BAC3624 (2220) Advanced Auditing Tutorial 5 & 6 Q

TUTORIAL 5 & 6
Your firm has recently been appointed as the external auditor of Satria Sdn. Bhd.
(Satria) for the year ending 31 December 2022. The previous auditors did not seek
reappointment following the conclusion of the 2021 audit.
You are the audit senior and the engagement partner asked you to consider the
following two key areas of audit risk:
(1) Trade receivables
(2) Inventories.
During the audit planning, you have been provided with the following extracts from
the financial statements:
Statement of profit or loss for the year ending 31 December
2022 (estimated) 2021 (audited)
RM‘000 RM‘000
Revenue 125,500 108,137
Cost of sales (68,500) (64,007)
Gross profit 57,000 44,130

Statement of financial position as at 31 December

Current assets: 2022 (estimated) 2021 (audited)
RM‘000 RM‘000
Inventories 14,200 8,307
Trade receivables 15,500 9,222

In addition, the following information has been provided:

(a) Satria is a Malaysian-based producer of scientific instruments, for use in
hospitals and universities, which sells its instruments around the world. Each
year, the range of instruments is updated and presented in an online
catalogue which includes the selling prices. Customers either order directly
from the catalogue or agree a contract with Satria.

(b) Satria invoices customers in RM and requires payment within 30 days of the
invoice date. One major customer, Iriz Sdn Bhd (Iriz), is withholding payment
of RM1.3 million as it claims that the instruments it purchased are defective.

(c) Instruments are assembled, from bought-in components, to a standard

specification produced by the in-house design team. Components are
purchased from suppliers based in the Malaysia and overseas (China,
Thailand and India) who invoice Satria in their local currency. Satria operates
a perpetual inventory system for components and finished instruments.
Quantities recorded in the perpetual inventory system are checked by periodic
BAC3624 (2220) Advanced Auditing Tutorial 5 & 6 Q

counting throughout the year by the company’s employees. The company

does not undertake a full inventory count at the year end.

(d) The inventory system is fully integrated with the cost accounting system. The
cost accounting system records the cost of components, labour and
production overheads for each instrument.

(e) Each week, the inventory system generates an inventory valuation listing and
an aged inventory report. The inventory valuation listing includes the cost and
quantity on hand for each component and each instrument.

(f) During 2022, Satria experienced quality problems with components

purchased from one of its major suppliers, Kilau Sdn Bhd (Kilau). Satria
terminated its contract with Kilau on 30 September 2022 and switched to a
new supplier which charges higher prices for higher quality components.
Satria has not passed on these costs to its customers.

(g) The chief buyer had also exceeded reorder limits in respect of a number of
components in year 2022.

During the interim audit, the managing director of Satria requested that the audit
team completes the audit by 31 January 2023. The company requires the audited
financial statements to support an application for a bank loan to finance the purchase
of equipment. As an incentive to complete the audit to this deadline, the managing
director offered the audit team and their close family free use of Satria’s private box
for a premier league football match. He also offered to pay for the costs of travelling
and overnight accommodation at a luxury hotel following the football match.

Required:
i. Justify why the items listed as (1) and (2) in the scenario have been identified as
key areas of audit risk. For each item identified above, describe the audit
procedures that should be included in the audit plan to address those risks.
(21 marks)
Justification Audit Procedures
(1) Trade receivables may be overstated
because:
1. Iriz is withholding payment of RM1.3 1. Send direct confirmation of trade
million. It is material because this is receivables balances to debtors at the
1.04% of revenue. (1.3 mil / 125.5 mil X year end.
100)
2. Identify cash received from customers
2. AR turnover increased from 31 days in after 31 December 2020 which relates to
BAC3624 (2220) Advanced Auditing
2019 to 45 days in 2020.
3. Trade receivables days in 2020 is 45
days. Therefore, it is inconsistent with the identify the customers with overdue
credit terms of 30 days.
(Trade receivables / Revenue X 365
days)
[365 / (125.5 mil / 15.5 mil)]
4. Even if Iriz’s balance is excluded,
trade receivables days are 41.3 days in
2020.
[365 / (125.5 mil / 14.2 mil)]
5. Issues with the quality of components
may indicate potential disputes with other customers and solicitors and review
customers.
(2) Inventories may be overstated
because:
1. Inventory days have increased from
47.4 in 2019 to 75.7 in 2020.
[365 / (Cost of sales/Inventory)]
Tutorial 5 & 6 Q
trade receivables at the year end.
3. Review the trade receivables aging to
balances.
4. Inquire the management on the basis
of allowance for doubtful debts.
Recalculate the allowance for doubtful
debts.
5. Inspect contracts to ascertain if credit
terms have changed.
6. Inspect correspondence with
board minutes for evidence of any
disputes.
7. Inspect credit notes raised after the
year end for evidence of amounts
disputed at 31 December 2020.
8. Use data analytics to identify items for
further investigation, for example,
reproduce the receivables aging
analysis, and three-way matches
between sales orders, goods despatched
records and invoices.
1. Plan to attend an inventory count to:
i. evaluate and test the controls over
procedures.
ii. perform two-way test counts of
inventory (list to floor, floor to list)
BAC3624 (2220) Advanced Auditing Tutorial 5 & 6 Q

2. The gross margin has increased from iii. obtain details of the last goods
40.8% in 2019 to 45.4% in 2020 which is delivery and last despatch records.
inconsistent with higher prices changed
by the new supplier. 2. Follow up inventory count notes to:
[Gross profit/Revenue] i. ensure provision is made for slow
moving or obsolete inventory identified at
3. The annual update of the product the count.
range may result in some instruments ii. reconcile inventory at the count date to
becoming obsolete. the year-end figure.

4. There have been quality issues with 3. Review reports of previous inventory
components. counts, evaluate the level of
discrepancies and consider the
5. There was over purchasing by the implications for the reliability of the
chief buyer. inventory system.

6. Obsolete inventory will require write 4. Evaluate and test controls over
down to net realisable value. updates to the cost accounting and
inventory systems.
7. The standard costing system may be
inaccurate and may not reflect up to date 5. Inspect aged-inventory analysis to
costs of components and labour. identify slow-moving or obsolete items.

8. Production overheads may not reflect 6. For those items in inventory at the
the normal level of activity. year end, check post year-end selling
prices to determine whether net
9. The inventory system may be realisable value is less than carrying
recording incorrect balances due to value.
inadequate controls over the interface
between inventory and cost accounting 7. Review after date movements of over
systems. ordered items.

10. Foreign suppliers are paid in local 8. Discuss with management the basis of
currency and there is the potential for the provision for slow-moving or obsolete
translation errors. inventory to ensure there is appropriate
provision for Kilau inventory.

9. Obtain written representation that all

defective items are identified and written
down.

10. Obtain standard cost specifications

for each instrument and for a sample of
instruments by discussing with
 BAC3624 (2220) Advanced Auditing Tutorial 5 & 6 Q

management the basis of costings,

agreeing the cost of components to
suppliers’ invoices, vouching labour costs
to payroll, ascertain the basis of the
overhead allocation, and ensuring the
overhead allocation.

11. For a sample of items purchased

from overseas suppliers, recalculate the
foreign exchange translation and check
the rate used to a reliable independent
source such as referring to Bank
Negara’s rate.

12. Use data analytics to identify items

for further investigation, for example,
inventory items with negative margins
(cost greater than selling price), inventory
items that are slow moving, or inventory
items with the highest discrepancies at
inventory counts.

ii. Explain the ethical issues arising in respect of the offer of the free use of a
private box at a premier league football match and paid travel and hotel costs.
(4 marks)

iii. Outline the process set out by the ICAEW Code of Ethics that your firm should
have undertaken to obtain professional clearance from Satria’s previous
auditors. List the reasons for this process. (6 marks)