ACC605 Auditing: Analyzing Financial Audit of Kereru Brewing Company

This case study provides a comprehensive audit analysis of Kereru Brewing Company Limited, focusing on the audit for the year ending June 30, 2018. Part A assesses acceptable audit risk, significant risks of material misstatement (inherent and control risks), and performs preliminary risk assessments. It includes horizontal and vertical analysis of the balance sheet, relevant financial ratio analysis, and identifies accounts requiring special attention. Materiality levels are calculated, and the impact of misstatements is evaluated. Part B examines the relevance of internal controls, including their underlying objectives, tests of controls, and substantive controls, and their stage during the audit. Finally, it considers situations affecting the audit plan, culminating in conclusions and recommendations for the auditors and management. Desklib offers a wealth of similar solved assignments and past papers to aid students in their studies.

AUDITING
Student Name:
Student ID:
6/2/2018

EXECUTIVE SUMMARY
Every business operating in the different industry shall identify the appropriate risks. These risks
may be financial or non financial depending upon the requirements of the management of the
company. The report has been framed with the four basic objectives. First object is to consider
various aspects as to how the audit will be conducted in an efficient manner. Second object is to
perform the analysis through the different ratios and the materiality levels through which the
audit plan can be prepared with the according modification. The third object has been to consider
the impact of the adjusting or the UN - adjusting events and the last object has been to analyze
as to how the internal control impacts the working of the auditor of the company and how the
auditor consider the same. With these objectives and the considerations, the report is being
prepared for the benefit of the auditor as well as the management of the company.
Contents
EXECUTIVE SUMMARY.........................................................................................................................2
INTRODUCTION.......................................................................................................................................2
PART A.......................................................................................................................................................3
a) Acceptable audit risk and Influencing Factors.................................................................................3
b) Significant Risk of Material Misstatement.......................................................................................4
c) Preliminary Assessment of Risk......................................................................................................6
d) Overall Analytical Review...............................................................................................................7
(i) Horizontal and Vertical Analysis.................................................................................................7
(ii) Relevant Financial Ratios........................................................................................................9
(iii) Accounts requiring Special Attention....................................................................................11
e) Materiality.....................................................................................................................................12
(i) Different Levels.........................................................................................................................12
(ii) Calculating Materiality levels................................................................................................12
(iii) Calculating Materiality levels for Brands..............................................................................13
(iv) Impact of Misstatements........................................................................................................13
PART B.....................................................................................................................................................14

a) Relevance of Internal Controls......................................................................................................14
(i) Underlying Objective.................................................................................................................14
(ii) Test of Controls and Substantive Controls.............................................................................14
(iii) Stage during the audit............................................................................................................14
b) Situation affecting Audit Plan........................................................................................................14
CONCLUSION AND RECOMMENDATION.........................................................................................15
REFERENCES..........................................................................................................................................15
INTRODUCTION
Auditor of the company plays the fiduciary relation in its working and reporting. Fiduciary
position has been mentioned because of the fact that the auditor has to consider the interest of the
stakeholders as well as the interest of the company. The auditor is required to present the report
with all the material facts and figures which is necessary to the stakeholders and the shareholders
of the company. As the title suggests, the whole report revolves around the auditing of the
company – Kereru Brewing Company Limited. The report has been bifurcated into two parts.
First is Part A and second is Part B. The part A of the report has started with the assessment of
the audit risk at different levels. It has included the meaning of the acceptable audit risk and
performing the analysis through the accounting ratios, horizontal and vertical analysis of the
financial statements of the company. Then the materiality levels for the year under audit has been
finalized and identified as to how the same will have the impact on the audit of the company.
Then in this the importance of the adjusting event has been mentioned as to how the same has
been considered in the planning of the audit. The next section is Part B which has dealt with the
analysis of the internal control and how the same is very useful for the auditor with the detailed
analysis as to how the same will impact on the planning of the audit. The report has then ended
up with the conclusion and the recommendation. The data has been obtained from the reasonable
sources and the report has been presented for the benefit of the auditors of the company for
having an effective and efficient planning of audit.

PART A
a) Acceptable audit risk and Influencing Factors
The risk which the auditor can undertake or considers while issuing the audit report to the
client with the opinion which is not qualified in any manner is known as the acceptable
audit risk. Also the auditor takes this level of risk knowing of the fact that the financial
statements so stated have the material misstatements (AASB, 2016). The acceptable
audit risk has the direct relationship with the detection risk and the inverse relationship
with the findings of the audit evidence. If the level of the acceptable audit risk increases
then the auditor will be less interested in collecting and obtaining the audit evidence.
Thus, the acceptable audit risk has inverse relationship with the audit evidence. And if the
level of the acceptable audit risk increases then the detection risk also increases as the
auditor will be least interested in detecting the material misstatement if present in the
financial statements. Thus, the acceptable audit risk will have such an effect of issuing
the unqualified audit report. The acceptable audit risk is influenced by mainly three
factors. These three factors have been described below:
- Reliance by External Users – This factors states that the level of acceptable audit risk
shall be kept as low where the external users are highly interested in the financial
statements of the company. These external users are found more in case of the three
factors:
o If the company has the larger clients. In the given case the company has
entered into the area of international expansion and starts sending the goods to
Japan in the beginning of the December 2017 and has the largest shareholder.
o If the company is publicly held corporation- The KBC limited is not the
publicly held company (Mock, 2015).
o If the company has the extensive use of liabilities – The Company has
obtained the borrowing on the hypothecation of the plant and equipment
amounting to 960000 New Zealand Dollar and hence there is the extensive use

of the liabilities. Also the company is planning to have the additional loan in
the year of 2019 so as to expand the business.
Thus, in this manner, the reliance level will be low or medium and the acceptable
audit risk will be medium to high.
- Chances of the failure of Finance – The company has the current ratio and liquidity
ratio with the increased figure in the year of 2018 as compared to the year of 2017.
The current ratio has been increased from 1.18 to 1.84 and the liquidity ratio has been
increased from the 0.42 to 0.83. These figures details that with the addition of the
loan of 150000 New Zealand dollar, the current and the liquidity ratio has been
improved through which the risk level will be medium to high.
- Management Integrity - In the given case of the company, there has been many
noticed integrity issues which entails that higher the issues noticed and confirmed on
the management of the company more will be the chances of having the acceptable
audit risk as low. Following are the reasons for the above statement:
o At first the Chief Executive Officer of the company has been known by the
name of high flyer and had undergone through the stage of the bankruptcy.
o Secondly he operates the company where he rules all the employees and takes
the tough decisions.
o Thirdly he has been in the process of having the delegation of the
responsibility done but not the authority.
o Lastly, during his tenure, auditors have identified the material misstatement
which can affect the presentation of the financial statements.
Thus, the level of the risk will high.
b) Significant Risk of Material Misstatement
The material misstatement is the figure or the fact which is presented in the financial
statements of the company and has the power to have the decision changed of the users of
the financial statements of the company. It includes the shareholders as well as the
stakeholders of the company. Following are the significant risk of the material

misstatement which requires the attention of the management and have been divided into
two parts. One is the inherent risk and other one is the Control risk:
Inherent Risk –
- The chief executive officer of the company has been the high flyer in the earlier years
due to which has faced the bankruptcy also.
- The chief executive officer of the company has been ruling over the company
matters in the dictatorship and autocratic manner.
- He only thinks that his job is only to take the important and meaningful decision and
big ones.
- The material misstatement has occurred in the earlier periods during his tenure (Gary,
2017).
- He only remains in the manner where he delegates the appropriate responsibility but
does not delegate the authority. The delegated responsibility will not work until the
appropriate authority will not be given.
- The company is making all the sales on the credit basis. No time has been defined and
no component of cash sales is there due to which the liquidity of the company may
gets affected.
- The rising amount of the New Zealand dollar will lead to the loss in the foreign
exchange difference and the company has not complied with any of the hedging
instruments for the cash flows that will be required to be made in the near future.
- The new virus has arisen which is known as the Hop Mosaic virus and will lead to the
lesser supplies in the future as the raw material is used for the manufacture of the
beer.
Control Risk –
- The company has not charged any depreciation on the plant and equipment and that
too including the leasehold property improvements.
- The company is required to maintain two ratios as per the banks so as to keep the loan
active as obtained from the banks. These two ratios are the net tangible assets to the

total liabilities and current ratio and as per the requirement the both the ratios shall be
positive.
- The employees are under pressure to finalize the financial statement at the earliest so
as to provide to the auditors for issuing the audit opinion thereon. The deadline as
mentioned is 15-09-2018.
- The company is facing the legal case regarding the health and the safety of the
employees working under the organization and accordingly there may be the risk of
the liability creation in the near future (AASB, 2013).
Thus, the above are the significant risk of material misstatements.
c) Preliminary Assessment of Risk
After the identification of the significant risk of material misstatement, it is very
necessary to assess the level of the risk in order to plan the audit accordingly.
Under the head of the inherent risk, the level of risk that has been assessed is Medium to
High. It is because the major impact has been due to the chief executive officer of the
company which has all the bad images and due to which the functioning of the company
will be affected badly and there might be the high chances of having the material
misstatement in the financial statements of the company (Anastasia, 2015).
Under the head of the Control risk, the level of risk that has been assessed is high. It is
because all the risks that have been identified will affect the financial statements in any
manner. On one hand the depreciation will be charged on the assets of the company and
on other hand the ratios are required to be maintained as per the stipulation made by the
bank.
Thus, the overall risk that has been assessed from the above identified risks and their
impact is high.

d) Overall Analytical Review
(i) Horizontal and Vertical Analysis
HORIZONTAL AND VERTICAL ANALYSIS OF THE BALANCE SHEET
Horizontal 2018
Vertical
2018
Vertical
2017
(On 2017
Figures)
Cash and Cash Equivalents 182% 1% 1%
Trade and other Receivables 159% 20% 18%
Allowance for doubtful debts 56% -1% -2%
Inventories 116% 25% 31%
Prepaid Expenses 119% 0.16% 0.20%
Total Current Assets 136% 46% 48%
Plant and Equipment at cost 131% 70% 77%
Less Accumulated depreciation 116% -24% -30%

Total plant and equipment 141% 46% 46%
Loan to previous CEO 100% 2% 3%
Intangible Assets 348% 7% 3%
Total Non Current Assets 150% 54% 52%
Total Assets 143% 100% 100%
Trade and Other payables 85% 12% 20%
Bank Loan Payable 0% 1% 0%
Accrued Liabilities 121% 4% 5%
income Tax Payable 68% 7% 14%
Current portion of long term bank loan 100% 1% 2%
Total Current Liabilities 87% 25% 41%
Long Term bank Loan 80% 5% 10%
Total Non Current Liabilities 80% 5% 10%
Net Assets 202% 70% 50%
Shareholder's Equity 202% 70% 50%
Total Liabilities 100% 100%
HORIZONTAL AND VERTICAL ANALYSIS OF THE INCOME STATEMENT
Horizontal 2018
Vertical
2018
Vertical
2017
(On 2017
Figures)
Sales 146% 100% 100%
Less Cost of Sales -135% 55% 59%
Gross Profit 160% 45% 41%

Distribution, Administration, Sales and
Marketing 119% 21% 26%
Lease Expense 119% 1% 1%
Superannuation Expense 122% 2% 2%
Loss on Foreign Exchange 154% 1% 1%
Interest Expense 80% 0% 0%
Total Operating Expense 119% 25% 31%
Operating profit 280% 20% 10%
Income Tax 158% 4% 4%
Operating Profit After Tax 343% 16% 6.87%
(ii) Relevant Financial Ratios
RELEVANT FINANCIAL RATIOS
S.
No
. Ratio Formula
Company
Ratio 2018
Company
Ratio 2017
Industry
Average
2018
1 Current Ratio
Current Assets /
Current Liabilities
1.8
4 1.84:1
1.1
8 1.18:1 1.91:1
2 Liquidity Ratio
CA- Inventory /
Current Liabilities
0.8
3 0.83:1
0.4
2 0.42:1 0.92:1
3
Debt To Total
Assets Ratio
Total Liabilities /
Total Net Assets
0.4
3 0.43:1
1.0
2 1.02:1 1.11:1
4
Time Interest
Earned
Net Operating profit /
Interest Charges
91.
04
91
times
21.
25
21.25
times 3.00 times
5
Inventory
Turnover
Cost of Goods Sold /
An Inventory held
6.1
3
6.13
times
4.8
9
4.89
times 5.85 times

6
Day Sales in
Inventory
365 / Inventory
Turnover
59.
53 59.53
74.
57 74.57 62.39
7
Account
Receivable
Turnover
Credit Sales /
Accounts Receivable
13.
25
13.25
times
14.
50
14.50
times 10.43 times
8
Average
Collection period
(days)
365 / Accounts
Receivable Turnover
27.
54 27.54
25.
18 25.18 35
9
Total Assets
Turnover Sales / Total Assets
2.6
1
2.61
times
2.5
7
2.57
times 2.83 times
10
Gross Profit
Margin Gross Profit / Sales
45.
11
45.11
%
41.
00
41.00
% 50.37%
11
Net Operating
Margin
Net Operating Profit /
Sales
16.
16
16.16
%
6.8
7 6.87% 8.34%
12
Return On Total
Assets
Net Profit Before
Taxes / Total Assets
0.5
2 0.52%
0.2
7 0.27% 6.44%
 The current ratio and the liquidity ratio has been increased from the year of 2017
to 2018 which shows that there is no liquidity crunch in the company and is very
near to the industry average but requires the attention of the auditor (Abidin,
2015).
 The ratio of the time interest earned has been increased 400 times from 21.25
times in the year of 2017 to 91 times in the year of 2018. It shows that the
company has been paying the amount regularly and now it can pay more and on
the other hand is the doubtful situation for the auditor and shall be check by the
auditors (ACCA, 2016).
 Debt to total assets ratio for the last two years has been below the industry
average of 1.11:1 which is the alarming situation for the company as it should at
least meet the industry criteria.

 Net Operating margin has been increased two and a half times and is double of
the industry average although the gross profit margin is below the industry
average. The auditor is required to check the accounts in detail.
(iii) Accounts requiring Special Attention
Following are the accounts which require the special attention:
- Cash and Cash equivalents have been increased by 182% which shows that the
company is cash rich company. On one hand it’s the cash rich company and on the
other hand it is applying for obtaining the loan.
- The loss on foreign exchange has been increased by 154% as compared to the last
year. It depicts that the company is not focusing on the ways as to how to hedge the
loss that is being incurred from the foreign currency fluctuations.
- The intangible assets have been increased by 348% as with the figure of the last year.
The major change has been due to the inclusion of the brands of NZ855000 dollars.
The auditor is required to check the detail of the acquisition of the brands (Kharisova,
2014).
- Sales have been increased by 146% whereas the corresponding expenditure has been
increased by 119%. The attention is required regarding the correctness of the amount
mentioned in the income statement and the corroborative evidences.
- The amount of distribution, selling and administration expenses has been reduced by
5% from 26% in the year of 2017 to 21% in the year of 2016. It requires the special
attention as to ascertain with the increase in the sales of the company, the
corresponding expenses have not been increased rather reduced.
- Loan to previous CEO has been decreased by 2% in 2017 to 1% in 2018 which
requires attention as to first ascertain why the loan has been given and whether the
same is being paid as per the terms of the contract.