Nova Foods: materiality, risks and acceptance

Tick each point that your answer made clearly and only once. Points here are this site's own. A real examiner may accept other valid points.

• 5% of profit before tax = $105,000.
• 1% of revenue = $420,000.
• 1% of total assets = $300,000.
• Materiality is a matter of judgement, and the benchmark should be one that users focus on.
• Profit before tax is relevant because the covenant, the bonus and lenders focus on it, but it is a small figure, and a lower materiality means more work. A figure based on revenue or assets is more stable.
• Any reasoned choice is acceptable, for example a figure close to $105,000 because the covenant headroom is only $300,000 and profit is the key concern.
• Performance materiality should be set below the chosen figure, and lower where risks are high.

Marks counted: 0 of 5

Tick each point that your answer made clearly and only once. Points here are this site's own. A real examiner may accept other valid points.

• New system: there is a risk of errors in the data transferred and in processing, because staff were not trained. Response: test the data migration, perform tests of general IT and application controls, and extend substantive testing.
• Inventory: there is a risk about the existence and valuation of inventory at the third-party facility. Response: attend the count where possible or obtain direct confirmation from the third party, and test the cut-off and the lower of cost and net realisable value.
• Covenant and going concern: the covenant needs profit before tax above $1,800,000, so management may be tempted to overstate profit. Response: review the covenant calculation, assess forecasts and consider the going concern disclosures.
• Management bias and fraud: the finance director's bonus depends on profit, so there is an incentive to manipulate results. Response: maintain professional scepticism, test journal entries, and review estimates for bias.
• Customer concentration: 40 percent of revenue comes from one customer who wants price cuts, so there is a risk to the future of the business and to the recoverability of receivables and inventory valuation. Response: review the correspondence and contract, test after-date receipts and consider the impact on going concern.
• Opening balances: it is a first-year audit, so there is a risk in the opening balances and in comparatives. Response: review the predecessor's working papers (with consent), and perform procedures to check the opening balances.
• Revenue recognition, including rebates and price reductions to the customer, may be misstated. Response: test the rebate accruals and the cut-off of sales.
• A risk is explained clearly, with a reason from the scenario, in each case (rather than just named).
• Each response is specific and linked to the risk, and not a general statement such as increase testing.
• The answer shows that the auditor links the assessed risks to the extent of the work in the audit plan.

Marks counted: 0 of 10

Tick each point that your answer made clearly and only once. Points here are this site's own. A real examiner may accept other valid points.

• Communicate with the previous auditor (with the client's permission) to find out why they resigned and whether there are any matters that affect acceptance.
• The fee dispute with the previous auditor may indicate management integrity issues, or that the entity disputes the fees for legitimate reasons, and the firm should assess this.
• Consider the integrity of management, particularly given the bonus incentive and the covenant pressure.
• Assess whether the firm has the competence, time and resources to audit a manufacturer with a new system and a third-party location.
• Confirm independence and the absence of conflicts of interest, and carry out customer due diligence.
• Agree the terms in an engagement letter, including the scope and responsibilities.

Marks counted: 0 of 5