Question

Substantive testing at Sooty Ltd Lastly, Tyrone brings up the audit of Sooty Ltd. Sooty manufactures machine parts which are used for servicing heavy equipment in the mining industry throughout Australia. Tyrone informs you that during the planning stage of the audit of Sooty, it was found that one of Sooty’s key suppliers had gone into administration which had led to major shortages of key materials. In order to circumvent this problem, Sooty secured the supply of materials through an alternative supplier, however Tyrone notes that the alternative supplier is new to the market and that some of Sooty’s production staff have been complaining that the materials are of inferior quality. Tyrone says that Sooty has also suffered from cash flow problems recently as one of their debtors, Brown Ltd, has also been experiencing financial problems, taking up to 4 months to pay amounts which are normally due within 30 days. Tyrone notes that Brown makes up 35% of Sooty’s sales and that management wish to maintain a good relationship with Brown. The resulting cash flow implications has meant that Sooty has been drawing on its lines of credit, which has subsequently caused it to temporarily violate the terms of its contract with its bank, ASBC, which requires Sooty to maintain a current ratio of 2:1.

Question 5

In regards to Sooty Ltd: Two key account balances at risk of material misstatement. For each account balance, the key assertion at risk. A justification as to why the account balances and assertions are at risk. An outline of one (1) substantive test of detail that Tyrone could undertake for each account to address the assertion and risk identified.

Answer 1

Answer:

a.Inventories and cost of goods sold

b.Inventories - Valuation / Allocation

Cost of goods sold - Valuation / Allocation

c.Inventories and Cost of goods sold are interrelated with each other .Inventories should be fairly valued of internal control purposes .Since inventory is used in manufacturing machine parts , this can be identified in a purchase cycle.In a manufacturing concern,valuation of inventories is also affectedby the production cycle, in which various costs are assigned to inventories, and the cost of inventories is then transferred to the cost of goods sold account.The determination of inventory value therefore affects the cost of goods sold and has a major impact on net income .Valuation or allocation assertion is at risk because of the changes in the supplier.Since Brown Ltd. makes up 35% of Sooty's sales,accuracy and consistency of costs assigned to cost of goods sold in a material risk.There may be some discrepancies in recording costs in order to maintain the sales of Sooty Ltd.disregardiing the facts that the alternative materials are of inferior quality,suffers from cashflows problems and the dilemma of whether to have a good relationship with a major supplier by prolonging the payment period of its debts.This also poses serious threats with the going concern of the company as their inventory would not be enough to manufacture quality machine parts.

d.Perform analytical review related to inventory and cost of goods sold

Gross profit rate - Gross profit / Net Sales

Inventory Turnover - Cost of goods sold / Average Inventory

Number of days sales in Inventory - 365 / Inventory Turnover

Inventory / Total Current assets.