your firm has been the external auditor of Tushman Plastics Ltd (Tushman) for five years.

On 1 January 2019, Isabel Tushman sold her 100% shareholding in Tushman to WonderPlas plc (WonderPlas). WonderPlas immediately appointed a new board of directors. Your firm has accepted the new board's offer of reappointment as the auditor of Tushman for the year ended 31 July 2019.

You are the audit senior responsible for planning the audit of Tushman. The engagement partner asked you to consider the following three key areas of audit risk:

(1) Land and buildings

(2) Plant and machinery

(3) Related party transactions

Tushman manufactures disposable plastic products, such as cutlery, plates and straws. It sells its products to European distributors operating in the catering industry.

In 2018 the EU announced that it would ban a range of plastic items, such as those manufactured by Tushman. The ban is expected to come into effect in 2021. In response to the announcement, Tushman invested in the development of a new range of disposable products made from materials which degrade quickly when disposed of. Tushman believes that its new range will not be subject to the EU ban.

As part of your planning for the audit of the financial statements for the year ended 31 July 2019, you met with Tushman's new finance director, Auggie Pullman, who provided you with the following information:

• On 31 March 2019, Tushman sold part of the land where its factory is located to Navas Ltd (Navas). Tuchmans new chief executive is the majority shareholder of Navas.
• Tushman's freehold factory and remaining land was revalued for the first time at 31 July 2019 to make Tushman's accounting policy consistent with that of WonderPlas. Auggie obtained a valuation from Beecher Associates, a firm of chartered surveyors where his wife, Olivia, is a partner. Tushman has recognised this valuation in the financial statements for the year ended 31 July 2019.
• To enable the manufacture of the new range of disposable products, Tushman made several modifications to its production plant. Some components of the existing machinery were replaced. Tushman has included the cost of the new components in plant and machinery. These components were purchased, in euros, from suppliers in Europe. The labour costs associated with making the modifications have also been included in plant and machinery.
• Tushman's board has received a report from the WonderPlas internal audit team, which recently conducted an audit of Tushman's internal controls. The report identified the following internal control deficiencies:

(a) Several contracts negotiated with new customers during 2019 have terms of trade which are more favourable to the customer than Tushman's standard terms.

(b) Instances of management override were found in respect of the approval process for the purchase of machinery components. This included transactions with suppliers that are not on Tushman's list of approved suppliers.

Auggie also provided you with the following financial information:

Notes to the financial statements for the year to 31 July 2019 (extract)

Property, plant and equipment

	Land 000	Freehold Factory 000	Plant and Machinery 000
Cost / Valuation
At 1 August 2018	7,000	10,675	2,136
Revaluation	2,000	2,325	-
Additions	-	-	597
Disposals	(3,000)	-	(23)
At 31 July 2019	6,000	13,000	2,710
Depreciation
At 1 August 2018	-	8,302	1,208
Revaluation	-	(8,302)	-
Charge for the year	-	-	189
Disposals	-	-	(10
At 31 July 2019	-	-	1,387
Carrying Amount
At 31 July 2019	6,000	13,000	1,323
At 31 July 2018	7,000	2,373	928

From the previous year's audit file, you note that plant and machinery is depreciated over 10 years and that the charge for the year ended 31 July 2018 was 237,000.

WonderPlas is audited by a different firm, Petosa LLP. Tushman is a significant component of WonderPlas and financial information relating to Tushman will be included in the WonderPlas group financial statements for the year ended 31 July 2019. Your firm is required to cooperate with Petosa LLP.

Requirements

1. Describe the steps that your firm should have performed before accepting the board's request to continue as Tushman's external auditor.

(8 marks)

2. Justify why items (1) to (3) above have been identified as key areas of audit risk. For each key area, describe the procedures that should be included in the audit plan to address those risks. You may wish to present your answer using a two column format with the headings (i) justification and (ii) procedures

(30 marks)

3. Outline the potential consequences of each of the internal control deficiencies (a) and (b) above and include recommendations of controls that would address these deficiencies.

(7 marks)

4. List the requirements and information that you expect Petosa LLP, the external auditor of Wonderplas, to include in its communication to your firm. Explain why it is essential for the Group external auditor to evaluate the sufficiency and appropriateness of the audit evidence obtained by the component auditors.

(5 marks)