1813728, 249 PM TestRieach Briefing note To: Ted Hastings, audit engagement partner From: Audit manager Subject: Audit planning - Mercurio Co Date: 1 July 20X5Hello Introduction The purpose of writing this brief note is to evaluate the significant business risks and risk of material misstatement in planning the upocoming audit .Further this notes includes the impact of outsourcing on auidt planning and audit procedures on holiday obligation (a)Evaluate the significant business risks faced by Mercurio Co.(8 marks) Import Restrictions/welfare standards ‘Some stores sell more unusual pets such as spiders, snakes and other reptiles and require compliance with specific import restrictions and welfare standards, if Mercurio CO fails to comply with the requires restictions an welfare standards they might fine with huge penalties and cosniderg this is a listing comapny it might affect the reputation and the goodwill it has as it is been estanblished almost 15 years ago and is one of the largest reatlier of pet related products in the country Cost rising The costs associated with the vaccinations and health checks have risen over recent years, Mercurio. Co has not been able to increase the prices due to customer price sensitivity over annual pet healthcare plan. This will impact Mercurrio Co's profitbaility as it squeeze the margins .This will result in Mercurrio co not able to buy the required vacinartions and unable to provide health checks to their customers. this cost keeps rising this will later comes to the attention of customers and customers might switch to the competitors health plans.Considerng the plan revenue accounts to 10% of the total revenue.Mercurio should take neccesary precautions to meet the loss. Trade receivables Trade receivable has increased by $20M which is 90% increase . The increase in receivables will adverlsy affect on the Mercurio co's liquidity .The receivable days has increased from 10 days to 19 days, This increase in receivable days will affet the working capital .as it taken more days to get the cash in hand . Also the purchase of stores from Lakewell was made thoruth cash which is evident that the cash balance has reduced by 45MS. Therfore it can be concluded that MErcruio co cash flow position is worse , New business The introduction of mercurio range will have a risk on compliance with legal and regulatory requiement of the foreign counrty inorder to manfacture , the non complaince will put Mercurio into |itiagtion which will impact the image of Mercurio . The other risk assocuiated with introduction are , the risk of importing goods which might result in damage and also the exposure the forex risk as it expected to accoutn30% of revenue in futre , The volatitiy in forex rate will cause huge impact on both cash flow and profitability of Mercurio Gearing Risk hitpssicbept accaglobal.comir-candidalolexam 141329, 249 PM TestReach The gearing level of Mercurio is worse ,as it has increased by 181% .The increasing in gearing level will put Mercurio Co in a position that banks will be reluctant to provide loan further . This will be among one of the reason that will result in declining the profit beacuse of the amount of finance cost involved (b)Evaluate and prioritise the significant risks of material misstatement which need to beconsidered in our audit planning, Materiality Overalll materiality to be based on the company's profit before tax as this is a key measure for investors and providers of financ. The PBT for the year is $60M. The materiality range for PBT is from 5%(lowest end) to 10%(Highest end). 5 %PBT is $3M and 10% of PBT is $6M. Considering this is a recurring client and have an idea /kownledge about the business, materiality level cant befixed with lowest end (5%) . Also considering the exhibits therefurther risk indicators invioved ,therfore materiality cant be fixed at higher end(10%). Thus it is logical to set the materiality level at 7% of PBT which is 42 Annual pet healthcare plan The annual income from plan accounts for 10% of company's revenue which is 80.3M (803*10%).Thus it is material to FS as it exceeds the materiality threshold stated above, Revenue should be recognised when the performance obligation is satisifed. With respect to Mercurio,the plan covers the quarterly health checks and essential vaccitnatiosn ,therefore only after performing the required checks and vacctions Mercurio is aloowed to recongise the income from plan as Revenue -The risk here ithat company's policy of recongising revenue will result in ealry recognition which will result in overstatetment of revenue which can be explained by the 7% increase in revenue over the last year Stores purchases The store purchases from Lakewell of 174M is material to FS , as it exceeds the materiality threshold The intention of managemnt at year is important ,as if stores are retained it should be classifes as PPE and if planning to selll it sgould be calssifed as asset held for sale . If management intend to sell them within 12 months after reclassfication and meeting the other required to classify as held for sale , it hsould be vaued at lower of cost and FV less cost of disposal. Therfore if managemnt does not claasify it properly ,it will result in under/overstatement of PPE or assets held for sale Trade receivabl The trade receivable balance of 42M is material to FS in accordance with threshold defined above. The increase in receivables will result in risk of inapropriate valuation receivbables this might be dure to customer struggling to pay or over due inovices. Goods in transit The purchase made for pet food supllies for $12M is material FS as in accordance with threshold stated above . As the ownership is passed when at date of shipping ,therfore the damged goods are considered as Mercurio CO inventory .Inventory should be valued at lower cost or NRV as it seems that entir suplly of goods is destroyed therefore NRV will be 0. INcorrect valuation of inventory will result in overstatement of closing inventory and profits Insurance hitpssicbept accaglobal.comir-candidalolexam 2141923, 248 PM TestReach The 80% of goods destroyed accounts to 9.6M wich is material to FS as in accordance with materiality threshold defined above.Dislcoure on notes to FS should be provided when it is probable that the claim amount will be recevied and receivables can only be recongised as when it is virtually certain As the latest correspondace with insurance company confirms that Mercuio should provide disicure on the conitngent asset with 9.6M. The risk involved her is Mercurio might not proivide dislocusre on the contigent asset which will matrially misstate the FS Holiday pay obligation The forecat holdiaypay obligation for the year is 21.1M$ which is material to FS as in accordance with materiality thershold defined above .There is a risk of management bias , as management tries to understate the holiday pay inorder to reduce the payroll expense and hence can increase the profit Management estimates is an inherent risk, though there is an increase in 82% management might massaged figures inorder to attract the FS Payroll system As the control in payroll system is weak ,as there seems to be fictious employees in the payroll system which seems to hae happend due to the collusion of two system .Such weakness will result in overstaing payroll expenses at large considerng payroll expense has a mterial nature in the FS. Though there is system capable to record holdiarys ,employees are prefering the manual process to record ,which might lead to employees manually recording for hours they didnt work inorder to get the desired pay Forex risk The pruchase from foreign supplliers are predicted to be $7M which is amterial to FS as it exceeds the materiality threshold stated above Forex trasncations, initally recongised at rate at the date of transcationd and should be retranslated at year end ,there is a risk that wrong exchnage rate are used which will result in over/unserstateing the pruchase balances The amount of bank loan taken has increased from 75M to 251M which is an increase of 176M, which is material to FS as it exceeds the materiality threshold . This is a risk of management bias .The mangement might took the loan inorder to manipulate the figures in the FS ,as Mercurio is a listed entity and is the largest retailer in the country ,they might manipuate the figues which investors is interested in knowing .One of the idncator of manipulating is the unexceptional increase in Operatimg profits which not notes or justification is been provided nelusion Business risk has been priortised on the basis impact on reputation being a broader issue followed by profitability and Igiudity as Mercurio is a listed enity and shareholders are interested in more on profits Risk of material missatetements is prirotised on the basis of their quantitative materiality taking each risk in the order of how significant it to the overall materiality level defined by the auditor (c)Discuss and conclude on the impact which outsourcing the credit control function will have on our audit planning,(7 marks) The outsorucing of credit control function will impact the audit planning if it is material or not , consideimg the trade recievable is $42M and the materiality threshold stated in the brief note is Ips: accaplbal com/t-canddaalexam aa1813728, 249 PM TestRieach $4.2M can conclude that it is material to fs Audit team should thoroughly read the agreement between Fairbank and Mercuro to identify the terms and conditions to know the scope of the function which fairbank will be offering Audit team should also esnure whether FairbankCO is involved in taking management decision like identfying which balances should be written off Audit team should be aware of any reports that is been preented by Fairbank to Mercurio on recovery or bad debts Aduit team should evaluate the competence ,expericnces and market standing of Fairbank inorder to confirm reilaibile or not Audit team should also consider whether is there any need to visit the serivce orgainsation to gather evidence , to discuss with management , to test controls at fairbank so that team can rely on them Audit team should need to confi whether any extra resources should be deputed to visit ther serivee orrgansiation ,also extra finding extra time..Audit team might need to alter the timetable accordingly In conclusion , the outosorucing of credit control fucntion is material to FS and careful attention at planning stage should be given to identify the relvent procedures need to performed for service organisation (d)Design the principal audit procedures to be performed in respect of the holiday payobligation.(7 marks) Follwing are the principal audit procedures to be performed in respect of the holiday payobligation + Review the HR policy to confirm that emplyees are allowed to carry forward maximum of 3 days unsused holiday to the next year + Discuss with Mercurio co's management the rationale of the basis calcuation of holiday pay obligations to confirm its reasonableness * Confirm prior year obligation is used for calcuating the current year obligation by reviewing the prior year FS + Confirm the pay rises to HR doscumets for evidences of the pay rise and how much is the pay rised over the last year * Discuss with HR manager the changes in staff level during the year and the business rationale for changes to confirm number of changes in staff + Recalculate the forecast holiday pay obligation for 30 sept 20x5 to conifrm it is accurate + Seek a written reprsenation from manegment to confirm the completeness of holiday pay obligation hitpssicbept accaglobal.comir-candidalolexam 4