Nicolas Drinks Inc. (Nicolas) manufactures fizzy drinks such ascola and lemonade as
well as other soft drinks and its year end is 31 December 2017. Youare the audit
manager of B&J CPAs LL.P. and are currently planning the auditof Nicolas.
You attended the planning meeting with the engagement partner andfinance director
last week and recorded the minutes from the meeting shown below.You are reviewing
these as part of the process of preparing the audit strategy.
Minutes of planning meeting for Nicolas
Nicolas’ sales results have been strong this year and the companyis forecasting
revenue of $85 million, which is an increase from the previousyear. The company has
invested significantly in the cola and fizzy drinks productionprocess at the factory. This
resulted in expenditure of $5 million on updating, repairing andreplacing a significant
amount of the machinery used in the production process.
As the level of production has increased, the company has expandedthe number of
warehouses it uses to store inventory. It now utilises 15warehouses; some are owned
by Nicolas and some are rented from third parties. There will beinventory counts taking
place at all 15 of these sites at the year end.
A new accounting general ledger has been introduced at thebeginning of the year, with
the old and new systems being run in parallel for a period of twomonths.
As a result of the increase in revenue, Nicolas has recentlyrecruited a new credit
controller to chase outstanding receivables. The finance directorthinks it is not
necessary to continue to maintain an allowance for receivables andso has released the
opening allowance of $1·5 million.
In addition, Nicolas has incurred expenditure of $4·5 million ondeveloping a new brand
of fizzy soft drinks. The company started this process in January2017 and is close to
launching their new product into the market place. The financedirector stated that there
was a problem in November in the mixing of raw materials within theproduction process
which resulted in a large batch of cola products tasting different.A number of these
products were sold; however, due to complaints by customers aboutthe flavour, no
further sales of these goods have been made. No adjustment has beenmade to the
valuation of the damaged inventory, which will still be held atcost of $1 million at the
year end.
As in previous years, the management of Nicolas is due to be paid asignificant annual
bonus based on the value of year-end total assets.
Required:
1. Using the minutes provided, identify and describe SIX auditrisks, and explain the
auditor’s response to each risk, in planning the audit of NicolasDrinks Inc. (12
marks)
2. Describe substantive procedures the audit team should perform toobtain
sufficient and appropriate audit evidence in relation to thefollowing three matters:
(i) The treatment of the $5 million expenditure incurred onimproving the
factory production process;
(ii) The release of the $1·5 million allowance for receivables;and
(iii) The damaged inventory.