Draft a report to the Senior Partner of your audit firm

Assignment Brief

CASE STUDY – CKC WEAR LIMITED

The senior partner of your audit firm has informed you that you are to be in part of a team to audit a new client, CKC WEAR LIMITED, for the audit of the year ended 31st October 2018. The company is engaged in the import of fabrics from Asia and Africa and the manufacture and wholesaling of clothing. The company turnover is approximately £60,000,000 and it has a workforce of about 200 and plans to employ another 20 staff in the next 4 months. The company has grown from a small family-owned business to a highly successful company over the last 10 years. Currently, it has three warehouses and manufacturing location in Romford, east London. This will be the only client your firm has in the clothing industry.

As part of the preparation work of the audit, you arrange a meeting with Jean Edwards, the CEO of CKC WEAR LIMITED, in order to familiarise yourself with the company’s operations. From your meeting, you discover the following:

The company’s Board of Directors is comprised of three family members from the James family, (the business owners); two close business associates/friends of the family; and two respected members of the Romford business community.

The financial statements of the company show a steady decrease in profit over the last two years, mainly because of reducing sales volumes. Jean attributes this to slipping market share of the company as smaller sized competitors are increasingly encroaching on its customer base.

Over the last 12 months, the accounts department has experienced a high turnover of staff, with most ex-staff joining the company’s competitors who have more attractive pay packages. Therefore, of the 15 accounts staff, only the financial controller and management accountant have been with the company for more than two years.

The purchasing system at CKC WEAR LTD was automated during the period being audited. Purchase orders are now generated automatically by the computerized inventory system when inventory falls below a given level. However, this system is not working well because it uses complicated purchasing and production models, making it difficult to use, hence many manual adjustments are required. So far only two members of the production manager’s clerical staff are able to use it. As a result, sometimes the items ordered are delivered late or in the wrong quantities. In addition, the system takes up a lot of space on the company server and is causing problems in other systems.

In terms of record keeping, the most comprehensive records maintained within the company are the sales records, which are reconciled and reviewed weekly by the chief accountant together with the sales manager. However, production figures and inventory figures are not reviewed as diligently. Stocktaking is done periodically throughout the year and not at the year-end.

Jean mentioned in the meeting that even if she is taking this exercise, she has lost trust in auditing because of the many reports and cases been reported on poor quality of auditing by auditing firms. She has thus asked you to prepare short notes for her and the board in which you should outline current issues to do with the quality of Auditing, using some examples of current cases and outline what can be done to bring back the confidence of clients in Auditing.

Required:

Draft a report to the Senior Partner of your audit firm, in which you:

1. Identify the key business risks CKC WEAR LIMITED faces and the possible consequences and suggest how these risks could be mitigated. (20 Marks)
2. Describe the information you will seek, and procedures you will perform, during the planning and risk assessment phase of the audit in accordance with ISA 315 ‘Obtaining an understanding of the entity and its environment and assessing the risks of material misstatement’. (20 Marks)
3. Describe the tests of controls you would plan for (and why) in order to obtain sufficient appropriate evidence concerning purchases. (20 Marks)
4. Undertake some research in relation to Jean concerns about Audit quality and reassure her by outlining what can be done to improve auditing and bring back the confidence of clients in the same. (30 Marks)

Sample Answer

Report to the Senior Partner

Subject: Audit Planning and Risk Assessment for CKC WEAR LIMITED

Key Business Risks, Possible Consequences, and Mitigation Strategies

Based on the meeting with Jean Edwards, CKC WEAR LIMITED is facing several business risks that could impact profitability, operational efficiency, and compliance.

a) Declining Sales and Market Share

• Risk: Increased competition from smaller, agile companies is eroding the company’s market share.

• Consequence: Continued decline in revenue and profit, potential cash flow issues, and loss of investor confidence.

• Mitigation: Diversify product lines, strengthen marketing strategies, conduct competitor analysis, and enhance customer loyalty programmes.

b) High Staff Turnover in Accounts Department

• Risk: Loss of experienced staff leads to operational disruptions and increased risk of errors in financial records.

• Consequence: Inaccurate reporting, delays in closing accounts, and risk of fraud.

• Mitigation: Improve pay and benefits to match competitors, invest in training and retention programmes, and implement robust handover processes.

c) Ineffective Automated Purchasing System

• Risk: Poor system usability and reliance on a small number of trained staff leads to incorrect or late orders.

• Consequence: Production delays, higher costs due to urgent procurement, and dissatisfied customers.

• Mitigation: Provide system training to a wider group of staff, simplify system processes, and introduce periodic performance reviews of the software.

d) Weak Inventory and Production Data Controls

• Risk: Lack of regular review and year-end stocktake creates risk of misstated inventory and cost of sales.

• Consequence: Financial misstatements and potential audit qualification.

• Mitigation: Implement more frequent and documented stocktakes, assign responsibility for inventory review, and introduce integrated production reporting systems.

e) Reputational Concerns About Auditing

• Risk: CEO’s scepticism about audit quality may affect cooperation and openness during the audit.

• Consequence: Reduced access to information and potential misunderstandings between client and auditor.

• Mitigation: Communicate transparently about audit processes, provide assurance on quality standards, and maintain a collaborative approach.

Information to Seek and Procedures in the Planning and Risk Assessment Phase (ISA 315)

Under ISA 315, we must obtain a clear understanding of CKC WEAR LIMITED’s operations and environment to identify and assess risks of material misstatement. Key information and procedures will include:

a) Understanding the Entity and Its Environment

• Obtain organisational structure, governance arrangements, and decision-making processes.

• Review the company’s industry position, competitors, and economic environment.

• Understand the nature of operations, including importation of fabrics, manufacturing, and wholesaling.

b) Understanding the Internal Control Environment

• Evaluate management’s commitment to financial reporting accuracy.

• Review internal control policies for purchases, inventory, and sales.

• Examine staffing structure and segregation of duties in the accounts department.

c) Understanding the Company’s Financial Performance

• Review budgets, forecasts, and variance analyses.

• Analyse two-year trends in sales, costs, and profit margins.

• Obtain explanations for declining profits.

d) Risk Assessment Procedures

• Conduct walkthroughs of the purchasing, inventory, and sales processes.

• Review minutes of board meetings for key decisions.

• Make inquiries of management, operational staff, and IT personnel about system performance.

• Perform preliminary analytical procedures to identify unusual fluctuations.

Continued...