Week 4: Planning, understanding the entity and assessing

business risk
Tutorial Discussion Problems and Case Studies
5.16 Protector Ltd (Protector) is a company that supplies and distributes security screen
doors and is an ongoing audit client of your audit firm, Pratt & Associates. You have
ascertained the following information from a telephone call to the general manager of
Protector, prior to the commencement of this year’s audit.

a) Protector has experienced considerable staff turnover in its accounts payable

department, including the departure of the Accounts Payable Manager, who
resigned early in the year. This has created some delays in the processing of
payments.
b) As part of its cost-cutting program, Protector has decided to retrench its internal
audit department 3 months before year end.
c) Protector plans to upgrade its general ledger reporting by acquiring a new software
package. The conversion is planned for two months prior to its financial year end.
d) During the year, Protector received a visit from the Australian Tax Office for a
desk audit of its recent income tax returns. As a result of this audit, a number of
issues were raised, but to date no assessment has been issues. The company’s tax
advisers are presently following up these matters.
e) Last year, Protector received adverse comments from some debtors concerning the
confirmation letters that they were sent. As a result, Protector’s credit manager has
asked that you do not send confirmation letters to debtors this year.

REQUIRED
Explain how each of the above matters will affect your overall planning in regard to
the expected scope and conduct of the audit of Protector for the current year.
 Week 4: Planning, understanding the entity and assessing
business risk
Tutorial Discussion Problems and Case Studies
5.21 You are currently planning the audit of Cheap Groceries Pty Ltd (Cheap Groceries), a
large proprietary company that operates a small chain of supermarkets. You are in the
process of gaining an understanding of Cheap Groceries’ objectives and strategies and
the related business risks.

Competition in this business sector is intense, with major supermarket chains

aggressively purchasing smaller rivals and discounting goods below cost in order to
increase market share. In order to compete, Cheap Groceries has had to offer value-
added services, such as free home delivery and loyalty rewards.

While these strategies have helped to maintain its customer base, its gross margins
have dropped by 10%. In an effort to increase profits, Cheap Groceries has recently
added higher margin products such as gourmet foods to its range. To date, these items
have achieved only limited acceptance among its customers.

All of Cheap Groceries premises are leased. Three of the leases are due to expire prior
to the end of the current financial year. In two cases, the land on which the premises
are situated has been rezoned as residential. Due to’prior use’ legislation, this does not
prevent the premises from being used as a supermarket in the future. However, it does
mean the land’s value has increased and, on this basis, the lessor is demanding a 50%
increase in rent.

Cheap Groceries is also experiencing difficulties with one of its major suppliers,
which has withdrawn their volume rebates and reduced payment terms from 30 days
to 14 days. Cheap Groceries has recently initiated legal action against a major
supermarket chain for anti-competitive behaviour and predatory pricing.

REQUIRED
a) Identify five business risks for Cheap Groceries that may lead to the risk of
material misstatement in the financial report.
b) For each business risk you identified in (a) above, describe how it may lead to the
risk of material misstatement in the financial report.
 Week 4: Planning, understanding the entity and assessing
business risk
Tutorial Discussion Problems and Case Studies
5.23 You are an audit senior with Crompton & Hasaad and you are planning the audit of
Mining Supplies Ltd (MSL) for the year ended 30 June 2015. MSL sells mining
equipment and spare parts to mining companies across Australia. MSL has
operational centres in Perth, Newcastle and Mt Isa. Each operational centre
warehouses the equipment and spare parts and provides sales and maintenance
services. MSL’s head office is located in Melbourne where finance, IT and other
corporate services are provided.

MSL has equipment purchase order contracts with a number of manufacturing

suppliers based in Europe, US and China. These manufacturers build the specialised,
made-to-order equipment and spare parts and ship them to MSL’s operational centres.

Each item of equipment purchased by a customer comes with a 2 year spare parts and
labour warranty from MSL. The warranty entitles the customer to a maximum of one
free maintenance service per year during the warranty period.

Depending on the type of equipment and the customer’s location, a maintenance

service can take between one day and one week. MSL uses contracted mobile
mechanics who travel to the customer’s location to carry out all the maintenance
services. Some services require the mechanic to travel long distances, due to the
remote locations. Any maintenance services that are outside the warranty conditions
are billed to the customer. The billing covers a daily labour rate for the mechanic’s
time, any parts replaced and reimbursed for travel, accommodation and living
expenses incurred by the mechanic.

REQUIRED
a) In relation to the purchasing of equipment and spare parts, describe two business
risks to MSL that Crompton & Hasaad will consider in planning the 2015 audit.
b) For each business risk identified in (a), describe a specific audit risk that could
arise. Each response should include the identification of account balances that are
impacted directly by the audit risk.
 Week 4: Planning, understanding the entity and assessing
business risk
Tutorial Discussion Problems and Case Studies

5.25 You are responsible for preparing an audit strategy for the following three
independent situations.

(a) Since your last audit the client, Sleek Bicycles Ltd, has introduced a new
computer system for inventory. Management has indicated that the main
advantage of the new system over the old one is that it is capable of providing
information on inventory levels and gross margins for both product line and
geographical area.
(b) Your audit strategy for sales for Amazing Creations Ltd places substantial reliance
on the system of internal control and the use of analytical procedures. Your testing
of the internal control system for sales has found a significant number of instances
where customer’s credit ratings have not been checked and approval has not been
sought when abnormally large discounts have been given. The sales manager
states that these changes to control procedures have been the result of difficulties
in maintaining past sales levels.
(c) Management of Blue Marine Ltd has recently introduced a new state-of-the art
plant and equipment register. All plant and equipment is now barcoded, scanned
and classified, with depreciation calculated automatically based on asset class. A
big advantage of the new register is the variety of detailed reports it can produce,
for example, depreciation by asset class, additions for the year and profit on
disposal.
REQUIRED
Outline how the information provided would affect your audit strategy in each case.
Week 4: Planning, understanding the entity and assessing
business risk
Tutorial Discussion Problems and Case Studies

5.28 You have just completed preliminary analytical procedures of your client, Modern
Technology Ltd (MTL), which has a 30 June financial year end.

MTL is involved in the development and design of new computer games and is in
the final development stages of a new game that it expects to be a huge success. The
game has involved substantial research and development over the past year. The
CEO, Jackson Clark, is extremely excited about this new product and believes that
its sales will reverse any past trading problems the company has had. He has also
told you that he has raised sufficient finance to enable finalisation and launch of the
new game within four months.

During the initial years when the company experienced rapid growth, all profits
were ploughed into research and development, computer equipment and the
purchase of an office block as its corporate headquarters. Office space not required
by the company is rented out to tenants on normal commercial terms. The results of
the ratio analysis undertaken as part of your preliminary analytical procedures are as
follows:

Ratio 2013 2014 2015

Quick Asset ratio 1.13 .86 .75
Days in receivables 21 31 40
Debt to equity ratio 1.7 1.95 2.35
Gross profit ratio .35 .27 .21
Net profit ratio -.05 -.07 -.09

REQUIRED
Discuss MTL’s overall financial position with reference to the ratio analysis
undertaken as part of the analytical procedures.
Week 4: Planning, understanding the entity and assessing
business risk
Special Question 1 – Analytical Procedures – What are they?

What are analytical procedures and when can they be used during an audit?

Special Question 2 – Analytical Procedures – Their purpose.

What is the purpose of preliminary analytical review procedures. What types of comparisons are
useful when performing preliminary analytical review procedures.