Question 1 (40 marks)
You are the audit manager of a medium-sized firm and have just received a package from Rachel Jones, the financial controller of KidSpace Ltd., an electronic toy manufacturer. This is your firmâs first year as auditor of KidSpace Ltd. The information below was prepared for a board meeting and Rachel, the acting Chief Financial Officer, felt it might be useful to you in preparation of the forthcoming audit for the year ended 30 June 2017.
KidSpace Ltd.
Statement of Financial Position $'000s
Current assets 2017 2016 2015 Cash 1,586
1,743
830
Accounts receivable and other receivables 13,734
11,200
9,623
Inventory 16,498
11,731
7,197
Total current assets 31,818
24,674
17,650
Non-current assets Property, plant and equipment 14,606
12,840
9,572
Long-term loan receivable 5,200
3,600
3,300
Intangible assets 1,400
Total non-current assets 21,206
16,440
12,872
Total assets 53,024
41,114
30,222
Current liabilities Trade payables and other payables 9,012
6,288
2,021
Provisions 4,875
3821
4577
Total current liabilities 13,887
10,109
6,598
Non-current liabilities Long-term loan 20,000
16,000
12,000
Total liabilities 33,887
26,109
18,598
Net assets 19,137
15,505
11,624
Shareholder's equity Share capital 2,000
2,000
2,000
Retained earnings 17,137
12,505
9,624
Total shareholder's equity 19,137
14,505
11,624
KidSpace Ltd.
Income Statement $'000s
2017 2016 2015 Sales revenue 76,945
74,927
89,735
Cost of sales 51,840
51,765
63,066
Gross profit 25,105
23,162
26,669
Depreciation 5,595
4,332
2,796
Inventory obsolescence 990
1,173
670
Selling expenses 2,405
3,153
3,317
Administrative expenses 8,925
8,727
11,516
Finance costs 1,040
1,275
1,140
Total expenses 18,955
18,660
19,439
Profit before tax 6,150
4,502
7,230
Tax expense 1,518
1,621
2,386
Profit after tax 4,632
2,881
4,844
Notes: Trade Receivables 12,034
10,655
9,300
Pre-paids 1,600
500
300
Other receivables 100
45
23
Total Trade & other receivables 13,734
11,200
9,623
Inventory Raw Materials 6,599
5,866
3,845
WIP 4,333
2,588
1,550
Inventory held for sale 6,699
3,520
1,972
17,631
11,974
7,367
Provision for Inventory obsolescence (1,133)
(243)
(270)
Total inventory 16,498
11,731
7,197
Ratios 2017
2016
2015
Profit ratio 7.99%
6.01%
8.06%
Return on shareholder equity 24.20%
19.86%
41.67%
Quick Ratio 0.99
1.18
1.54
Times Interest Earned 6.91
4.53
7.34
Accounts Receivable Turnover (times) 6.78
7.51
9.33
Asset Turnover 1.45
1.84
2.94
Inventory Turnover (times) 3.50
5.35
8.76
During a brief telephone call with Rachel, you made the following notes:
1. One of the conditions of the long-term loan is that the company is not to exceed a debt-to equity ratio of 2:1 at any time and they must maintain a current ratio of 2:1. The loan is reviewed each year on 31 July.
2. Provision for obsolescence of finished inventory held for sale and work-in-progress is provided for at a flat rate of 10%. The amount provided in previous years was 20%. Rachel said that the company believes it has been overly conservative in previous years and 10% is a more realistic level, given the nature of its products.
3. To combat declining sales a senior management incentive scheme based on sales and profit levels was introduced in July 2016.
4. The long-term loan receivable is from a company involved in the development and production of computer software. It is owned by one of the directors.
Required:
a) Identify and explain what the inherent risks for KidSpace Ltd. that you will need to consider. (6 marks)
b) From the information provided, perform additional preliminary analytical procedures:
i) Simple comparison (3 marks)
ii) Current ratio (1 mark)
iii) Return on assets (1 mark)
iv) Gross profit ratio (1 mark)
v) Debt-to-equity ratio. (1 mark)
c) Drawing on information from a) & b), identify and justify:
i) Three key account areas that would require special attention during the audit of the 30 June 2017 financial statements. Also, indicate if those accounts are likely to be over or understated. (12 marks)
ii) Two key assertions at risk for each of those account areas. (12 marks)
d) Identify and discuss any going concern issues to be considered at this stage?. (3 marks)
Question 1 (40 marks)
You are the audit manager of a medium-sized firm and have just received a package from Rachel Jones, the financial controller of KidSpace Ltd., an electronic toy manufacturer. This is your firmâs first year as auditor of KidSpace Ltd. The information below was prepared for a board meeting and Rachel, the acting Chief Financial Officer, felt it might be useful to you in preparation of the forthcoming audit for the year ended 30 June 2017.
| KidSpace Ltd. | |||
| Statement of Financial Position $'000s | |||
| Current assets | 2017 | 2016 | 2015 |
| Cash | 1,586 | 1,743 | 830 |
| Accounts receivable and other receivables | 13,734 | 11,200 | 9,623 |
| Inventory | 16,498 | 11,731 | 7,197 |
| Total current assets | 31,818 | 24,674 | 17,650 |
| Non-current assets | |||
| Property, plant and equipment | 14,606 | 12,840 | 9,572 |
| Long-term loan receivable | 5,200 | 3,600 | 3,300 |
| Intangible assets | 1,400 | ||
| Total non-current assets | 21,206 | 16,440 | 12,872 |
| Total assets | 53,024 | 41,114 | 30,222 |
| Current liabilities | |||
| Trade payables and other payables | 9,012 | 6,288 | 2,021 |
| Provisions | 4,875 | 3821 | 4577 |
| Total current liabilities | 13,887 | 10,109 | 6,598 |
| Non-current liabilities | |||
| Long-term loan | 20,000 | 16,000 | 12,000 |
| Total liabilities | 33,887 | 26,109 | 18,598 |
| Net assets | 19,137 | 15,505 | 11,624 |
| Shareholder's equity | |||
| Share capital | 2,000 | 2,000 | 2,000 |
| Retained earnings | 17,137 | 12,505 | 9,624 |
| Total shareholder's equity | 19,137 | 14,505 | 11,624 |
| KidSpace Ltd. | |||
| Income Statement $'000s | |||
| 2017 | 2016 | 2015 | |
| Sales revenue | 76,945 | 74,927 | 89,735 |
| Cost of sales | 51,840 | 51,765 | 63,066 |
| Gross profit | 25,105 | 23,162 | 26,669 |
| Depreciation | 5,595 | 4,332 | 2,796 |
| Inventory obsolescence | 990 | 1,173 | 670 |
| Selling expenses | 2,405 | 3,153 | 3,317 |
| Administrative expenses | 8,925 | 8,727 | 11,516 |
| Finance costs | 1,040 | 1,275 | 1,140 |
| Total expenses | 18,955 | 18,660 | 19,439 |
| Profit before tax | 6,150 | 4,502 | 7,230 |
| Tax expense | 1,518 | 1,621 | 2,386 |
| Profit after tax | 4,632 | 2,881 | 4,844 |
| Notes: | |||
| Trade Receivables | 12,034 | 10,655 | 9,300 |
| Pre-paids | 1,600 | 500 | 300 |
| Other receivables | 100 | 45 | 23 |
| Total Trade & other receivables | 13,734 | 11,200 | 9,623 |
| Inventory | |||
| Raw Materials | 6,599 | 5,866 | 3,845 |
| WIP | 4,333 | 2,588 | 1,550 |
| Inventory held for sale | 6,699 | 3,520 | 1,972 |
| 17,631 | 11,974 | 7,367 | |
| Provision for Inventory obsolescence | (1,133) | (243) | (270) |
| Total inventory | 16,498 | 11,731 | 7,197 |
| Ratios | 2017 | 2016 | 2015 |
| Profit ratio | 7.99% | 6.01% | 8.06% |
| Return on shareholder equity | 24.20% | 19.86% | 41.67% |
| Quick Ratio | 0.99 | 1.18 | 1.54 |
| Times Interest Earned | 6.91 | 4.53 | 7.34 |
| Accounts Receivable Turnover (times) | 6.78 | 7.51 | 9.33 |
| Asset Turnover | 1.45 | 1.84 | 2.94 |
| Inventory Turnover (times) | 3.50 | 5.35 | 8.76 |
During a brief telephone call with Rachel, you made the following notes:
1. One of the conditions of the long-term loan is that the company is not to exceed a debt-to equity ratio of 2:1 at any time and they must maintain a current ratio of 2:1. The loan is reviewed each year on 31 July.
2. Provision for obsolescence of finished inventory held for sale and work-in-progress is provided for at a flat rate of 10%. The amount provided in previous years was 20%. Rachel said that the company believes it has been overly conservative in previous years and 10% is a more realistic level, given the nature of its products.
3. To combat declining sales a senior management incentive scheme based on sales and profit levels was introduced in July 2016.
4. The long-term loan receivable is from a company involved in the development and production of computer software. It is owned by one of the directors.
Required:
a) Identify and explain what the inherent risks for KidSpace Ltd. that you will need to consider. (6 marks)
b) From the information provided, perform additional preliminary analytical procedures:
i) Simple comparison (3 marks)
ii) Current ratio (1 mark)
iii) Return on assets (1 mark)
iv) Gross profit ratio (1 mark)
v) Debt-to-equity ratio. (1 mark)
c) Drawing on information from a) & b), identify and justify:
i) Three key account areas that would require special attention during the audit of the 30 June 2017 financial statements. Also, indicate if those accounts are likely to be over or understated. (12 marks)
ii) Two key assertions at risk for each of those account areas. (12 marks)
d) Identify and discuss any going concern issues to be considered at this stage?. (3 marks)
