ACCT300 | Auditing | The Auditing Measures Adopted By TCW

Background

You are a manager in the audit division at Miller Yates Howarth (MYH), an accounting firm with offices throughout the major regional centres of NSW and Queensland. Although a medium sized firm by national standards, MYH is the second largest regional accounting firm in Australia. Most of MYH’s audit clients are in the agriculture, mining, manufacturing and property industries. All those industries are currently under pressure, either from a downturn in commodity prices or fierce competition from overseas competitors. Ratios extracted from an unaudited set of financial reports at 30 June 2018 together with audited comparatives for the year ended 30 June 2017 and 2016 are set out below for your review. 

You are gathering information to prepare the audit plan of Trunkey Creek Wines Limited for the year ended 30 June 2018. Trunkey Creek Wines (TCW) is one of MYH’s most significant and longstanding clients. The following information has been gathered to date.

Principal activities of TCW
 • growing grapes for wine production;
 • production and distribution of red, white and sparkling wines;
 • beef cattle production on land surplus to grape production; and
 • investment of surplus funds.

TCW was originally a family company incorporated in 1968 and has operated successfully and profitably since that date. In the 1990’s shares were sold to a small number of investors to increase funds for the development and upgrading of the winery and the purchase of additional land for the vineyards. Insufficient rainfall had meant that some land was no longer suitable for wine grape production, as a result, TWC moved into Wagyu beef cattle production on this surplus land. The Wagyu operation is now starting to return a profit.

TWC now find that the 2 degrees increase in temperature at some vineyards is affecting the production of sparkling wine and are now looking at purchasing land in cooler climates. TWC has built up a strong following for their sparkling wine which earns significant profits in both domestic and overseas markets. TWC are currently negotiating the land purchase and part funding in part from medium term bank loans. The remaining purchase price will be sourced from surplus funds.

The Wagyu beef is sold through the Wagyu Selling Group (WSG) in which TWC has shares. These shares form a material part of TWC’s investment portfolio. WSG buys, butchers and sells the Wagyu beef to high end domestic restaurants and regularly sends frozen shipments to Japan and China. TWC are heavily marketing their pinot, both domestically and overseas, as a perfect accompaniment to the Wagyu beef. 

The directors of TCW are:

• Mrs Claire Harewood, Chairman. Mrs Harewood has significant experience in the industry and replaced her husband as chair when he died 10 years ago.
• Mr Phillip Strange, Chief Executive Officer
• Mr. Joe Quade
• Mr Steven Harewood, son of Claire Harewood and has oversight of the Wagyu beef operation
• Dr Mary Owens
• Ms Hilary Jones
• Mr Geoffrey Owens

Your audit partner, John Richards, has approached you and advised that there are several areas he is concerned about and he wants to you to report back to him about these areas before you complete your audit program. These areas and accounts are:
 • Accounts receivable
 • Investments
 • Property assets
 • Marketing expense

Internal control 

The financial controller at TCW has been refining the system of internal controls and informs you, at the planning stage of the current year's audit, that he has put together an internal control manual for the company. He has stated that this manual will create greater awareness of controls in the company, particularly with management which, in the past, has not been overly conscious of the need to implement and enforce effective internal controls.

Management staff receive bonuses based on certain agreed-upon target ratios which include measures such as targeted monthly sales volumes, variance of actual to budget departmental overheads and profit before interest and tax. The Board takes an active interest in the performance of the company and is quick to request explanations on variances from the agreed-upon monthly budgets.

Two years ago, the company devoted significant time and resources to the development and implementation of a new IT system. All teething problems associated with the implementation phase have now been resolved, and the financial controller is satisfied that the automated controls in place are assisting in producing accurate and complete accounting records. The management accountant also looks after the IT function as the position is not regarded by management as being a full-time job. Once application programs have been tested, strict password control exists over access to the programs. Passwords are not required for access to databases.

To assist in the planning for the current year's audit engagement, you extracted the following information from a review of the systems notes in the permanent file and a perusal of the new internal control manual:

• There are three section managers, one each for grape production, wine production and beef production. Each can order supplies for their respective operations up to a limit of $10,000 for each order. Orders between $10,000 and $30,000 must be approved by the management accountant. Orders over $30,000 must be approved by the CEO. Orders over $50,000 must be approved by the Board.
• Orders must be made through the computer ordering system which has direct links to the approved suppliers.
• Supplier information is contained in a supplier master file. Each supplier has a unique supplier code. If a section manager orders from an unapproved supplier, the order is rejected and sent to the management accountant for approval.
• The supplier information file is maintained by the accounts clerk. Changes to the file are approved manually by the management accountant.
• When supplies are received at the winery, the storeman checks the supplies received to the online copy of the order and the delivery docket provided by the supplier. Any discrepancies are noted on the online copy of the order. 
• The delivery docket is filed by the storeman in a folder that is kept at the winery.
• The invoice is received electronically from the supplier and matched to the order by the accounts clerk. If the order and the invoice match the invoice is included in a payments file. 
• The payments file is approved online by the management accountant once a week and used to generate an ABA file which is then uploaded to the bank by the management accountant.
• When the payments file is approved by the management accountant, the invoice is automatically recorded as being paid in the accounting system.
• When services such as repairs are ordered for the winery by the wine production manager, a service order is generated within the computer system and automatically sent to the service provider. 
• When the service has been delivered, the wine production manager or the storeman signs the service delivery docket on the service man’s tablet. 
• The invoice from the service company, with a copy of the signed service delivery docket, is received online by the accounts clerk. 
• The accounts clerk checks the signed service delivery docket to the invoice and the order and adds the invoice to the payments file for final approval by the management accountant. 
• In the case of discrepancies, the accounts clerk contacts the supplier and the wine production manager to resolve the issue. Payments are not made until the issue has been resolved. 

Required

Write a report, including a brief executive summary, to your managing partner that addresses the questions below. Where indicated, use the required format to answer that question.

1.a. Analyse the ratios and additional information associated with the four accounts listed by your audit partner, John Richards. Identify the potential audit risks and any audit steps that need to be undertaken to reduce audit risk.
Answer this question using the following table:

1.b. Analyse the ratios and additional information to outline business risks that TWC faces.

2.a. Identify the internal controls in the system that are potentially effective, the risk that the control could alleviate and one test of control for each of the identified potentially effective controls.
Answer this question using the following headings:

2.b. List and justify the weaknesses in internal control for purchases and accounts payable.

Introduction

In the modern world, audit processes are very vital on the part of corporates to thrive in such complicated environment. This is because auditing assists in recognizing all material risks that has made the entire business vulnerable in nature. Besides, it also assists in reflecting whether the depicted financial performance of the company is true and fair. This makes it clear that if proper auditing measures are not implemented by corporates, errors and frauds are more likely to be observed in their financials. Thus, with this report, the auditing measures adopted by TCW has been highlighted so that its material risks can be effectively determined. For such purpose, the company’s internal control mechanis

1.a. Evaluation of prime ratios and risks of the company

Ratio evaluation can play a key role in determining the financial performance of a company. Furthermore, it can allow in ascertaining which matters are of crucial importance and that requires immediate actions on the part of the company. With the help of the given table, the accounts of the company that is subject to audit risks have been discussed. With such discussion, it can be analysed whether these risks have affected the financial performance of the company or not (Roach, 2010). Nevertheless, the table also consists of effective audit steps that can be undertaken by the company to get rid of such risks.

1.b. Business risks that can be encountered by the company

The company has been able to sustain its presence in both domestic and international markets and even though it has been facing immense competition challenges from its rivals, yet it has left no strings attached to explore all other sections in the market. However, it can be noted that the financial performance of the company has been witnessing a declining trend in comparison to the last year, which is a negative sign (Hoffelder, 2012). This can be done by evaluating the company’s material ratios so that a thorough analysis on all aspects can be determined.

Firstly, it can be viewed that the number of days of collection of debts have increased in comparison to the last two years. The reason behind this can be attributed to the fact that the company has become incapable of recovering its dues on the part of debtors in proper time. Moreover, if debt recovery has become problematic for the company, it means the smooth flow of operations can be easily impacted and therefore, it results in a major risk 9 Geoffrey et. al, 2016). Secondly, the company has been a failure in offering required return on equity to its investors specially in comparison to the last years. This can be proved by the fact that the company’s ROE (return on equity) has declined by seven percent in comparison to the last years. Therefore, this can result in another business risk as investors will become unwilling to invest their funds in such company. Thirdly, it can be observed that the net profit margin together with the gross profit margin of the company has deteriorated in the current year. The reason behind this can be attributed to the increase in costs or decrease in sales. Hence, this is a sign of major concern for the company because it directly reflects on the financial performance and if the same is ineffective, it may result in a material business risk. Lastly, there is a massive enhancement in the company’s current ratio because of significant increment in its liquid assets (Gay & Simnet, 2005). This is also an area of major concern because it signifies inability on the part of the company to take its liquid assets into best use and therefore, resulting in another material business risk.

2.a. Measures of internal control

2.b. Justification behind the weakness in internal control mechanism

There are few issues in the accounts section like purchases and accounts payable that must be addressed as soon as possible.

Purchase

In relation to purchase, the first weakness is that there is no checking of the stores file and the justification is that the purchase order is not independently checked with the goods that can result in additional stocking in the warehouses of the company. The second weakness is that there are no separate files made for inferior or lower-quality commodities and the justification behind this is that the clerk has been aligning the order information and their respective bills, and then records it in the payment file (Blay, Geiger & North, 2011). Nonetheless, there can be few inferior goods that have not been accounted by the clerk. The third weakness is that the company has unwilling relied upon the approved suppliers to a large extent and the justification is that such suppliers are offered goods as per their reputation and goodwill but various factors like changes in terms and conditions, change in delivery time, etc are not considered.

Accounts payable

In relation to accounts payable, the first weakness is that there is no regular monitoring of payment files and the justification behind the same is that the same must be conducted by the management accountant and verification once a week is not enough in nature. The second weakness is that the company has not conducted reconciliation strategies to such account and the justification is that the accountant has primarily relied on IT system and has failed to draw proper reconciliations to the accounts payable ledgers (Baldwin, 2010). The last weakness is that the higher department has not checked the payment approval process in a proper way and the justification is that only the management accountant is responsible for approving such payments and inform the banks later.

Conclusion

The internal control measures of TCW have been adequately discussed through this report and it can be seen that there are various inefficacies that has resulted in the company’s inefficient performance when compared to the previous years. Furthermore, in the presence of adequate risk management strategies, any company can sustain in the environment because auditors can assist in recognizing material risks and report the same to the department for corrective actions. Nevertheless, in relation to TCW, the company has solely relied on the task of management accountant and not entrusted different duties to different persons. This is a very risky factor because if there are different duties to be fulfilled, there must be proper delegation of responsibility as well. Such reliance has created many risks for the company and that has forced it to lag. Moreover, risk management and auditing measures have come out to be the need of the hour because these can assist in identifying all such issues, thereby assisting in mitigation of such material risks. Overall, this can also assist the company in safeguarding its reputation in the market, thereby creating an opportunity to rise in the future as well.

References

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