You have just been appointed junior partner in Joe and Partners, an audit firm.

In late April, you are approached by Mr Solomon Loose, the Chairman of the Board of Fancy Clothes Ltd (FC) a clothing manufacturing business with a small factory and six shops to conduct the audit of FC. Mr Loose explains that the previous auditor was too expensive, and they are looking for a more economical audit.

As part of your review of FC you undertake enquiries of businessmen in the neighbourhood. There is nothing directly adverse known about FC, however there is a rumour that is circulating that Mr Loose has used unscrupulous tactics when dealing with his suppliers. You approach Mr Loose to obtain a letter of authority to the previous auditor to discuss the audit history with you. Mr Loose explains that he is so disappointed with the previous auditor that he will not correspond with him at all.

You decide to accept the engagement and commence your preliminary analytical review, which reveals the following ratios:

Fancy ClothesIndustry Average

Current Ratio0.91.8

Quick Ratio0.50.9

Debt to Equity2.70.7

Gross Margin Ratio50%37%

Profit margin10%2.5%

Inventory Turnover (days)180100

Receivables Turnover (days)606

Question 1.

Considering the above ratios, indicate any concerns you may have about the audit of FC and where within FC you would concentrate your auditing activities. Support your choices with a critical analysis of the above ratios.

Question 2

You meet with your audit team, to discuss FC's internal controls. An assistant who recently graduated from a top 10 university asks you to explain with a detailed analysis of reasons, why you should worry about internal controls.

Required:

Give the assistant a full and complete explanation of the Australian rules surrounding internal controls including a description of the Audit Risk Model as a tool. You may do this by giving an example.

Question 3

You have commenced planning the audit of FC, as part of your preliminary planning you visit the factory. While there you notice there are large quantities of high value raw materials, genuine silks and other similar high value items stored in an unlocked store room at one end of the building. Workers would walk in select bolts of material and take them back to the cutting tables. On enquiry you are told that each night the storeman notes down the bolts of material in the store, and uses those notes to calculate re-order requirements.

Required:

Given the above information critically analyse the control system surrounding raw materials, and explain in depth, using the Audit Risk Model as a tool, what effect the above information will have on your approach to the audit of raw material inventory.

Question 4

You travel to one of the shops where you park your car beside a Ferrari Testa Rossa in the store car park, and enter the store to find an immaculately dressed lady who runs the store on her own. The dresses sold in the store retail for several thousand dollars an item. On chatting to the lady, you discover the Ferrari is her "getting to work" car. You note that there is no cash register and are told that given the value of the dresses, only a few sales a day are processed, and these are either by EFTPOS using a single machine, or cash, which is immediately banked. Customers are given handwritten detailed receipts, which do not carry a serial number.

Required:

Given the above situation critically analyse the sales process and describe in detail what management assertions may be at risk relative to sales. Give full reasons for your choices. In your answer explain what management assertions are.

Question 5

You send your assistant out to verify the purchases for occurrence, and he returns, very pleased. It appears that Mr Loose was very helpful. You assistant explains that as instructed he used the random number table to select the items he would investigate. He selected several line items in the purchases ledger and traced them to the journal and from the journals to payment vouchers attached to inward goods notes and shipping documents. Al the items traced were correct.

Required:

Has your assistant tested for occurrence? Explain.

Question 6

You go to a second shop (shop number 2) to test count the inventory of finished goods held in that shop, but on arrival find it locked. On enquiry with Mr Loose, you are told the shop manager is ill, so the shop is closed. On enquiry of neighbouring shops, you find that the shop is rarely open. The inventory holding however is substantial, (more than twice the holding at any one other store), and you arrange with Mr Loose to count the inventory the following day. On completion of the count, all inventory of finished goods in the store appears complete.

Required:

Given everything is in order, would you require further testing of the inventory?

Question 7

You are examining the sales, your aim being to prove the management assertions.

Required:

List the management assertions you will wish to test, and construct an appropriate substantive test that will prove each listed assertion.

Question 8

It is now the end of July, and you are finalising the audit. On 10 July, one of FCs shops was burgled. You note from your working papers that insurance does not cover the loss and there is a material discrepancy between the expected insurance payout and the loss.

Required:

Explain what you expect FC's management to do relative to the accounts in this circumstance.

Question 9

As you leave FC's premises to go home one evening, you meet a close friend and he notices that you are leaving FC's premises and remarks that he thinks they are a really good business and Mr Loose has just persuaded him to make a substantial investment in the company. You are aware that your proposed audit report will probably reduce that share price by 10%.

Required:

Critically analyse the ethical implications of your discussion with your friend.

Question 10

Mr Loose has been asking you daily when you might be ready to sign the audit report. As the accounts seem to be in order, but the notes do not include any statement about the burglary. You receive the signed director's report and certification of the accounts and decide to sign your audit report.

Required:

Explain in detail what type of audit report and critically explain the choice of this report.