Question: You are currently working on the Accounts Receivable section of the financial accounts of ‘Jim’s Big Building Supplier’.

22 Oct 2022,11:29 PM

 

1. You are currently working on the Accounts Receivable section of the financial accounts of ‘Jim’s Big Building Supplier’. Your client supplies building materials to both individuals for home improvements and large building companies for building projects across Scotland. At the year end the accounts receivable balance stands at £1.61 million based on turnover of £5.84 million. Last year’s sales (pre-COVID19) were in excess of £10 million.

 

A breakdown of the year-end accounts receivable balances reveals the following:

Credit band	Amount owing	Number of customers	Average age in days
A	Between £0 - £1,000	61	35
B	Between £1,000 - £20,000	36	38
C	Between £20,001 - £50,000	27	76
D	Between £50,000 - £100,000	12	95
E	Over £100,000	3	106

 

On discussion with the sales director you are told the following:

(i) The initial lock-down introduced as a result of COVID19 meant that sales plummeted this year.

(ii) Since the restrictions were lifted on the building industry sales picked up rapidly. The company was delighted to see a lot of new accounts being opened by new companies set up by individuals made redundant as a result of the pandemic.

(iii) New agreements were reached with our larger customers to allow them more flexibility in paying. The company felt that this would encourage such customers to continue buying from them in what were particularly trying business times.

(iv) While the company agreed that several of the customers in credit bands C, D and E currently exceed their agreed credit limits in terms of days allowed, the company were confident that all monies owed at the year-end were recoverable in full. Having said that the company have set up a bad debts provision of 5% (£80,000).

 

Required

Based on the numbers given above in relation to the company’s accounts receivable and the explanations given by the sales director:

• Explain your approach to agreeing the level of bad debts provision which may be required in relation to the company’s year-end accounts receivable.

(6)

• Outline the tests you would perform in relation to the ‘completeness’ and ‘valuation’ of the balance on accounts receivable at the company’s year-end.

(12)

• Explain the relative value of the information given by the sales director in respect to other evidence you obtain regarding the accounts receivable balance.

 

2. Consider the following audit scenario

 

In the year 2020, a new incoming Chief Executive of Skylight Plc discovered that the first-half profits were overstated by an estimated £200m. Rose & Auditing (R&A) LLP has been Skylight Plc’s auditor since 2000 and received a little over £30m for its services last year. Skylight Plc appointed Adam & Partners (A&P) LLP to undertake a comprehensive review of its accounts.

 

A&P LLP concluded that sums of payments to Skylight’s suppliers had been deferred increasingly period by period in a controversial manner to Skylight’s accounting policies in the years 2016, 2017, and 2018. R&A said that they noted the estimates of commercial income, as a key driver of Skylight’s profits, exhibited an inherent risk of manipulation.

 

As a result of this announcement, R&A said that in the audit in the year 2018/19 also considered the impact on prior period financial statements of the issues identified during the current period.

 

R&A also stated that their audit approach and results of their work on this area were responsibly discussed on a number of occasions with the audit committee, whereby Skylight’s audit committee persuaded them that the preparation of financial statements gave a true and fair view as appropriate in the circumstances in the years 2016, 2017, and 2018.

 

R&A concluded that the audit procedures that they had conducted did not identify any matters that resulted in a significant audit adjustment. R&A ascertained that they acted responsibly by flagging up the risk of manipulation to investors in the most recent auditor’s report.

 

Required

 

• With reference to the R&A audit on Skylight Plc, critically discuss the role of the audit committee and the external auditor and the relationship between these two parties in achieving the highest standard of corporate governance.

(3)

• Explain the difference between fraud and error, outline the indicators and risk factors that could indicate fraudulent activity and identify the audit procedures that should be undertaken if fraud is suspected.

 

3. Your firm is signing off THREE audit engagements by the end of the current week and the following matters have been brought to your attention because you are the engagement partner.

 

Engagement 1 - Wish and Fashion Plc (W&F), a UK multinational clothing, footwear and home products retailer, estimated like-for-like sales would rise 8% in 2020 despite that fact that its retail sales had fallen 3% between 2018 and 2019. The management of W&F expected the store’s annual loss would shrink by £40m in 2020 from £79m the previous year given that margins expanded, and sales rose.

 

Engagement 2 - Diamonds and Pearls Plc (D&P), a UK listed company that designs, manufactures and markets contemporary jewelry made from high-quality materials, reported a total loss of £51 million and net cash outflow of £10 million for the financial year ended March 2020. It also indicated that it is exposed to certain material uncertainties concerning guarantees provided and contingent liabilities that could cause significant financial obligations. D&P has taken steps to get funding for its investment and operational needs; however, there was no evidence on the likely outcome of the initiatives. Besides, D&P included in a loss of £8.5m from discontinued operations (net of tax) in its consolidated statement of comprehensive income. This loss is attributed to a subsidiary before it had been discontinued and deconsolidated. You could not get enough audit evidence on this loss, and so could not determine if any adjustment to the financial statements was needed.

 

Engagement 3 – You found that there are certain “control deficiencies” in Nuts & Bolts Plc (N&B), a large UK listed company. You discovered certain accounting entries appear to have been made at the direction of certain former members of senior management without appropriate support. You also found that N&B did not maintain effective internal control over its financial reporting as of the end of its financial year because of material weaknesses related to general IT controls and risk assessments in a fresh blow to its accounting credibility. N&B would have to restate its financial statements for 2016 to 2019 and the quarters ended March 31, June 30 and September 30 in 2020. N&B said that restating four years of accounts would cut its book value by £3.8bn.

 

Required

 

• Identify and describe the elements of the auditor’s report.

(5)

• Critically evaluate EACH of the above engagements and explain the impact on the final audit report for the THREE separate engagements.

 

4. Consider the following audit scenario

 

Jane Doe joined the audit practice of Smith and Jones earlier this year. Four months since starting with the firm she is about to join colleagues on her first audit engagement, a large regional chain of hardware stores, Heyes and Curry plc. The client, which sells to both trade customers and the general public, has over twenty stores located across Scotland and has been audited by Smith and Jones for over 15 years. It has been estimated that sales to trade customers represents approximately 60% of the overall turnover in any year, with over 250 trade accounts active throughout the year. This year’s draft accounts show a turnover of £12.6m, estimated net profit of £975k and accounts receivable balances totaling £480k.

 

At the audit briefing the team were made aware by the audit manager of the necessity of completing the audit engagement on time and within budget. According to the audit manager, the previous two year’s audits had been several weeks late in completing and considerably over budget as a result of both poor planning and difficulties in agreeing necessary year-end adjustments with the client. In order to remedy this the manager has said that this year’s  audit has been planned to be completed within the planned audit time by focusing only on critical areas of the clients system allowing the audit team to obtain sufficient appropriate audit evidence, taking into account the relative materiality of the item being audited and relying heavily on sample testing.

 

Planned as an efficient audit the aim was still to gather sufficient evidence to be able to draw reasonable conclusions on which to base the auditor’s opinion.

 

Required

 

• In the context of the above audit engagement explain with examples the terms ‘sufficient’ and ‘appropriate’ in relation to the audit evidence gained during the audit.

 

• Given that there are several sampling techniques available to auditors to use in such an audit, critically compare and contrast the use of judgemental sampling with that of statistical sampling in the context of the above audit.

 

• In the context of the above audit, define the term audit materiality and explain how the auditor might determine what is material and what is not.

 

5. Consider each of the following audit scenarios

 

Audit 1 - Mrs Sarah Henry is in charge of the audit of Sport & Fitness Ltd (S&F). Four young assistant accountants are working on the engagement with Mrs Sarah, and several are avid personal trainers. S&F owns a villa with athletics track, a gym and sports hall which it uses to entertain clients. The comptroller of S&F has told you that the audit staff is welcome to use the villa at no charge any time they are not already in use.

 

Audit 2 - Auditors Network LLP and Innovation and Creativity Plc (I&C) co-developed and co-marketed a software product called “ANTECH for I&C”. Auditors Network’s used components of I&C’s proprietary source code in software previously developed and marketed by Auditors Network’s tax department. In return for the code, Auditors Network agreed to pay royalties ranging from 20 per cent to 40 per cent from each sale of the resulting product. Auditors Network consulted revenues from implementing the software for clients who were derived from close co-ordination and co-marketing. As evidence, Auditors Network cited reciprocal endorsements, linked to each other’s websites, held themselves out as business partners of one another, and shared customer information, customer leads, and target accounts.

 

Audit 3 - Gumble & Co is a big-sized firm of chartered accountants. Your firm has been the auditor of Burns & Rex Plc (B&R) which specialises in the production of metalwork solutions for a variety of businesses across the UK. Your firm has been the auditor of B&R since it was incorporated eight years ago, during which time one of the senior partners at Gumble & Co, Mr Jack, has been the audit engagement partner. Mr Jack had a long and close business association with the Chief Financial Officer (CFO) of B&R. In 2020, B&R paid Gumble & Co £570,000 in audit fees and £3,000,000 in non-audit fees. Gumble & Co’s report to B&R’s audit committee suggests that the figure was even higher at £4,100,000. The value of non-audit services that Gumble & Co sold to B&R exceeded the value of the audit services that it sold to B&R by 14 percent in 2017 and 2018 and by 16 percent in 2019. Besides, in relation to a pensions incentive exercise, Gumble & Co was in line to collect more fees the more the number of pension scheme members of B&R they were able to persuade to change their pension benefits.

 

Required

 

• With reference to EACH of the above scenarios, identify and justify your reasoning behind any ethical threats which may impact on independence in the THREE Your answer should also indicate ways in which these threats can be mitigated.

(12)

• Explain your understanding of the FIVE fundamental principles that accountants should follow if they are applying the IESBA Code of Ethics and critically evaluate whether you think a principles-based code will meet the IFAC aim of universal applicability.

 

6. Consider each of the following audit scenarios

 

David Alexander has been working with the audit firm Show and Tell for nearly fifteen months. During that time, he has been heavily involved in the performance of substantive testing over a variety of different audit clients.

 

As part of David’s training with the firm he is working with one of the firms audit seniors, Sarah Chan, who is talking through with David the processes by which an audit team focusses, where possible, on relying on a client’s systems of internal control. Sarah explains that if the client’s systems are robust and reliable then the work of the auditor with regard to substantive testing can be reduced. Sarah also explains that any client’s system can have weaknesses and it’s up to the audit team to spot these weaknesses, assess the likely effect of any weakness on the reported accounts before deciding on the level of substantive testing necessary to complete the audit. David is obviously struggling to understand the finer points of Sarah’s talk.

 

Required

 

• Taking Sarah’s part, outline to David the work an auditor would need do to understand a client’s systems of control.

(4)

• Also explain to David the term control risk and the work the auditor needs to do to determine the level of control risk.

(4)

• Explain to David what options an auditor would have if the control risk was determined to be at an unacceptably high level.