Task Background You are a manager in the audit division atMiller Yates Howarth (MYH), an accounting firm with officesthroughout the major regional centres of NSW and Queensland.Although a medium sized firm by national standards, MYH is thesecond largest regional accounting firm in Australia. Most of MYH’saudit clients are in the agriculture, mining, manufacturing andproperty industries. All those industries are currently underpressure, either from a downturn in commodity prices or fiercecompetition from overseas competitors. Ratios extracted from anunaudited set of financial reports at 30 June 2018 together withaudited comparatives for the year ended 30 June 2017 and 2016 areset out below for your review. You are gathering information toprepare the audit plan of Trunkey Creek Wines Limited for the yearended 30 June 2018. Trunkey Creek Wines (TCW) is one of MYH’s mostsignificant and longstanding clients. The following information hasbeen gathered to date. Principal activities of TCW • growing grapesfor wine production; • production and distribution of red, whiteand sparkling wines; • beef cattle production on land surplus togrape production; and • investment of surplus funds. TCW wasoriginally a family company incorporated in 1968 and has operatedsuccessfully and profitably since that date. In the 1990’s shareswere sold to a small number of investors to increase funds for thedevelopment and upgrading of the winery and the purchase ofadditional land for the vineyards. Insufficient rainfall had meantthat some land was no longer suitable for wine grape production, asa result, TWC moved into Wagyu beef cattle production on thissurplus land. The Wagyu operation is now starting to return aprofit. TWC now find that the 2 degrees increase in temperature atsome vineyards is affecting the production of sparkling wine andare now looking at purchasing land in cooler climates. TWC hasbuilt up a strong following for their sparkling wine which earnssignificant profits in both domestic and overseas markets. TWC arecurrently negotiating the land purchase and part funding in partfrom medium term bank loans. The remaining purchase price will besourced from surplus funds. The Wagyu beef is sold through theWagyu Selling Group (WSG) in which TWC has shares. These sharesform a material part of TWC’s investment portfolio. WSG buys,butchers and sells the Charles Sturt University Subject OutlineACC568 201860 S I Version 1 - Published 31 May 2018 Page 21 of 38Wagyu beef to high end domestic restaurants and regularly sendsfrozen shipments to Japan and China. TWC are heavily marketingtheir pinot, both domestically and overseas, as a perfectaccompaniment to the Wagyu beef. The directors of TCW are: • MrsClaire Harewood, Chairman. Mrs Harewood has significant experiencein the industry and replaced her husband as chair when he died 10years ago. • Mr Phillip Strange, Chief Executive Officer • Mr. JoeQuade • Mr Steven Harewood, son of Claire Harewood and hasoversight of the Wagyu beef operation • Dr Mary Owens • Ms HilaryJones • Mr Geoffrey Owens Your audit partner, John Richards, hasapproached you and advised that there are several areas he isconcerned about and he wants to you to report back to him aboutthese areas before you complete your audit program. These areas andaccounts are: • Accounts receivable • Investments • Property assets• Marketing expense Ratio 2018 (Unaudited) 2017 (Audited) 2016(Audited) Return on equity % 10.80 17.5 15.2 Return on beefproduction assets % 1.67 -0.82 -3.45 Return on grape and wineproduction assets % 12.2 14.5 16.2 Gross margin % 24.5 30.00 31.76Net profit margin % 14.38 20.27 17.85 Marketing expense % of totalS & A expenses 23.67 17.89 15.2 Times interest earned 6.67 7.518.10 Days in inventory - wine367 423 460 Days in accountsreceivable - wine 50.2 60.65 53.24 Days in accounts receivable -beef 57 36 24 Current ratio:1 2.80 2.54 2.66 Quick asset ratio:11.18 1.15 1.20 Debt to equity ratio:1 0.54 0.63 0.67 Internalcontrol The financial controller at TCW has been refining thesystem of internal controls and informs Charles Sturt UniversitySubject Outline ACC568 201860 S I Version 1 - Published 31 May 2018Page 22 of 38 you, at the planning stage of the current year'saudit, that he has put together an internal control manual for thecompany. He has stated that this manual will create greaterawareness of controls in the company, particularly with managementwhich, in the past, has not been overly conscious of the need toimplement and enforce effective internal controls. Management staffreceive bonuses based on certain agreed-upon target ratios whichinclude measures such as targeted monthly sales volumes, varianceof actual to budget departmental overheads and profit beforeinterest and tax. The Board takes an active interest in theperformance of the company and is quick to request explanations onvariances from the agreedupon monthly budgets. Two years ago, thecompany devoted significant time and resources to the developmentand implementation of a new IT system. All teething problemsassociated with the implementation phase have now been resolved,and the financial controller is satisfied that the automatedcontrols in place are assisting in producing accurate and completeaccounting records. The management accountant also looks after theIT function as the position is not regarded by management as beinga full-time job. Once application programs have been tested, strictpassword control exists over access to the programs. Passwords arenot required for access to databases. To assist in the planning forthe current year's audit engagement, you extracted the followinginformation from a review of the systems notes in the permanentfile and a perusal of the new internal control manual: • There arethree section managers, one each for grape production, wineproduction and beef production. Each can order supplies for theirrespective operations up to a limit of $10,000 for each order.Orders between $10,000 and $30,000 must be approved by themanagement accountant. Orders over $30,000 must be approved by theCEO. Orders over $50,000 must be approved by the Board. • Ordersmust be made through the computer ordering system which has directlinks to the approved suppliers. • Supplier information iscontained in a supplier master file. Each supplier has a uniquesupplier code. If a section manager orders from an unapprovedsupplier, the order is rejected and sent to the managementaccountant for approval. • The supplier information file ismaintained by the accounts clerk. Changes to the file are approvedmanually by the management accountant. • When supplies are receivedat the winery, the storeman checks the supplies received to theonline copy of the order and the delivery docket provided by thesupplier. Any discrepancies are noted on the online copy of theorder. • The delivery docket is filed by the storeman in a folderthat is kept at the winery. • The invoice is receivedelectronically from the supplier and matched to the order by theaccounts clerk. If the order and the invoice match the invoice isincluded in a payments file. • The payments file is approved onlineby the management accountant once a week and used to generate anABA file which is then uploaded to the bank by the managementaccountant. • When the payments file is approved by the managementaccountant, the invoice is automatically recorded as being paid inthe accounting system. • When services such as repairs are orderedfor the winery by the wine production manager, a service order isgenerated within the computer system and automatically sent to theservice provider. Charles Sturt University Subject Outline ACC568201860 S I Version 1 - Published 31 May 2018 Page 23 of 38 • Whenthe service has been delivered, the wine production manager or thestoreman signs the service delivery docket on the service man’stablet. • The invoice from the service company, with a copy of thesigned service delivery docket, is received online by the accountsclerk. • The accounts clerk checks the signed service deliverydocket to the invoice and the order and adds the invoice to thepayments file for final approval by the management accountant. • Inthe case of discrepancies, the accounts clerk contacts the supplierand the wine production manager to resolve the issue. Payments arenot made until the issue has been resolved. Required Write areport, including a brief executive summary, to your managingpartner that addresses the questions below. Where indicated, usethe required format to answer that question. Question 1A 8% Analysethe ratios and additional information associated with the fouraccounts listed by your audit partner, John Richards. Identify thepotential audit risks and any audit steps that need to beundertaken to reduce audit risk. Answer this question using thefollowing table: Account Analysis Audit Risk Audit Steps to reducerisk Question 1B 2% Analyse the ratios and additional informationto outline business risks that TWC faces. Question 2A 7% Identifythe internal controls in the system that are potentially effective,the risk that the control Charles Sturt University Subject OutlineACC568 201860 S I Version 1 - Published 31 May 2018 Page 24 of 38could alleviate and one test of control for each of the identifiedpotentially effective controls. Answer this question using thefollowing headings: Effective control Risk alleviated Test ofcontrol Question 2B 2% List and justify the weaknesses in internalcontrol for purchases and accounts payable. Weakness JustificationRationale This assessment task will assess the following learningoutcome/s: • be able to demonstrate risk management methodologiesand the role of internal controls in an audit context. • be able todesign an audit plan and select and apply appropriate auditprocedures for a financial statement audit. • be able to exercisecritical and reflective judgement and appreciate the value ofethical practice