Audit for Real Good Food Plc - Case Study Example

Audit for Real Good Food Plc. Table of Contents Introduction 3 Materiality and Risk Assessment 3 Areas of Heightened Risk 4 Revenue 4 Trade and Other Receivables 5 Trade and Other Payables 6 B: Substantive Audit Procedures 7 Analytical Procedures 7 Occurrence 7 Cut-off 8 Confirmation 8 Completeness/Classification 9 Conclusion 9 Appendix: Trend Analysis 10 References 11 Introduction The Real Good Food Company plc is a pioneer in the food business. It not only serves retailers but has its name engraved in wholesale and exports as well. The company has a number of brands that engage their operations in the production and distribution of a wide variety of food items including jams, baking materials etc. Owing to the size of the company, the audit of its accounts is of paramount importance to the shareholders. This paper would identify 3 risk areas for the audit of Real Good Food Plc and would suggest 5 substantive audit procedures on one of the risk areas identified. Materiality and Risk Assessment A common method to identify the areas of potential risk in the financial statements is to perform analytical procedures. ISA 315 Identifying and Assessing the Risks of Material Misstatement through Understanding the Entity and its Environment (Redrafted) requires the use of risk-based approach by auditors (Pine, 2015). It requires them to identify any material misstatements by assessing the levels of risk associated with the different figures that appear on the face of financial statements. When the term ‘material’ appears it automatically directs toward the omissions or misstatements that may impact the economic decision of the users of company’s annual statements (Henriques, 2010). The decision on the materiality level depends upon the auditor’s professional judgment and perception about the company’s record (Knapp & Bender, 1998). However, professional skepticism remains at the heart of auditing and calls for a microscopic and skeptical analysis of statements to identify any risk areas and report them accordingly (Hay, Knechel & Willekens, 2014). In general, the materiality levels are set at approximately ½%-1% of Revenue, 1-2% of total assets and 5%-10% of profits, however the materiality level differs in every case (AccountancySage, 2014). For our case, we will assume the materiality thresholds as described above. Areas of Heightened Risk The risk-based approach, when applied to Real Good Food Plc., identifies the following risky areas for auditing purposes: Revenue The financial statements of Real Good Food plc show the following record: 2014 2013 Revenue 272,567 265,754 Cost of Sales (239,187) (228,469) Gross Profit 33,389 37,285 The auditor must expect that sales and gross margin would move in the same direction and with the same pace. However, the analysis reveals an altered reality with revenue increasing by 2.56% in 2014 and gross margin showing a decrease of 10.45% in 2014. In addition, the segmented data as appeared in Note 4 shows: 2014 Napier Garrett Renshaw R&W Haydens RGFE Total £’000s £’000s £’000s £’000s £’000s £’000s £’000s Total Revenue 172,089 31,803 43,495 10,440 27,255 481 285,563 The Key strategic priorities provide the revenue expectations for 2013/14 (p. 17) as: 2013/14 Napier Garrett Renshaw R&W Haydens RGFE £’m £’m £’m £’m £’m £’m Total Revenue 162.3 30.4 42.9 9.1 27.3 0.5 On a closer look, we find a higher actual figure for all the segments which further makes it questionable for the audit risk assessment purposes. Since both the change in sales and Gross margin and the comparison of expected and actual result show remarkable improvement in revenue, there is a risk that fictitious sales is recorded to beat the competition in the market and meet expectations of the shareholders. Hence, this area is potentially risky and requires closer attention during the audit process. Trade and Other Receivables The financial statements of Real Good Food plc show the following record: 2014 2013 Trade and Other Receivables 34,260 30,213 Provision for impairment of receivables (50) (105) On the other hand, Note 22 Trade and Other receivables shows that “The Group recognised a credit of £45k (2013 – credit of £2k) for impairment of its trade receivables during the period, to reflect debts significantly past their due dates” with loss being accounted for in the operating profit for the year. Keeping an eye on the increasing Trade and other receivables, a decline of allowance-to-receivables ratio is questionable by 42% decline in 2014. If the receivables are increasing with an increase in impairment of trade receivable from £2k to £45k in a year, the provision for impairment should not reduce with as high a percentage as 48%. Hence, the trade and receivables remain a potentially risky audit area. It appears that the provision for impairment of receivables is understated. Trade and Other Payables The financial statements of Real Good Food plc show the following record: 2014 2013 Trade and Other Payables (Due within a year) 29,820 21,282 Trade and Other Payables (Due after a year) 191 __ Cash and Cash Equivalent 8,568 7,134 Short Term Borrowings 31,221 23,032 From the above information, it should be noted that the increase in cash and cash equivalents is just 20% compared to the increase in payables (within one year) of 40% in 2014. The company seems to rely on taking more loans as is apparent by the short term borrowing level being increased by 35.5% in 2014. These trends show a probable liquidity issue that the company is, or might face. Hence, it is of paramount importance to the audit of Real Good Food plc. as it may end up with ‘going concern’ issues in the worst case scenario. The payables due within a year are material if the thresholds, as described above, are applied. These are approximately 11% of sales and 18% of total assets. B: Substantive Audit Procedures Analytical Procedures Analytical procedures are concerned with the study of relationships, trends and unusual dispersions measured in the data for a number of years (Whittington, 2013). Since, revenues are material and one of the most valuable items on the financial statements; they need to be audited carefully. While auditing Real Good Food Plc., there is a need to establish expectations to check the trends against them. These expectations can be the use of forecasting based on past or historical data. There are many ways of doing this including the moving average and weighted average forecasting tools (Rittenberg, Johnstone & Gramling, 2012). Another important measure is the use of financial ratios and studying the trends in those ratios. If the ratio, for instance gross profit margin is materially different from the expectations or industry averages, the revenues can be over / understated. Occurrence To ensure that the revenues recorded actually exist, there is a need to assure the occurrence of the sales recorded (Rittenberg, Johnstone & Gramling, 2012). For the purpose, the auditor will require a sample of sales invoices, customer orders and sales journal. The auditor can: Compare the sales mentioned on the financial statements to customer orders and delivery notes The number of products delivered and invoiced can be compared at different dates Sales journals can be reviewed to identify duplication of sale records. Identify any fictitious sales by checking sales invoice, delivery notes and financial records as provided Cut-off The audit procedures must include checking the cut-off period for revenues. These reveal if the recorded transactions occurred in the period mentioned. Usually the issue arises with the transactions made in the start of a new accounting period or end of the current period. The audit procedures may involve: Taking a sample of sales invoices generated and comparing them back to the customer orders and delivery notes for date confirmations. The sales order may mention the date of delivery which can confirm the correctness of the record Compares sales journal entries with the dispatching department records to further confirm the cut-off period Confirmation Confirmation through enquiry is valuable external audit evidence. Using this auditor may send enquiries to the major customers for confirmation on the delivery of certain quantity of products at a specified date at a specified rate. However, this procedure should be used in agreement with the management to avoid any undue influence on their relationship with the major customers. For confirmation the auditor may use: Positive enquiry i.e. the customer must respond to complete the procedure. The response, forms the source of evidence and if the customer fails to respond, the audit procedure will be redundant. It is more time consuming and may call for another procedure in case of customers’ ignorance. The auditor must keep ensure the receipt of cash from the customer after the period ends to ensure that the revenues were generated and correctly recorded. However, the auditor must be sensitive to the details and ensure that the cash receipts belong to the previously recorded sales and do not represent a subsequent sale. Hence, negative enquiry can also be used which entails to a response from customer only when he disagrees with the amount, date or any particulars mentioned thereof. In negative enquiry case, the irresponsiveness of the customer can confirm his acceptance of the provided information as true and accurate. Completeness/Classification There is a need to identify if the sales recorded represent real sales agreement and is not an enquiry or a proposed quotation with no real value. For the purpose, the sale records need to be verified with the customer orders and invoices generated. Moreover, in order to detect and prevent fraudulent activities, the completeness must be checked. The inventory in the warehouse should match the records to ensure the promised products and revenues recorded have already been dispatched. The sales invoices should be checked using proper sampling method to ensure all sales have been recorded in the sales journal. Conclusion In conclusion, we can say that Real Good Food plc, like any other business, is exposed to risks due to the agency relationship that exists. The company should opt for the safest alternative to keep its records clear from material misstatements and to hold the management accountable for any discrepancies that are found. Appendix: Trend Analysis Previous Year’s Comparison Results Revenue Growth 272567/265754=2.56%inc Cost of sales Growth 239187/228469=4.69%inc Gross Profit Growth 33389/37285=10.45% dec Trade & other Receivables 13.4% Increase Trade & other Payables 40.1% Increase Cash and Cash Equivalent 20% Increase Short Term Borrowings 35.5% Increase References Pine, B. (2015). A risk-based approach to auditing financialstatements. 1st ed. [ebook] Student Accountant, pp.42-43. Available at: http://www.accaglobal.com/content/dam/acca/global/PDF-students/2012s/sa_feb08_pine.pdf [Accessed 26 Mar. 2015]. Rittenberg, L. E., Johnstone, K. M., & Gramling, A. A. (2012). Auditing: A business risk approach. Melbourne, Vic.: South-Western Cengage Learning. Real Good Food plc. (2014). Annual report and Financial Statements 2014 [online], Real Good Food plc. [Accessed 26 March 2015] Henriques, A. (2010). Corporate Impact: Measuring and Managing Your Social Footprint. London: Earthscan. Knapp, C. L., & Matthew Bender (Firm). (1998). Commercial damages: A guide to remedies in business litigation. New York, N.Y: M. Bender. Hay, D., Knechel, W. R., & Willekens, M. (2014). The Routledge companion to auditing. AccountancySage, (2014). ISA 320 Materiality in Planning and Performing an Audit - Accountancy sage. [online] Accountancy sage. Available at: http://accountancysage.com/isa-320-materiality-planning-performing-audit/ [Accessed 27 Mar. 2015]. Whittington, R. (2013). Wiley CPA examination review 2014. Read More