Auditing - Whittington, Sparrow & Co.

Whittington, Sparrow & Co.

Student guidance for the completion of this assignment:

§  You are required to act, for the purposes of the case study, as a professional external auditor. This means responding in a professional and business like way to all tasks set

§  All means of communication used will be assessed as if produced in a real life situation and they must be prepared by you as if being communicated an actual business client

§  Where evaluation or judgements are required always use acceptable yardsticks (legal rules and / or audit standards) to measure against. Further, when critical appraisal is required and subjective judgement necessary always try to explain your point by using realistic examples

Part 1:

Whittington, Sparrow & Co. is a firm of chartered accountants and registered auditors operating from offices in central Manchester. You are employed as an audit manager for the firm.

Simon Blake Ltd (Blake’s) is a company specialising in the manufacture and installation of reception masts and electronic components used in the industrial and domestic power generation and wind farms industry.

Whittington, Sparrow & Co. has been invited to tender for the external audit of Blake’s.

Justin Whittington (your firm’s senior audit partner) has expressed his keenness in the success of the tender. This would serve to expand the firm’s business in this high growth area and dilute the total of audit fees. The firm has a single client, the recurring audit fees from which; last year, accounted for 12.5% of total audit fees and, for this reason, Justin has recommended that a very competitive price be offered.

The original invitation to tender came after a discussion between Justin Whittington and Carol Bond (the chief accountant for Blake’s).

Carol Bond trained at your firm and was a senior member of the audit staff before leaving to set up in business on her own 4 years ago.

The original discussion disclosed the following information:

• Blake’s has, until this year, been exempted from the requirement for statutory because annual turnover had peaked at around £6.0m. Carol, acting as external accountant to Blake’s, had been engaged to prepare an annual independent financial statement review and statutory returns for Companies House and the Inland Revenue

• Due to a significant increase in demand for Blake’s products and services over the last two financial years, it is expected that, for the current year, the statutory exemption will be removed. As a result of the growth, Carol became chief accountant for Blake’s 2 years ago and, with the support of two junior staff, has commenced the development of a number of internal audit initiatives

• There are 10 shareholders in the company, all drawn from the Blake and the Glossop families. Chris Blake and Denise Glossop work full – time for the company; involved in day – to – day management operations. The rest of the shareholding is on an investment finance basis only

§  Today’s date is 1^st August 2013 and the company’s accounting year – end date is 30^th September 2013.

§  A meeting has been arranged between your firm and Blake’s (in one week’s time) the objective being to present and clarify the legal and practical requirements of the statutory audit to management and to outline the basis of audit fees (with a view to helping secure the engagement)

Required for part 1:

1.1     Prepare explanatory notes to support your forthcoming presentation to the management of Blake’s. Your notes should include explanation of:

a.       The legal rules relating to the statutory audit – including the small companies exemption and corporate governance requirements

200 - 10%

b.      The nature, purpose and scope of the external audit and the difference between the statutory audit and the independent financial review

300 - 10%

1.2     Explain:

a.       The purpose of the threshold placed on a single audit fee as a proportion of total recurring audit fee income

200 - 5%

b.      An appropriate basis for audit fee setting and any issues you feel may arise through competitive tendering

200 - 5%

Total for part 1

Part 2:

Thanks, in part, to your clear and informative presentation and competitive fee structure, Blake’s has engaged Whittington, Sparrow & Co. as external auditors for the current year.

Through subsequent meetings, communications and investigations, the following information has emerged:

Chris Blake:

Chris is the sales director and, with an office of eight staff, controls all dealings with the company’s customers. This includes:

§  Sales contract negotiations

§  Product distribution and installation (including the sub – contracting of specialist labour)

§  Sales invoicing and chasing outstanding payments

§  Banking customer receipts

§  Maintenance of the sales ledger (using spreadsheets)

Chris spends most of his time on the road and delegates much responsibility to Barbara Chipley, the senior sales manager. David is actually brother to a colleague auditor at your firm.

Denise Glossop:

Denise is the production (works) manager. The production office employs 5 staff and is responsible for all supplier relations including:

• Raw materials ordering, delivery and stock control

• Production scheduling and machinery maintenance

• Factory workers (60 direct labour employees)

• Dealing with purchase invoice receipts and supplier payments

• Maintenance of the purchase ledger (using spreadsheets)

Denise spends all of her time at the factory / office site. Purchasing requirements and production scheduling is based on future sales order requirements discussed with Barbara Chipley at weekly planning meetings. Denise is the only authorised signatory of company cheques.

Carol Bond:

Carol Bond is the company accountant and will ultimately be responsible for the preparation of the year – end financial statements. The accounting function is a sub – section of the business administration office (manager Tom Plant). Carol’s main responsibilities are:

§  The co ordination of the financial activities of Chris Blake and Denise Glossop to produce monthly management reports (from spreadsheet print – outs)

§  Control of the payroll function and paying wages

§  All dealings with the business bankers

Blake’s employed Carol as a result of the growth in activity and a requirement for more specific control of the financial function. Her first task was the preparation of a forecast income statement and statement of financial position. This allowed her to become familiar with all of the business operations.

Internal audit work currently consists of testing sales and purchasing operations, through documentation, to the accounts, and reconciliation’s for receivables, payables and bank accounts.

She admits that the on – site directors largely control operations (as they always have) and do not fully understand audit and the internal audit function although she does not doubt their integrity in business matters.

The accounting system is not really appropriate for the size of the business. It is hoped that a new (bespoke) system will be developed and installed early next year.

Required for part 2:

2.1     Discuss any matters you may feel arise from the information provided above. Your discussion should include consideration of:

1. Family links between auditor and client

200 - 4%

1. Internal control systems, their effectiveness and internal control risks

300 - 8%

1. The audit expectation gap and the purpose of the letter of engagement

200 - 4%

2.2     Prepare the letter of engagement for the approval of the Board of Blake’s (dated 25^th August 2013)

N/A - 4%

Total for part 2 - 20%

Part 3:

Assume that today’s date is 15^th October 2013.

The draft financial statements for the year ended 30^th September 2013 have been prepared and you have obtained additional relevant information (see appendices A and B).

Required for part 3:

3.1     Examine the financial data provided at appendices A, B and C and:

1. Extract and analyse any (auditor generated) information that you may feel relevant for the purposes of analytical review and audit risk (all workings must be shown)

N/A - 20%

1. Explain the term ‘materiality’ and the importance of dis – aggregation as part of analytical review

200 - 5%

3.2     Audit planning for the audit will take a risk – based approach involving a detailed analysis of Blake’s internal control systems

1. List and explain the four risk elements of audit (including possible sources of evidence for each element)

300 - 5%

1. List and describe 5 methods that the auditor may use to generate internal control systems audit evidence and how you would apply the methods described in your work for Blake’s

300 - 10%

3.3     You have been made aware of Carol Bond’s internal audit aims for the organisation

1. Describe the circumstances where the external auditor might use the work of others as a means to obtaining audit evidence and the extent to which the work of others can be relied upon

300 - 5%

1. Discuss the extent to which you might use the Carol’s work

200 - 5%

Total for part 3 - 50%

Assignment total – 100%

Appendix A:

Edward Blake Ltd

Income statements

for the years ended 30^th September:

2012

2013

2013

Actual

Budget

Draft

£000

£000

£000

Turnover

6,850

7,200

7,000

Manufacturing costs

(4,380)

(4,320)

(4,200)

GROSS PROFIT:

2,470

2,880

2,800

Distribution costs

(500)

(436)

(390)

Administrative expenses

(740)

(644)

(1,165)

OPERATING PROFIT:

1,230

1,800

1,245

Interest and similar charges

(100)

(220)

(180)

PROFIT BEFORE TAX:

1,130

1,580

1,065

Taxation

(300)

(470)

(235)

PROFIT AFTER TAX:

830

1,110

830

Edward Blake Ltd

Statement of financial position

as at 30^th September:

2012

2013

2013

Actual

Budget

Draft

£000

£000

£000

Fixed assets

3,420

4,800

4,600

Inventory

420

470

725

Accounts receivable

600

690

780

Bank and cash

100

200

Total current assets:

1,120

1,360

1,505

Accounts payable

460

530

660

Interest

25

40

45

Taxation

75

100

70

Bank overdrafts

120

Total current liabilities:

(560)

(670)

(895)

Net current assets:

560

690

610

Total assets less current liabilities:

3,980

5,490

5,210

Long -term debt

(1,200)

(2,200)

(1,500)

Net assets:

2,780

3,290

3,710

Shareholders’ funds (Appendix B)

2,780

3,290

3,710

Appendix B:

Reconciliation of Shareholders’ Funds

2012

2013

2013

Actual

Budget

Draft

Reconciliation of shareholders funds:

£000

£000

£000

Ordinary share capital (£1 ordinary shares)

2,000

2,500

3,500

Revaluation reserve (land)

100

100

Retained profits B/fwd:

700

780

780

Add profit after tax

830

1,110

830

Dividends (paid and proposed)

(750)

(1,200)

(1,500)

Retained profits c/fwd:

780

690

110

Shareholders’ funds c/fwd:

2,780

3,290

3,710

Appendix C:

Condor & Viper (Financial analysis)

Industry average

Power generation - manufacturing

as at 31st December 2011

Gross profit margin

37.50%

Net profit margin (operating profit)

20.00%

ROCE (total capital employed)

25.00%

Interest cover

9 times

EPS

35p

Dividend per share

40p

Average receivable (days)

35 days

Average payable (days)

40 days

Average inventory turnover (days in stock)

40 days

END of ASSIGNMENT