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Auditing Project
 

PWC, a Halifax accounting firm, has just taken on the audit of Custom Cabinets, a medium sized cabinet manufacturer and cabinet retailer that began operations in 2005. The company is owned by Cameron Daniels and Randy King. The previous auditor has resigned because of poor health. You are an audit senior with PWC and have been asked to work on the audit.
 

Custom Cabinets has a facility that was purchased at the start of the operations. Due to anticipated growth the company acquired another warehouse located 10 kilometers from its existing facility on April first of the current year. In addition the company acquired a state of the art saw and drill press which is expected to reduce the amount of waste resulting from cabinet manufacturing. The organization employs 25 full time employees and has a list of individuals that can be called if needed at any given time.
 

Custom Cabinets has done well since it began operations but PWC is concerned about the profit for the first six months of this year. The economy has been in a downturn and other companies in the industry have experienced a decline in revenue. Existing equipment is fully depreciated and the company is waiting on the audited financial statements to apply for debt to replace this equipment. The warranty has expired on this equipment. The company has just returned equipment that was under lease and for which the lease has expired.
 

You held an audit planning meeting with Cameron Daniels and Randy King and one of the partners Jessica Noland. You were provided with the interim financial statements for the first six months of the current year along with the prior year audited statements (Appendix 1). Your notes for the meeting are in Appendix 2.
 

A junior accountant from your office has done work on the inventory and property plant and equipment. The work done is documented in Appendix 3.
 

Required
 

1. Indicate which CAS requires you to perform analytical procedures. Perform the planning analytical review for the financial statements of Custom, analyzing the key movements. Include supporting calculations. (10 marks)
 

2. Using the audit notes that you took, 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. Present your answer in a table with column one identifying the risk and column two explaining the risk. (20 marks)
 

3. Calculate planning materiality for the 2015 fiscal year-end audit. Provide both quantitative and qualitative analysis supporting your figure for preliminary materiality. (5 marks)
 

4. Evaluate the audit work done by the audit junior on the inventory and property plant and equipment and outline additional procedures that should be performed by the audit team on future work in this area.(20 marks)
 

5. Prepare the property, plant and equipment (PPE) audit program that will be used by PWC accounting for the December 31, 2015, fiscal year-end audit of Custom. (20 Marks)
 

6. Discuss the importance of documentation in the audit file and identify which parts of the audit file require documentation.(10 marks)
 

7. Assume the 2015 fiscal year-end audit of Custom is completed and that PWC has determined that the financial statements of Custom are presented fairly, in all material respects, except for the area of inventory. Inventory is material. Your audit work indicated the two classes of cabinets are not carried in the inventory at lower of cost and net realizable value; however, Custom did not want to do this. The amount is material but not pervasive to the financial statements. Draft the expected audit report that will be issued by PWC for this engagement. Assume that the financial statements of Custom are prepared under one of the two general purpose accounting frameworks used in Canada.(15 marks)
 
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Appendix 1: Extracts from management financial statements
 

Income statement Extracts
 

 

	Notes	Six months ended June 30, 2015	Year ended December 31, 2014
Revenue	1	814,050	1,138,418
Operating Expenses	2	624,881	982,479
Other income and (expense)	3	(6,379)	(10,679)
Income before tax		195,771	166,617

 
 

Notes
 

1. Revenue is evenly spread throughout the year.
2. Operating expenses include repairs and maintenance expense of property, plant and equipment of 253,125 for the six months ended June 30, 2014 and 281,575 for the year ended December 31, 2014.
3. The amount for the six months ended June 30, 2015 includes a loss on disposition of equipment. Proceeds on sale of equipment was $50,000.
4. Assume that COGS is included in Operating expenses and 2014 total COGS were 341,500 and 2015 COGS were 212,120.
 

Balance Sheet Extracts
 

	Notes	As at  June 30, 2015	As at December 31, 2014
Assets
Current Assets
Cash and cash equivalents		196,344	440,061
Accounts Receivables		41,645	31,813
Inventory		11,475	11,123
		–	–
Non-current assets		–	–
Property, plant and equipment	1	977,418	614,250
Goodwill	2	15,878	15,878
		–	–
Total Assets		1,402,391	1,170,818
		–	–
Liabilities and shareholders’ equity		–	–
Current liabilities		–	–
Accounts Payable		169,740	143,750
Warranty Liability	3	172,194	144,045
		–	–
Non-current liabilities		–	–
Long-term debt		215,375	179,419
Maintenance provision	4	44,500	45,518
Total Liabilities		798,008	710,720
		–	–
Shareholders’ equity		–	–
Share capital		21,875	21,875
Retained earnings	5	406,623	247,905
		–	–
Total liabilities and shareholders’ equity		1,402,391	1,170,818

 

Balance Sheet Extracts
 

Notes to Financial Statements
 

1. Property, plant and equipment
 

	Six months ended June 30, 2015	Year ended December 31, 2014
Cost
Opening	1,013,637	1,019,885
Additions	456,250	216,853
Disposals	99,771	223,101
Closing	1,220,115	1,013,637
	–	–
Accumulated Depreciation	–	–
Opening	399,386	324,593
Depreciation expenses	93,083	168,544
Disposals	99,771	93,750
Closing	392,698	399,386
	–	–
Net Book Value	977,418	614,250

 
2. Intangible asset – goodwill
Goodwill is stated at a cost of $15,878, and no impairment has been made to date.
 

3. Warranty liability relates to the 2 year guarantee included on the sale of cabinets.
 

4. Maintenance provision represents amounts accrued for leased Equipment that have been returned at the end of the lease. The equipment must be in a specific condition or the company is charged the costs to bring the equipment to the required condition.
 

5. Dividends paid during the six months to June 30, 2015 amounted to $37,053.
 

Appendix 2: Notes from meeting
 

Cameron Daniels and Randy King explained that Custom Cabinets prided itself on its high quality products and the excellent warranty that it offered. Most companies in the industry offered a warranty of one year or less. The owners have noticed that the current economic conditions have resulted in customers delaying the update of cabinets or choosing cabinets from lower priced companies. Because of these conditions, the owners had decided on a lower price for the cabinet lines and have been offering reduced rates to remain competitive. Custom has been paying strict attention to cost controls and have introduced a bonus for management that is based on the company’s profitability.
 

Recently two of Custom’s major customers have gone into bankruptcy. However, Custom indicated it was not necessary to write of the $42,000 that was in Accounts Receivable since any bad debts would have been accrued. The owners have been thinking of ways to boost the business. The company intends on partnering with building companies in order to gain cabinet contracts for residential and commercial buildings. Custom is optimistic that there will be an 40% increase in revenue from these efforts.
 

One of Custom’s planers was damaged as a result of over heating during extensive operations. Although the equipment was insured the insurance company is disputing the claim because the company did not preventive maintenance requirements. The cost of the damage is estimated at $160,000. Because Custom is anticipating additional work in the new year, it will need to lease or purchase additional equipment. Custom has begun discussions with a leasing company in regards to leasing the equipment. They expect the leasing agreements to be in place by year end.
 

Appendix 3: Notes regarding the inventory and property, plant and equipment work performed by the junior auditor.
 

Inventory / Warranties

 

When customers place an order for cabinets, a work order is created. Once the cabinets are installed, revenue and cost of goods sold is recorded for the sale. At this point a portion of the revenue is deferred related to the warranty. The statistics for the amount of warranty have been developed over the ten years of operations. This year the owners decided that the amount of revenue related to warranty could be reduced and a higher amount charged to revenue.
 

The prior year audit file indicates there were issues with inventory in prior years – Custom had neglected to adjust inventory amounts to lower of cost and net realizable value. Further there were older cabinets that the auditors believed were out of style but the owners insisted they were not obsolete. There was no physical count of inventory.
 

The junior accountant performed analytical review on inventory noting that percentage of inventory as a percentage of total assets was consistent with the prior year. There were several credit balances in inventory which the junior ignored. No counts of inventory were performed. The junior auditor concluded the inventory was fairly stated for the interim period.
 

Property Plant and Equipment
 

Property plant and equipment represents the largest item on the balance sheet and represents the warehouses and equipment owned by Custom. They are separated in the general ledger accounts. The junior auditor traced each item on the subsidiary ledger to the original invoice, added the subsidiary ledger and agreed the total to the general ledger. Then the junior auditor signed the working paper concluding that property plant and equipment was fairly stated for the interim period.
 
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