Section 2- To be completed by the ‘Audit Senior’ of the Audit Team

 Subsidiary 2 – Fashion Designers Limited (Case for Audit Senior)

You are the audit senior of Fashion Designers Limited, a subsidiary company of Las Vegas Group Corporation (USA) Limited. Fashion Designers Ltd is a large multi-national manufacturer and distributor of fashion accessories.

The company is listed on the New York Stock Exchange and its major shareholder (51%) is the US Company which controls the use of the accessory brand names throughout the world. Fashion Designers Ltd operates predominantly out of Australia but is rapidly expanding into Asia and Eastern Europe. In 1992 overseas operations accounted for 15% of the group turnover and 10% of the Group profit. In 1993 this is expected to increase to 23% of turnover and 18% of profit. As the American market is considered to be stagnant, future growth is expected to come from the Asian and European markets.

The audit structure is such that all overseas operations are audited by the same international audit firm, XYZ & Co, who were the auditors of the major US shareholder. Your audit firm, DisneyLand Audit & Co, is responsible for the audit of all the American branches.

The consolidated Statement of Financial Performance and Statement of Financial Position for  Fashion Designers Ltd for the year ended  31 December 1992 and the estimate for the canting  year ending 31 December 1993 are as follows:

Statement of Financial Performance

	Estimate	Audited
	31112/93	31/12/92
	$’000	$’000
Operating profit before abnormal items	113220	86974
Abnormal items	-17050	–
Operating profit before income tax	96170	86974
Income tax expense	-25970	-24720
Operating profit after income tax	70200	62254
Retained profits at the beginning of the year	114257	52003
Dividends paid	-53274	–
Retained profits at the end of the year	131183	114257
Statement of Fi	nancial Position
Current Assets
Cash	21720	24915
Receivables	391278	352307
Inventories	189702	153978
Total Current Assets	602700	531200
Non-Current assets
Property, plant & equipment	573291	495973
Investments	8357	21952
Brand names	474852	398115
Total Non-current Assets	1056500	916040
Total Assets	1659200	1447240
Current Liabilities
Creditors & borrowings	587294	401253
Provisions	170446	219077
Total Non-current Liabilities	757740	620330
Non-current Liabilities
Creditors and borrowings	392877	360112
Provisions	79803	68328

 

Total Non-current Liabilities	472680	428440
Total Liabilities	1230420	1048770
Net Assets	428780	398470
Shareholders Equity
Share Capital	101908	101563
Reserves	195689	182650
Retained Profits	131183	114257
Total Shareholders Equity	428780	398470

 

The abnormal item relates to the loss made on the sale of an investment during the year. ‘Brand names’ relates to the price paid for the brand names purchased from the major shareholder. The asset is not being amortised as the company believes that asset to be a tangible asset with a value which will never decrease below that paid due to the proven success of the brand names worldwide for over half a century.

The stock valuation system used by Fashion Designers is an average costing system. Each time a delivery is entered into the stock system, the system automatically uses the new cost and the current average cost in the computer to calculate a new average cost.

All stock is physically counted at balance date and then the average cost in the computer is applied to the units on hand to calculate the year end inventory valuation. Fashion Designers also runs several fashion accessory stores. The inventory in the stores is valued using the retail inventory method.

As an Audit Senior of your Audit team, you are required to complete the following:

• A) Set a group materiality level based upon the estimated 31 December 1993 figures.
• B) Prepare a memorandum to the audit partner detailing the procedures required regarding reliance on the audit work performed by XYZ & on the overseas operations.
• C) What audit procedures would you adopt to verify the carrying value of the brand names?
• D) Assuming you disagree with the non-amortization of the brand names to the extent that a qualified audit opinion is required, what type of qualification would you issue?
• E) Prepare an audit strategy document outlining the audit procedures which should be adopted in the verification of the stock valuation assumption of Fashion Designers and each of its retail
• F) You have ascertained and recorded the system of internal control and decided that you wish to place reliance on the controls in many The results of your compliance tests on purchases and stocks reveal that:

1. i) Out of I 00 purchase invoices selected for inspection, 2 could not be found and 2 were not initialed as checked and approved for

1. ii) Out of  120  stock  cards inspected, 4 contained an  instance  where the delivered quantity had been altered by a significant
2. iii)         One supplier is regularly paid before supplies are delivered on the basis of pro forma invoices which are processed through the creditors’ ledger system on receipt so as to initiate the necessary payments.

No other exceptions were noted.

I) Outline what further procedures should be carried out in order to be able to reach a conclusion on whether the company’s  system of internal controls can be relied upon, indicating what factors you would consider in reaching your

 

H) Having reviewed your files you find that previous management letters have outlined the problem that one supplier is being paid based on pro forma invoices prior to delivery. No action has been taken by management to rectify this problem. What should be done about this?

G) The credit controller of Fashion Designers Ltd has provided you with an aged debtor’s  trial balance as at 30 November There are over 5000 individual accounts distributed over a wide range of values. The system of internal control over debtors has been assessed as satisfactory and reliable.

1. I) What audit objectives would you be concerned with in testing the trade debtor’s balance?
2. 2)         Describe the steps that you would include in an audit program to test the trade debtors balance as at 30 November 1993.
3. 3)           What further testing would you perform as at year end?
4. 4)         What analytical review procedures could be used to examine the possible overstatement or understatement of the provision for doubtful debts?

H) While reviewing Fashion Designers payroll computer system you note the following weaknesses in internal control:

 

 

1. i) When the weekly timesheets are received the details are keypunched into a transaction file. An edit report is then generated and the details are agreed back to the Once all the timesheets have been input the employees’ master file is then updated by a batch program. There is no output from the batch update program.

 

1. ii) A special password and user ID is required to be entered by payroll staff before they can input changes to employee pay This special password and user ID is the same for all of the payroll staff members who input pay rate details.

 

Describe the potential impact each of  the above weaknesses could have and suggest control procedures which would overcome them.