Q no 205 –HART CO
PART-A
Benefits of Audit Planning:
Audit planning is addressed by ISA 300. It states that the adequate audit planning benefits the audit of
FS in different ways:

Helping the auditor to devote appropriate attention to important areas of the audit.

Helping the auditor to identify and resolve potential problems on a timely basis.

Helping the auditor to properly organize and manage the audit engagement so that it is
performed efficiently and effectively.

Facilitating the direction and supervision of engagement team members and the review of their
work.

Assessing, where applicable, in coordination of work done by experts.
Part-B
AUDIT RISKS
New Client:
Hart Co is the new audit client for Morph & Co.
and the audit team should have proper
knowledge of the client who is being audited.
There is a detection risk that auditors might not
be able to detect all the misstatement as they are
not familiar with client controls, accounting
policies and transactions. There is also less
assurance on opening balances as Hart is a new
client and we did not perform the audit last year.
AUDITOR’S RESPONSE
The firm should ensure that the audit team have
a sufficient level of expertise, knowledge of the
industry, and also consider the need for an
expert.
In addition to this, the team should take sufficient
time to obtain an understanding of the company
and its environment in order to get sufficient and
appropriate audit evidence.
Also, there is a risk that the audit team might not
have appropriate skills and knowledge required
for the industry of designing and constructing
playgrounds.
Director’s bonus:
The bonuses of directors are based on PBT and FS
should have been prepared based on applicable
FR standards.
The audit team should assign more experienced
team members to areas where estimates and
judgments are applied, who should be alert all
the time for any kind of MMs in the FS.
There is a risk of creative accounting and
overstating the profits by omitting or
understating any expenses in order to allow the
overstatement of PBT and maximize the personal
bonuses as they are based on profit.
The team should maintain professional
scepticism during the entire audit as there is
increased risk of manipulation and increased
testing should be performed relating to adjusting
general entries.
Initial 25% unearned income:
The audit team should discuss with management
the basis on which treatment of unearned
income is performed and ensure it is in
accordance with relevant accounting standards.
Customers are required to pay 25% initial deposit
at the time of signing the contract to purchase
the playgrounds. This amount should be classified
as deferred income or unearned income and
should be recognised as liability.
Also, they should obtain a copy from client of
contract between Hart Co and their customer to
ensure the performance obligation is satisfied
before recognising the revenue.
There is a risk that income might be overstated,
and liabilities understated as management might
have fraudulently (or by error) recognised
unearned income as income to overstate profit.
Warranty Provision:
The warranty provision for the year is calculated
as 2% of revenue, last year it was 6% of revenue.
The FD made this change despite any significant
differences in construction techniques or the
level of claims in the year.
As per IAS 37 the if a future liability is probable, it
should be recognised as a provision in FS and this
should be recognised as warranty provision.
Calculating provision is based on judgement and
is an uncertain amount. There is a risk of
understatement of provision and overstatement
of profit due to decrease in percentage of
provision without any significant reason.
Capitalisation of development cost:
$1.8m expenditure incurred to R&D of new type
of environment-friendly building material. $0.6m
expensed to date in SOPL and $1.2m capitalised
as an intangible asset.
According to IAS 38, the development cost is only
capitalised when certain criteria (PIRATE)
mentioned in the standard are met.
There is a risk of overstatement of development
cost as requirements of the standards might not
be applied correctly and expenses might also be
understated if Research cost is Wrongly
recognised as Development cost resulting in
overstated profit.
New Machinery Contract:
Hart Co purchased machinery costing $2.4m and
paid $1m on signing the contract. Machinery was
due to be received in July 20x5 but due to a
supplier problem, delayed and now will be
received in Oct 20x5.
During the final audit they should perform
increased testing to review any cut-off revenue
and completeness of deferred income is properly
recognised.
The audit senior should discuss with FD, and ask
the reason, why they decided to reduce the
warranty the warranty provision.
Review the post year-end claim from customers,
industry average provision for warranties and
prior years provision to ensure the provision is
reasonable.
The audit team should obtain breakdown of R&D
cost and review supporting documents to ensure
they are correctly classified.
Any development cost should be agreed as
meeting the relevant criteria of recognition as an
intangible asset before being capitalised.
Also, discuss the accounting treatment with FD
and ensure it is in accordance with IAS 38 or
relevant accounting Framework.
The audit team should obtain a copy of contract
between Hart Co and its supplier to determine
the basis of contract.
Review the NCA register to determine if $1m is
recognised as an NCA and discuss with
As per IAS 16, Assets are recognised when they
are received or when they are physically present.
management the correct treatment of $1m and
confirm it is recognised as prepayment and if
incorrectly recognised then review the correcting
journal entries.
There is risk of overstatement of NCAs as the
machinery not yet received might be included in
the NCA of Hart Co and If $1m paid in advance is
included as NCA there is also a risk of
understatement of prepayments.
Payroll function outsourced:
Payroll function is outsourced to an external
service organisation, Chaz Co, which is
responsible for all elements of payroll processing
and maintenance of payroll records.
Consideration should be given to contact the
auditor of the company, Chaz Co, to confirm the
level of control in place. A type 1 or Type 2 report
should be requested.
There is a detection risk as it is difficult to obtain
details of controls in Chaz Co, the auditor will
face difficulty in obtaining sufficient appropriate
evidence.
Consider the extent to which sufficient
appropriate audit evidence can be obtained from
records held at Hart Co in respect of wages and
salaries expenses and liabilities.
Also, if proper controls are not being applied in
Chaz Co, there is a risk that the payroll and wages
expense and accrual might be misstated.
Director’s Remuneration:
Directors correctly disclosed their remuneration
details in the forecast FSs in line with IFRS,
however, local legislation in the country in which
Hart Co is based, require more extensive
disclosure.
The directors should follow local legislation
requirements as it must be followed before IFRS
standards as they are more comprehensive.
There are chances of fraudulently increasing
director remuneration as directors are not
providing additional information and also
director’s remuneration disclosure will not be
complete if additional information is not
provided.
Part C:
The audit team should discuss this matter with
directors and ask them to disclose extensive
information regarding director’s remuneration
and determine if the disclosure in the FS is
included appropriately as per local legislation.

Review the schedule of current liabilities and confirm the bonus accruals are included in the
year-end liabilities.


Confirm the bonus paid with the post year-end cash book and bank statement.
Review board minutes to identify whether any additional payments relating to this year have
been agreed for any directors.

Obtain written representation from management confirming the completeness of director’s
remuneration including the bonus.

Review the disclosures made regarding the bonus paid to directors and assess whether these
are in compliance with local legislation.

Recalculate the bonus payments and agree the criteria to supporting documentation and the
percentage rates to be paid to the director’s service contracts.
Part C:
Safeguards by Morph & Co to ensure conflict of interest is appropriately managed:

Assign different teams for all 4 construction companies including Hart Co to maintain
confidentiality.

Make all audit team members assigned to competitors and Hart Co, sign a confidentiality
agreement to ensure additional security against confidentiality.

Morph & Co should advise Hart Co and other competitors to seek additional independent
advice.

Hart Co and its competitors should be notified regarding the issue and consent should be
obtained from the management of Hart Co and all other competitors being audited by Morph &
Co.

A review of all work performed should be done by an appropriate reviewer who is not involved
in the audit to ensure judgement applied and conclusions are appropriate.

Regular monitoring of the application of the above safeguards should be undertaken by a senior
individual in Morph & Co not involved in either audit.