Red Earth Pty Ltd Pty Ltd - Case Study for Auditing

Red Earth Pty Ltd Pty Ltd, is a small proprietary company with less than $25 million in gross assets, and an annual turnover of less than $50 million.

A couple of years ago, the CEO of Red Earth Pty Ltd, with majority shareholder support, requested that audited General Purpose Financial Statements be prepared. Red Earth Pty Ltd Pty Ltd intends to enter new markets in the medium-term, which will require funding more than what the business will likely generate in profits. The CEO believes that having historical audited General Purpose Financial Statements will make it easier for Red Earth Pty Ltd to source that funding, and at better terms than if unaudited, Special Purpose Financial Statements were prepared. Red Earth Pty Ltd Pty Ltd had the last two years' financial statements audited by another external auditor, Holt and Co, and Bloom & Associates will be taking over from this financial year.

You (Junior Auditor of Bloom & Associates) have organised a meeting with Red Earth Pty Ltd outgoing auditor Holt, who is retiring, to find out about Red Earth Pty Ltd operations. After this meeting, Bloom & Associates accepted Red Earth Pty Ltd as an audit client and forwarded Engagement Letter.

To have a better understanding of the client, you asked for a copy of Red Earth Pty Ltd Financial Statements for the current financial year. You also conducted an initial meeting with the accountant and managers of the business.

Required:

1. Outline the duties and responsibilities of Bloom & Associates as the external auditors of Red Earth Pty Ltd.

2. Read the following documents to review and analyze client activities and procedures.

• Minutes of meeting with Holt

Student: Thanks for sitting down with me Mr Holt. Red Earth was happy for us to talk to you. I can't think of anyone better placed to assist me in getting the process started. The first thing I have to ask is, did you have any major issues in the two audits that you performed? Holt: Well, I performed the rst audit of Red Earth after they made the decision to begin preparing General Purpose Financial Statements. In both that audit and the audit I completed last year, I gave unmodified opinions. Overall, the company has a solid accounting system and the internal audit team was highly capable, we were able to rely on most oftheir controls. Student: Perfect. Now, in terms of the actual business, you must have a good idea about how it runs. Could you tell me a bit about it? Holt: Of course. Red Earth specialises in the sale of high-quality local tiles but recently they've looked to source their tiles from overseas. Their primary customers are building rms, but in recent years they have seen a steady increase in retail sales to regular consumers. They offer their products in three ways catalogue sales, physical sales in their retail outlets, and more recently, online sales. Their main retail outlet and warehouse is located in lCroydon, a suburb of Melbourne. They were incorporated in ZEUS and are still classified as a small proprietary company. In terms ofemployees, they have 25 full timers and 6 part time staff. Student: 0k. 1What can you tell me about their accounting system? Holt: It's pretty much a hybrid system, with both manual and computerised elements, which are based on a networked version of MYDE. Staff record all purchases, sales and inventory transactions using MYDB's desktop software. Customers can use their website to view prices and availability of products. To order something, they're directed to a form to input details like size and colour of the tiles. When they nish selecting products, delivery and credit card information is entered. Transactions are then manually processed in the MYDE system. Student: Thanks for that. Is there any final advice you'd give to our team? Holt: Hmm. 0h, right I'd say make sure your team understands how to handle confidential client data. We had a run in with Fred Earth's management last year over one of the junior team members in our firm taking home Red Earth's data to work on. Management wasn't too happy about that. Student: Thanks again for the chat Mr Holt, it's been really helpful. And I hope that you enjoy your retirement! Engagement Letter To the Management of Red Earth P/L Scope You have requested that we audit the financial statements of Red Earth as of and for the year ending 30/6/2021. We are pleased to confirm our acceptance and our understanding of this engagement by means of this letter. Our objective is to express an opinion on the financial statements. We will conduct a risk-based audit in accordance with the Australian Auditing Standards. Those Standards require that we comply with ethical requirements, and obtain reasonable assurance that the financial statements are free from material misstatement or express a modified opinion. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the financial statements. The procedures selected depend on the auditor's judgment, including the assessment of the risks of material misstatement of the financial statements, whether due to fraud or error. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of accounting estimates made by management, as well as evaluating the overall presentation of the financial statements. Because of the inherent limitations of an audit, together with the inherent limitations of internal controls, there is an unavoidable risk that some material misstatements may not be detected, even though the audit is properly planned and performed in accordance with Australian Auditing Standards. In making our risk assessments, we consider internal controls relevant to the entity's preparation of the financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity's internal controls. However, we will communicate to you in writing concerning any significant deficiencies in internal controls relevant to the audit of the financial statements that we have identified during the audit. The responsibility for the preparation of the financial statements belongs to the management of Red Earth. Our audit will be conducted on the basis that management of Red Earth acknowledge and understand that they have responsibility: a. For the preparation of the financial statements that gives a true and fair view in accordance with the Corporations Act 2001 and Australian Accounting Standards; b. For the design, implementation and maintenance of such internal controls as management determines is necessary to enable the preparation of financial statements that are free from material misstatement, whether due to fraud or error; and C. To provide us with: i. Access to all information of which the directors and management are aware that is relevant to the preparation of the financial statements such as records, documentation and other matters;ii. Additional information that we may request from the directors and management for the purpose of the audit; and iii. Unrestricted access to persons within the entity from whom we determine it necessary to obtain audit evidence. As part of our audit process, we will request from management written confirmation concerning representations made to us in connection with the audit. We look forward to full cooperation from your staff during our audit. Independence We confirm that, to the best of our knowledge and belief, we currently meet the independence requirements of the Corporations Act 2001 in relation to the audit of the financial statements. In conducting our audit of the financial statements, should we become aware that we have contravened the independence requirements of the Corporations Act 2001, we shall notify you on a timely basis. As part of our audit process, we shall also provide you with a written independence declaration as required by the Corporations Act 2001. The Corporations Act 2001 includes specific restrictions on the employment relationships that can exist between the audited entity and its auditors. To assist us in meeting the independence requirements of the Corporations Act 2001, and to the extent permitted by law and regulation, we request you discuss with us: The provision of services offered to you by Bloom & Associates prior to engaging or accepting the service; and The prospective employment opportunities of any current or former partner or professional employee of Bloom & Associates prior to the commencement of formal employment discussions with a current or former partner or professional employee. Yours faithfully Bloom & AssociatesRed Earth Pty Ltd Profit and Loss Statement for Year Ended 30 June 2021 FY 2020-21 FY 2019-20 Total Sales 5 27 903,787.20 5 27 128,582.00 Purchases 5 17,674 544.00 5 18,357 526.00 Change in inventory 651 336.00 5 107,530.00 Freight - Inwards 5 521, 120.00 5 416,895.00 Total COGS S 18 857,000.00 $ 18,882 052.00 Gross Profit 9.045 787.20 5 8,246 630.00 Selling & Marketing - Salaries 1 431 600.00 5 1 396,700.00 Selling & Marketing - payroll tax 5 57,267.25 5 57,268.98 Selling & Marketing - workcover insurance 5 34 467.00 5 32 117.00 Selling & Marketing - superannuaten 121 894.50 5 121,286.50 Delivery expenses 15 229 200.00|5 240,000.00 Advertising 5 130,400.00 5 65,000.00 Discount expense 421 600.00 5 544 520.00 Total Selling Expenses 2 426 448.75 5 2,456 912.48 Repairs/maintenance 345,800.00 5 165,000.00 Utilities Expense 115,000.00 5 105,000.00 Administration - Salaries 1 110 400.00 1,050,500.00 Management bonuses 180,000.00 5 240,000.00 Administration - payroll tax 53,278.56 5 53,284.40 Administration - workcover insurance 31 085.00 5 29,577.00 Administration - superannuateon 121 400.50 5 121 277.00 Provision for Long Service Leave 44 364.00 5 36,540.00 anes Jenuuy Jo! woamong 176,984.00 5 165,710.00 Depn. Expense - Building 125,000.00 5 125,000.00 Depn. Expense - Vehicles 111,000.00 5 146,000.00 Depn. Expense - Plant 90,000.00 5 120,000.00 Depn. Expense - Office Eg. 30,000.00 5 40,000.00 Amortisation on license 16,000.00 5 16,000.00 Insurance 80,506.00 5 76,430.00 Miscellaneous 25,300.00 5 83,200.00 Office Supplies 74 320.00 5 78 910.00 Bad debts 294 800.00 5 256,500.00 Doubtful debts expense 75,600.00 5 60,500.00 Consultancies 96,000.00 Phone, Mobiles and IT Expenses 96,300.00 5 36,500.00 Audit fees 31 500.00 5 26,000.00 Travel 54 750.00 5 76,700.00 Total administration expenses 3 376 201.06 5 3,221 028.40 Interest expense 141 950.00 5 166,750.00 Total Financial expenses 141 950.00 5 166,750.00 Total expenses 5 944 599.81 5,844 690.85 Net Profit after interest expense 3,102 187.39 5 2,401 939.12 Interest earned 1,500.00 5 6,750.00 Dividend Received 20 659.08 5 Net Profit Before Tax 3,124 345.47 5 2,408 689.12 Income Tax Expense @ 27.59% 858,195.26 5 562 389.51 Net Profit after tax S 2 265 151.19 5 1,746,299.61Red Earth Pty Ltd Balance Sheet as at 30 June 2021 FY 2020-21 FY 2019-20 Current Assets Petty Cash 1 200.00 1,200.00 Bank 31 542 95 37,722.76 Inventory 5 1,520,000.00 2,181,336.00 Accounts Receivable 2 520,000.00 2,020,000.00 Allowance for Doubtful debts 75,600.00 5 2 444 400.00 -5 60,600.00 6 1,959,400.00 Prepayments 5 143,600.00 94,000.00 Total Current Assets 5 4 140,743.00 4,273,659.00 Non-Current Assets Land 5 1 200.000.00 1,200,000.00 Buildings 5,000,000100 5,000,000.00 Accumulated depreciation 625,000.00 5 4 375.000.00 -5 500,000.00 5 4,400,000.00 Vehicles 844,000.00 144,000.00 Accumulated depreciation 511,000.00 5 393.000.00 400,080.00 444,000.00 Plant and Equipment 780.000.00 780,000.00 Accumulated depreciation 510.000.00 5 270.000.00 5 420,000.00 5 360,000.00 Office Equipment 360,000.00 360,000.00 Accumulated depreciation 270,000.00 5 90.000 00 5 240,000.00 5 120,000.00 License 80.000.00 50,000.00 Less: Provision for Amortisation 92,000.00 5 48.000 00 -5 18,000.00 6 64,000.00 Investments as of 30th June 5 2 119 500.00 S 450,000.00 Total Non-Current Assets 5 8,435,500.00 7,036,000.00 Total Assets $ 12 576,242.95 $ 11,311,656.76 Current Liabilities Creditors - trade 5 1,909,200.00 5 1,489,200.00 Sundry Creditors Mortgage(Current) 250.000.00 250,000.00 Long service leave position (current) 62 390.00 47,542.00 Annual leave position (current) 155 500.00 96,502.00 Accrued expense 80.075.00 300,000.00 GST liability 136,000.00 136,000.00 Income tax payable 173,731.00 253,731.00 Dividends payable 400 000.00 500,000.00 Total Current Liabilities 5 2,576,836.00 3,072,975.00 Non-Current Liabilities Long service leave provision 124.650.00 95,084.00 Annual leave position 311,000.00 193,004.00 superannuateon payable 5,000.00 10,000.00 Mortgage $ 3,800.000.00 4,050,000.00 Total Non-Current Liabilities 5 4,243,660.00 4,348,086.00 Total Liabilities 5 6,820,496.00 7,421,063.00 Net Assets 5 5,755,746.95 3,890.595.76 Owner's Equity Share Capita 5 2,400,000.00 2,400,000.00 Retained earnings 5 3 255,745 95 1,390,595.76 General reserve S 100.000.00 100,000.00 Total Owner's Equity 5 5,755,746.95 3,890,595.76Statement of Retained Earnings for Year Ended 30 June 2021 FY 2020-21 FY 2019-20 Opening Balance S 1,390,595.76 144,296.15 Net Profit after Tax S 2,265,151.19 $ 1,746,299.61 Available for distribution S 3,655,746.95 1,890,595.76 Less: Dividends S 400,000.00 500,000.00 Ending Balance 3,255,746.95 1,390,595.76