Adams Group
Briefing Notes
To: Joss Dylan, Audit engagement partner
From: Audit manager
Subject: Audit planning for the Adams Group
Date: 1 July 20X5
Introduction
These notes are in relation to the audit planning of Adams Group for the Year ended
31 May 20x6. These notes consist of an evaluation of audit risk, matters to be
considered in respect of using the work of Clapton & Co, and the relevant procedures
to be performed, details procedures to be conducted in relation to the investment in
associate of the group and the Adams brand name and lastly ethical and professional
issues which need to be addressed as a result of the requests made by the audit
committee of the Adams Group.
(a) Audit Risk
Materiality Level
Materiality level for the audit of Adams Group will be based on the Profitability. The
threshold range on materiality is between 5% to 10% on profit. In case of Adams
Group audit, it will be between range of $560,000 to $1,120,000. Our firm will use our
own professional judgment to set a materiality level after risk assessment audit of
Adams Group. Further, this is first year that our firm will audit Adams Group and
Adams Group is a listed entity so the risk will be high. Considering that our firm will
consider lower level of materiality which is $560,000.
New Audit Client
Our firm is appointed by Adams Group in January 20x6. So, it is first year that our firm
will audit the Adams Group. In first year, our firm will lack experience and knowledge
about the client business and its environment, there is a risk that our firm will not
detect the material misstatement in effect manner. This can be reduced through
rigorous audit planning. Further, our firm will audit the opening balances and previous
year audit was not done by our firm and our firm will rely on someone else work, there
is a risk that the previous year audit was not performed with care, and the opening
balances may be materially misstated.
Different Component Auditor
One of the group component, Lynott Co a foreign subsidiary co is audited by local
audit firm, Clapton & Co. This increased risk of our firm being a group auditor, as
accounts of Lynott co is audited by different audit firm will become part of
consolidated financial statements which is our firm responsibility. If the Clapton & Co
did not perform the audit in effective manner and care, there is a risk that the Lynott
Co accounts will be materially misstated, and it will also affect the consolidated
financial statements.
Increase In Revenue
The Group revenue is increased by 11.5%, which seems normal growth. However,
there is risk that the management overstated the revenue. Further, the management
may early recognise the revenue when services still need to be provided. These risk
factors increase more, as the management bonuses is directly connected to the
growth in revenue. The revenue head count exceeding the materiality level of
$560,000, therefore material to the financial statements.
Abnormal Movement in Inventory and Receivables
The inventory and receivable have abnormally increased by 100% and 59.1%
respectively as compared to last year. There is a risk that these heads are overstated,
as revenue is only increase by 11.5% which is not line with this increase. Further,
there is a risk that the inventory of Silk clothing needs to be revalued if its not sold
within 12 months and the management did not perform revaluation. It will lead to
overstatement the inventory head. The receivables and inventory head is exceed the
materiality level of $560,000, therefore material to financial statements.
Non-Amortization of Brand Name
According to the relevant accounting standard, the intangible assets should be
amortized over its useful life if it has finite life. In case of indefinite life, no
amortization will be charged. There is risk that the management assumption of
indefinite life of Brand name is wrong, and the Brand name has a finite life. Then it will
lead to overstatement of Intangible assets and profit if amortized did not expense out.
The Brand name worth $8000,000 which exceed the limit of materiality of $560,000,
therefore material to the financial statements.
Stewart Co
According to the relevant standard, if the company directly or indirectly holds 20% or
more than 20% of the voting rights it is consider as significate influenced on the entity
and will be consider as Associate. Unless there some clear clause to the investment
mentioned. There is a risk that this investment does not give rise to significant
influence and management has consider as Associate, rather it should be mentioned
as investment in Stewart Co.
Weak Internal Control
The Group has outdated accounting and management information system, which is
indication of weak internal controls. In parallel to date the Lynott co introduce new
inventory control system. It gives rise to risk that during the year new system launch
will faces control risk. As for new system it takes time to fully control the new system
and understand it properly. As the risk is relatively high in new system.
Financial Analysis
Growth in Gross Profit 12.7%
Growth Operating Profit 59.5%
Growth in Gross Profit Margin 0.83 %
Growth in Operating Profit Margin 41.67%
Decline in Cash 54.5%
Growth of 12.7 % in Gross profit seems normal, as in aligned with the revenue growth
of 11.5%. While Operating Profit growth 59.5% looks very abnormal and very high as
compared to revenue. There is a risk that the management wrongly classified the
operating expenses which lead to significant growth. The gross profit margin growth of
0.83% seems normal which there is significant growth in operating profit margin. The
Decline in cash is 54.5% looks very abnormal, and not in alignment the management
claims of high revenue and Beard Co considering as cash rich company.
Conclusion
There are multiple audit risk that our firm will face. As our firm will audit first time the
group. And we must reply on the work on component auditor. The management bonus
is directly link with revenue so there were some high risk account head like revenue,
profits and revaluation and impairment.