10.20You are an assurance services senior and your client is Antique Collectibles Pty Ltd (AC), a small company that specialises in buying and selling antique Australian-made bush furniture. AC purchases pieces at auction, cleans and repairs them, then sells them to the general public. This is the first year that your firm has conducted AC’s audit. AC is a small owner-managed business that does not have complex organisational structure or an advanced information system. Due to the size of the entity, there is very little separation of duties at AC, and most employees at AC are related to the owner. AC tends to focus purely on sales and market share, and the owner has admitted that, at times, he has treated the finance department as a bit of an afterthought. He has also admitted that he hasn’t paid much attention to the controls at AC, as he trusts the staff members, due to their relationships to him. Required
Describe whether the auditor will take a substantive approach or a combined tests of controls and substantive approach to the audit. Explain your answer, with reference to the background information and to ASA 330. ASA 330.7a states that the auditor, when designing further audit procedures shall 'consider the reasons for the assessment given to the risk of material misstatement at the assertion level for each class of transactions and account balance, including the likelihood of material misstatement due to the particular characteristics of the relevant class of transactions or account balance'. In other words this paragraph is referring to the inherent risk of the company. NOT RIGHT
The auditor should use ASA 330.7a and the background information provided as guidance for determining the most appropriate audit approach. AC is a straightforward small business where staff members are related to the owner. This information supports a low inherent risk assessment, as the chance of material misstatements is low. However there is little separation of duties and the owner doesn't seemed concerned or doesn't understand about the controls which can result in material misstatements, either fraud or human error. In addition this is the first year the auditor is conducting AC's audit, thus a medium inherent risk is more appropriate.
Following the assessment of inherent risk and background information, the auditor will take substantive approach to the audit of AC. The auditor’s objective in a substantive approach is to obtain reasonable assurance that the accounting records are accurate and reliable, in accordance with ASA 200.11a. It involves inspecting underlying documents, tracing the flow of transactions through the system as well as recalculating for clerical accuracy, detecting potential material misstatements in the financial report assertions.
The substantive approach is the most appropriate in these circumstances as the auditor can't really place any reliance on the internal controls of AC thus employing a combined tests of controls and substantive approach would be ineffective. They can’t rely on control risks.
Sales, cash receipts and accounts receivable
10.26You are the senior accountant working on the audit of Dynasty Ltd (Dynasty) for the year ended 30 June 2010. While assessing the risk of material misstatement, you note that Dynasty appears to have a significant debt-recovery problem. The majority of Dynasty’s debtors are outstanding for more than 60 days. Dynasty’s current bad debt provision is calculated as 1 per cent of the debtors balance at month end. Required
(a) Describe the analytical procedures you would perform in order to form a view on whether a 1 per cent bad debt provision is reasonable. 1. Substantive analytical procedures: using substantive analytical procedures such as ratio comparisons and analysis, the auditing team may view empirically whether a 1% bad dept provision is reasonable. In conjunction with the review of aged trial balance procedure, a monthly inspection...