Week 8 - Question Two

You are the audit manager at Price & Coopers a medium-sized audit firm undertaking the audit for the year ended 30 June 2018 of Sera Ve Tech Ltd, an electronic component manufacturer located in Sydney. During the planning stage of the audit you discovered that one of Sera Ve Tech Ltd’s major suppliers went bankrupt one month ago, causing major product shortages. To overcome the problem, James Marshall, the husband of the finance director, Norita James, provided electronic components to Sera Ve Tech Ltd through his private company. There is no formal agreement in place with James Marshall, however, the goods are being provided at competitive prices. You are concerned about the electronic components that James Marshall, company is supplying, because his products are new to the market and you have heard some of Sera Ve Tech Ltd’s staff complaining that they are of poor quality.

The board has informed you that although sales have been strong this year, Sera Ve Tech Ltd has suffered significant cash flow problems because a major debtor, Merrinda Ltd, is experiencing financial difficulties. As a result, Merrinda Ltd is taking well over 120 days to pay outstanding amounts, despite Merrinda Ltd’s terms of trade being payment within 30 days. Merrinda Ltd makes up 40 per cent of Sera Ve Tech Ltd’s sales and the board has been reluctant to take any action that might adversely affect those sales. As a result, Sera Ve Tech Ltd has had to increase its dependency on its line of credit, and this has caused it to temporarily breach the debt to equity ratio required in its loan covenant with Commonwealth Bank Ltd.

Required:

(a) Identify two (2) key account balances at risk of material misstatement.

(b) For each account balance identify the key assertion at risk.

(c) Explain why the account balance and assertion are at risk.

(d) Describe one (1) substantive test of detail that you would undertake for each account to address the assertion and risk identified.