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DEPARTMENT OF ACCOUNTING, FINANCE & ECONOMICS 3102AFE Auditing Audit Assignment 2 – Risk Assessment (Group) Due Date: 10am on 23 September 2020 Weighting: 25% Total Marks: Word limit: 25 1500 Submission: Submitted by ONE group member only (in MS Word) through the ‘Audit Assignment 2 Submission’ link in the Assessment folder. General Instructions to answer the assignment · You must answer the question in the context of the case and not provide a general discussion. · A list of references is NOT required. · You do not need to provide an introduction nor a conclusion – just answer the questions asked, and number your answers clearly. · Maximum word limit is 1500 words. Use 12-point font in either Times New Roman or Arial font. Assignments that exceed this limit by more than 10% will be penalized. · Include a title page that includes assignment heading, course name (3102AFE), your name, student number and total number of words. · Please ensure that you also complete the electronic assignment cover sheet before submitting your assignment. ___________________________________________________________________________ 2 CASE STUDY: HARRISONS LTD You are a new staff member of Monet & Associates, a mid-sized accounting firm and have been assigned to an engagement team that is conducting the financial report audit for Harrisons Ltd (Harrisons). The engagement team, under the guidance of the engagement partner, Vince Mater, is currently performing a preliminary risk assessment of the audit client. The following documents have been provided to you: 1. Memo from audit partner, Vince Mater, dated 6th January 2020 which includes a summary of the initial audit procedures undertaken by the engagement partner for the 31 December 2019 audit. 2. A relevant industry outlook report provided by the Australian Construction Industry Forum published on 7 November 2019. REQUIRED: You have been asked to assess the inherent risk of the client and perform preliminary analytical procedures as part of the audit planning process in obtaining an understanding about the client’s business and indicate where there is an increased likelihood of misstatements. Refer to the information provided and answer the following questions: (1) Assess overall inherent risk at the financial report level of Harrisons Ltd. In your answer you should discuss, based on the materials provided in the memo from the audit partner (excluding Appendix A and B) and the industry outlook report, the factors that would increase and decrease the inherent risk of material misstatements for Harrisons at the financial report level. (i.e. For this part of the question, you are to ignore the ratios provided in the appendix to the Partner’s Memo). Conclude with an overall assessment of the qualitative level (high/medium/low) of inherent risk for Harrisons Ltd at the financial statement level. (Hint: This conclusion only needs to be one sentence that states your overall assessment based on the balance of factors discussed). (9 marks) (2) Examine the year-to-year changes and the common ratios documented in Appendix A to the Partner Memo, and provide the following analysis from an audit perspective: a. Use the case information and the ratios provided to evaluate the risk of material misstatement for Harrison’s completeness assertion for cost of goods sold. (3 marks) b. Assume that you have established that the client has the following control in place that is designed to prevent fictitious sales from being recorded: Customers are required to sign the delivery documents on receipt of merchandise. Suggest an appropriate test of this control.(1 mark) c. Describe any observations about accounts payable and inventory and discuss any areas that you believe warrant further investigation during the current year audit. (3 marks) d. Describe your observations around interest expense. Indicate whether the results are unexpected or not within the context of the case information, and whether they require further investigation.(2 marks) (3) Refer to Harrisons’ Income Statement data which is located in Appendix B to the Partner’s Memo and record your answers to the following questions: a. Perform analytical procedures for the completeness assertion of advertising expense, security expense and bad debts expense and indicate whether you believe that there is a concern about material misstatements in each account. (6 marks) b. Suggest an appropriate substantive procedure to test the completeness of security expense. (1 mark) (Total: 25 marks) Monet & Associates Memo To:Dean Smith (Audit Senior) From:Vince Mater (Audit Partner) Date:6th January 2020 Re:Harrisons Ltd Audit for 31 December 2019 I just wanted to fill you in briefly on our client, Harrisons Ltd, as you are just joining the audit team and it is your first year on the audit. I have been out to visit the client in order to get some information which will help us with planning this year’s audit for their financial year ending 31 December 2019. I have conducted some initial audit procedures for the upcoming audit and have included these in the current audit file for the client. Harrisons Ltd is a publicly traded company that is listed on the ASX. This will be the second year that we have audited the company (and I was the engagement partner last year). In last year’s audit we found no material misstatements. Harrisons Ltd is an Australian manufacturer of building materials and cement, founded in 1948 in NSW. Their operations include both manufacturing plants and wholesale distribution centers in 68 locations across Australia. They have developed a good reputation with their clients and employees and maintained strong relationships with their suppliers, who are all Australian owned and operated companies. However, there has been some recent lobbying activity by environmental groups who have expressed concerns regarding the pollution levels at their Coffs Harbour manufacturing plant. The CFO indicated to me that they do have some concerns about how this may affect their relationship with stakeholders in the community and their social licence to operate in the region. While revenues have grown year on year, and profit growth has been above 5% between 2016 and 2018, the CFO noted that inventory turnover had slowed in 2019, partly due to increased competition in the domestic market. The company operates a results-oriented work environment that holds employees as well as managers accountable for success and utilizes systems that reward employee and group output. Notably, senior managers and sales staff were advised that they are to be rewarded with a bonus if the firm achieves profit growth of 5% in 2019. The CEO and two Directors of Harrisons have spent some time over the last few months engaging with industry counterparts and attending conferences in the UK and have recognized the need for innovation in fire retardant building materials. Consequently, the Board of Directors has approved the establishment of a $20 million dollar Research Centre, which they envisage will become the leading edge for research in the building industry in Australia. The company took out a loan with a local bank for $12 million in August 2019 to purchase a property in Brisbane that will house the Research Centre. The debt contract requires the audit client’s interest coverage ratio to be above 3, and the debt to assets ratio is required to be below 50%. The balance of the capital required to set up the Research Centre will be obtained through the issue of additional shares. The prospectus for the share issue has already been published and the applications for the share issue closes on 15 January 2020. The CEO has been anxious to ensure that the financial results will present the company in the best possible light for the share issue and has been asking staff over the last several months to focus on cost cutting. Yesterday the client sent through a copy of their draft financial information for the year. I have calculated some ratios based on this information and included in the attached Appendix A. I also attach an extract of income statement data for the last four years in Appendix B. You might find this information useful for planning the audit. 1 2 APPENDIX A – FINANCIAL DATA YEAR TO YEAR CHANGES % Change % Change % Change Account Balance 2018-2019 2017–2018 2016–2017 Net sales 3.72% 2.98% 1.54% Cost of goods sold -0.63% 3.79% 2.11% Operating expenses 3.25% 0.94% -0.02% Operating Income 3.43% 2.13% 1.76% Interest Expense -2.32% -5.62% -6.41% Net receivables 51.30% 8.61% 11.11% Inventory 12.78% -0.93% 3.60% Accounts Payable 22.42% 18.12% 14.46% Current portion of long-term debt -40.51% 0.00% 11.11% Long-term debt 24.72% -1.37% 1.35% Common Ratios of Harrisons Ltd 2019 2018 2017 Gross margin % 33.98% 30.03% 30.57% Net Inc. bef tax/sales 0.04 0.04 0.04 Profit growth 5.01% 5.98% 5.98% Days Sales Outstanding 25.20 19.97 18.73 Bad Debt Expense as percentage of gross sales: 0.47% 0.62% 0.67% Days Inventory Outstanding 88.40 86.73 88.87 Accounts payable turnover rate 12.1 15.4 15.2 Payables turnover in days 30.17 23.70 24.01 Debt to assets 0.49 0.46 0.46 Interest coverage 3.01 2.81 2.50 These are the formulae I have used in the calculations: · Gross margin % = Gross profit divided by net sales. · Net income before tax/sales = net income before tax divided by gross sales. · Profit growth = the difference between current period profit and prior period profit divided by prior period profit, i.e., (Profit t – Profit t-1) / Profit t-1. · Accounts receivable turnover = Net sales divided by average net accounts receivables · Days sales outstanding = 365 divided by accounts receivable turnover, where accounts receivable turnover = Net sales divided by average net accounts receivables · Days inventory outstanding = 365 divided by inventory turnover, where Inventory turnover = cost of goods sold for year t divided by average inventory (i.e., the average of beginning and ending inventory balances for year t). · Debt to assets ratio = Total liabilities divided by total assets. · Interest coverage ratio = Net profit divided by interest expense. APPENDIX B Harrisons Ltd Extract from Income Statement for the Year Ended December 31 (draft) 2019 2018 2017 2016 $ $ $ $ Sales 196,423,039 189,318,978 183,841,948 181,049,153 Sales Returns and Allowances 301,379 223,148 217,290 215,670 Cost of goods sold 131,480,975 132,319,374 127,485,206 124,846,646 Accounting fees 379,945 386,221 374,736