be adopted in the verification of the stock valuation assumption of Fashion Designers and each of its retail outlets. F) You have ascertained and recorded the system of internal control and decided that you wish to place reliance on the controls in many areas. The results of your compliance tests on purchases and stocks reveal that: i) Out of 100 purchase invoices selected for inspection, 2 could not be found and 2 were not initialed as checked and approved for payment. ii) Out of 120 stock cards inspected, 4 contained an instance where the delivered quantity had been altered by a significant amount. iii) One supplier is regularly paid before supplies are delivered on the basis of pro forma invoices which are processed through the creditors ledger system on receipt so as to initiate the necessary payments. No other exceptions were noted. 1) Outline what further procedures should be carried out in order to be able to reach a conclusion on whether the companys system of internal controls can be relied upon, indicating what factors you would consider in reaching your conclusion. 2) Having reviewed your files you find that previous management letters have outlined the problem that one supplier is being paid based on pro forma invoices prior to delivery. No action has been taken by management to rectify this problem. What should be done about this? G) The credit controller of Fashion Designers Ltd has provided you with an aged debtors trial balance as at 30 November 1993. There are over 5000 individual accounts distributed over a wide range of values. The system of internal control over debtors has been assessed as satisfactory and reliable. 1) What audit objectives would you be concerned with in testing the trade debtors balance? 2) Describe the steps that you would include in an audit program to test the trade debtors balance as at 30 November 1993. 3) What further testing would you perform as at year end? 4) What analytical review procedures could be used to examine the possible overstatement or understatement of the provision for doubtful debts? H) While reviewing Fashion Designers payroll computer system you note the following weaknesses in internal control: i) When the weekly timesheets are received the details are keypunched into a transaction file. An edit report is then generated and the details are agreed back to the timesheets. Once all the timesheets have been input the employees master file is then updated by a batch program. There is no output from the batch update program. ii) A special password and user ID is required to be entered by payroll staff before they can input changes to employee pay rates. This special password and user ID is the same for all of the payroll staff members who input pay rate details. Describe the potential impact each of the above weaknesses could have and suggest control procedures which would overcome them.