It can be a very informative learning experience for auditors to focus on the Decision Notices (DN) published by the Financial Reporting Council. This week we focus on the audit failings in a case involving inventory.
One decision that we will examine over the coming weeks is the 2021 DN involving Haysmacintyre LLP and its audit partner David Cox (Hays) and the audit of the consolidated financial statements for ‘Associated British Engineering plc’ (‘ABE’) for the FY 2018. ABE was an engineering company based in the UK whose core operating activity was manufacturing/supplying spare parts for diesel engines and associated repair services.
The FRC clarifies that it did not make a finding that the FY2018 financial statements of ABE were misstated.
The carrying value of ABE’s inventory (i.e. the lower of cost and Net Realisable Value) stated in the FY2018 financial statements, at £1.037 million, represented 55% of current assets and 35% of total assets. There were multiple, serious failures in Hays’ audit work on inventory/stock valuation.
The inventory testing procedures in question were:
- poorly designed and
- were inadequate to test the key elements of the provisioning assessments so as to provide sufficient evidence for the relevant assertions in the FY2018 financial statements.
Sample selection failings
The selected sample size of 30 items was not appropriate, given that inventory was deemed an area of significant risk, and the audit file does not provide a justification for the sample size.
The whole population of the items that could have been selected was many times greater than 30; the audit file itself refers to an alternative, balance-sheet measure which might have been adopted and would have involved a sample more than ten times larger than the selected sample.
Execution of the tests by the audit team was deficient.
Hays communicated to ABE’s audit committee that, for each item within the sample of stock lines they had selected, they had traced:
- the cost price both to a purchase invoice, to ensure that costs had been correctly recorded, and
- to a sales list, to ensure that stock was subsequently recorded at the lower of cost and net realisable value.
In fact, Hays had not carried out those procedures.
Of the 30 items in the sample:
- only 17 were traced to a purchase invoice and
- only 10 were traced to a post year-end sales invoice.
Hays carried out testing work on the stock ageing data of [Subsidiary A], on which management based their provisioning.
The test of [Subsidiary A]’s stock ageing data that Hays designed and executed was inadequate in that it did not seek to verify the ageing data by checking the allocation of purchases to their respective financial periods.
Hays’ work on the carrying value of inventory within the Audit was therefore wholly inadequate. There were extensive and significant failings in this area of the Audit which constitute breaches of the following requirements of the ISAs:
ISA 200 (Overall objectives):
- Paragraph 15, by failing to plan and perform an audit with professional scepticism recognizing that circumstances may exist that cause the financial statements to be materially misstated;
- Paragraph 16, by failing to exercise professional judgment in planning and performing an audit of financial statements; and
- Paragraph 17, by failing to obtain sufficient appropriate audit evidence to reduce audit risk to an acceptably low level and thereby enable the auditor to draw reasonable conclusions on which to base the auditor’s opinion.
ISA 500 (Audit Evidence):
- Paragraph 6, by failing to design and perform appropriate procedures to obtain sufficient appropriate audit evidence; and
- Paragraph 9, by failing to carry out an appropriate evaluation as to whether information produced by the audited entity was sufficiently reliable for the auditor’s purposes.
ISA 330 (Response to Risks)
Paragraph 21, by failing to perform substantive procedures that were specifically responsive to the assessed significant risk of material misstatement in relation to inventory.
ISA 530 (Audit Sampling):
- Paragraph 6, by failing to design an audit sample giving consideration to the purpose of the audit procedure in question and the characteristics of the population from which the sample was to be drawn;
- Paragraph 7, by failing to determine a sample size sufficient to reduce sampling risk to an acceptably low level; and
- Paragraph 10, by failing to perform on a replacement item an audit procedure which was not applicable to the item first selected.
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