Fundamentals Level – Skills Module, Paper F8 (INT)Audit and Assurance (International) June 2010 Answers1 (a)
Identiﬁcation of risk Explanation of risk
Smoothbrush supplies 60% of its goods Per IAS 2
should beto Homewares at a signiﬁcantly reduced stated at the lower of cost and net realisableselling price, hence inventory may be value (NRV). Therefore, as selling prices are muchovervalued. lower for goods sold to Homewares, there is a riskthat the NRV of some inventory items may belower than cost and hence that inventory couldbe overvalued.Recoverability of receivable balances as Smoothbrush has extended its credit termscredit period extended. to Homewares from one month to four months.Hence there is an increased risk as balancesoutstanding become older, that they maybecome irrecoverable.Valuation of plant and equipment. The production facility has a large amountof unused plant and equipment. As per IAS 16
Property, Plant and Equipment
and IAS 36
Impairment of Assets
, this plant and equipmentshould be stated at the lower of its carryingvalue and recoverable amount, which may be atscrap value depending on its age and condition.Cut-off of purchases and inventory may not Smoothbrush imports goods from South Asia andbe accurate. the paint can be in transit for up to two months.The company accounts for goods when theyreceive them. Therefore at the year end only goodsthat have been received into the warehouseshould be included in the inventory balance and arespective payables balance recognised.New inventory system introduced in the year. Smoothbrush has introduced a continuous/perpetualThis could result in inventory balances being inventory counting system in the year. These recordsmisstated. will be used for recording inventory at the year end.If the records and new system have not initially beenset up correctly then there is a risk that the year endbalances may not be fairly stated.Inventory may be overstated as Smoothbrush Previously Smoothbrush maintained an inventoryno longer has a slow moving provision. provision of 1%, however, this year it has decidedto remove this. Unless all slow moving/obsoleteitems are identiﬁed at the year end and their valueadjusted, there is a risk that the overall value of inventory may be overstated.Provisions/contingent liability disclosures may The company’s ﬁnance director (FD) has left andnot be complete. is intending to sue Smoothbrush for unfair dismissal.However, the company does not intend to make anyprovision/disclosures for sums due to the FD.Under IAS 37
Provisions, Contingent Liabilities andContingent Assets
, if there is a present obligation,a probable outﬂow of resources to settle theobligation and a reliable estimate can be made of theobligation then a provision should be recognised.If the obligation is only possible, or if there is a presentobligation but it is not recognised as there is nota probable outﬂow of resources, or the amount of theobligation cannot be measured with sufﬁcient reliabilitythen a contingent liability should be disclosed, unlessthe likelihood of payment is remote.
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