You are an auditor with Buoy & Alex (B&A). B&A has just been appointed as the external auditor of Hope Anchor Ltd. (H.A.). The audit partner, Kamren Green, has called you to a meeting. Karmen explains that you will be the lead auditor on the external audit work. The initial audit planning must be done in the next week or two. She briefs you on H.A. and gives you her file of notes from her recent meetings with H.A.’s managing director. Extracts from the file are documented below.
Karmen would like you to prepare a memo in order to inform the audit team. The memo will include your analysis of the inherent risks relating to the audit of H.A’s financial statements.
There are two new audit trainees with B&A who will be on the H.A. audit team. Because of this, Karmen has asked for two more areas of information to be included in the memo to help develop the new trainees’ knowledge of auditing. Firstly, Karmen wants you to provide a note of the general areas an auditor must gain an understanding of in order to assess inherent risk in the context of an external audit, and; secondly, Karmen wishes you to outline the actions an external auditor must undertake before accepting a new audit client.
Extracts from Audit Notes made by Partner from meetings with H.A.’s managing director
H.A. makes boats for sport and leisure and sells these to rich individuals who like to sail or be on board their own boat to entertain rich friends and celebrities. The business began ten years ago when its founder, James Fisher, the managing director, and majority shareholder, established the company to manufacture boats using his long list of rich friends as contacts and customers. The company was initially very successful with several lucrative orders in each of the first five years. James had to work very hard in terms of sourcing the right skills, suppliers, and materials for making the boats. After this initial success, the last few years have been harder. Revenue is falling and several complaints have been received from previous customers saying their boats are leaking and parts are falling off important safety equipment during sailing trips. James recently received a lawyer’s letter from a former friend and customer threatening to sue him if he did not return the full amount of the sales price of a boat to the customer due to it now being unusable.
Because of the small facilities and factory and the specialist nature of the boats made, H.A. makes a maximum of five boats each year. The boats are ‘made to order’ to unique customer specifications. Each boat comprises thousands of individual parts, many of which are made by H.A. specifically for individual boats. Boats also include the best available radio and radar equipment. At the financial year-end several boats are part-finished and recorded as work in progress (WIP). In addition to the WIP, there is a significant amount of raw materials and parts on the factory shelves – much of which is leftover from boats built in previous years.
During the last year, James employed his best friend from school days, Betsy May, as his company accountant. Betsy is very rich and does accounting as a hobby to keep herself busy. She has tried to pass her professional accounting exams but has not been successful. Nevertheless, she feels she knows enough to do a good job of the accounts and financial statement preparation for James.
Orders have been falling in the last three years and so James has launched an ambitious marketing campaign to get more customers. This has involved him flying first class around the world, showing potential rich buyers his colorful and high-quality brochure of boats, and trying to get new orders. So far, no new orders have been achieved, but James remains hopeful. He approached the bank manager in the last month to ask for a loan, but the bank manager refused.
Prepare a memo for use by the audit team:
(a) Identify six areas, relevant to the external audit of any company, in which an auditor should gain a detailed understanding in order to assess inherent risk.
(b) Identify and explain the inherent audit risks in the external audit of H.A.’s financial statements.
(c) Explain actions an auditor must undertake before accepting a new external audit client.
The credit of 3 marks are available for presentation: for example clarity in writing style including recognition of the relevant professional context, relevance of content, formatting, and layout. For more information on Hope and Anchor Islington check on this: https://en.wikipedia.org/wiki/Hope_and_Anchor,_Islington
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