Reference no: EM13228453

Gustavo Sarmiento and Alberto Morales are the two audit partners at AMS Accounting LLP. They have just taken on the audit of Matty Kitchens Ltd., owned by Irmgard Dotto and Gerda Birk. You are an audit senior with AMS Accounting and have been asked to work on the audit. 
Matty Kitchens prepares and distributes packaged meals that are sold in grocery stores nationwide. Matty Kitchens operates from rented premises and uses leased kitchen equipment. 
Matty Kitchens has operated successfully for several years, but profitability has recently started to fall, resulting in a significant reduction in profit for the six months ended September 30, 20X2. This is causing concern to Irmgard and Gerda. As well, in the last six months, two key cooking staff have left. Although recruitment is under way for permanent replacement staff, the company's cooking is being handled by temporary replacements. 
You have held an audit planning meeting with Irmgard, Gerda and Gustavo, the lead audit partner. You discussed the performance of Matty Kitchens for the six months ended September 30, 20X2, and were given excerpts of the management financial statements for the period ended September 30, 20X2, along with the prior year audited financial statements (Appendix 1). Your notes from the meeting are in Appendix 2. 
Alberto hired a new audit junior who did some work on the Matty Kitchens inventory count. The work done is documented in Appendix 3. 
Required: 
1. Perform the planning analytical review for the financial statements of Matty Kitchens, analyzing the key movements. Include supporting calculations. 

2. Using the notes that you took on the company's performance, identify the audit risks and explain how each audit risk could result in a material misstatement in the financial statements. Design the audit approach for each significant audit risk identified.

3. Calculate planning materiality for the 20X3 fiscal year-end audit. Provide both quantitative and qualitative analysis supporting your figure for preliminary materiality. (5 marks) 
Module 7 - Audit and Assurance Project 
3 / 9 


4. Evaluate the audit work done by the audit junior on the weekly inventory counts and outline additional procedures that should be performed by the audit team in future inventory counts. 
5. Prepare the property, plant and equipment (PPE) audit program that will be used by AMS Accounting for the March 31, 20X3, fiscal year-end audit of Matty Kitchens. 

6. Discuss the importance of documentation in the audit file and identify what parts of the audit file require documentation. 

7. Assume the 20X3 fiscal year-end audit of Matty Kitchens is completed and that AMS Accounting has determined that the financial statements of Matty Kitchens are presented fairly, in all material respects, except for the area of obligations under lease agreements. AMS Accounting was unable to obtain any audit evidence to verify the value recorded by Matty Kitchens for the obligations under lease agreements as of March 31, 20X3, because the lease contracts were destroyed in a fire. The possible effects of AMS Accounting's inability to obtain assurance over these contracts are material but not pervasive to the financial statements. Draft the expected audit report that will be issued by AMS Accounting for this engagement. Assume that the financial statements of Matty Kitchens are prepared under one of the two general purpose accounting frameworks used in Canada.
Module 7 - Audit and Assurance Project 
4 / 9 

Appendix 1: Extracts from management financial statements 
Extract from statement of profit or loss Notes Six month period ended
September 30, 20X2
Unaudited Year ended
March 31, 20X2
Audited
($000s) ($000s)
Revenue 1 13,200 32,700
Cost of goods sold (11,000) (26,200)
Gross profit 2,200 6,500
Administrative expenses 2 (1,330) (1,620)
Profit 3 870 4,880
Notes: 
1. Revenue is evenly spread throughout the year. 
2. Administrative expenses include repairs and maintenance expenses of property, plant and equipment of $821,000 for the six months ended September 30, 20X2, and $957,000 for the year ended March 31, 20X2. 
3. The amount for the six months ended September 30, 20X2, includes the loss on sale of property, plant and equipment. Proceeds on sale of property, plant and equipment were $120,000. 
 


 
Notes to financial statements 
1. Property, plant and equipment 
Six month period ended 
September 30, 20X2 
(Unaudited) Year ended March 31, 20X2 (Audited)
($000s) ($000s) 
Cost 
Opening $ 14,500 $ 13,850 
Additions 1,200 650 
Disposals (500) - 
Closing $ 15,200 $ 14,500 
Accumulated depreciation 
Opening $ 8,132 $ 5,507 
Depreciation expense 1,269 2,625 
Disposals (300) - 
Closing 9,101 8,132 
Net book value $ 6,099 $ 6,368 

2. Intangible asset - goodwill 
Goodwill is stated at a cost of $530,000, and no impairment has been made to date. 
3. Dividends 

Dividends paid during the six months to September 30, 20X2, amounted to $825,000. 
4. Current taxes payable 

Current tax liabilities comprise corporation tax and payroll taxes.
 
Appendix 2: Notes from meeting 
Gerda explained that Matty Kitchens operates in a very competitive market. Slow economic growth has led to firms competing for the same business. Matty Kitchens has reduced margins on some of its breakfast meals to sustain and win business. Grocery stores (Matty Kitchens' main customers) are paying slower than ever before. As a result, Matty Kitchens has introduced strict cost-control measures to improve its profitability and has introduced a profit-based bonus plan for management and staff to ensure they focus on these cost-control measures. 
A few of Matty Kitchens' long-time customers have gone into liquidation, resulting in falling demand for certain meals. These customers have not been replaced by new ones. The majority of customers also continue to stretch their credit terms with Matty Kitchens, despite being chased by the credit department. 
In order to generate new business, Irmgard is planning to provide a new dessert line to customers on long-term sales contracts, offering them enhanced rates to ensure sales orders for a longer period of time. Although one new long-term grocery contract has been agreed with a customer, nothing has been delivered yet. Delivery will occur before the March 31, 20X3, fiscal year-end date. 
An accidental fire caused approximately $500,000 worth of damage to third-party equipment held on a lease contract by Matty Kitchens. The company has made an insurance claim, but the insurers have disputed it because they say the equipment should not have been left with the power on and the lease documentation was not completed appropriately. The cost of the writeoff is estimated to be $200,000. 
Gerda stated that the condition of the undamaged equipment is generally good. However, she thinks the equipment will need to be replaced sooner than originally planned. Based on this, Matty Kitchens will need to reduce the economic useful lives of its equipment. The company has purchased additional plant and equipment in the six months ended September 30, 20X2, and are also negotiating with another leasing company to start leasing additional equipment. The new leasing agreements are expected to be finalized before the end of the current (20X3) fiscal year.
 
Appendix 3: Notes regarding the inventory work by the junior auditor 
Inventory counts 
Each week, the inventory system automatically selects a sample of inventory items that must be counted. The system ensures that all items are counted at least once a year, with higher value items counted more than once. Obsolete and slow-moving inventory is held in separate areas within the warehouse, and is separately identified. Each manager reviews slow-moving inventory on a quarterly basis and provides a report to head office for updating of the inventory system. 
There are several warehouse locations and a standard report with inventory count details is automatically emailed to each warehouse manager. The report provides a list of the product lines that are to be counted; however, the report does not include the expected level of inventory (per the inventory system). The report also contains detailed instructions on how to carry out the inventory counts to ensure that these are properly controlled. Counts are carried out that day at the warehouses, and the results are emailed back to head office by the end of the day. A member of the finance department at head office compares the count results to the level of inventory recorded on the inventory system; all differences are followed up with the relevant warehouse manager, and the results are documented, with the inventory system being corrected where required. 
At each warehouse, a separate member of the finance department oversees the inventory count. The results of these counts are checked and any differences followed up, resolved and documented with the assistance of the warehouse managers. 
The junior auditor randomly attended a sample of the inventory counts that were carried out across the company, although not every warehouse was visited. The following is a summary of the inventory held by Matty Kitchens as at September 30, 20X2. Included in the summary is a breakdown by number of product lines, the approximate value of inventory held at each location and the locations where the junior auditor attended the inventory count. 
Information on inventory holdings Location Number of 
product lines Approximate 
value of inventory Junior attended count 
Central warehouse 479 $ 220,000 Yes 
New Westminster 207 $ 376,000 No 
Surrey 298 $ 438,000 Yes 
Abbotsford 156 $ 87,200 No 
Chilliwack 348 $ 401,800 Yes 
Port Moody 97 $ 107,000 No 
The junior auditor performed reviews of the inventory counting procedures at the central warehouse, the Surrey warehouse and the Chilliwack warehouse. The Chilliwack warehouse is a new warehouse that opened in September 20X2.
At the central warehouse, two items were noted by the junior auditor: 
• Movements in inventory were not stopped during the count, although there was no evidence that any misstatement of inventory resulted from this. 
• New finance staff carried out the inventory counts; these individuals lacked experience in inventory counts. 

In Surrey, there were three items noted: 
• No documented inventory-taking instructions were given to staff. 
• The email to head office contained no documentation of the results of the inventory count. 
• Individuals with direct responsibility for inventory carried out the counts, in direct contravention of stated company policy. 

No findings were detected at the Chilliwack warehouse.

Required minimum-10 page