Task - Case Study
You are the audit senior for the audit of Nirvana Produce Pty Ltd (NP), a large wholesale fruit and vegetable supplier. NP operates out of a warehouse and office near the fruit and vegetable markets and also sources product directly from organic growers. Your firm has recently been appointed as auditor of this business.
Discussions with George Bowles has revealed that George Bowles and Thomas Hayes started the business 30 years ago as equal partners. They later converted the partnership to a proprietary limited company, each owning 50% of the shares. When Thomas died last year, George's brother Marcus and his sons, George Junior and Jason bought out 50% of Thomas' share at a market value of $2m. Thomas' widow, Anna, holds the remaining 25% of shares in the business. The company now wishes to buy back Anna's 25% shareholding but needs to raise the funds for the buy back through a loan from their bank.
Key ratios include:
|
Ratio
|
Unaudited 2016
|
Audited 2015
|
Industry Benchmark
|
|
Current ratio
|
1
|
1.89
|
1.8
|
|
Days in receivables
|
12 days
|
8 days
|
7 days
|
|
Inventory turnover
|
3 days
|
3 days
|
3 days
|
|
Debt to equity
|
.50
|
.50
|
.20
|
Debt is in the form of a mortgage over the warehouse and offices. The total value of shareholders' funds is relatively small as the past dividend policy has been to pay out 90% of after tax profits.
Additional information-
NP uses basic accounting software which can import a bank statement but has no facility for generating a file of creditor payments to be uploaded into the NP bank account. The software, which comprises order/sales, purchases/creditors and payroll modules, is on a server that is accessed through a number of networked computers in the office. Passwords are required to access various modules and authorisation levels of the system.
There are two sales' clerks who take phone and email orders and generate packing/buying slips through the sales order module of the accounting software. These slips are used by warehouse and buying staff to purchase produce on the following morning and pack the produce into boxes. The debtors' clerk uses the completed packing/buying slips to generate invoices which are attached to the boxes to be collected by the purchaser or a courier later that morning.
Often when the customer arrives to collect their order they identify other produce that they want and take that with their order. These goods are then added to the original invoice in the system and the revised invoice is emailed to the customer. Payments on sales invoices are due within seven days of invoice date and are generally paid by electronic funds transfer (EFT). A brief review of debtors identified that there were a significant number of short payments on the invoices. The debtors' clerk matches the EFT payments to the invoices and chases up outstanding payments.
George and his sons do the buying in the morning on the basis of the information on the buying slips. Purchases are often made in cash at the market and the details noted on slips of paper which are passed to the bookkeeper when all the purchasing for the day has been concluded. Purchases direct from contracted growers are paid for through EFT on receipt of the goods and the purchase invoice.
Warehouse staff agree the goods to the invoice and pass the signed purchase invoice to the bookkeeper. The bookkeeper maintains and reconciles the cash purchase float daily. The bookkeeper also maintains the creditors' ledger, approves and makes payments to creditors and reconciles the bank account monthly.
Payments to creditors are made within 7 days of the date of the invoice through the bank's online payment system and then entered into the accounting software. The invoice is then stamped as paid and the date of payment and the bookkeeper's initials are entered on the invoice. A brief review of the creditors' ledger revealed that there were a number of duplicate payments to creditors which were being resolved.
The payroll is completed by the bookkeeper on the basis of normal hours worked though George must authorise any holiday pay, paid sick leave and overtime. All holiday, sick pay and overtime authorisation is completed online.
Question 1 - Analyse the ratios in conjunction with the additional information and identify implications for the audit and any particular audit steps that need to be undertaken to reduce audit risk. For example, if there was a worsening inventory turnover, one of the audit steps would include a review for obsolete inventory. Ensure that you also identify any potential weaknesses in this ratio analysis and any additional information that you will need to make a judgement about the business risk facing the company.
Question 2 - Identify the strengths and weaknesses in the internal control system described above. For each control weakness, identify the financial report assertions that may not be met. Suggest a control to correct any of the deficiencies identified. Identify how this weakness will affect your audit, indicating the additional audit steps and audit evidence that you will need to collect to reduce audit risk.
Question 3 - Outline the audit approach that you would take with the networked personal computer based accounting software in this audit engagement. As part of this audit approach develop and justify the use of at least two CAATs that you would use in this audit.