Smoothbrush PLC Audit Case Study: Risk Assessment and Procedures

This case study presents an audit of Smoothbrush PLC, a paint manufacturer, for the year ending August 31, 2021. As an audit senior at Ledger and Co, the assignment focuses on the planning phase, including identifying audit risks such as inventory valuation, extended credit terms, and the valuation of plant and equipment. The case study delves into the implications of these risks, referencing relevant accounting standards like IAS 2, IAS 16, and IAS 37. It also examines the importance of effective stock taking procedures and proposes substantive procedures for verifying inventory valuation and physical stock, including correlating accounting records with inventory slips, categorizing inventory, and evaluating damaged goods. The case study provides a comprehensive analysis of the audit process, emphasizing the importance of risk assessment and the application of appropriate audit procedures.

Smoothbrush PLC audit case
study

TABLE OF CONTENTS
QUESTION 1.............................................................................................................................3
(a)...........................................................................................................................................3
REFERENCES...........................................................................................................................5

QUESTION 1
(a)
Identification of Audit Risk Explanation of Risk
Smoothbrush supplies 60% of its goods to
homewares by significantly reducing its
selling price, thus, the stock might be
overvalued.
According to IAS 2, inventories should
value at cost or net realizable value
whichever is lower (HAZAR, 2020). Thus,
the selling price is lower for the goods sold
to the homewares, therefore, there is a risk
that NRV of some stock items might eb
lower than cost making inventory to be
overvalued.
Recoverability of receivable balances
as credit period extended.
The company ahs extended its credit terms
to the Homewares from 1 month to 4
months. Therefore, this leads to an increase
in risk as balances outstanding become older
which might not be recovered.
Valuation of plant and equipment The production facility is having a large
amount of unused plant and equipment and
in accordance to IAS 16 and IAS 36, this
plant and equipment required to be stated at
the lower of it’s carrying value and the
realizable amount which might be scrap
value depending on its age and conditions
(Hassine and Jilani, 2017).
Cutting off of the purchases and the
inventory might not be accurate.
The company imports the goods from South
Asia and the paint can be in the transit for
nearly 2 months and thus, the entity
accounts for these goods when received.
Thus, at year end, only the goods which ahs
been received into the warehouse would eb
incorporated in the stock balance along with
the respective payable balances is to be
recognized.
The implementation of the new inventory
system in the year might result into making
balances being misstated.
The organization has implemented the
perpetual inventory accounting system and
these records will be utilized for the
recording eth stock at the year end. If eth
relevant change in the value of the inventory
is not made initially then there is a risk that
eth closing balance at year end is not fairly
stated.
Stock might be overstated as Smoothbrush
no longer has a slow moving provision.
Earlier, the organization made a provision
of inventory of 1 per cent, however, in this
year, this provision has been removed.
Therefore, till the time all the slow moving
or obsolete items are being identified at the
completion of the year along with the
adjustment in their fair value, there is a risk
that the value of the stock might be

overstated.
Provisions/contingent liability disclosures
might be incomplete.
The financial director has left and has the
intention to sue the company for the unfair
dismissal. But the company have not made
any provision or disclosure related to it. As
per IAS 37, in case there is a present
obligation which involves outflow of eth
financial resources in order to settle down
the obligation and a reliable can be made,
then a provision is needed to be recognized
(Acar and Ozkan, 2017).
Stock balance might be over or understated
if new inventory system is not complete and
accurate.
The inventory counts should cover all line
and if any warehouse area is left then it will
be required to done at year end.
b) The assessment of the risk pertaining to the audit has to be conducted at the planning stage
of conducting the audit as this shall ensure in the quality audit performance by the external
auditors of the company. The analysis of the risks shall be helping the auditors in finding out
the material misstatements that are made in the financial statements of the company. Such
material misstatements can either be unintentional or it can be the part of fraudulent practices
that are conducted internally to avoid important disclosures (Jeppesen, 2019). Planning for
the audit in advance shall give a structured manner of investigation that is to be conducted by
the company. Formation of the blueprint in respect of the risks pertaining to the particular
organization shall be assisting the company in designing the structure as to what documents
are to be demanded and checked, which accounting is to be majorly evaluated and the
significant areas where a close eye has to be established.
In the current scenario of Smoothbrush it can be identified that the major risks are
pertaining to the stock taking policy of the company and the inventory valuation. It can also
be in relation to the treatment of the over and understocking issues that might be felt by the
company due to the extended credit period and the discounts that are offered to the suppliers.
The closing inventory of the business is to be valued at the cost or net realizable value
whichever is lower. Since the auditors have planned the audit beforehand and analyzed all the
policies that are followed by the business, it has fair idea about the risks of the business and
the areas that might have inefficiencies. This shall help them in smoothly conducting an
effective audit that shall give true and fair related to the financial statements of the business.
c) The process of stock taking shall be effectively undertaken by the company so that the
physical stock quantity can be assessed by the business. Smoothbrush Company is
conducting this process by following the method of continuous and perpetual inventory

counting system in the regular intervals of the business. The effective results can be drawn
from the method only when the company uses suitable controls which are established on the
company for the fairness of the transaction of audit. Now, one of major inefficiencies that are
currently existing is that in the counting team both the internal auditor and the warehouse
member are working. This increases the chances of fraudulent practices and malpractices by
the internal management. The company can put independent members in such team to ensure
that suitable controls are put on the inventory management. Apart from that also double
check must be imposed on the slips that are generated after inventory is counted (Tiberius
and Hirth, 2019). The physical stock taking must also be done at the gate of the warehouse so
that proper count is maintained. The routine operations must be put to hold so that in between
counting the errors are not incurred related to stock. These controls can result in the effective
management of the inventory that is maintained in the company.
d) The various substantive procedures can be undertaken by the auditor at the end of the year
in order to check or verify the valuation of the inventory and the physical stock of the
company are:-
1) One of the most significant techniques that is frequently applied by the qualified auditors
is that they correlate the books of accounts and the slips of inventory calculation generated in
the process of physical stock taking. The auditor shall check the accuracy of the count as
presented by the perpetual inventory method through tallying it with the general ledger of
inventory. Post the recording of all the purchase and sales transactions it shall be depicting
the exact balance of the closing stock with the company (Knechel, Thomas and Driskill,
2020).
2) Another way is to categories the goods in A, B and C category and then verify the balances
of the high to low quality of the goods that are present with the company. In this the highest
preference is to be provided to the best quality and highly priced inventory of the company.
3) Another policy can be evaluating the damaged goods quantity, how are they accounted for,
method of disposal and the residual value that is received in respect of such goods.
1.

REFERENCES
Books and Journals
HAZAR, H. B., 2020. The Application Of Ias 2 Inventories Standard In Accounting
Practices. Business & Management Studies: An International Journal. 8(2).
pp.2414-2430.
Hassine, N. M. and Jilani, F., 2017. Earnings management behavior with respect to goodwill
impairment losses under IAS 36: The French Case. International Journal of
Academic Research in Accounting, Finance and Management Sciences. 7(2).
pp.177-196.
Acar, E. and Ozkan, S., 2017. Corporate governance and provisions under IAS 37. EuroMed
Journal of Business.
Tiberius, V. and Hirth, S., 2019. Impacts of digitization on auditing: A Delphi study for
Germany. Journal of International Accounting, Auditing and Taxation. 37.
p.100288.
Jeppesen, K. K., 2019. The role of auditing in the fight against corruption. The British
Accounting Review. 51(5). p.100798.
Knechel, W. R., Thomas, E. and Driskill, M., 2020. Understanding financial auditing from a
service perspective. Accounting, Organizations and Society. 81. p.101080.