You are the senior auditor on the audit of Unique Furniture Manufacturers Pty Lt

Question

You are the senior auditor on the audit of Unique Furniture Manufacturers Pty Ltd (Unique). Your firm has recently been appointed as the first auditors of the company. You interview the managing director of the company to obtain background information on Unique and to understand its business operations, its environment and system of internal control. Unique was founded 30 years ago and makes ‘grandfather’ clocks (freestanding, weightdriven, pendulum clocks). The clocks are made in one factory (situated in the Blue Mountains) and are distributed through boutique homeware and antique furniture stores. The clocks are advertised mainly in local newspapers and through pamphlet drops. In order to promote longer production runs and minimise finished goods stocks, Unique’s retail distributors are offered stock on a ‘sale or return’ basis. This means that the homeware and antique furniture stores are invoiced immediately, subject to a 90-day term of payment, but are allowed to return the stock up to 30 days before payment is due. Only the marketing manager has been given the authority to make these offers.All of Unique’s timber is obtained from offshore sources. Timber prices, which are denominated in US dollars, have risen substantially over the past two years and the recent drop in the value of the Australian dollar has caused them to rise even further. Timber purchases are secured by providing Unique’s suppliers with letters of credit which become due when the container shipment of timber arrives in Australia. Labour costs are high due to the craftsmanship and quality required for the production of the grandfather clocks. Skilled labour is not easy to obtain and wage rates have recently risen. Unique has found it difficult to pass on these timber and labour price increases to customers. An analysis of costs indicates that there have been material negative purchase price variances inpurchases of timber over the course of the year.

You have compiled the following information fromUnique’s financials:
the current ratio as at 30 June 2014 is 1.24
on an annualised basis, net sales are $350,000
the shareholders’ funds to total assets ratio is 30%
gross profit margins and net profit margins for the year ended 30 June 2014 have dropped to the
level where losses are being incurred.

Unique’s bank finances the company’s timber purchases using bills of exchange drawn at 90 days from
the date of payment of the shipment. It has also extended loan finance to Unique. The bank covenant,
which is due for review shortly, requires Unique to:
maintain a current ratio of 1.2
maintain a shareholders’ funds to total assets ratio of at least 30%
maintain net sales of a minimum of $100,000 per quarter
prepare a general purpose financial report for the year ended 30 June 2014 and have it audited
according to Australian Auditing Standards. Note that this is a requirement of the bank covenant
as Unique is not required to produce a general purpose financial report under the Corporations
Act.

Required
For parts (a), (b) and (c) of this question, please disregard all going concern considerations. Based on
the background information above and your use of preliminary analytical procedures, answer the
following questions:
(a) Identify and explain two (2) asset accounts at risk of material misstatement.
(b) Describe one (1) issue regarding the prior year’s figures.
(c) Describe three (3) factors that may bring into question the going concern assumption for Unique.
Disregarding the evaluation of management’s assessment of the going concern assumption,
briefly describe the effect of the facts on your audit planning.

Explanation / Answer

a). The asset accounts subject to material misstatement are Accounts Receivable and Inventory.

b). The net sales of the firm are below the bank’s required benchmark level. The firm is incurring losses both due decline in margins and decline in sales and receivables/inventory of the firm have increased.

c). The three factors that may bring into question the going concern assumption for Unique are:

i. The firm is incurring continuing losses due to decline in operating margins and due to decline in sales.

ii. The sales of the firm are low but the variable costs like wages are increasing and skilled labour is hard to find.

iii. The timber is procured from offshore sources and the rise in price of timber denominated in US Dollars and drop in value of the Australian Dollar is expected to sharply increase the costs.

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