Audit Risk Analysis: TWC Case Study

The assignment content requires students to analyze business risks that TWC faces, identify internal controls in their system that are potentially effective, and test these controls. Additionally, students need to list and justify weaknesses in internal control for purchases and accounts payable. The assessment also evaluates the students' ability to demonstrate risk management methodologies and the role of internal controls in an audit context, as well as their design of an audit plan and selection of appropriate audit procedures.

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
Ratio 2018 (Unaudited) 2017 (Audited) 2016 (Audited)
Return on equity % 10.80 17.5 15.2
Return on beef production assets %1.67 -0.82 -3.45
Return on grape and wine
production assets %
12.2 14.5 16.2
Gross margin % 24.5 30.00 31.76
Net profit margin % 14.38 20.27 17.85
Marketing expense % of total S &
A expenses
23.67 17.89 15.2
Times interest earned 6.67 7.51 8.10
Days in inventory - wine 367 423 460
Days in accounts receivable - wine 50.2 60.65 53.24
Days in accounts receivable - beef 57 36 24

Current ratio:1 2.80 2.54 2.66
Quick asset ratio:1 1.18 1.15 1.20
Debt to equity ratio:1 0.54 0.63 0.67
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.
Question 1A 8%
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:
Account Analysis Audit Risk Audit Steps to reduce risk

Question 1B 2%
Analyse the ratios and additional information to outline business risks that TWC faces.
Question 2A 7%
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:
Effective control Risk alleviated Test of control
Question 2B 2%
List and justify the weaknesses in internal control for purchases and accounts payable.
Weakness Justification
Rationale
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This assessment task will assess the following learning outcome/s:

 be able to demonstrate risk management methodologies and the role of internal controls in an audit context.
 be able to design an audit plan and select and apply appropriate audit procedures for a financial statement audit.
 be able to exercise critical and reflective judgement and appreciate the value of ethical practice.
Marking criteria and standards
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Criteria High Distinction Distinction Credit Pass
Question 1
Analysis of ratios and other
information
demonstrating auditrisk
assessment skills and critical
and reflective judgement (4
marks).
Correct interpretation of
ratios and other
information provided,
demonstrating a
sophisticated
understanding of how
the ratios can be used to
analyse the audit risks.
Correct interpretation
of ratios and other
information provided,
demonstrating a clear
understanding of how
the ratios can be used
to analyse the audit
risks.
Most interpretations of ratios
and other
information provided correct,
demonstrating an
understanding of how the
ratios can be used to analyse
the audit risks.
Most interpretations of ratios and
other
information provided correct but
a limited understanding of their
usefulness in identifying the audit
risks.
Identification of audit steps
that minimise audit risk
identified through the
analysis of the ratios and the
additional information (4
marks).
All appropriate audit
steps identified with a
clear statement as to
how these will minimise
audit risk, demonstrating
a sophisticated level of
audit planning.
Most appropriate audit
steps identified. A
clear understanding of
how audit tests
minimise audit risk.
Many appropriate audit steps
identified. Some
understanding of how audit
tests minimise audit risk.
Some appropriate audit steps
identified.
Basic understanding of how audit
tests minimise audit risk.
Analysis of ratios and other
information
demonstrating business risk
Strong application of
analytical procedures
and other provided
Sound application of
analytical procedures
and other provided
Some application of analytical
procedures and other provided
information to assessment of
Use of some provided information
in listing at least three items of
business risk. Basic application of

Criteria High Distinction Distinction Credit Pass
identification skills (2
marks).
information to provide
comprehensive
assessment of at least
four items of business
risk.
information to provide
assessment of at least
four items of business
risk.
at least three items of business
risk.
analytical procedures.
Question 2
Appraisal of the client's
internal control environment
and application to the audit
risk model (5 marks)
Identification of at least
four internal controls
that are potentially
effective, with
a comprehensive
explanation of the risk
each one could mitigate.
Tests of control
Identification of at
least four internal
controls that are
potentially effective,
with an explanation of
the risk each one could
mitigate.
Identification of at least three
internal controls that are
potentially effective, with an
explanation of the risk each
one could mitigate.
Identification of three internal
controls that are potentially
effective with basic explanation of
the risk each one could mitigate.
Development of a series of
audit steps that assess the
effectiveness of
internal controls (2 marks).
Development of a
comprehensive series of
audit steps designed
to assess the
effectiveness of internal
controls. This
demonstrates a deep
understanding of the
audit process.
Development of a
series of high quality
audit steps designed to
assess the effectiveness
of internal controls.
This demonstrates
a clear understanding
of the audit process.
Development of audit steps
designed to assess the
effectiveness of internal
controls. This demonstrates a
moderate understanding of the
audit process.
Development of basic audit steps
designed to assess the
effectiveness of internal controls.
This demonstrates a basic
understanding of the audit
process.
Identified internal control
weaknesses (2 marks)
Identification of and
comprehensive
justification for at least
five sales and
Identification of and
justification for at least
four sales and
receivables internal
Identification of and
justification for at least three
sales and receivables internal
control weaknesses.
Identification of but limited
explanation for at least three sales
and receivables internal control
weaknesses.

Criteria High Distinction Distinction Credit Pass
receivables internal
control weaknesses.
control weaknesses.
These last two criteria
relate to the whole of the
case study.
Professional communication
(Note: you are required to
space between paragraphs;
use Arial 10pt or TNR 12 pt;
use 1.5 or double line
spacing) (0.5 mark).
Work contains distinct
understandable
statements with no
errors.
Extremely well
organised. Content is
structured in a manner
that facilitates the
reader’s understanding.
Work contains distinct
understandable
statements with
minimal errors.
Answer is well
organised. Content is
structured in a manner
that facilitates the
reader’s understanding.
Minor spelling, grammar and
punctuation errors. Work
shows evidence of
proofreading. Well-structured
with one main idea or
argument provided per
paragraph.
Some spelling, grammar and
punctuation errors found but the
work is readable and structured.
Work may include too many ideas
in one paragraph.
Appropriate resources and
correct referencing
(0.5 mark).
Used a range of sources.
All work has been
referenced correctly as
per APA (6th edn)
requirements.
Used two or more
sources. All work has
been referenced
correctly as per APA
(6th edn) requirements.
Used one or more sources. All
work has been referenced
within the body of the answer
and in the reference list, with
some omissions or errors in
terms.
No additional sources used other
than the text. Others’ work is not
always acknowledged and there
are a number of errors or non-
compliance with the APA (6th
edn).