Your firm is the external auditor of MA, a UK-based company, for the year ending 30 September…

Your firm is the external auditor of MA, a UK-based company, for the year ending 30 September 20X0.

MA designs and sells wireless home security cameras to retailers. Homeowners purchase MA’s security cameras from a retailer, install them at their property and link them to their smartphones via a free mobile app. Homeowners receive alerts in the app when a camera detects motion at their property and they can also view video recordings made by the cameras. Some homeowners use MA’s premium service. The premium service allows storage of larger volumes of video recordings in the app compared with the basic plan, which is free.

You are the audit senior responsible for planning the audit. The engagement partner has asked you to consider inventory as key areas of audit risk:

MA has contracts to supply 32 major retailers in Europe and North America with its security cameras. Each contract with a retailer states the number of cameras to be supplied in the contract period and the price to be paid to MA for each camera, denominated in the retailer’s local currency. Homeowners who use the premium service pay MA on an annual basis in advance by entering their credit card details in the app. The annual cost is denominated in the homeowner’s local currency. MA’s security cameras are assembled by Pemmican Ltd (Pemmican) a company based in Asia. Pemmican purchases components for the cameras, based on specifications set out in its contract with MA. Pemmican delivers the assembled cameras to a shipping company in Asia which then ships them to one of MA’s 12 warehouses in Europe and North America. Ownership of the cameras passes to MA when Pemmican delivers them to the shipping company. In accordance with the contract, Pemmican invoices MA a fixed price, denominated in sterling, for each camera assembled. MA maintains a perpetual inventory system at each of its 12 warehouses. Inventory at each warehouse is counted once a year with one warehouse being selected for counting each month. The year-end inventory included in the financial statements is based on the quantities recorded in the perpetual inventory system.

On 30 April 20X0, an audit junior attended the inventory count at MA’s UK warehouse and noted the following issues:

(a) The movement of cameras to and from the warehouse continued throughout the count.

(b) There was a large quantity of one camera, the GBK-I model, which appeared to be old with damaged packaging. The UK warehouse manager said that he had not had time to review the aged inventory report for many months.

(c) There were several discrepancies identified between the perpetual inventory records and the quantity of physical inventory count at the warehouse. The UK warehouse manager explained that adjustments are made to the perpetual inventory records for any discrepancies without further investigation.

As part of your planning for the year ending 30 September 20X0, you met with Alan Walker, MA’s finance director, who provided you with the following information:

  • > MA is currently discussing quality issues with Pemmican. Pemmican has been sourcing cheaper components, which are inferior to those stipulated in its contract with MA, to improve Pemmican’s profit margin.

  • > During the year, MA received a significant number of complaints about its cameras malfunctioning shortly after installation. In response to the resulting adverse media attention, MA has publicly promised refunds to all affected homeowners. MA’s quality control team is currently investigating whether the malfunctions are due to the inferior components used by Pemmican.

  • > MA is currently renegotiating eight of its retail contracts which are due to expire by June 20X1. Susan is concerned that other retailers might exercise early termination clauses in their contracts if the quality issues are not resolved quickly.

  • > In August 20X0, MA was the victim of a cyber-attack that prevented MA from operating for two days. MA’s IT security department is currently investigating whether any personal data of homeowners was stolen during the attack.

    1. 1. Justify why inventory has been identified as a key area of audit risk and, for this key area, describe at least five procedures that should be included in the audit plan to address those risks (for example, review the aged inventory analysis for any slow-moving items,…).

    2. 2. For each of the issues (a) to (c) noted by the audit junior, state the internal control deficiency, outline the possible consequence(s) and provide recommendations to address the deficiency.

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