Question

You are an audit senior of Charania & Amlani CPA’s and you are planning the audit of your client, Bravo Bags Inc. (BBI) which manufactures backpacks and luggage. The year end for BBI was December 31, 2020. Bravo Bags Inc. purchases most of its raw materials from suppliers in China and these goods are shipped directly to the company’s warehouse and the goods are usually in transit for up to four weeks. During the year, BBI spent $1.3 million on developing a new range of backpacks using recycled materials which are due to be launched into the market in November 2021. In September 2020, BBI also invested $1.0 million in a new piece of machinery as part of the development process. The full amount has been capitalised and this cost includes the purchase price, installation costs and the costs to service the equipment over the next 3 years. To finance the cost of this new equipment BBI issued more shares and it also took out a line of credit with its bank. This year, the bonus scheme for senior management has been changed so that rather than focusing on net income, it is instead based on the value of year-end total assets. Because you were worked on this engagement the last three years, you know that for accounts receivable, in previous years, an allowance for doubtful accounts, made up of specific balances, which equalled almost 2% of trade receivables was maintained. However, the controller feels that this is excessive and unnecessary and therefore has not included it for 2020.

A new general ledger system was introduced in July 2020; the controller has stated that the old and new systems were run in parallel until the end of October 2020. Because this created additional work for the accounting group, some of the control account reconciliations were not completed during this period, including the bank reconciliation. The controller is comfortable with this as these reconciliations were completed successfully in November 2020. In addition, the purchase ledger was closed for the year on December 18, 2020, because the accounts payable clerk planned to take time off for Christmas.

The following are select preliminary financial results for Bravo Bags.

2020 net income before audit adjustments was $2,700,000. For 2020, its income would have been $3,100,000, but for a loss on sale of equipment of $400,000. Reid had revenues for the year of $20,000,000 and reported total assets in its balance sheet of $30,000,000. The auditor determined an adjustment to the allowance for doubtful accounts of $200,000 should be booked.

Required:

Part A

Identify Seven audit risks. Your answer should include the specific risk and why it is a risk. (14 Marks)

Part B

Determine planning materiality, assuming that a benchmark on the lower end of the scale is appropriate.

Part C
Using the number you calculated in Part B- if the client refuses to record an allowance for doubtful accounts, what should be the impact on the audit report, if any?

Answer 1

answer - seven risks are -

1. revenue recognition - revenue shall be recognised as per AASB
2. going concern - It is assumed that the company will continue its operation forever
3. internal control over financial reporting - effective internal contral shall positively affect on financial statements.
4. auditing accounting estimates, including fair value measurements - assets shall be valued at fair value.
5. engament quality review - audit shall be reviewed by quality assured auditing team.
6. professional skepticism - auditor shall always be updated with new technological knowledge & amendments in laws.
7. related party & unusual transaction - fraud may be in related party transaction or unusual transraction.