Question 1 (40 marks)

You are the audit manager of a medium-sized firm and have just received a package from Rachel Jones, the financial controller of KidSpace Ltd., an electronic toy manufacturer. This is your firms first year as auditor of KidSpace Ltd. The information below was prepared for a board meeting and Rachel, the acting Chief Financial Officer, felt it might be useful to you in preparation of the forthcoming audit for the year ended 30 June 2017.

KidSpace Ltd.
Statement of Financial Position $'000s
Current assets	2017	2016	2015
Cash	1,586	1,743	830
Accounts receivable and other receivables	13,734	11,200	9,623
Inventory	16,498	11,731	7,197
Total current assets	31,818	24,674	17,650
Non-current assets
Property, plant and equipment	14,606	12,840	9,572
Long-term loan receivable	5,200	3,600	3,300
Intangible assets	1,400
Total non-current assets	21,206	16,440	12,872
Total assets	53,024	41,114	30,222
Current liabilities
Trade payables and other payables	9,012	6,288	2,021
Provisions	4,875	3821	4577
Total current liabilities	13,887	10,109	6,598
Non-current liabilities
Long-term loan	20,000	16,000	12,000
Total liabilities	33,887	26,109	18,598
Net assets	19,137	15,505	11,624
Shareholder's equity
Share capital	2,000	2,000	2,000
Retained earnings	17,137	12,505	9,624
Total shareholder's equity	19,137	14,505	11,624

KidSpace Ltd.
Income Statement $'000s
	2017	2016	2015
Sales revenue	76,945	74,927	89,735
Cost of sales	51,840	51,765	63,066
Gross profit	25,105	23,162	26,669
Depreciation	5,595	4,332	2,796
Inventory obsolescence	990	1,173	670
Selling expenses	2,405	3,153	3,317
Administrative expenses	8,925	8,727	11,516
Finance costs	1,040	1,275	1,140
Total expenses	18,955	18,660	19,439
Profit before tax	6,150	4,502	7,230
Tax expense	1,518	1,621	2,386
Profit after tax	4,632	2,881	4,844
Notes:
Trade Receivables	12,034	10,655	9,300
Pre-paids	1,600	500	300
Other receivables	100	45	23
Total Trade & other receivables	13,734	11,200	9,623
Inventory
Raw Materials	6,599	5,866	3,845
WIP	4,333	2,588	1,550
Inventory held for sale	6,699	3,520	1,972
	17,631	11,974	7,367
Provision for Inventory obsolescence	(1,133)	(243)	(270)
Total inventory	16,498	11,731	7,197
Ratios	2017	2016	2015
Profit ratio	7.99%	6.01%	8.06%
Return on shareholder equity	24.20%	19.86%	41.67%
Quick Ratio	0.99	1.18	1.54
Times Interest Earned	6.91	4.53	7.34
Accounts Receivable Turnover (times)	6.78	7.51	9.33
Asset Turnover	1.45	1.84	2.94
Inventory Turnover (times)	3.50	5.35	8.76

During a brief telephone call with Rachel, you made the following notes:

1. One of the conditions of the long-term loan is that the company is not to exceed a debt-to equity ratio of 2:1 at any time and they must maintain a current ratio of 2:1. The loan is reviewed each year on 31 July. 2. Provision for obsolescence of finished inventory held for sale and work-in-progress is provided for at a flat rate of 10%. The amount provided in previous years was 20%. Rachel said that the company believes it has been overly conservative in previous years and 10% is a more realistic level, given the nature of its products. 3. To combat declining sales a senior management incentive scheme based on sales and profit levels was introduced in July 2016. 4. The long-term loan receivable is from a company involved in the development and production of computer software. It is owned by one of the directors.

Required:

a) Identify and explain what the inherent risks for KidSpace Ltd. that you will need to consider. (6 marks) b) From the information provided, perform additional preliminary analytical procedures: i) Simple comparison (3 marks) ii) Current ratio (1 mark) iii) Return on assets (1 mark) iv) Gross profit ratio (1 mark) v) Debt-to-equity ratio. (1 mark)

c) Drawing on information from a) & b), identify and justify:

i) Three key account areas that would require special attention during the audit of the 30 June 2017 financial statements. Also, indicate if those accounts are likely to be over or understated. (12 marks) ii) Two key assertions at risk for each of those account areas. (12 marks)

d) Identify and discuss any going concern issues to be considered at this stage?. (3 marks)