Question

You are in charge of the audit of Enron Electric Limited (EEL), a subsidiary company of Las Vegas Group Corporation (USA) Limited. Enron Electric Ltd., is a manufacturer and distributor of household electrical products. The EEL Company contains a number of subsidiaries with diverse operations.

A new graduate has also been assigned to assist you on the job. During discussions with management, the graduate has become aware of the following matters:

A).          EEL has bank borrowings totaling $2m. As part of its borrowing contract, the company agreed that it would not borrow additional money from any other financial institution. EEL management has advised you that the company has no other borrowings.

B).           The company has a policy of rewarding its successful salespeople with performance bonuses. For the current year, the company decided that every salesperson who achieved sales to the value of $300, 000 would be given a week-long overseas holiday for 2 people to Hawaii. The company calculated that they needed a provision of $50,000 for this bonus.

C).           As part of its drive to introduce innovative products to the American market place, EEL recently purchased the licence to manufacture and distribute a new generation ‘kitchen whiz’ from an American company at a cost of $350, 000. The new ‘kitchen whiz’ was launched onto the market one month prior to the company’s 30 September 1998 balance date.

As at 15 November 1998 sales of the new product have been disappointing, with sales only half those initially projected. However, management is very optimistic that with Christmas approaching, sales will dramatically improve. EEL has recorded the value of the licence in its accounts as at 30 September 1998 at cost price.

D).           Just prior to balance date, EEL’s factory in Melbourne caught fire. The Melbourne factory is the smallest of its 6 factories in Australia. The entire building and all its contents, including inventory and machinery, were destroyed. Management plans to rebuild the factory totally and claim that it has suffered no loss, as all the items destroyed were covered by insurance.

E).           Another subsidiary company of EEL is involved in the distribution of gas. It has a large number of small customers. The gas is supplied in cylinders which are delivered to the customers’ premises. The cylinders are owned by the company and recorded as fixed assets and rented to the customers. No deposits are taken on the cylinders. The written down value of the cylinders in the company’s 1998 accounts was $20m.

In the year ended 30 June 1997 the directors had established a general provision for lost cylinders of $100, 000. Subsequent discussions with the directors indicated that they intend to carry the same provision for the 1998 year.

F).           PQR is a subsidiary company which has a $10m investment in a soft drink manufacturing and distribution company which commenced operations in 1997 in Laos. This company is trying to manufacture and market American branded soft drinks but to date has incurred losses of $4m.

Management has indicated that penetration of this market is a long term endeavour and does not wish to write down the value of its investment in the soft drink company.

G).           An importing subsidiary has been raided by the Customs Duty Department which alleges that the company has been avoiding customs duty payment on products it is importing. Management has indicated that it disagrees with this contention and will strenuously defend its position.

H).           One American based subsidiary owns and leases out to customers certain highly specialized earthmoving equipment. The average lease term is 4 years. Due to expansion over recent years, 45% of its equipment is leased to customers who reside in New Zealand, Papua New Guinea and South East Asia.

You are required to complete the following:

A)     In respect of each of the above A-H, advise the graduate on the audit procedures necessary to confirm the information provided by management.

B)     What are the general issues related to deciding whether to use a test of controls approach or a substantive approach?

C)     How do the risk assessments relate to the choice of audit approach?

Answer 1