- 15 Marks
Question
Ecowud Co. LTD (Ecowud) is a sustainable goal-oriented company that develops, manufactures, and sells plywood made from rice husk and plastic waste. The company has a wide customer base, including construction companies and furniture manufacturers across Ghana and West Africa.
You are the Audit Manager of Adomako & Associates and are planning the audit of Ecowud for the year ended 31 December 2023. You and the Audit Engagement Partner attended a planning meeting with Ecowud’s Finance Manager.
You are reviewing the initial meeting notes to develop the audit strategy and plan. The following key matters were captured:
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Development Expenditure: Revenue for the year was forecast at GH¢32 million. During the year, Ecowud spent GH¢3.5 million on developing new types of plywood. Some of these are in the early stages of development, while others are nearing completion. The Finance Manager intends to capitalize the entire GH¢3.5 million spent on development since all projects are likely to succeed.
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Inventory Valuation: Ecowud uses a standard costing method to value inventory. However, the company has never updated its standard costs since adopting this policy. The company operates multiple warehouses in Ghana and across West Africa, most of which are third-party rented premises.
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Accounting Software: A new accounting software was developed internally and implemented in August. The old and new software did not run parallel, as management deemed it burdensome. Two months after implementation, the IT Manager resigned, and a new IT Manager will take over in January 2024.
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Long-term Loan and Share Capital: Ecowud restructured its finances, raising GH¢2 million through share issuance and GH¢3.5 million through a long-term loan. The loan has bank-imposed financial conditions, including a minimum total asset level. If breached, the loan becomes immediately repayable.
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Revaluation of Land & Buildings: Ecowud follows a revaluation model for land and buildings. The Finance Manager has announced that all land and buildings will be revalued at the year-end.
Required:
Identify FIVE audit risks in relation to Ecowud Co. LTD and for each risk, explain how the auditor should respond.
Answer
| Audit Risk | Auditor’s Response |
|---|---|
| 1. Development Expenditure: Risk that the GH¢3.5 million capitalized may not meet the recognition criteria of IAS 38 – Intangible Assets. Incorrect capitalization may lead to overstated assets and profits. | – Obtain evidence supporting management’s claim that capitalization criteria are met. |
- Review IAS 38 requirements for development cost recognition.
- Inspect project documentation, feasibility studies, and future revenue projections.
- Discuss with management and inspect test results to assess viability. |
| 2. Inventory Valuation: Risk that Ecowud’s outdated standard costing method may not reflect current costs, leading to misstatements in inventory valuation as per IAS 2 – Inventories. | – Review the reasonableness of standard costs by comparing them to actual costs. - Discuss with management and assess whether standard cost updates are required.
- Perform inventory count at third-party warehouses to ensure existence and completeness. |
| 3. Accounting Software Implementation: Risk of data migration errors as the old and new software did not run parallel. The resignation of the IT Manager further increases the risk of financial misstatements. | – Assess whether data transfer was accurate and complete. - Perform reconciliation of opening and closing balances between both systems.
- Identify transactions that might have been duplicated or omitted during migration.
- Discuss with management how post-implementation issues are being managed. |
| 4. Long-term Loan Compliance: Risk of breach of financial covenants that require a minimum total asset level. A breach would require immediate repayment, affecting going concern. | – Obtain a copy of the loan agreement and review compliance clauses. - Reperform calculations of total assets to assess the likelihood of covenant breaches.
- Evaluate management’s going concern assessment and seek confirmations from lenders.
- Assess whether reclassification of the loan to a current liability is necessary. |
| 5. Revaluation of Land & Buildings: Risk that the Finance Manager’s decision to revalue assets may not be in line with IAS 16. Incorrect valuation could overstate assets and mislead stakeholders. | – Verify that independent valuation experts were engaged. - Assess the competency and objectivity of the valuation expert.
- Inspect valuation reports and confirm compliance with IAS 16.
- Ensure disclosure in the financial statements is adequate
- Topic: Audit Approach
- Series: Nov 2024
- Uploader: Salamat Hamid