Abrahams Co develops, manufactures and sells a range of pharmaceuticals and has a wide customer base across
Europe and Asia. You are the audit manager of Nate & Co and you are planning the audit of Abrahams Co whose
financial year end is 31 January. You attended a planning meeting with the finance director and engagement partner
and are now reviewing the meeting notes in order to produce the audit strategy and plan. Revenue for the year is
forecast at $25 million.
During the year the company has spent $2·2 million on developing several new products. Some of these are in the
early stages of development whilst others are nearing completion. The finance director has confirmed that all
projects are likely to be successful and so he is intending to capitalise the full $2·2 million.
Once products have completed the development stage, Abrahams begins manufacturing them. At the year end it is
anticipated that there will be significant levels of work in progress. In addition the company uses a standard costing
method to value inventory; the standard costs are set when a product is first manufactured and are not usually
updated. In order to fulfil customer orders promptly, Abrahams Co has warehouses for finished goods located
across Europe and Asia; approximately one third of these are third party warehouses where Abrahams just rents
In September a new accounting package was introduced. This is a bespoke system developed by the information
technology (IT) manager. The old and new packages were not run in parallel as it was felt that this would be too
onerous for the accounting team. Two months after the system changeover the IT manager left the company; a new
manager has been recruited but is not due to start work until January.
In order to fund the development of new products, Abrahams has restructured its finance and raised $1 million
through issuing shares at a premium and $2·5 million through a long-term loan. There are bank covenants attached
to the loan, the main one relating to a minimum level of total assets. If these covenants are breached then the loan
becomes immediately repayable. The company has a policy of revaluing land and buildings, and the finance director
has announced that all land and buildings will be revalued as at the year end.
The reporting timetable for audit completion of Abrahams Co is quite short, and the finance director would like to
report results even earlier this year.
Explain the components of audit risk and, for each component, state an example of a factor which can result in increased audit risk.
Using the information provided, identify and describe FIVE audit risks and explain the auditor’s response to
each risk in planning the audit of Abrahams Co.
Describe substantive procedures you should perform to obtain sufficient appropriate evidence in relation to:
(i) Inventory held at the third party warehouses; and
(ii) Use of standard costs for inventory valuation.