You have just been appointed as the auditor of
Gritty Manufacturing Ltd and you are in the process...

Question

You have just been appointed as the auditor of
Gritty Manufacturing Ltd and you are in the process of planning your first
audit. Gritty manufactures security cameras and is a part of the electronics
industry.

Gritty’s operations consist of a factory and a head
office which is located in the Sydney suburb of Alexandria. Gritty has
distribution outlets in each capital city of Australia, as well as sales agents
scattered throughout South East Asia, the USA and Western Europe.There
has been heavy capital expenditure on the factory at Alexandria in recent
years, and the security camera industry has in recent years been increasingly
competitive and volatile. There is also a lot of discounting undertaken by
manufacturers of inferior quality products. The industry faces problems with
changes to technology, government legislation and health and safety issues for
the staff in the different jurisdictions in which Gritty operates. As a result,
obsolete stock is a problem for the security camera industry.

The CEO of Gritty is Fred McKenzie, a radio
engineer who started the company 15 years ago. Fred is heavily reliant on his
accountant, Mrs Norris, as he has minimal understanding of accounting.

The previous auditors have informed you that there
were a number of issues with the previousaudit. They also inform you that
the accounting methods used for the valuation of foreign currency profits and
losses were unreliable and of concern.

Your discussions with the Alexandria production
manager, Dennis Watkins, reveal that he has a very stressful time managing
production levels, with constant concerns of both over and under production,
given the volatile nature of the industry.

Gritty sells its products overseas through foreign
agents and it also has an internet website. You note that this year there is a
large amount of unsold inventory in Gritty’s USA warehouse. The inventory
was to be sold via a Government contract for use in US prisons, but the US
authorities decided at the last minute to upgrade to a more advanced security
camera product. Gritty is yet to decide whether the cameras can be sold
elsewhere, as they were produced to work with specific US electrical
requirements.

Gritty has a bank loan with a contract that requires
them to maintain a current ratio of 1.5 to 1 and a quick ratio of 0.9 to 1.

In a discussion with the accountant you discover
that the company is experiencing cash flow problems, both with the failure to
secure the contract with the US prisons and due to foreign exchange losses.

Required:
You are the senior auditor planning the audit of
Gritty Ltd.
1. Identify at
least ten (10) issues that increase the inherent risk of material misstatement
2. For each of
the issues you have identified, explain why they require special attention; and
3. Briefly
outline one audit procedure that would address this inherent risk

Use the following column headings:
Inherent
risk
Reason
Procedure

David · Accepted Answer

Inherent risk of the material misstatement refers to that portion of the auditors risk which 
relates to the disclosure, account or financial statement being audited and attested by the 
independent auditor and states that the financial report is materially misstated without 
considering the fact that the internal controls placed were effective or not and that it amounts 
to error or fraud.  
In the given situation, Gritty Manufacturing Ltd is a firm dealing in manufacturing of security 
cameras in the electronics industry. The facts that relate to the firms material misstatement as 
inherent risk due to the managements decision and reporting issues are given as below: - 
1) Firstly, we can see that the CEO of the company, Mr. Fred Mckenzie, is heavily 
dependent on the accountant of the company Mrs. Norris who is supposed to have 
minimal accounting knowledge and given that they operations worldwide, the inherent 
risk of the company increases widely. 
This requires attention because accounting is the core part of any firm and given that the 
accountant does not possess required knowledge, the same would impact the firm badly.  
The audit procedure to rectify this problem would be to manage a better accountant in the 
given situation who can manage and tackle the problems at expert level. 
2) The previous auditors have informed that the company have had issues previously which 
imply that the opening balances of the company might have issues which could bring 
threat to the present audit for the current year. 
This requires special attention because an audit starts with the phase of measuring the 
opening balances of the company and checking whether there is correct reporting being 
done previously.  
The audit procedure to rectify this problem would be to go through the last years audit 
report and the audit issues and deals with them with the help of management to rectify 
any issues that are left. 
3)  The accounting methods relating to the foreign currency profits were unreliable and 
much of concern, given that the company has operations in the foreign countries; it 
increases the risk of financial reporting widely.  
The issue with the accounting methods is that they lead to incorrect reporting of the 
entities financial statements and are considered to be unreliable for the investor purposes.  
An audit procedure to rectify the same would be to place the proper accounting methods 
and assumptions where required. 
4) The unsold inventory lying at the warehouse implies that they have huge unsold stock and 
much of the firm’s free cash is blocked by the inventory. This has the potential of making 
the company liquidate on the grounds of insufficient cash and increases the inherent risk. 
The unsold inventory is a big concern for the company as this implies the company is not 
managing inventory levels properly.

You have just been appointed as the auditor of Gritty Manufacturing Ltd and you are in the process of planning your first audit. Gritty manufactures security cameras and is a part of the...

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