Hart Co – Audit Risk & Auditor’s Response

Audit Risk Auditor’s Response

Hart Co is a new client for Morph & Co. Increased audit procedures should be
performed over opening balances.
As the audit team is not familiar with the
accounting policies, transactions & balances
of Hart Co, there will be an increased of
detection risk on the audit.

The directors are paid a bonus based on a % This particular risk is relating to
of PBIT. judgemental areas such as provisions &
estimates.
There is a risk that the directors will try to
manipulate & overstate the profit & their The audit team should be aware of the
bonuses by increasing the revenue & increased risk & assign more experienced
income recorded & decreasing the audit members to significant estimates &
expenses. judgemental areas.

Customers pay a 25% deposit on signing the The audit team should obtain a copy of the
contract, with the balance payable when contracts with customers & review them to
control of the playground is transferred to determine whether the performance
the customer. obligations have been satisfied & the
treatment of deposits received is correct.
The deposit should not be recognized as
revenue immediately & instead should be
recognized as deferred income within
liabilities until the performance obligations
have been satisfied, that is when control of
the playground is passed to the customer.

There is a risk that revenue is overstated &

liabilities understated if the deposits have
been recorded within revenue.

A WIP count & valuation will be carried out The auditor should ensure that the WIP
at all 16 sites. However, arrangements have count the team will attend are the most
been made for the audit team to attend likely to be those with the most material
only 5 of the WIP counts. WIP balances or the one that have the
greatest risk of misstatement.
As the audit team is not attending all sites,
detection risk is increased as the team is For those WIP count not attended, the
unable to directly obtain evidence relating audit team will need to obtain & review
to WIP. documentation relating to the controls
surrounding the counts, & reports from any
experts used to value the WIP.
Hart Co offers its customers a warranty at The audit team should discuss with
no extra cost, which guarantee that the management the basis of the provision
playgrounds will function as expected for a calculation & compare this to industry
period of 3 years. averages.

The warranty provision for the current year

has been calculated as 2% of the revenue. They should also discuss the rationale
In the previous year the warranty was behind of reducing the level of provision
based on 6% of revenue. this year.

The finance director has made this change The audit team should also compare the
despite no significant difference in prior year provisions with the actual levels
construction technique or the level of of claims in the year, if any, made by
claims in the year. customers, to assess the reasonableness of
the judgements made by management.
Under IAS 37 Provisions, Contingent
Liabilities & Contingent Assets, this should
be recognized as a warranty provision.
Calculating warranty provisions required
judgement as it is an uncertain amount.

There is a risk that the warranty provision

could be understated, leading to
understated expenses & liabilities.

Hart Co has incurred expenditure of $1.8m The audit team should obtain a breakdown
relating to the R&D of a new type of of the research expenditure recognized in
environmentally friendly building material. P/L & development costs capitalized, &
review supporting documentation to
$0.6m of the expenditure to date has been determine whether they have been
written off to the SOPL, & the remaining classified correctly.
$1.2m has been capitalized as an IA.

IAS 38 Intangible Assets has criteria as to

which costs can be capitalized as
development expenditure. There is a risk
that the requirements of the standard have
not been applied correctly.

If research costs have been classified

incorrectly as development expenditure,
there is a risk that IA could be overstated &
research expenses be understated.

In June 20x5, the company contracted to # Review the NCA register to determine if
purchase new machinery costing $2.4m. It the $1m paid in advance has been
paid $1m on signing the contract to secure capitalized.
the machinery, which was due to be
delivered in July 20x5. Due to a supplier Confirm with management that the amount
problem, the delivery is delayed & is now paid in advance is recognized as a
scheduled to be delivered in October 20x5. prepayment.

Only assets which physically exists at year

end should be capitalized as PPE. The $1m
deposit paid in advance should be
recognized as a prepayment.

If the deposit of $1m paid in advance have

been classified within PPE, then
prepayments are understated & PPE will be
overstated.

In order to finance the R&D costs & the The audit team should obtain legal
machinery purchase, Hart Co made a rights documentation to agree the number of
issue to existing shareholders at a price of shares issued & the rights price.
$0.75 for each $0.50 shares.
The audit team should also agree that
This a non-standard transaction & there is disclosures are adequate & consistent with
increased risk that the issue has not been standards & legislation.
recorded correctly.

There is also a risk that the right issue has

not been disclosed in accordance with
accounting standards.

Hart Co’s payroll function is outsourced to #

an external service organization, Chaz Co,
which is responsible for all elements of
payroll processing & maintenance od
payroll records.

A detection risk arises as to whether

sufficient & appropriate evidence is

Hart Co’s directors correctly disclosed their Discuss this matter with management &
remuneration details in the forecast FS in review the requirements of local legislation
line with IFRS Standards. However, local to determine if the disclosure in the FS is
legislation in the country which Hart Co is included appropriately.
based, requires more extensive disclosure.
The directors have stated that they consider
this onerous & so do not intend to provide
the additional information.

Where the local legislation is more

comprehensive than IFRS Standards, it is
likely that the company must comply with
local legislation.

The directors’ remuneration disclosure will

not be complete if the additional
information is not disclosed.