audit plan for aero inventory plc

Accounting Policies

They are following International Accounting Standards consistently over the years. They have adopted FRS 20 this year; therefore they have restated their financial results for 2006 in accordance with FRS 20.

Related Party Transactions

We have found two different related parties transactions. One is related to Rupert Lewin Racing Limited in which PR Lewin is a director and shareholder who is also the chief executive of AI. The other one is related to Potenza Enterprises Limited, a service company owned by Mr Turner and his family, who is a non-executive director of AI.

Client’s Legal Obligations

We will examine corporate charters and bylaws of the company, minutes of board of directors and stockholders meetings & contracts to make sure that there is proper disclosure in the financial statements.

Preliminary Analytical Procedures

We will perform analytical procedures as given below to understand the client’s business and events occurring since the prior year’s audit and to identify areas that may represent specific risks of material misstatements.

Ratio Analysis of Aero Inventory Plc

Comparison with Industry(Latest)

Key Ratio Analysis

Now we are better informed and can plan the audit in a better way. Audit planning helps to reduce the audit risks. Gray et al says that audit risk is the risk that may be material misstatements in the accounts subject to audit.(_)

AUDIT RISKS

Audit risk is the risk of the auditors giving an inappropriate opinion on the financial statements. There are three major component of audit risk:

1. Inherent risk
2. Control risk
3. Detection risk.

 

Key audit risks in respect of this client are as under:

Inherent Risk- Financial Statement Level

• We have witnessed major expansion and increased financing in the year 2007. It increases going concern risk and it must be taken into account while planning the audit and sufficient evidence to be obtained to support management assertion that the going concern basis is appropriate.
• The firm is operating at multi-locations which increase inherent risk. For example, the movement of assets between locations creates risk of double counting or omission.
• Controls over the recording of cash income may affect the truth and fairness of the financial statements as a whole.
• The amount of long-term debt increased by £55.861(M) which was nil in previous years, this is due Bank Loan. It is a material inherent risk because it will increase interest charges as well.
• A significant percentage of the Group’s purchases and sales are denominated in US$ rather than sterling, which is its functional currency therefore, there may be some level of inherent risk in the calculations and risk management.
• On 7 September 2007 the Group got a revolving credit facility of £175(M) from Lloyds TSB Plc. This condition did not exist at the date of balance sheet but emerged after that date, therefore it needs to be disclosed in the financial reports.

Inherent Risk- Assertion Level   

• The legal form of the contracts of AI with its suppliers & purchasers like Qantas etc need in depth review to determine rights of ownership of inventory. A physical inspection of inventory will therefore be required at the year end.
• Liabilities (actual & contingent) arising under the contracts of warranties & guaranties will require some provision (to the extent that they are expected to materialise) and disclosure, in accordance with IAS37 Provisions, Contingent Liabilities and Contingent Assets.
• Inventory valuation will depend on the aging and obsolesce factors. The year end physical inventory count will insure appropriate categorisation according to their valuation.
•  Mr Lewin & Mr Turner are key figures in AI management. Therefore transactions related to their companies are to be considered as related party transaction under IAS 24 Related Party Disclosures.
• Intangible fixed assets have increased by £13.184m which were nil in previous year which could be a high degree of inherent risk and to reduce this risk we have to look at the internal control and may require some system tests. The increase is due to purchase of stocks worth £57.231(M) from Qantas Airlines and paid them £14.253(M) on account of intellectual property, which is going to be amortized over 10 years.

Control Risk

• The existence of an internal audit function can reduce the assessment of control risk; however, we have to determine the extent to which reliance can be placed on it.
• Tests of control will be planned on continuous stock-checking to determine the extent of reliance to be placed on this internal control. We have to check whether stock keepers of AI are carrying out test counts in a manor to insure that all inventories are counted at least ones in each financial year. Discrepancies between book records and physical counts must be corrected by persons independent of the stock keeping function.  
• Turnover has increased by 101% to £127.8m in 2007 was £63.5m in 2006, which is material controlled risk. There is possible explanation, which is turnover, was principally driven by the contract with Qantas  and others. This 10-year contract, which has been successfully implemented, has effectively doubled the size of their business.

• Pre-tax profit has increased by 171% to £ 26.8m in 2007, was £9.9m in 2006, This is material and poses a control risk, the raise of £16.9 m by last year is a material but we can justify it because of 10 years long term contract with Qantas Air Ways.
• Net profit for the year 2007 has increased from £6.573m in 2006 to £18.532m. It is an extra ordinary increase of 183.5%, which is material and poses a control risk.  Considering the £11.9m raise in profit, which can be explained because of long-term large contract with Qantas. We would need to check the documents of long-term contracts.
• Aero Inventory relies heavily on the use of IT based systems for its business activities.  It poses a control risk and in case of their failure data could be lost, e.g. stock control.  We would need to test the systems to make sure they are working correctly; this could include stock control and security checks.  We would also need to see that the level of back up and recovery process.

Detection Risk

• At 30 June 2007 there were annual commitments under non-cancellable operating leases, including property leases.
• The comparative figures for the year ended 30 June 2006 have been restated as a result of a change in accounting policy for FRS 20 share-based payments as described in note 11. The restatement has reduced the profit for the year ended 30 June 2006 by £609,000.Net assets were unchanged as at 30 June 2006.

Audit Approach

There are three primary types of audit: financial audit, operational audit and complains audit.

Financial Audit

We are being engaged to give opinion on the financial statement; therefore we shall adopt financial statement audit approach. It is conducted to determine whether the overall financial statement are stated in accordance with specified criteria usually the criteria are generally accepted accounting principals. The financial statements most often included are the balance sheet, income statement and statement of cash flows, including accompanying footnotes.

The following approaches are not relevant in this case.

Operational Audit

It is normally carried out to measure the operational efficiency and effectiveness of any department such as customer satisfaction or inventory management of a company. Here we have to examine financial statement and express our opinion. In operational audit the scope of audit is not limited to accounting; they can include wide range of area from evaluation of organisational structure to marketing issues and any other area in which the auditor is qualified. Loebbecke (1999 p12) says that, operational audit is more like management consulting than auditing.

Compliance Audit

According to Loebbecke (1999 p12), compliance audit is conducted to evaluate whether the company’s different departments are following specific rules and regulations set by some higher authorities. Compliance audit results are usually meant for internal consumption.

Now we have to assess our acceptable audit risk, which is largely affected by the factors such as the likely users of the statements. Aero Inventory is a public limited company and statements are going to be used extensively. Therefore we have to accumulate extensive evidence and information in the audit process, the additional information even during the audit will help us in assessment of acceptable audit risk.

3.5 Letter of Engagement

After assessment of acceptable risk we are able to issue engagement letter clearly specifying terms and conditions of engagement. The proposed letter is given below.  

Audit Programme

Objective

Our audit programme states the audit procedures that we believe are necessary to accomplish the objective of the audit.  

Audit Assignment

Abid Sharif (Partner), Syed Zaidi (Audit Manager), Cheetan gadhavi (Audit Senior) & Cheki chun (Audit Junior)

Abid (Group Leader)/Syed- Carry out day-to-day detailed audit work, including researching on market sector and AI’s background, investigating AI’s company’s financial and corporate information.

Cheetan – Identify AI’s material audit risks, which includes inherent risk, business risk and control risk.

Cheki – Responsible for audit planning and overall conduct.

Timing of the audit process

 Communicating with the Existing Auditor

We need to communicate directly with the predecessor auditor, the Deloitte & Touche LLP, Chartered Accountants and Registered Auditors. We determine if the existing accountant has been notified by the AI Plc and given permission to discuss the client’s affairs fully and freely. We then request permission from the AI to communicate with the Deloitte & Touche LLP.

Search for Evidence

We intend to search ‘sufficient’ and ‘appropriate’ evidence.

• Sufficient evidence: enough evidence has to be obtained by the auditor to meet audit objectives, a major factor being the degree of confidence required.
• Appropriate evidence means the evidence is:

       Relevant: the evidence must be pertinent to the matter in hand, to a          

       management assertion statement we wish to prove.

              Reliable: the evidence must be trustworthy.

We should obtain sufficient audit evidence that:

1. The opening balances do not contain misstatements that materially affect the current period’s financial statements.
2. The prior period’s closing balances have been correctly brought forward to the current period or, when appropriate, have been restarted.
3. Appropriate accounting policies are consistently applied or changes in accounting polices have been properly accounted for and adequately disclosed.

Audit Strategy

We will consider the mix of audit procedures and will attempt to balance top–down and bottom-up audit procedures while developing our audit program.

Following tests will be included in our audit program.

1-Initial procedures

With the help of information collected by us in first part of our plan we will develop an understanding of the competitiveness factors for a client’s business, industry and its internal control structure.

We will perform initial procedures on all accounts balances and records that will be subjected to further testing.

We will apply the following substantive testing for all head of accounts:

1. We will trace opening balances for all accounts to prior year’s working papers.
2. We will review activity in general ledger accounts for all head of accounts and investigate entries that appear unusual in amount or source.
3. We will obtain trial balances of all accounts and check their accuracy according to accounting records by footing trial balances & determining agreement with (1) the totals of the subsidiary ledgers and (2) the general ledger.

2-Analytical procedures

We will analyse relationships among both financial & non financial data to develop and expectation for financial statement balances.

We will apply the following substantive testing for all head of accounts:

1. We will analyse results relative to expectations based on prior years, industry data, budgeted amounts, or other data.
2. We will analyse results relative to expectations based on inventory purchased.
3. We will calculate all relevant ratios for all head of accounts.

3-Tests of transactions

We will apply substantive test for tracing or vouching transactions based on underlying documentary evidence. Important points in this respect are given bellow:

1. We will vouch the sample of recorded transactions to support documentation in all head of accounts.
2. We will perform cutoff tests for all head of accounts to determine that transactions are recorded in the proper period, by selecting an appropriate sample.
3. We will also perform cash receipts/payments cutoff tests and we will review documentation such as daily cash summaries, duplicate deposit slips & bank statements to determine proper cutoff.

Tests of balances

We will obtain evidence directly about an account balances and the individual items that form the account balances.

1. We will select and execute the samples and investigate exceptions.
2. We will summaries the results of confirmation and alternative follow procedures.

Tests of presentation and disclosure

We will evaluate the fair presentation of disclosure required by GAAP to determine that various items are properly identify and classified and to determine appropriateness of disclosures like related party transaction, subsequent events & prior year’s adjustments.

Evaluation of Need for Outside Specialists

We need IT specialist due to fully computerised systems in vogue in the company. The company deals in hi-tech aircraft parts therefore we will also require specialist to evaluate and check the obsoleteness of the inventory. We will also consult a lawyer on the legal interpretation of contracts and titles.

 

 

 

3.8 Documentation

We document the overall audit strategy and the audit plan, including the events, conditions, or results of audit procedures that resulted in any changes. The manner in which these matters are documented is for us to determine based on professional judgment.