MAA303 Auditing Assignment

Learning outcomes from this Assignment

This assessment task contributes to the learner’s achievement of the following unit learning outcomes (ULOs):

LO1: Use professional and ethical judgment in applying relevant legal and professional pronouncements to all stages of a given assurance engagement.

LO2: Apply the concepts and processes used by audit and assurance service providers to plan and perform assurance engagements in a professional manner.  

Part A – Audit planning case study (20%)

Medium Business Ltd. (MBL)

Introduction

In September 2014, Michelle Jackson, an audit partner at XYZ Chartered Accountants (XYZ)— a second-tier auditing firm based in Melbourne—evaluated and recommended accepting a new audit client, Medium Business Ltd (MBL). MBL is a medium-sized business engaged in retail trading in Melbourne. Michelle evaluated the MBL and XYZ’s independence from this client. She also assessed XYZ’s competence to conduct the audit and considered the firm’s ability to exercise due care in this engagement. XYZ issued an engagement letter and started MBL’s audit for the year 2014. Alex Jones was assigned as an audit manager in charge of planning and supervising the conduct of the MBL audit.

MBL’s background

 MBL is a retailer of office equipment and supplies. Its inventories include computers, printers and stationery products. The company was established as a family business in the 1990s by Joseph and his wife, Melissa. A total of five family members owned all of MBL’s shares as of 30 June 2014. Joseph is MBL’s chief executive officer and chairman of the board of directors. All other shareholders hold positions in the board. MBL is organised into six divisions, namely, Sales & Stores (S & S), Purchases, Inventory, Shipping, Finance, and Information Systems (IS). Each division is headed by a division manager reporting to Joseph. The S & S division conducts sales both online and in MBL’s stores located in five suburbs in the Melbourne region.

Most of MBL’s sales are made on credit. Sales are also made in cash and by EFTPOS (Electronic Funds Transfer at Point of Sale) to a range of customers. The Purchases division buys inventory upon receipt of purchase requisitions from the S & S division. All transactions of MBL are automated, and MBL’s IS staff regularly evaluate the system and upgrade it as appropriate. The existing system, in which the activities of the six divisions are integrated, has been installed five years ago. According to the assessment of the IS division head, MBL’s system is currently considered adequate for the company’s needs.

Over the past few years, demand for some of MBL’s inventories declined because of environmental awareness of customers and the increasing adoption of more environment- friendly office practices. As a result, the company introduced new products during the current accounting period. In addition, competition has increased in the industry in which MBL operates. To maintain its slightly declining market share, MBL extended its standard credit period from 30 days to 40 days.

The accounting division of MBL has experienced high staff turnover during the past three years although MBL has been offering competitive salary and benefits to attract and retain well- qualified accounting staff.

Financials

Alex and his team of three staff auditors formulated the audit plan during the first half of November 2014. This task involved conducting risk assessment, determination of the overall audit strategy, setting a materiality threshold and identification of key areas of audit attention. Exhibits 1 and 2 below present information extracted from the working paper for MBL’s audit for 2014.

 Exhibit 1. Comparative financial statement information

Medium Business Ltd Statement of financial position

  At 31 December 2014                                                                            

	2014 ($'000)	2013 ($'000)	2012 ($'000)
Current Assets
Cash	1,360	1,375	1,150
Inventory	6,996	5,867	3,317
Prepayments	749	620	250
Trade Receivables	3,016	2,320	1,928
Total current assets	12,121	10,182	6,645
Non-current assets Property, plant and equipment	10,011	4,125	3,231
Long-term receivable	3,168	4,205	4,947
Total non-current assets	13,179	8,330	8,178
Total assets	25,300	18,511	14,823
Current Liabilities
Trade Payables	4,893	3,966	4,192
Provisions	1,014	1,500	750
Total current liabilities	5,907	5,466	4,942
Non-current liabilities
Long-term loan payable	10,518	4,305	3,792
Total liabilities	16,425	9,771	8,734
Net assets	8,875	8,740	6,088
Shareholder's equity
Share capital	3,846	3,846	3,846
Retained earnings	5,029	4,894	2,242
Total Shareholders' equity	8,875	8,740	6,088

   

Medium Business Ltd Income Statement For the Year ended 31 December 2014
	2014 ($'000)	2013 ($'000)	2012 ($'000)
Sales	25,282	29,750	30,383
Cost of sales	20,144	20,952	23,862
Gross profit	5,138	8,798	6,522
Depreciation Expense	2,422	2,521	2,209
Inventory obsolescence	484	531	166
Marketing expense	25	80	35
Administrative expense	1,434	1,136	1,334
Interest expense	565	450	650
Total expense	4,930	4,718	4,394
Profit before tax	208	4,080	2,128
Tax expense	73	1,428	745
profit after tax	135	2,652	1,383

Exhibit 2:  Key ratios identified by the audit team

MBL key financial ratios*				Industry Averages
	2014	2013	2012	2014	2013	2012
Current ratio (Note 1)				2	2.01	2.12
Quick ratio (Note 2)				1.01	1.15	1.11
Debt-to-equity ratio (Note 3)				0.64	0.6	0.49
Times interest earned (Note 4)				3	4.5	5
Ave. Coll. period (days) (Note 5)				32	31	30
Ave. pay. period (days) (Note 6)				30	22	22
Days to sell inventory (Note 7)				48	45	40
Gross profit Margin (Note 8)				25	23	27
Net profit Margin (Note 9)				5	6.5	8

* Note that MBL’s ratios are intentionally omitted. You are expected to calculate and interpret them as necessary, using formulas provided below.

Notes:

•  Current ratio = (Total current assets/Total current liabilities )
•  Quick ratio = (Cash + trade receivable)/(total current liabilities)
•  Debt to equity ratio = (Total liabilities)/total shareholders' equity
•  Times interest earned = (profit before interest and tax)/ interest expense
•  Ave. Collection period (days) = 365/[(Net sales)/(Trade receivables balance)]
•  Ave. payment period (days) = 365/[(Cost of Goods sold)/(Trade payables balance)]
•  Days to sell inventory = 365/[(Cost of Goods sold)/(inventory balance)]
•  Gross profit Margin = (Gross profit)/Net Sales
•  Net profit Margin = (profit after tax)/Net sales

Required: Assuming that you were in the position of Alex Jones, prepare an audit planning memo addressed to Michelle Jackson. Your memo should include:

• A discussion of audit risk indicators present in this audit engagement and how these factors affect your assessment of the risk of material misstatement.
• (If sufficient information is not provided in the case study, indicate possible sources of information and how you could have used such information in the risk assessment.)
• A recommendation of overall audit strategy appropriate for this engagement (with justification);
• Identification of key accounts (or transaction classes) that merit special audit attention (with justifications);
• Your preliminary quantitative materiality threshold (at the financial statement level), and explanation of how you will use the calculated materiality threshold in planning the audit.

  Part B - Evidencing Critical Thinking and Problem Solving (10%)

ObjectiveThe objective of Part B of this assessment is to consider, justify and then evidence your development of Critical Thinking and Problem Solving Skills in relation to Auditing, based on what you have done to address complete Part A of the assessment task. Critical Thinking: is defined in the Oxford Dictionary as an objective analysis and evaluation of an issue in order to form a judgment. This involves distinguishing between fact and opinion and evaluating the validity of information, theory and sources of  information. Within the Accounting Profession, Critical Thinking is defined as exercising judgment to solve problems using social, ethical, economic, regulatory and global perspectives (altc,  2010).    Problem Solving: is defined in the Oxford Dictionary as the process of finding solutions to difficult or complex issues. It is the process of working through the details of a problem, in order to reach a solution, in a systematic way.  Identify parts of your case study responses that provide evidence you have developed skills in Critical Thinking and Problem Solving. Provide a brief background to the excerpt selected so your audience understands the situation. Justify why you have selected these examples as evidence of your Critical Thinking and Problem Solving learning. How do you think that these excerpts showcase your Critical Thinking and Problem Solving skills? Often students can find reflective writing challenging and are unsure of how to do this and why it is important. Before attempting this section it is recommended that you review the resource available here