Advance Auditing

Assignment
AUDITING – PLANNING AND AUDIT RISK

Submitted by: Mehreen khan

01-112171-013
BS(A&F)7A

Submitted to: Sir Faisal Azam

Question: 01: Using the information provided, describe 6 audit risks and explain
the auditor’s response to each risk in planning the audit of Murray Co.

Answer 1.

Following are the audit risks that may arise during the audit of Murray Co. and
being auditors’ possible response to those risks are given below.

i. It is given in the scenarios that audit manager had been the previous
employee of Murray Co many years ago. This may arise familiarity &
independence threat. Although he was not part of preparation of financial
statement but he would have some insider information about the business
operations, further he must have had some colleagues working in
preparation of financial statements. To mitigate this threat, audit manager
needs to be independent during the conducting the audit. Further he needs
not to be engaged in irrelevant and unnecessary meetings of Murray & Co,
just to maintain his independency.
ii. Murray Co main source of revenue is sale of ergometers. During the year,
Company has refurbished the assembly line of preparation of ergometers.
There is a risk that refurbishment of processing/assembly line may not be
up to the standard mark which may cause the decrease in production and
quality of company’s main revenue generating item. Auditors need to
physically visit the assembly line and in case of further clarification, auditor
may ask for independent review of assembly line by independent third
party.
iii. During refurbishment of Warehouse, Murray Co has stored the
manufactured ergometers and One third of other finished products in Third
Party Independent Warehouse. From auditor’s point of view, there is a risk
that why Murray & Co does not has their own warehouse for storage!!! And
if they have stored their products in third-party warehouse, why didn’t they
store the other products instead of ergometer, which is their main product
of revenue generation. Further there is a question, is the third party ware
house provides the insurance services in case of damage, theft and stolen
of Goods. For the Purpose of assurance, auditors’ needs to review the
 contract of Murray Co with Third party for storage of products at their ware
house & further auditor may also visit the storage site for confirmation as
well.
iv. Murray Co is selling the products to individual customers for the first time.
Before that, they only had the experience of selling to retail customers.
There is a risk that the company doesn’t have the previous experience of
selling directly to customers further the selling terms and conditions are
also not defined, either they will sale on cash or trade receivable basis.
Being an auditor, selling terms and condition needs to be review and also
the accounting treatment which company is going to apply for booking of
revenue.
v. Murray Co is booking the sales and record revenue as and when customers
place an order online on website. There is a risk that the customer may
actually not willing to pay at later stage or don’t buy after placing the order.
However, the Sales should be booked on accrual basis. Auditors need to
verify the accrual doubtful debts & bad debts working of company to
ensure accuracy.
vi. Murray Co has capitalized the cost of development of Website. Auditors
needs to verify that whether the website development cost has met the
standard of development provided by IFRS or not.
vii. Murray Co customers are not paying their outstanding balances. So there
may be risk of erroneous trade receivable balances and financial statement
may not present true and fair picture. Auditors need to verify the trade
receivable working and provision for doubtful debts, either they met the
accounting standard or not.
viii. Murray Co has redundant sales teams’ member, so there may be risk of
going concerns as sales team play the role of backbone for selling and
generation of revenue & profit for company. Auditors needs to verify the
basis and ground on which they have been redundant, although company
has switched to online website where there is less use of sales
representatives but still there needs to be proper justifications and in case
of redundancy, company has to pay their termination benefits which may
affect the profitability and cash flow position.
ix. Murray Co is planning to list on the stock exchange. Auditors needs to
verify that either the company meets the standard requirement for listing
on stock exchange or not. Further, in terms of accounting, Fair value of
shares and earnings per share must be calculated on which basis. There is
also a risk that on one Side Company has changed its course of selling of
product from retail to individual customers, and refurbishment of
assembly, so there may be high exposure risk for company to encounter all
these challenges at one time. Auditors’ needs to arrange a meeting with
higher level management for their strategy and approach, how there are
going to plan and manage all this.

Questions 02: Using the financial information, provided and the information
from Case 1 above, perform analytical procedures on the draft financial
statements of Murray Co and explain the audit risks that arise.

Answer no. 2.

Following are the few analytical procedures which may apply on financial
statements of Murray Co.

i. Sales Revenue of Murray Co has an increase of $ 2,380,000 from year 2017

to 2018. This increase of revenue apparently looks good, but when it comes
to trade receivable, which has increased to $ 990,000 from the year 2017 to
2018. This increase of trade receivable is huge. Auditors need to verify the
accounting calculations of trade receivable and the pay back capacity of
vendors as well. Are they in position of paying back or they going to be
doubtful or bad debt. Company’s aging of receivable may need to be review
as well.
ii. Gross Profit margin of Murray Co in 2017 is 12.8% whereas in 2018 it is
15.5%. The increase in Gross Profit margin looks fine and it is basically due
to increase in Sales revenue whereas the cost of sales remains low.
Auditors need to verify either it is due to refurbishment of assembly line or
there may be some other reasons for the low cost of sales during 2018.
iii. Operating expenses of Murray Co remained same during both years under
consideration. Auditors needs to verify why they remain same during both
years, as in 2018 company has shifted their business to online selling, which
in fact decrease the transportation cost and some other operating nature
expenses. Further company has redundant selling team employees which
also decrease the salary expenses during 2018. Auditors need to probe the
working of operating expenses and their comparative analysis for the
respective period.
iv. Long term Loans of Murray Co has drastically increased to $2,800,000 from
$1,500,000 during the period. Apparently this may be because of shifting
the course of business from retail to online and development of website
but still increase of $1,300,000 is very huge and does not justify if company
is generating profit then why there is need for such huge loan which
ultimately increased the financial cost & Bank Overdraft in 2018. Loan
agreement and notes to the accounts degrading loan may be reviewed and
proper justification may be accomplished.
v. Website Development Cost of $150,000 may be reviewed either it complies
with the applicable accounting standard or not. If it does not comply then
the same is booked in Profit & Loss Statement instead of Statement of
Financial Position.
vi. Inventory has increased from $1,300,000 to $2,109,000 from 2017 to 2018.
Inventory valuation at the closing date of year end may be verified.
Auditors need to be physical present on the physical count of inventory at
the closing date. Further inventory valuation has increased so there may be
risk of theft damage and fire of inventory items. Auditors may also need to
review the company’s insurance policy availed if any.
vii. Property Plants and Equipment has shown an increased, apparently this
may be due to refurbishment of assembly line. However, auditors need to
verify the calculations and booking of Non-Current Assets and their
depreciation policy and subsequent booking of Fixed Assets.