AUDITING AND ASSURANCE – ACC300

AUDITING AND ASSURANCE – ACC300

BACKGROUND

You are an Audit Senior of Kamal Chartered Accountants (KCA) a boutique 3 partner firm with 20

staff. It is 16 July 2013 and your firm has engaged in the tender to become the external auditor of 4X

Heavy Ltd for the 30 June 2013 audit. 4X Heavy Ltd is a company that runs multiple Fitness Centres

throughout NSW, Australia and has been in operation since 1991.

Pammy Ngo, one of KCA’s Audit Managers was formerly a Fitness Instructor at 4X Heavy Ltd and

coincidently joined KCA on 16 February 2013 prior to tender.

4X Heavy Ltd are initiating an aggressive expansion in 2013, with management having plans to list

the company on the ASX within the next 5 years.

The 2013 financial year saw 4X Heavy Ltd encounter strong competition from new fitness gyms

entering the market as with facing the new popular fitness regime “Ya Ya Yoga”, which is a regime

exclusive to Ya Ya Fitness Gyms. Other Notable operational challenges for 4X Heavy Ltd faced in

2012/2013 were but not limited to:

- 4X Heavy Ltd borrowed substantially from KNVB Bank in order to purchase the

equipment required for its gyms. The finance involved a mixture of both leases over the

equipment where KNVB continued to hold legal title as well as some equipment on

chattel mortgages where 4X Heavy holds legal title. Overriding these finance

arrangements is a covenant from KNVB requiring 4X Heavy Ltd to maintain a debt to

equity ratio of no more than 2.5:1 at each reporting date.

- In order to rapidly grow its membership base and revenue stream, 4X Heavy has built a

substantial network of fitness instructors to recruit new members to the gym. These

fitness instructors are remunerated on a commission basis at 15% of the value of the

membership subscription signed up from each new customer. Each month the fitness

instructors are required to provide the finance department of 4X Heavy with a claim

sheet showing details of each new member to support the commission claimed. The

finance department checks this against membership contracts previously provided by

the fitness instructor when the new customer signed up prior to payment.

- Management of 4X Heavy perceived that the number of finance staff at 4X Heavy was an

excess to the requirements of the business. As a consequence an accounts payable clerk

and financial accountant were made redundant from the business during the year. This

resulted in the business only having one accounts payable clerk to maintain purchases

and monitor payables whilst all review of monthly reconciliations were left to the

financial controller. A number of 4X Heavy suppliers have complained about the

slowness at which 4X Heavy has been paying its invoices.

- An internal audit review of operations during the year found that the volume of people

entering and working out at the gym has increased but appears to be inconsistent with

membership numbers and revenues generated. A further analysis has shown that

repairs and maintenance expense as a percentage of sales has increased in 2012/13

compared with the previous financial year.

- Management of 4X Heavy have started to notice that an increasing trend of customers

have been leaving the gym and joining competitors who have been offering the latest

state of the art gym equipment as shown on late night infomercials featuring Chucky

Norris. 4X Heavy is finding it difficult to rearrange its finance with KNVB in order to

upgrade their existing equipment to react to this trend.

Your recent review of management financial data for 2012/13 has shown the following key statistics:

FINANCIAL DATA

2013 2012

Members 1,324 1,128

New Members 212 54

Members exiting 100 38

Membership fee per year $960 $940

Membership Revenue 984,880 1,053,986

Sales commissions expense 44,980 34,670

Balance Sheet

30/06/2013

$’000

30/06/2012

$’000

Current Assets

Cash Assets 600 590

Inventory 50 40

Other current assets 10 10

Total Current Assets 660 640

Non-Current Assets

Property, plant and equipment 3,480 2,800

Total Non-Current Assets 3,480 2,800

Total Assets 4,140 3,440

Current Liabilities

Accounts Payable 430 350

Unearned revenue 120 90

Lease liability 350 310

Total current liabilities 900 750

Non-current Liabilities

Lease Liability 500 460

Secured bank loan 1,560 1,000

Total non-current liabilities 2,060 1,460

Total Liabilities 2,960 2,210

Net Assets 1,180 1,230

Equity

Share Capital 500 500

Retained earnings 680 730

Total equity 1,180 810

QUESTIONS

PART A (12 marks)

Since 4X Heavy Ltd is a new client of KCA outline the steps that you would initially undertake as part

of taking on this client

PART B (8 Marks)

Based on the facts specific to 4X Heavy Ltd:

(a) Identify the audit inherent risk and rate the risk as low, medium or high.

(b) Identify the audits control risk

(c) Evaluate control and inherent risk

(d) Determine overall audit strategy

PART C (16 Marks)

a) Identify 2 key account balances that are at highest risk of misstatement

b) Explain why these are the highest risk

c) Design 4 substantive audit tests to carry out the work performed on each of the identified 2

key account balances.

d) For each of the 4 substantive audit test designed identify the key assertion it addresses.

PART D (4 Marks)

(a) Based on the above make 4 recommendations to management on completion of audit.

This assignment has a weighting of 20% of your final assessment. As a guideline you assignment

answers should be between 3,000 words at the most.