Audit Risk Auditor’s

Response

Research & Development:

Peach Co has been developing a new production process The audit team should obtain a
which will help to reduce sugar in its drinks by 50%. breakdown on the revenue
Development commenced on 1 November 20X4 and the total expenses and capitalised
amount capitalised was $0.8m. development expenditures
On 1 May 20X5, the food safety using supporting documents to
authority approved the process and production confirm whether it is in
of the new reduced‐sugar soft drinks commenced. accordance with the relevant
standard.
As per the relevant standard, Research expense
and development expenditures which does not meet the criteria Discuss with the management
must be expensed in Statement of Profit or Loss (SOPL) and and recalculate the
Develop. Expense which meets the strict PIRATE criteria must be amortisation expense to
capitalised as Intangible asset. Also, amortisation must be done after confirm whether it is in
the production. accordance with the relevant
standard.
There is a risk that the research and develop expenses which does
not meet the criteria can be capitalised and amortisation can be
incorrectly calculated.

Therefore, Intangible assets can be overstated and research expenses

will be understated also amortisation expenses can be misstated.

Staff Cost:

There were significant staff costs involved in preparing the site Discuss with the management
for the new machinery and in testing that the new machinery about the accounting
was operating correctly. These costs have been included within treatment and procedures to
the wages and salaries expense for the period. confirm whether it is in
accordance with the relevant
As per the relevant standard, Property Plant & Equipment (PPE) of an standard.
asset is the cost of the asset and all the cost relating to bring the
asset in the working condition. The audit team should request
to the finance director to
There is a risk that the staff cost is wrongly expensed with the wages exclude the staff cost expended
and salaries without including it with the cost of PPE. with wages and instead include
it with the cost of PPE.
Therefore, wages and salaries will be overstated and cost of PPE will
be understated.
Inventory:

Peach Co has inventories of high sugar drinks costing Discuss with the management
$227,000 which it can no longer sell in its home about the accounting
market due to lack of demand. treatment and procedures to
confirm whether it is in
As per the relevant accounting standard, Inventory must be valued accordance with the relevant
which is the lower of Cost or Net Realisable Value (NRV) standard. Also enquire about
Since the demand is lower, $227,000 must be written down to NRV. the reason for the low in
demand.
There is risk that the cost might not be written down to NRV.
Discuss with the finance
Therefore, it can result in inventory and cost of sales being director regarding the sale of
overstated. inventory and review any
agreements/contacts with the
international customer to
determine the probability of
sale and the selling price for the
inventory.
Provision:

Peach Co’s previous supplier has launched a legal claim The audit team should review
against Peach Co for breach of contract, stating that Peach Co correspondence with Peach co
did not have the right to exit the agreement early. Peach Co’s lawyer lawyers to understand the
s probability of supplier winning
have indicated that it is likely to lose the case and the case and the amount to be
have estimated the amount payable to be in the region of $0.3m paid by the Peach Co.

As per relevant standard, Provision should be recognised if there is

probable outflow, amount is reliably measurable and if it’s a present
obligation.

There is a risk that the Peach co may not have created a provision for
the amount $0.3M

Therefore, the provision and expenses are understated. And profit

will be overstated.

Bank Loan:

In order to fund the development of the new production The audit team should confirm
process and the purchase of new machinery, Peach Co with the finance director that
obtained an interest bearing bank loan of $1.2m on loan finance was received.
1 March 20X5 repayable over the next three years in arrears.
Also, discuss with the
As per the relevant standard, bank loan must be correctly split management about the split
between current liability and non-current liability. Also, as this is a between current and non-
new bank loan there should be additional finance cost. current liability to confirm
whether it is in accordance with
There is a risk that the Peach Co may not have made a correct split the relevant standards.
between current liability and non-current liability. And also, the
omission of finance cost in Statement of Profit or Loss (SOPL)
The audit team should
Therefore, this can result in understatement of finance cost and recalculate the finance cost
overstatement of profit. incurred. They should also
obtain and verify the loan
document to confirm whether
finance cost is accurate.
And verify it with the cashbook
to confirm whether the interest
it is paid or not.
Depreciation:

Despite the old machinery being sold at a significant loss, The audit team should obtain
during the year the directors of Peach Co decided to extend sample assets of those whose
the useful lives of plant and machinery by an average of five years. useful life has been revised.
And to know whether these
As per the relevant standard, useful life of an asset must be reviewed assets are disposed with
annually. If there is an increase in useful life of the asset is reasonable gain/losses to compare
then it results in decrease in depreciation. Also, if there is a decrease whether the change in useful
in the useful life of the asset is reasonable then the depreciation life is reasonable or not.
expense will me decreased.

There is a risk that if the old machinery is sold on loss, then the
increase in useful life of the asset is not reasonable.

Therefore, this can overstate the machinery and understate the

depreciation expense.
Fraud:

It was discovered that they had been fraudulently purchasing non‐ The audit team should maintain
current assets for personal use. Peach Co started to investigate the professional scepticism
fraud at the beginning of June 20X5 by throughout the auditing. Also
reconciling all physical assets to the noncurrent asset register experienced team members
but will not have completed the reconciliation by the year end date. must be considered in
significant areas of auditing.
As the reconciliation of the physical assets is still going even after the
year end. There are still chances that the assets used for personal use Discuss with the management
may also be included with company’s non-current assets. It is still yet on the procedures performed
to be identified and removed. to prevent and detect fraud.

Therefore, PPE will be overstated and there will be increase in control

risk.