Question 1

You are the audit manager of a medium-sized firm and have just received a package from Rachel Jones, the financial controller of Telechubbies Ltd, a toy manufacturer. This is your firm's first year as auditor of Telechubbies. The information contained in the statement of financial position and income statement was prepared for a board meeting and Rachel felt it might be useful to you in preparation of the forthcoming audit for the year ended 31 December 2021.

During a brief telephone call with Rachel, you made the following notes:

1. One of the conditions of the long-term loan is that the company is not to exceed a debt-toequity ratio of 2:1 at any time. The loan is reviewed each year on 31 December.

2. Provision against inventory obsolescence is provided for at a flat rate of 10%. The amount provided in previous years was 20%. Rachel said that the company believes it has been overly conservative in previous years and 5% is a more realistic level, given the nature of its products.

3. The long-term loan receivable is from a company involved in the development and production of computer software. It is owned by one of the directors.

Required:

(a) Suggest possible sources of information that would help you gather sufficient knowledge of the business to perform the audit of Telechubbies Ltd.

(b) Perform preliminary analytical procedures using the information provided. Identify key areas that would require special attention during the audit of the 31 December 2021 financial statements.

(c) Outline ways in which the analytical procedures performed could be extended using the information collected in (a).

(d) Suggest ways of using analytical procedures as a substantive test during the audit of Telechubbies Ltd.

Question 2

Face Paint Ltd sells cosmetics and markets itself on the basis that its products have not been tested on animals, it has ethical policies towards its staff and suppliers, and that it takes corporate responsibility very seriously. The company is associated with an organisation that represents a collective of suppliers and staff, EcoProducts, which holds one ordinary B share in Face Paint (under Face Paint's constitution, this gives EcoProducts significant powers, including a controlling vote on all matters of strategy).

In the financial year to 30 June 2020, Face Paint floated on the Australian Securities Exchange. As part of this float, there was also a restructuring of the shares. In the restructure, 50 000 ordinary A shares were bought back by the company and exchanged for 25 000 ordinary shares. A further 1 200 000 ordinary shares were sold on the securities exchange for $5 per share. The new issue was fully subscribed.

Face Paint's results show an increase on the previous year. Revenue is $26 040 196 (2019: $21 143 992) and profit before tax is $1 713 936 (2019: $819 293). The cash raised by the float enabled the company to pay off some long-term debts and improve its short-term liquidity position.

Face Paint has two main product divisions: makeup and gifts. Makeup includes everything that would be expected in a cosmetics line. Gifts include handmade soaps and shampoos, a range of handmade products from developing countries and products made from recycled materials.

The company markets its products in four ways: mail-order catalogue, company website, retail stores and personal selling. In recent years, the mail order and personal selling revenues have been falling significantly, but at the same time sales via the company's website have increased substantially.

As part of its commitment to its suppliers, many of whom depend exclusively on Face Paint, the company sometimes pays high prices for its purchases, even when other cheaper but less eco-friendly alternatives exist.

Also, as part of this commitment, Face Paint sometimes pays suppliers in advance of receiving goods or, in some cases, even before placing an order. Given that the business is expanding, there has been an increase in the range of products sold and therefore an increase in the number of suppliers from all over the world, resulting in a large increase in the level of advance payments.

At 30 June 2020 the amount paid in advance was $1 932 071 (2019: $614 221).

Required:

a) Who is responsible for minimising the business risk of an organisation.

b) Describe the auditor's responsibility with regard to business risk.

c) Consider the situation above and highlight the business risks.

d) Consider the extent to which those risks could have an impact on the financial statements.