Report on Interim of Yummy Yoghurts
This paper provides a report on the interim audit of Yummy Yoghurts (YY) Ltd, a company that produces and distributes a combination of fruit yoghurts, frozen desserts and puddings. The company sells its products through two channels: (i) through supermarket chains; and (ii) to retailers through its brand name (YY). An interim audit has been conducted on the company’s financial statements including its balance sheet as at 30 April 2010 and its income statement for the year ended 30th April 2010. As at 12th April 2010, the audit manager is interested in evaluating the work completed so far and determining the work that must still be done to complete the audit. With regards to the interim audit, the audit manager has identified four issues relating to (i) inventories; (ii) debtors (iii) loan to associated company; and (iv) fixed assets. The Audit Manager is interested in assessing the work conducted in these four areas by the junior audit team so as to determine the work done so far. This assessment will enable the audit manager determine whether there are any material misstatements with regards to these issues, determine whether to qualify the audit report or issue, include an ‘emphasis of matters paragraph’ in the audit report or ‘an other matters paragraph’, determine the substantive analytical procedures necessary to complete the audit and determine the audit team and experience needed to complete the audit. The audit team has just 6 days to finalise the audit because the financial statements have to ready for issue on 18th of April 2010.
YY Ltd operates two depots: (i) the Southall Depot; and (ii) the Acton depot. As the Audit Manager, I believe the work on the interim audit of inventories at the Southall depot was satisfactory. The audit team was in compliance with International Standard on Auditing (ISA 510) which requires auditors to attend a physical count of inventories so as to ascertain that the inventory is present and that it has been valued using the lower of cost and net realisable value as required by IAS 2 Inventories. Since the audit team attended a physical count of inventories at Southall and ascertained that the Southall inventory had been valued at cost and net realisable value, no further work needs to be done on inventories at this depot.
With respect to the work carried out at Acton, the auditors merely agreed with the figure presented to them by the depot manager. The auditors did not conduct any substantive analytical procedures on the inventories to ascertain their existence and valuation. It is likely that this inventory was not present or that the inventory was not valued correctly. Moreover, the inventory may have gone obsolete. The auditors cannot rely on the information given to them by the depot manager. This information needs to be verified by actually counting the inventory and making sure that it has been valued correctly (i.e., at the lower of cost and net realisble value as required by IAS 2). In addition, the auditors spent only one day at the depot which suggests that enough time was not given for the work to be done properly. Based on the foregoing analysis, the auditors need to attend a stock take at this depot to ensure that the figures given to them by the audit manager were correct. The inventory at this depot will need to be physically counted. In addition, the auditors will need to value the inventory to ensure that it is valued at the lower of cost and net realisable value. In doing so, auditors may need to conduct third party verifications by verifying a sample of purchase invoices with suppliers to agree the figures on the invoices with those entered in the purchases ledger. The auditors may find it beneficial to recalculate column totals on the ledger to ensure that the figure corresponds with the total amount for all purchase invoices. The quantities and units costs on the purchases ledger also need to be agreed with those on the invoices. Given the limited number of days for the audit work to be completed, more audit staff with experience need to be included in the exercise so as to ensure that the work is completed faster.
If the auditors find any material misstatements, then the audit report needs to be qualified. For example, if inventory is found to be undervalued or not present, and if this is going to significantly affect the decisions of YY’s shareholders on the financial statements then a qualified audit report should be issued.
One of the most important issues with regards to debtors is the disagreement over an invoice of £6,000 by one of YY’s customers who was not satisfied with the goods supplied by YY Ltd. Before further investigation, the auditors should make a bad debt provision for this figure pending the resolution of this matter with the customer. The auditors should also consider whether this figure is material and whether the audit report needs to be qualified. The net income of the company in 2010 is £416,000. This means that £6,000 is approximately 1.4% of £416,000. Assuming a materiality threshold of 3 percent, this figure is not material and thus is not going to significantly affect users’ decisions on the financial statements. Thus, the audit report should not be qualified based on the disagreement over £6,000. The auditors also selected only accounts with balances above £20,000 to be tested. Moreover, the auditors claim that a representative sample of 25 others was also selected. To be a sample, each item must have an equal chance of being selected. The approach taken in the interim audit does not meet this requirement in that:
– All large accounts are selected;
– The basis on which the 25 other accounts are selected is not explained.
Selecting all large accounts for testing is quite common but the basis for defining ‘large’ need to be explained. The population being sampled is then defined as all receivables balances below the threshold for items selected as large (Eilifsen et al., 2006; ACCA, 2008). The auditors need to explain why only account balances above £20,000 were selected for testing and how the 25 others were selected. By so doing one would be able to ascertain whether the sample was representative enough and whether the work done can be used as a basis for arriving conclusions about the debtor figure. More information should be sought from managers with regards to debtors. Once a representative sample of debtors has been selected and tested, the auditors should be able to determine whether there are any material misstatements and thus decide whether to qualify the audit report or not.
- Loan to Associated Companies
The nature of the relationship between YY and the Associated Company indicates that the company is an Associate. However, further investigation of the company in question needs to be conducted to determine whether it is an associate. It should be treated as an associated company if YY has 20% or more of the voting rights of the company. 20% or more of the voting rights will require that YY Ltd should hold at least 20% of the shares of the company. If the investigation concludes that the loan to the associated company is more than 20% of its total assets, then the associated company should be accounted for as an associated one. Although it has not been ascertained that the company is an associate, the information suggests that it is one. For example, the loan is unsecured and YY is interested in acquiring an equity stake in the company. In addition, considering the fact that the loan has been increasing (the loan moved from £40K to £240K without any repayments) it is obvious that YY Ltd has an equity interest in the company. Associates are usually accounted for using the equity method of accounting as required by IAS 28 Investments In Associates. The equity method of accounting is a method of accounting in which the investment is initially recorded at cost and adjusted thereafter for the post-acquisition change in the parent’s share of net assets of the associate (Epstein and Jermacowicz, 2007; Deloitte Touche Tohmatsu, 2010). The financial statements will need to be adjusted if it is ascertained that the company is an associate and thus need to be accounted using the equity method.
- Fixed Assets
The auditors did not perform any work on Property, Plant and Equipment (PPE). The following information is available:
– Land and buildings were revalued by a company surveyor;
– There is an overstatement in the figure for plant.
The auditors cannot rely on the company surveyor’s valuation because he is not independent of the company’s management. An independent valuation would need to be carried out to agree the figure with that of the company surveyor.
For the items of plant which were not treated correctly, the auditor should qualify the audit report if these figures are found to be material. The auditors should conduct a number of substantive procedures on PPE. Some of the work that may need to be done is to trace a sample of purchase requisitions and purchase invoices to the loading dock to ascertain that the transactions had actually taken place. Transactions in PPE at year end should be examined to ensure that the information has been recorded in the correct period. For example, transactions completed almost at the end of the year 2009 may have been recorded in the year 2010.
Based on the foregoing analysis, a number of conclusions can be drawn. With regards to inventories, enough work has been done at the Southall depot in my opinion, based on my analysis of data, but further work will need to be done at the Acton depot. With regards to debtors, the basis for sampling need to be justified and a representative sample of debtors needs to be tested. As for the loan to an associated company, further investigation needs to be conducted to ascertain whether the company is an associate or not. Finally, with reference to fixed assets, auditors need to revalue the land to agree an exact figure with that of the company surveyor. In all four cases, the auditor should consider whether there are material misstatements and, if this is the case, the audit report should be qualified.
ACCA (2008), “Auditing and Assurance (AA)”, Kaplan Publishing.
Deloitte Touche Tohmatsu (2010) “Summaries of International Financial Reporting Standards: IAS 28 Investments in Associates”, available online at: http://www.iasplus.com/standard/ias28.htm [accessed: 21st April 2010]
Eilifsen A., Messier W. F. Jr., Glover, S. M., Prawitt, D. F. (2006) “Auditing and Assurance Services”, International Edition, McGraw-Hill.
Eipstein, B. J., Jermacowicz, E. K. (2007),” Interpretations and Applications of International Financial Reporting Standards” Wiley and Sons Inc.