QUESTION 3 25 Marks

You are an audit manager at Bega & Associates working on the audit of Moss Vale Clothing Company Ltd (MVC) for the year ending 30 June 2021. MVC has two separate divisions. One division manufactures exclusive womens lingerie and the other division manufactures womens evening wear made from fabric imported from France. The divisions operate from two separate locations.

MVC operates throughout Australia and its customers include a number of exclusive womens retail clothing boutiques and upmarket department stores. A significant amount of stock on hand is represented by unsold stock returned by customers. Sales terms provided to MVCs customers are as follows:

• Settlement is required within 30 days of the invoice date.
• Any goods remaining unsold by a customer after six months can be returned for a full cash refund based on the original invoice price of the unsold goods.

MVC creates a provision for refunds based on an analysis of the trend in refunds over the previous three years.

Any unsold goods that are returned after the six months are then sold in MVCs factory shop to the general public at cost. Any stock remaining unsold in the factory shop after three months is donated to local charities.

Sales have declined by 15 per cent over the last two years, because Australian customers have become nervous about the impact of the European debt crisis upon local economic conditions. MVCs sales manager estimates that sales will continue to decline at the rate of 4 per cent per annum for at least the next couple of years.

The following are key balances extracted from MVCs draft financial report for the year ending 30 June 2021:

	$
Net profit before tax	4 150 000
Inventories	1 350 000
Property, plant & equipment (cost less accumulated depreciation)	5 300 000
Current liabilities	900 000
Owners equity	7 121 430

The following events have come to your attention during the final review of the audit:

1. Fixed assets: In accordance with the accounting standards, MVCs accountant tested the fixed assets of both of the manufacturing divisions for impairment. The impairment test revealed that the evening wear division required the recognition of an impairment loss of $200 000 to its manufacturing equipment. You raised this matter with the CFO, who stated that he did not believe that there was any need to record an impairment loss because the relevant fixed assets will be used for their entire useful life. He stated that the calculation of the impairment loss was based on the present value of future cash flows, which he believes is irrelevant to the current valuation of these assets.
2. Provision for refunds: After reviewing MVCs recent sales, you have calculated that the provision for refunds account is overstated by $140 000. However, MVCs CFO has informed you that he does not wish to reduce the provision and would rather release the excess from the provision in future financial years should profitability decrease.
3. Inventory: On 12 June 2021, MVC placed an order with its French supplier for high-quality silk fabric worth $700 000. In accordance with the FOB terms of the purchase agreement, ownership of the goods passes to MVC and a liability to the supplier is incurred when the container is loaded onto the ship at the overseas port. The container was loaded onto the ship in France on 26 June 2021 and arrived at MVCs warehouse on 11 July 2021. Given that no entry has been recorded to recognise the transaction in the year ending 30 June 2021, you advise the CFO that an entry should be recorded to recognise an asset stock in transit and a liability accounts payable, and the asset and liability be included in the statement of financial position at 30 June 2021. However, the CFO has stated that the transaction does not need to be recorded, as the shipment was received after the reporting date.
4. Bank overdraft: Although MVCs sales have declined over the last couple of years, MVCs bank is still confident about the companys future profitability and financial stability, and on 23 July 2021, MVC renegotiated its current bank overdraft facility. The new facility provides for the relaxation of the debt covenants, a reduction of the charge over accounts receivable from 100 per cent to 75 per cent and a reduction in the interest rate by 1 per cent. The new overdraft facility will significantly improve MVCs financial flexibility, as well as reduce its future costs of borrowing. However, the CFO has stated that it is unnecessary to include details of this event in the financial report since the renegotiation occurred after the reporting date.

The audit report was subsequently signed and issued on 14 August, 2021. However, on 29 August the chief executive officer (CEO) advised you that it had been discovered that the Melbourne warehouse manager had committed fraud and covered it up by including a material amount of fictitious stock in the 30 June stocktake sheets. As the audited financial report has already been issued, the CEO stated that nothing could be done in relation to the 2021 financial report and that it would have to be adjusted next year.

Required:

(a) Treating events 1 to 4 above as completely independent, identify the most likely audit opinion that you would express on MVCs financial report based on each separate event. Justify your answer, using calculations.

(b) Explain what actions, if any, the auditor should take in relation to the discovery of the fictitious stock error after the issue of the financial report? Justify your answer.