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 Clothes Industry Average

Current Ratio 0.9 1.8

Quick Ratio 0.5 0.9

Debt to Equity 2.7 0.7

Gross Margin Ratio 50% 37%

Profit margin 10% 2.5%

Inventory Turnover (days) 180 100

Receivables Turnover (days) 60 6

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. (6 marks)

Question 2

You meet with your audit team, to discuss FCs 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 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. (10 marks)