Analytical procedures and Substantive Testing
Below are the financial statements and additional information for Tehran Ltd.
Balance Sheet
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30/06/2012
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30/06/2011
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$'000
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$'000
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Current Assets
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Cash
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58
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73
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Receivables
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4579
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3928
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Inventories
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3624
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2047
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Total Current Assets
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8261
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6048
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Non Current Assets
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Property Plant & Equipment
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28763
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29417
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Receivables
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2000
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2000
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Total Non Current Assets
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30763
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31417
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Total Assets
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39024
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37465
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Current Liabilities
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Bank Loan - Secured
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5000
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7500
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Accounts Payable
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2500
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2473
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Provisions
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643
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610
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Total Current Liabilities
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8143
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10583
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Non Current Liabilities
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Bank Loan - Secured
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22000
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20000
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Provisions
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547
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510
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Total Non Current Liabilities
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22547
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20510
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Total Liabilities
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30690
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31093
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Net Assets
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8334
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6372
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Shareholders Equity
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Share Capital
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5000
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5000
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Retained Profits
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3334
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1372
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Total Shareholders Equity
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8334
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6372
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Income Statement
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30/06/2012
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30/06/2011
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$'000
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$'000
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Revenue
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20007
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19943
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COGS
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13305
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15428
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Gross Profit
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6702
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4515
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Operating Expenses
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3486
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3047
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Net Profit Before Tax
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3216
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1468
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Tax
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1254
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572
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Net Profit After Tax
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1962
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896
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Retained Profits: Beginning
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1372
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476
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Retained Profits: End
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3334
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1372
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Tehran Ltd manufactures carpets. Approximately 80% of the company's sales arise as a result of exports. When Tehran sells abroad the customers are billed in the currency of that country.
The main raw material used by Tehran is wool, which is purchased locally in Australia. You have been informed that the company's profitability has improved due to a recent slump in wool prices.
With the exception of the managing director, Hank Largow, all of the management of Tehran are from Australia. Hank is on a five year contract which was put in place by Tehrans' US parent company. Hank has a reputation for delivering results from subsidiaries which have not performed well in the past. Hank does not much like Australia and has every intention of returning to the US when his contract is finished. The US parent company was dissatisfied with the company's 2011 performance and has paid close attention to the company's performance in 2012.
The company operates a standard costing system and the finished goods inventory is valued at standard cost. Raw materials are valued at actual invoiced cost. No work in progress exists at year end. During 2012, production has been increased by 10% compared to 2011 levels. His has resulted in favourable absorption variances which have contributed to the improved profitability during 2012.
Tests on the compnay's inventory and debtors controls in prior years have shown the systems to be reliable. The systems are capable of producing reports on the ageing of inventory and debtors and the sales history of individual profit lines.
Approximately 80% of the company's receivables are overseas customers and the debt is denominated in foreign currency. Most of these customers are on 60 day credit terms.
Midway through the year a new financial controller, Mr Pink, was appointed after the previous financial controller resigned. Mr Pink has informed you that a number of customers have complained about the quality of Tehran's products.
The property plant and equipment account is broken down as follows:
Property - factory building 27,000,000
Plant & Equipment (including vehicles) 1,763,000
28,763,000
Additions and disposals of fixed assets have not been substantial during 2012. The factory itself was acquired 6 years ago and since that time no independent valuation has been carried out. Hank has assured you that the current market value of the company is not less than $27,000,000.
The bank loans are secured by a fixed charge over the company's buildings. A loan repayment of $5 million due on 30th November 2012 was reduced to $500,000. Hank has stated that this was done with the agreement of the bank and that the bank is comfortable with the company's performance. Hank also pointed out that the company has made all of its interest payments on time.
The non-current receivable is an export market development grant from the federal government.
In prior years no serious differences between the auditors and the management have arisen. The audit has always been completed on time with an unqualified opinion issued.
Required:
a) Calculate the following ratios: Gross Margin, Net Profit Ratio, Return on total assets, Current Ratio, Quick Ratio, Inventory Turnover, Accounts Receivable turnover, Debt to Equity Ratio (NB, for inventory turnover and accounts receivable turnover, assume the balances for 2010 are the same as 2011).
b) Making reference to the ratios you calculated in part a) and the additional information provided, describe what you consider to be the risk factors that will impact on the audit of receivables and inventory.
c) What other risk factors (aside from those related to receivables and inventory) do you think will impact on the audit?
d) In respect to the accounts of Inventory, Accounts Receivable and Land and Buildings, outline the substantive procedures you would perform. (In your answer you will need to identify the audit assertion(s) most at risk for each of these accounts).