You are an engagement partner at Divine Accountancy, which is a medium sized audit firm based in Brisbane with offices in Sydney, Melbourne and Perth. The firm has recently opened offices in Singapore, Hong Kong, and Dubai to service the growing client base in Asia and Middle East. It provides assurance services and other advisory services such as risk management, secretarial and valuation. The firm comprises 38 partners across all services.
Case – Auditing ABC Organics
ABC Organics is a medium-sized business supplying high quality organic food products to Australian customers. The company was established in 1998. The company had adopted the strategy of making available a range of quality organic products to a selective customer base at reasonable prices. Due to increased popularity, the company increased its production capacity and is now one of the leading providers of organic food in Australia.
Assurance and advisory services
ABC Organics approaches and asks your advice on the following potential assurance and advisory service.
There had been a few improvements in internal controls in the processing of payroll and accounts payable function in the company. Despite all efforts, discrepancies in payments to employees and suppliers were noticed. The company has asked you to evaluate internal controls in the processing of payroll and accounts payable function, highlight areas of weaknesses and recommend remedial action.
The company is in the process of being listed on ASX and asks you to provide the following services. A report on the assessment of the prospective financial information prepared by the company that is to be included in the prospectus to potential investors with information about future expectations.
The company is in the process of being listed on ASX and asks you to provide the following services – an investigating Accountants Report covering pro forma unaudited historical financial information. You propose to apply ASRE 2405 in doing this report.
You are of the view that it is really a matter of judgment whether the above-mentioned services are assurance or non-assurance services, and what level of assurance it is likely to be provided when performing the service.
Audit Planning & Risk of Material Misstatement
In the process of assessing the risk of material misstatement (RMM) at the financial report and assertion level as part of audit planning for the year 2019-2020 on ABC Organics, the following information which in your opinion might affect the assessment of RMM has been flagged.
This is your firm’s first year audit of ABC Organics. The financial statements have been audited for the past three years and an unqualified opinion has been issued by the previous auditor for each of the three years.
ABC Organics has a line of stores in Queensland that sell organic food products directly to Queensland consumers. On 20 September 2019, the board decided to link store managers’ pay to performance. Under the new remuneration scheme, every store manager is now given a profit target to achieve and a bonus of $10,000 upon achievement of the target. The store managers are further eligible to 1.5% of profits if their store profits exceed the set profit target.
On 25 November 2019, Bank Brisbane provided the company with a $640,000 working capital loan at 5% interest subject to being provided quarterly financials and maintaining a minimum current ratio of 2:1 at all times.
You are asked to make comments on the risk of material misstatement (RMM) for the audit engagement on ABC Organics.
The review of the payroll system has indicated that when an employee is hired or terminated, the payroll clerk immediately prepares the paperwork and enters the information into the master file of the payroll computer system. In addition, the payroll department at the head office processes payroll on a weekly basis. All timesheets that are submitted by factory workers are signed off by the factory manager. The timesheets are input into the computer by the factory manager and payment is then made by the payroll department.
Susan Leung, a junior audit associate in your engagement team, has approached you to inquire the implication of the above-mentioned information on the audit of the payroll system.
Auditing Accounts Payable
In your audit of ABC Organics for the year ended 30 June 2020, you have identified that accounts payable is at risk of material misstatement.
ABC Organics produces canned fruits. To achieve the best quality, ABC Organics has always selected the best quality Australian grown organic fruit. This has helped ABC Organics establish a strong brand name, a large and diverse customer base, which includes major retail chains, grocery shops, and social clubs. This also contributes to its consistently strong profitability and positive cash flows.
There has been an extended drought in Queensland since last year. ABC Organics has not been able to obtain the required quantity and regular supply of organic fruits. In February 2020, ABC Organics signed renewable supply agreements with overseas fruit growers. ABC Organics is bound to purchase a minimum quantity of specified fruits, with the agreements being renewed every two years. The current agreements expire on 31 December 2022. All shipments to ABC Organics are invoiced and require settlement in US dollars. Overseas suppliers now represent 37% of trade payables. Local and overseas suppliers are maintained separately within the accounting system. ABC Organics is required to pay for freight and insurance costs. The insurance covers the period from the day the goods are loaded onto the ship until the day they arrive in ABC Organics’ warehouses. All shipments arrive in Australia within 15 days after loading onto a ship. All overseas suppliers accounts are settled 28 days after shipment. Overseas suppliers now represent 37% of trade payables. Local and overseas suppliers are maintained separately within the accounting system.
Andrew Morrison, a junior audit associate in your engagement team, has approached you to inquire the implication of the above-mentioned information on the audit of the accounts payable account.
Audit Completion & Subsequent Event
Today is 10 August 2020 and your audit team has completed the fieldwork on the audit of ABC Organics. The audit opinion is due to be signed on 14 August 2020. ABC Organics will release the financial report on 18 August 2020. In completing the audit fieldwork, the following material event comes to your attention.
On 1 July 2020, there was an accident in the local area, which had the effect of turning off all electricity, including the fridge and freezer facilities at ABC Organics’ warehouse. The energy providers were unable to restore power for 48 hours, which resulted in all the frozen and fresh food on hand at the warehouse being ruined. The financial controller estimates that total inventory lost was worth $1 million, with 80% of it having been on hand at year end.
In the follow-up process, Susan approaches you to ask the appropriate treatment of this event in ABC Organics’ financial report for the year ending 30 June 2020.
Answer the following questions with relevant information.
1) Prepare a note to ABC Organics identifying the potential engagements that could be undertaken by Divine Accountancy. The note should address the type of engagement (i.e., assurance or non-assurance) and the level of assurance that are likely to be provided in performing the engagement. Justifications are required.
2) You are asked to make comments on the risk of material misstatement (RMM) for the audit engagement on ABC Organics. Write a note that covers:
- the types of RMM that are affected,
- how the RMMs are affected, and
- whether the impact of the identified factors will be at the financial report or at the assertion level.
3) Write a note to Susan in relation to the internal control and tests of Controls in auditing payroll. The note should cover:
- an introduction of the COSO internal control framework.
- Describe how the matter in the case could lead to a material misstatement in the financial report, suggest the appropriate control activities, and design appropriate tests of controls.
- Explain to Susan how you have considered nature, timing and extent in your design of tests of controls.