Glisten plc

I have been given an opportunity to audit Glisten plc, which

produces snacks. The company is listed on Alternative Investment
Market (AIM) at London Stock Exchange. As this is my first audit,
therefore I will take all possible measures that are essential to carry
out effective audit for the company.

ISA 300 states that auditors should obtain an understanding of the accounting
and internal control systems sufficient to plan an audit and to develop an
effective audit approach.

1. Control over stock and work in progress:

Company is engaged in manufacturing business, stock includes raw material,

consumables, finished goods and goods for resale. The stated amounts should
represent all and only existing stock and work in progress. It must be valued on
acceptable basis and an adequate provision should be made for foreseeable losses. It
should be assured that stock and work in progress presented in the financial
statements in accordance with the Companies Act and accounting standards.

2. Control over revenues and purchases:

All transactions should require authorization by an appropriate responsible person

with authorized limits. For example all credit sales must be approved by credit control
department, all overtime should be approved by the works manager and higher
purchases must be approved by the chief accountant.

3. Assigning of Responsibility

Delegation of responsibility should be clearly specified. Every function should be in

the charge of a specified person who might be called the responsible official.
Keeping of petty cash should be entrusted to a particular person who is then
responsible and answerable for that function.

4. Transactions Records:

Completeness of transactions it should be ensured by internal control that all

transactions are recorded and proper and valid paper documents are available for all
expenses.
Accuracy and validity the assurance that the expenditure is proper expenditure of the
business made for legitimate business reasons and is correctly described in the
accounts.

5. Treasury procedures and review of banking arrangements

Treasury has increasingly become a strategic business partner across all areas of the
business that adds value to the operating divisions of the company. As an auditor I
want to see strict internal control over treasury procedures like borrowings,
repayments, investment portfolio and working capital procedures.
6. Segregation of Duties

One person should not be responsible for the recording and processing of duties.
Involvement of many people reduces the risk of intentional manipulation or error and
increases the element of checking. Functions which should be separated include
authorization, execution, custody, recording and in case of computer-based
accounting system, systems development and daily operations.

7. Custody of Assets:

Physical custody of assets and procedures and security measures designed to ensure
that access to assets is limited to authorised personnel. Access can be direct, e.g being
able to enter the warehouse or indirect access via documentation e.g personnel
knowing the correct procedures, may be able to extract goods by doing the right paper
work.
Examples are locking of securities (share certificates etc) in a safe with procedures for
the custody of use of keys. Use of passes to restrict access to the warehouse. Use of
password to restrict access to particular computer files.

Task 2: Preliminary Judgment about materiality.

The second part of my assignment is to determine the preliminary judgment about

materiality for the company. Materiality refers to the quantitative and qualitative
omissions or misstatements that make it probable the judgment of a reasonable
person would have been changed or influenced. These omissions or misstatements
can be material individually or in the aggregate. Assessment of materiality is
important in planning the audit and in evaluating truth and fairness of the financial
statements. The assessment that I will made may differ from the materiality levels
used at the conclusion of audit in evaluating the audit findings, because the
surrounding circumstances may change and the additional information about the
entity will have obtained during the course of the audit.

Materiality judgements involve an assessment of both the amount (quantitative) and

the nature (qualitative) of the misstatements. At this planning stage I will only
consider the misstatements that are quantitatively material.

Risk Assessment:

In developing a rational audit approach I have exercised professional skepticism that

demands a critical assessment of audit evidence. I also considered risk relating to the
company. As this was my first audit I reduced the materiality level. The reason for
reduced aggregate materiality levels is the increased probability that several accounts
or transaction classes might be misrepresented in order to effect concealment of the
initial misrepresentation.

Inherent risk and control risk related to the company set to be high that suggest less
reliance on internal control. I relied more heavily on external evidence such as
confirmations, physical inspections, calculations and reconciliations.
Materiality for Income Statement:

For the income statement materiality could be related to revenue or to profit.

Company’s net income shows negative figure a loss of £675,000. I consider any
misstatement of over £700,000 would be material for income statement as it will
convert the loss figure into profit.

Materiality for Balance Sheet:

Based on the total assets of the company the estimated errors totalling £800,000 or
1% of total asset would be material for balance sheet.

Aggregate materiality:

For planning purposes I consider £700,000 to be material for any one of the financial
statements. If any one of the financial statements errors totalling exceeds this figure, it
will be considered materially misstated.

Task 3.

Materiality levels judged in part 2 are further classified on individual basis that means
the impact of a single misstatement on the financial statements. I also considered
aggregate materiality that is the total effect of two or more misstatements, each of
which is not material by itself. In this third part I allocated the materiality to the
relevant accounts and set a tolerable misstatement for each account. The tolerable
error is the minimum misstatement that can exist in an account balance for it to be
misstated.

Allocation of Materiality to Income Statement Accounts

Revenues:

Although revenue figure does not fluctuate considerably if compared with previous
year. But still possibility of misstatement of the figure is high. Revenue amount could
be highly overstated or understated. Any overstatement or understatement of 50% of
aggregate materiality i.e £350,000 will be material and revenue will be considered
misstated.

Cost of Sales:

Cost of sales £58.6m represents 80% of total revenues that lowers the profit margin of
the company. As an auditor I suspect an overstatement of this figure. It can misstate
the profit figure sizeably. Some precise measures are needed to evaluate the reliability
of the stated figures because it directly effects the profits of the company. Therefore
low materiality levels are suggested and any misstatement over £300,000 is
considered as material.
Finance Cost:

The group holds an interest hedge over £23m of its debt to bring stability to its
financing costs. These hedges are classed as derivatives. The marked to market fair
value of this hedge at the year end was a liability of over £4m which give rise to the
finance cost of the company to £6 million. There is a probability of misstatement of
this figure due to its importance. As compare to previous year it shows an abnormal
increase, that raise the chances of overstatement of figure. With low materiality level
an amount of £50,000 is considered material which is 7% of aggregate materiality.

Table: Materiality to Income Statement Accounts

Account Materiality Allocation

Amount (£) (%)
Revenue 350,000 50%
Cost of Sales 300,000 43%
Finance Cost 50,000 7%
700,000 100%

Allocation of Materiality to Balance Sheet Accounts

Allocation of the preliminary judgement about materiality to the accounts level
depends on relative size and importance of the accounts.
I expect certain accounts to be audit 100 percent. These accounts are cash, intangible
assets and line of credit. These accounts are not sample accounts. Audit sampling is
an audit procedure to less than 100 percent of the items within an account balance or
class of transactions for the purpose of evaluation.

Goodwill and other intangible Assets:

The carrying amount of goodwill is based on the company’s cash generating units.
Goodwill is valued on assumptions of forecasted profits, growth rates and discount
factors. Significant fact is that the amount of goodwill is more than half of the total
assets amount. I expect there is more chances of materiality to be overstated.
Therefore it will require a 100% audit.

Cash and Bank balance:

I expect no errors in cash and bank balance as these are very important for liquidity
consideration of the company. Any error in cash can mislead investors decision.
Therefore I suggest zero materiality and a 100% audit.

Equity:
Equity figure needs to be accurate and I expect no error under this head. This account
needs a 100% audit.

Inventories:
Inventories represent 10% of total assets and this amount does not vary noticeably
from previous year. There are possible chances of errors in the inventory figure and
cost of detection is higher. An error upto 30% of aggregate materiality i.e 200,000/- is
estimated to be maximum misstatement in this account.

Property, plant and equipment:

I expect few errors in property, plant and equipment figure. There are acquisitions,
additions, disposals and accumulated depreciation in this head. An 8% of aggregate
materiality i.e 56,000 is the maximum tolerable amount for this account.

Trade and other Receivables:

It represents 15% of total assets. Any understated or overstated amount can
significantly misrepresent the balance sheet figure. Keeping in view the previous year
figure the estimated limit for any misstatement is amounted to 250,000 which is 35%
of aggregate materiality.

Long-term & Short-term Liabilities:

Financial Liabilities:

The group holds an interest hedge over £23m of its debt to bring stability to its
financing costs. These hedges are classed as derivatives. The marked to market fair
value of this hedge at the year end was a liability of over £4m which give rise to the
finance cost of the company to £6 million. There is a probability of misstatement of
this figure due to its importance. As compare to previous year it shows an abnormal
increase, that raise the chances of overstatement of figure. With low materiality level
an amount of £35,000 is considered material which is 5% of aggregate materiality.

Borrowings:

Company has three loans and overdraft facility from banks. Bank loans due after one
year showed £24m. Materiality is presumed to be zero and a 100% audit required for
this head.

Table: Materiality Allocation:

`

Account Materiality Allocation

Amount (£) (%)
Inventories 245,000 35%
Trade and other receivables 350,000 50%
Property, Plant & Equipment 70,000 10%
Financial Liabilities 35,000 5%
700,000 100%

This allocation is made on the basis of expected monitory misstatements and audit
costs. Larger materiality allocations are made to receivables and inventories as I
expect more misstatements in these accounts and also the cost of detection related to
these accounts is high.
Task 4:

As I mentioned earlier materiality levels are subject to revised or reallocate as the

audit work proceeded. I allowed greater proportion of the total allowable
misstatements to remain in those accounts where it would be most expensive to
detect the misstatements.

On the basis of evidence and information I gathered from the work I have performed I
need to reallocate some portion of materiality to accounts.

Controls over Revenue and the Purchasing:

During the audit of the company I found that the company has adequate controls over
its revenues. Sales registers for Cash and Credits are maintained separately with
supported documents. All credit sales are authorized by credit control department that
also maintains a record of receivables. Therefore there are less chances of
misstatements and the maximum misstatement in revenue account is estimated to be
£250,000 that was previously £350,000.

On the other hand in purchasing process I found some weaknesses that need to be
adequate. Some large amount purchases need to be verified from external sources. I
expect some overstatement that will effect the cost of sales. Therefore materiality
levels need to be high. The maximum tolerable misstatement figure is increased by
£100,000 i.e from £300,000 to £400,000.

Controls over Inventory

Inventory figure includes raw material, consumables, finished goods and goods for
resale. The stated amounts represent all and only existing stock and work in progress.
Adequate provisions are made for foreseeable losses. I found reasonable evidence that
stocks and work in progress presented in the financial statements in accordance with
the Companies Act and accounting standards. The maximum misstatement in
inventory account is estimated to be £250,000.

Controls over additions to plant, depreciation and impairment

Property, plant and equipment are stated at cost less depreciation. Depreciation is
provided at rates calculated to write off the cost of fixed assets less their estimated
residual value over their expected useful lives. Any addition or disposal require
approval by concerned department. Additions of £2 m has been made during the year.
Disposals also show a large figure for the year. All additions, depreciations and
impairments has made according to the rules.

Controls over the valuations of financial instruments

Financial instrument of the company comprise borrowings, some cash and liquid
sources and items such as trade receivables and trade payables that arise directly from
its operations. The purpose of these financial instruments is to manage the finances of
the company’s operations. Loan and receivables are non financial assets with fixed or
determinable payments that are not quoted in an active market and are included in
current assets. Financial liabilities are carried at amortized cost. Company has good
internal control procedures to value these instruments. I expect less errors under this
head.