Gifts Ltd (Gifts) operates 30 specialty gift stores. The company’s year-end is 3

Question

Gifts Ltd (Gifts) operates 30 specialty gift stores. The company’s year-end is 30 June 2018. The audit manager and partner recently attended a planning meeting with the finance director and have provided you with the planning notes below. You are the audit senior, and this is your first year on this audit. The audit manager has asked you to undertake some research to gain an understanding of Gifts, so that you are able to assist in the planning process. He has then asked that you identify relevant audit risks from the notes below and also consider how the team should respond to these risks. Gifts spent $2.1 million in refurbishing all of its stores and extending their central warehouse. In order to finance this refurbishment, Gifts borrowed $2 million from the bank. This is due to be repaid over five years. The company will be performing a year-end inventory count at the central warehouse, as well as at all 30 stores, on 30 June 2018. Inventory is valued at selling price less an average profit margin, as the finance director believes that this is a close approximation of cost. Prior to the 2018 financial year, each store maintained its own financial records and submitted returns monthly to head office. During the 2018 financial year all accounting records were centralised within head office. Therefore, at the beginning of the 2018 financial year, each store’s opening balances were transferred into head office’s accounting records. The increased workload at head office has led to some changes in the finance department and in May 2018 the financial controller left. Her replacement will start in late June 2018. REQUIRED: a) List two (2) sources of information that would be of use in gaining an understanding of Gifts, and for each source describe what information you would expect to obtain. (4 Marks) b) Using the background information provided above, identify six (6) audit risks and explain the auditor’s response to each risk in planning the audit of Gifts. (12 Marks)Gifts Ltd (Gifts) operates 30 specialty gift stores. The company’s year-end is 30 June 2018. The audit manager and partner recently attended a planning meeting with the finance director and have provided you with the planning notes below. You are the audit senior, and this is your first year on this audit. The audit manager has asked you to undertake some research to gain an understanding of Gifts, so that you are able to assist in the planning process. He has then asked that you identify relevant audit risks from the notes below and also consider how the team should respond to these risks. Gifts spent $2.1 million in refurbishing all of its stores and extending their central warehouse. In order to finance this refurbishment, Gifts borrowed $2 million from the bank. This is due to be repaid over five years. The company will be performing a year-end inventory count at the central warehouse, as well as at all 30 stores, on 30 June 2018. Inventory is valued at selling price less an average profit margin, as the finance director believes that this is a close approximation of cost. Prior to the 2018 financial year, each store maintained its own financial records and submitted returns monthly to head office. During the 2018 financial year all accounting records were centralised within head office. Therefore, at the beginning of the 2018 financial year, each store’s opening balances were transferred into head office’s accounting records. The increased workload at head office has led to some changes in the finance department and in May 2018 the financial controller left. Her replacement will start in late June 2018.

REQUIRED:

a) List two (2) sources of information that would be of use in gaining an understanding of Gifts, and for each source describe what information you would expect to obtain. (4 Marks)

b) Using the background information provided above, identify six (6) audit risks and explain the auditor’s response to each risk in planning the audit of Gifts. (12 Marks)

Explanation / Answer

included within non-current assets or expensed as repairs.

the income statement.

within the income statement.

ensure compliance with relevant accounting standards.

the disclosure of any security given is not complete.

circularised as part of the bank confirmation process.

counts.

and/or those with a history of inventory count issues.

the case, then inventory could be under or overvalued.

valued correctly.

is not the case, then inventory could be under or overvalued.

cost.

supermarket to head office to identify any errors.

replacement will only start in late december.

financial statements and resolve any audit issues.

issues the new financial controller is unable to resolve.

audit risk auditor response sunflower has spent $1·6m on refurbishing its 25 foodsupermarkets. this expenditure needs to be reviewed toassess whether it is of a capital nature and should be

included within non-current assets or expensed as repairs.

review a breakdown of the costs and agree to invoices toassess the nature of the expenditure and, if capital, agree toinclusion within the asset register and, if repairs, agree to

the income statement.

during the year a small warehouse has been disposed of ata profit. the asset needs to have been correctly removedfrom property plant and equipment to ensure the non-currentasset register is not overstated, and the profit on disposalshould be included within the income statement. review the non-current asset register to ensure that theasset has been removed. also confirm the disposal proceedsas well as recalculating the profit on disposal.
consideration should be given as to whether the profit ondisposal is significant enough to warrant separate disclosure

within the income statement.

sunflower has borrowed $1·5m from the bank via afive year loan. this loan needs to be correctly split betweencurrent and non-current liabilities. during the audit the team would need to confirm that the$1·5m loan finance was received. in addition, the splitbetween current and non-current liabilities and thedisclosures for this loan should be reviewed in detail to

ensure compliance with relevant accounting standards.

in addition, sunflower may have given the bank a chargeover its assets as security for the loan. there is a risk that

the disclosure of any security given is not complete.

the loan agreement should be reviewed to ascertain whetherany security has been given, and this bank should be

circularised as part of the bank confirmation process.

sunflower will be undertaking a number of simultaneousinventory counts on 31 december including the warehouseand all 25 supermarkets. it is not practical for the auditor toattend all of these counts; hence it may not be possible togain sufficient appropriate audit evidence over inventory

counts.

the team should select a sample of sites to visit. it is likelythat the warehouse contains most goods and thereforeshould be selected. in relation to the 25 supermarkets, theteam should visit those with material inventory balances

and/or those with a history of inventory count issues.

sunflower’s inventory valuation policy is selling price lessaverage profit margin. inventory should be valued at thelower of cost and net realisable value (nrv) and if this is not

the case, then inventory could be under or overvalued.

testing should be undertaken to confirm cost and nrv ofinventory and that on a line-by-line basis the goods are

valued correctly.

ias 2 inventories allows this as an inventory valuationmethod as long as it is a close approximation to cost. if this

is not the case, then inventory could be under or overvalued.

in addition, valuation testing should focus on comparing thecost of inventory to the selling price less margin to confirmwhether this method is actually a close approximation to

cost.

the opening balances for each supermarket have beentransferred into the head office’s accounting records at thebeginning of the year. there is a risk that if this transfer hasnot been performed completely and accurately, the openingbalances may not be correct. discuss with management the process undertaken totransfer the data and the testing performed to confirm thetransfer was complete and accurate.
computer-assisted audit techniques could be utilised by theteam to sample test the transfer of data from each

supermarket to head office to identify any errors.

there has been an increased workload for the financedepartment, the financial controller has left and his

replacement will only start in late december.

the team should remain alert throughout the audit foradditional errors within the finance department. this increases the inherent risk within sunflower as errorsmay have been made within the accounting records by theoverworked finance team members. the new financialcontroller may not be sufficiently experienced to produce the

financial statements and resolve any audit issues.

in addition, discuss with the finance director whether he willbe able to provide the team with assistance for any audit

issues the new financial controller is unable to resolve.

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