You are currently planning the audit for the year ended 30 June 2024 for a large regional Milk company based in Canberra. This is your first engagement with this company.

You note that competition is particularly strong in the fresh milk industry, led by the price pressure from large supermarket retailers. The fresh milk industry regularly raises concerns about the ability of the large supermarkets to 'crowd out' the market by being able to sign up many diary farmers, but at the same time apply pressure around the pay-out to these farmers.

As a new approach to competition, the milk company has decided to offer a bonus amount of milk per bottle - so 1 litre of milk comes with a bonus 125 ml, 2 litres comes with a bonus 250 ml and a 3 litre bottle of milk comes with a bonus 375 ml of milk. The company believes that this 'bonus' will be well received by customers, as the price of a bottle of milk stays the same. The company is aware though that during the current economic climate with cost of living and inflationary pressures, customers tend to shift their shopping behaviours towards cheaper/non-branded milk offerings. Note that the impact of this 'bonus' is to reduce gross margins by 25 per cent. The milk company hopes that the bonus will create brand loyalty and recognition and attract new customers. However, the price for this local milk is at least 30% higher than the price of supermarket own brand offerings.

In an attempt to offset the impact of the competitive pressures, the company has recently engaged in two different activities. The first is sponsorship and the company is a named sponsor of a number of Canberra sports teams. This does cost the business a fair amount of money, but the company sees this as part of its advertising budgets. The second activity has been to purchase a cheese manufacturer on the South Coast. The company sees this as a horizontal integration move and believes that this gives them options around expansion with respect to changing market conditions, as well as a potential to add an export business to their domestic markets.

In your initial work around testing internal control systems, you were concerned to note that there were some observable gaps between the control policy and its implementation. In particular, you have concerns around wastage, around distribution and around processing customer payments, managing customer accounts and recording sales.

You are provided the following financial information:

Accounts/Amounts ($M) Forecast 31st December 20-23 Actual 30th June 2024

Net Assets 804 816

Profit before Tax 309 91

Revenue 1,341 1,237

Total Assets 1,804 1,673

Given your internal control insights, you believe that you need to look at the accounts receivable accounts of the milk company for the year ended 30 June 2024. The company's accounts receivable balance was recorded as $5,260,000 and comprised more than 2,300 customer accounts. However, the five largest customer balances comprised a high percentage of the recorded accounts receivable (more than $1,000,000, or 20%). In relation to the determining a sampling technique, your team has advised of the following parameters:

Risk of incorrect acceptance 5% Tolerable error $200,000 Expected error $50,000

Required:

1. In a paragraph, explain any risks that you perceive in this company.

2. Determine appropriate materiality thresholds set overall for this audit (as a pre-audit assessment (ie. prior to year end). Explain the judgements and the approach you take in the materiality threshold.

3. Elect one particular sampling method and use that approach to calculate the necessary sample size for your audit of the accounts receivable. Explain your judgements in calculating the sample size.

Answer rating: 100% (QA)

ANSWER 1 Risks Perceived in the Company The key risks I perceive in this company include Competitive pressures and margin pressure The company is facing intense competition from large supermarket reta... View the full answer