Your firm has recently been appointed as the external

Your firm has recently been appointed as the external auditor of Naga Berhad (Naga), a listed company, for the year ended 30 November 2021, following the resignation of the previous auditor. Naga is an online retailer offering customers a choice of over 1,000 items of groceries and household goods. Customers place their orders online and their orders are hand-picked and delivered to customers by Naga using its own delivery vehicles. Naga operates from 10 freehold distribution centers throughout Malaysia.

You are the audit senior and the engagement partner has asked you to consider the following three key areas of audit risk:

  • Volume-based supplier rebates

  • Non-current assets - delivery vehicles

  • Non-current assets - freehold distribution centers.

The engagement partner provided you with the following extracts from the draft financial

statements:

Draft statement of profit or loss for the year ended 30 November (extract)

2021 2020

(unaudited) (audited)

RM million RM million

Revenue 2,885 2,352

Cost of sales (gross of supplier rebates) (1,194) (987)

Volume-based supplier rebates 110 65

Loss on sale of delivery vehicles (45) (25)

Depreciation charge for delivery vehicles (47) (55)

Draft statement of financial position as at 30 November (extract)

2021 2020

(unaudited) (audited)

Non-current assets RM million RM million

Delivery vehicles (carrying value) 664 558

Continued…

In addition, the engagement partner has provided you with the following information:

  • Naga has negotiated individual terms for supplier rebates with each of its 100 principal suppliers. Rebates range from 1% to 10% of purchases. The terms are set out in signed annual contracts with each supplier. The contracts end at different times of the year. Rebates are paid in arrears to Naga on the conclusion of the contract if Naga exceeds the volumes of purchases stipulated in the contract. Naga's operation managers prepare revenue forecasts for each product. The revenue forecasts are then used to estimate the annual volume of purchases that will be placed with each supplier. If the volume of estimated purchases exceeds that required in the contract to earn a rebate, a rebate is recognised in the financial statements. Naga maintains a rebate management system that was developed by its IT department to collate the necessary information and calculate the rebates. An earlier version of this system was replaced in September 2021.

  • The delivery vehicles are serviced and repaired in Naga's workshops. It is company policy to replace delivery vehicles every six years. Delivery vehicles are purchased from a Malaysian dealer. Employees in Naga's workshops modify the delivery vehicles to make them suitable for transporting frozen food and to brand the delivery vehicles with Naga's corporate identity. All costs associated with both purchasing and modifying the delivery vehicles, including time spent by Naga's workshop employees, is included in the cost of delivery vehicles in the non-current asset register. The cost less any estimated residual value is depreciated on a straight-line basis over six years.

  • Five of the ten freehold distribution centers were valued by an external valuer in October 2021. The distribution centers are currently included in the accounting records at cost less accumulated depreciation which is lower than the valuation figure. The directors wish to recognise the new valuation in the financial statements for the year ended 30 November 2021.

  • Naga has applied for a bank loan to finance the modernisation of some of its distribution centres. The bank has requested the audited financial statements by 31 December 2021 in support of the loan application.

Required:

  1. Identify and explain the matters that your firm should have considered before accepting appointment as external auditor of Naga. (7 marks)

  1. Justify why volume-based supplier rebates and non-current assets have been identified as key areas of audit risk and, for each key area, describe the procedures that should be included in the audit plan to address those risks. You should present your answer using the following subheadings:


Continued…

  • Volume-based supplier rebates

  • Non-current assets - delivery vehicles

  • Non-current assets - freehold distribution centers 


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