You are the manager responsible for the audit of Osier Co, a jewellery manufacturer and retailer. The final audit for the year ended 31 March 2017 is nearing completion and you are reviewing the audit working papers. The draft financial statements recognise total assets of $1,919 million (2016 $1,889 million), revenue of $1,052 million (2016 $997 million) and profit before tax of $107 million (2016 $110 million). Three issues from the audit working papers are summarised below:

(a) Cost of inventory

Inventory costs include all purchase costs and the costs of conversion of raw materials into finished goods. Conversion costs include direct labour costs and an allocation of production overheads. Direct labour costs are calculated based on the average production time per unit of inventory, which is estimated by the production manager, multiplied by the estimated labour cost per hour, which is calculated using the forecast annual wages of production staff divided by the annual scheduled hours of production. Production overheads are all fixed and are allocated based upon the forecast annual units of production. At the year end inventory was valued at $21 million (2016 $20 million). (7 marks)

(b) Impairment

At the year end management performed an impairment review on its retail outlets, which are a cash generating unit for the purpose of conducting an impairment review. While internet sales grew rapidly during the year, sales from retail outlets declined, prompting the review. At 31 March 2017 the carrying amount of the assets directly attributable to the retail outlets totalled $137 million, this includes both tangible assets and goodwill.

During the year management received a number of offers from parties interested in purchasing the retail outlets for an average of $125 million. They also estimated the disposal costs to be $15 million, based upon their experience of corporate acquisitions and disposals. Management estimated the value in use to be $128 million. This was based upon the historic cash flows attributable to retail outlets inflated at a general rate of 1% per annum. This, they argued, reflects the poor performance of the retail outlets. Consequently the retail outlets were impaired by $9 million to restate them to their estimated recoverable amount of $128 million. The impairment was allocated against the tangible assets of the outlets on a pro rata basis, based upon the original carrying amount of each asset in the unit. (7 marks)

(c) Warranty provision

Each year management makes a provision for jewellery returned under warranty. It is based upon an estimate of returns levels for each product type (rings, bracelets, necklaces, watches, earrings, etc) and is calculated on an annual basis by the sales director. The breakdown for the current provision, as extracted from the notes to the financial statements, is as follows:

$million

At 1 April 2016 115

Provisions charged during the year 05

Provisions utilised during the year (19)

Unutilised provisions reversed (31)

At 31 March 2017 70 (6 marks)

Required:

Comment on the matters to be considered, and explain the audit evidence you should expect to find during your file review in respect of each of the issues described above.

Note: The split of the mark allocation is shown against each of the issues above. You are not required to discuss any potential implications for the auditors report. (20 marks)