ACCT3101-Fine Food Ltd Auditing Case Study – Accounting & Finance Assignment Help

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Auditing Case Study

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You are a senior auditor of the accounting firm Aus Audit Partners. Your audit team is currently planning the 2021 audit of FineFood Limited, a medium sized listed company in Australia that manufactures a variety of food including sweets, biscuits, canned fruit and vegetables. The company does not have its own retail stores. It directly supplies goods to supermarkets, grocery stores and some restaurants in most Australian cities. The company uses as much Australian grown ingredients as possible, but as there is also a demand for authentic ethnic food, the company also imports food such as spices, canned drinks, sweets and pickled vegetables from other countries.

This is the third year your accounting firm is engaged to perform the audit for this client. The financial year under audit ended on 31st December 2021. Past audit work and initial inquiries this year have revealed the following information.

FineFood Ltd (hereafter referred to as “the company” or “the audit client”) has had stable profit growth in the past. The company was founded by Terry Brown who served as the CEO until Terry retired in December 2020. However, Terry still holds about 15% of the company’s shares
and is currently the chair of the Board of Directors. Terry wants to sell all the shareholding in the near future in order to fully enjoy life after retirement, so Terry often half-jokingly told the other directors and top management that they better keep the share price and profit performance high. The new CEO Alex was promoted from the position of the CFO. As this is Alex’s first job as a CEO, Alex is very keen to perform well and keep the new position. The board will evaluate Alex’s performance for the 2021 year before deciding whether to renew Alex’s employment contract. In addition, Alex will receive a special cash bonus if the company can achieve a 5% profit growth ratio for 2021.

The Coronavirus crisis which started in early 2020 has had mixed impact on the company’s sales performance. While there is a period of increased demand for canned food etc. due to lockdowns and quarantine requirements, many of the company’s smaller clients such as local grocery stores and restaurants had to close their stores for long periods of time and therefore, either had trouble paying their bills or had to totally shut down their business. These events resulted in an increase in the audit client’s bad debts and a drop in sales to small businesses. In 2021, as people became more used to living with the virus, demand for canned food etc. returned to a more normal level but businesses including your audit client faced rising operating costs caused by shortages in raw materials/other supplies, labour shortages caused by travel restrictions and self-quarantine requirements, freight cost increases and delays in transportation of goods. In response, the audit client had to increase the selling price of most of its products, but this also resulted in a decline in sales. For similar reasons, many of the audit client’s overseas and domestic suppliers also could not deliver goods on time, and some of them went bankrupt. This forced the audit client to discontinue the sale of many of its imported products. 

The lack of reliable suppliers also caused inventory shortages that resulted in lost sales. The audit client tried alternative suppliers even though the products from new suppliers were often more expensive and some products were of lower quality, resulting in a negative impact on sales.
The audit client often had to mark down the price of such low-quality products very heavily to sell them. To make the situation worse, some of the audit client’s customers sued the audit client for breach of contract because the audit client could not deliver products on time due to inventory shortages. In July 2021, the audit client lost the lawsuit and was ordered by the court to pay a substantial amount of compensation to the customers. The audit client’s insurance company refused to cover any part of the compensation payment.

To help fund the company’s increasing costs and the compensation payment, the audit client took out a $14 million bank loan in August 2021, to be repaid after 3 years. One of the conditions in the debt contract requires the audit client’s interest coverage ratio to be above 7, and the debt to assets ratio is required to be below 60% for the duration of the loan. Another problem for the audit client was that many employees were sometimes required to selfquarantine so they could not go to work. Many departments including the manufacturing department and the accounting department had a shortage of both junior and senior staff. It was not always possible to immediately hire replacement staff who were qualified with sufficient experiences, so the company had to employ some casual staff and gave them quick training sessions. Various department managers expressed concerns about the quality of work by the casual staff. 

For example, the manufacturing department had an increase in material wastage, faulty products, and machine down times, caused by new employees who were not familiar with their work. There was also a shortage of experienced staff for important work such as product quality control checks and machine maintenance. These problems also resulted the production of a higher level of poor-quality products that were difficult to sell. Several of the company’s main warehouses in Queensland and New South Wales were flooded during the summer storm season in December 2021. The CEO told the auditor that as the company is very short-staffed at the moment, the extent of the inventory damage is yet to be fully evaluated.

As the company encountered various challenges throughout the financial year, the CEO Alex decided to cut some staff to reduce costs. The CEO’s e-mail communications to all employees emphasised that, to minimise job losses, all employees need to help improve revenues and cut costs. Several senior staff are also let go from the accounting department, and sometimes temporary casual staff are hired to help the remaining accounting staff during busy times. The audit client’s accounting department is separate from other operating departments. Only the accounting staff and the CEO have access to the accounting system. However, the company’s policies require the CEO to consult with the chief accountant about any proposed changes to the accounting records. Such discussions are required to be documented by both the accounting department and the CEO’s secretary. 

The computer systems for sales, inventory management and accounting are integrated. However, access to different systems is restricted to authorised staff via individual passwords s that only sales staff has access to the sales computer system, and only accounting staff has access to the accounting system, etc. The audit client uses a perpetual inventory system. The audit client uses external delivery  companies to help deliver goods to customers. Customers are required to sign a paper copy of the delivery document upon receipt of the goods they ordered. A copy of the signed delivery document is then given to the audit client as proof of the delivery. Sales invoices are serially numbered. The accounting staff checks the details in the customer orders and sales invoices against signed delivery documents before giving authorisation to the accounting system to record sales in the accounting records. Senior accounting staff are required to regularly check recent sales transactions to see whether there are duplicate or missing sales invoice numbers, and whether each sales transaction has both a sales invoice number and a delivery document number.

Fortnightly inventory reports are prepared by the inventory management computer system. These reports list different types of inventories by the date the last sale was made for a particular type of inventory. That is, these “last sales” reports help show inventory categories that have not had a sale for some time. The total value of each inventory category is also shown in the report. A copy of the report is distributed to the sales managers, purchasing managers, chief accountant and the CEO. These reports are often used for reference when senior accounting staff holds meetings to discuss major accounting issues such as inventory write-downs. The audit client’s draft financial statements for 2021 do not include any inventory write-down expense or an allowance for inventory obsolescence account. Inquiries of the accounting staff reveal that the chief accountant said there is no need to recognise unrealised inventory losses because the amount of the loss is uncertain so the information would be misleading to financial report users. The chief accountant told the staff that such losses will be recorded when inventory items are sold.

At the end of each financial year, the CEO and the chief accountant meet to discuss major accounting issues such as appropriate accounting estimates to be reported in current year financial statements. Data such as the inventory reports are used for such decisions. Discussions in these meetings are documented by a secretary. The chief accountant and the current CEO have worked together for several years and have become close friends. The chief accountant keeps the CEO updated about the company’s financial progress and discusses major accounting issues with the CEO. However, they both say that the CEO does not attempt to override the chief accountant’s professional judgment. 

For the (A) occurrence general audit objective of the sales revenue account, and (B) the net realisable value (NRV) general audit objective of the inventory account, answer all of the following questions in accordance with the Australian Auditing Standards. You need to perform your analysis using the facts in the case study.

For each of the two audit objectives of the accounts specified above:

(1) Assess inherent risk and perform analytical procedures to assess the risk of misstatements for each of the two general audit objectives of the accounts given above. Analyse and explain your arguments. In your answer, state one type of fraud that would breach the general audit objective (i.e., one type of fraud for sales occurrence and one type of fraud for the NRV objective of inventory). 

(2) Assess control risk for each of the two general audit objectives of the accounts given above. In your answer, identify existing internal controls that are relevant to the specified general audit objectives, and briefly explain how each internal control can prevent/detect misstatements for the specified general audit objectives for sales and inventory.

(3) Identify an existing internal control that is specific to each of the two general audit objectives of the accounts specified above, and design one test of control for each case. The internal controls and tests of controls must be based on the facts given in the case study. Briefly explain how the tests of controls specifically check the relevant general audit objectives of the accounts specified. 

(4) Design one substantive procedure that produces reasonably reliable evidence for each of the two general audit objectives of the accounts given above. Do NOT use analytical procedures for the sales occurrence objective.

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