Audit planning and testing

 
2013 Semester 2ACCT3101AuditingAssignment (10 marks)
You are a senior auditor of the accounting firmDJFS. Your audit team iscurrently planning the 2013 audit of Pinnacle Limited, a medium sized business which manufactures home and office furniture. This is the third year your accounting firm is engaged to perform the audit for this client. The financial year being audited ends on 31 December 2013. Past audit work and initial audit procedures performed this year revealed the following information:
Due to poor economic conditionsand increasing competition in the industry, Pinnacle Ltd’ssales have dropped by about 15% from 2010 to 2012. The audit client’s CEO (Chief Executive Officer) told its shareholders in the last Annual General Meeting that the company would at least maintain its 2012 profit level in 2013. However, by July 2013, profit for the first 7 months is 20% below the profit level for the prior corresponding time period in 2012. The CEO is concerned that the company may not be able to meet its profit forecast by the end of the year. This would be a big disappointment to the shareholders and would likely have a major impact on the share price. About 30% of the CEO’s remuneration is in the form of the company’s shares. The CEO has asked all employees to make every effort to improve sales and cut costs. The CEO warns the employees that if the company’s sales continue to decline, many jobs will be at risk. A special bonus for sales staff is introduced in late October to boost sales performance. Sales revenue for the last two months of the financial year improved substantially relative to the first 10 months of the year.
Accounting staff are paid a fixed salary with no performance-based bonus payments. However, all staff in the company used to receive a Christmas bonus when the company achieves a satisfactory profit level for the year.
The accounting department is separate from other operating departments. Only the staff in the accounting department have access to the accounting system. Even the CEO does not have direct access to the accounting records. The CEO needs to consult with the chief accountant about any proposed changes. If the chief accountant agrees that an adjustment is appropriate, the chief accountant would then make the change in the computer system.
The accounting staff check all related documents before recording journal entries in the computer system, e.g., copies of customer order and shipping documents signed by the customer. Senior accounting staff regularly review the work of junior staff and report any major issues to the chief accountant who reports to the CEO and board of directors.
The chief accountant has worked for the company for three years. Based on past experience, the auditor finds the chief accountant to be cooperative and ethical. The chief accountant tends to adopt conservative accounting policies and estimate. From recent conversation, the auditor finds that the chief accountant is applying for jobs with other companies. The chief accountant is unwilling to discuss this matter in detail but just said the pressure at work is substantial. The chief accountant keeps the CEO updated about the company’s financial progress and discusses major accounting estimates with the CEO.

Required

For the occurrence assertion ofsales revenue, answer the following questions.You need to provide sufficient explanations using the facts in the case study.
(1) Assess inherent risk for the occurrenceassertion of sales revenue.(3marks)

(2) Assess control riskfor the occurrence assertion of sales revenue. (3 marks)

(3) Based on your analysis in part (1) and part (2), apply the audit risk model using the table below to assess planned detection risk. (1 mark)

Audit risk Inherent risk Control risk Detection risk
Low

(4) Suggest and briefly explain one analytical procedure that can help identify misstatements related to the occurrence assertion of sales. The procedure should be based on the facts given in the case study. (1 mark)

(5) Suggest one test of control to help test the occurrence assertion of sales revenue for the audit client.The test should be based on the facts given in the case study. Explain how this test of control specifically tests the occurrence assertion of sales revenue.This test should be based on your earlier analysis of control risk factors. (1mark)

(6) Explain how the auditor should test the occurrence assertion of sales revenue using substantive procedures in this case. The procedures should be based on your earlier analysis of risk factors. (1 mark)
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