HINT … there is no need to locate and use Case 1-1.doc that is referred to in the question as it is NOT provided; you need to be using the relevant ASA to frame your response here (ASA 240) – there is no need to locate the US standard referred to in the question.
The following are matters that you might have included about the conference with Rogers. I have simply shown matters of concern with a brief rationale (remember, it is OK if you have simply produced a list of identified matters and included other items from Case 1).
Remember that time is paramount in audits and the purpose here is to point out areas of concern to members of the audit team with high charge-out rates to clients (partners & managers). Focus on the issues rather than the detail, and especially avoid too much crystal-ball gazing … just focus on the information provided and not speculation. Remember, as noted above, you should have been referring to ASA 240 Appendix 1 (and maybe even Appendix 3) … the idea is to see if you can see any examples (or illustrations) of the Appendix factors in the Case 1 facts for Lakeside. This is not the only approach I have taken below BUT it is an excellent early opportunity for you to practice developing the skill of “applying” the relevant ASA(s). The results should be comparable.
The following 11 matters are briefly expanded on below:
The previous auditor (King & Co) issued a qualified opinion based on the uncertainty of the sixth store being able to continue as a going concern – a situation that has not pleased Rogers. This will need to be carefully reviewed during the current audit as it may remain a valid basis for qualification. (last two dot points attitudes/rationalizations, ASA 240, Appendix 1)
The seventh store, currently under construction, involves a financial arrangement with Rogers. While not unusual per se, related party transactions may prove difficult to corroborate and specific disclosures will be necessary in the financial reports. (first dot point opportunities, ASA 240, Appendix 1)
Rogers is concerned that internal controls may be antiquated. The operation of the stores interstate also imposes constraints on controls. The concerns over controls acknowledged by Rogers require careful documentation and evaluation of controls to determine the nature, timing and extent of the audit testing – test controls or substantive testing? (last section on internal control deficiencies in the opportunities section, ASA 240, Appendix 1)
The size, multiple locations and electronic nature of the inventory will make inventory and important asset to verify. Storage and handling of the asset will be important to consider in regards to obsolescence. Related warranty obligations may also pose valuation challenges for our audit. (second dot point incentives/pressures, ASA 240, Appendix 1)
Lakeside policy is that for distributorship sales (which have become very successful in the last two years) that are made on credit, up to 20% of the inventory can be returned within four months. This gives rise to a large contingent liability at year-end based on sales for the preceding four months and the accuracy of the estimate will require careful consideration.
The success of the distributorship sales on credit and the concerns about internal controls noted above, also gives rise to caution about the resulting accounts receivable balances and their collectability.
The rapid increase in distributorship sales will require careful verification. The associated issues of inventory, warranty, returns and accounts receivable are noted above. The issue of the bonus scheme for store sales is noted below.
This is the first full year the store sales bonus scheme has been in place. Accordingly, special attention to its basis and calculation is cautioned. The potential incentive for revenue manipulation is present, especially in light of the aforementioned concerns over internal control effectiveness.
Five stores are rented. We will need to examine the nature of these agreements to see if they are operating or finance arrangements. This will have income statement and disclosure implications for the balance sheet.
There are a number of loans outstanding and the associated covenants or restrictions of each will need to be considered for disclosure and compliance. This issue is worthy of careful consideration given Rogers’ desire for growth and the arrangement reached for financing the seventh store noted earlier – outside the existing type for the company.
Since Lakeside has been operating since 1993, there may be non-current assets that have been held longer than a decade. Satisfactory evidence about their cost and continuing usefulness will be required.
NOTE: take a moment to reflect back to the material you covered in Module 1 about audit evidence and how this might be illustrated by this activity. I have added my own reflection below about this … this was NOT required by the question, but I hope that it allows you to see an example of how you need to be continually fitting “new knowledge” into and onto what you already know. This accumulation of “evidence” is very important in auditing … remember our goal is to obtain sufficient and appropriate audit evidence (ASA500.6) from our procedures and ensure that it documented in our workpapers to provide reasonable assurance on which to base our opinion.
You should be able to appreciate that the meeting with Rogers constitutes oral (spoken) evidence. Importantly, this oral evidence has now been noted (documented) in your working papers! Why “importantly”? Since oral evidence is not a strong type of evidence, you will need to corroborate (confirm) matters noted as the audit progresses. The more corroboration on each matter you obtain as your audit unfolds, the more you will be comfortable that you have obtained sufficient and appropriate audit evidence (required by ASA 500.6). In Case 2, you will see a similar dialogue is presented with the previous auditor and in Case 2, Ex 2 you were asked to document your understanding of these discussions using questionnaires. Hopefully there will be corroboration by other “independent” sources of Roger’s views as you progress.
The point here is that you will develop a more thorough understanding of some of the terminology introduced here as you progress through the unit … be patient and try not to get overwhelmed and frustrated that things do not immediately “make sense”. And, of course, don’t forget that it is OK to ask for clarification on the Module DFs!!