Faculty of Management Technology

Auditing and Assurance services

WS 2017

The Holding Company for Textile Manufacturing

Balance Sheet
On December 31st, 2016
Assets Liabilities and Stockholders’ Equity

Cash at hand 1,000,000 Liabilities

Trade accounts payable 3,000,000
Cash at bank 2,000,000 Notes payable 200,000
Other short term liabilities 1,160,000
Accounts Receivable 3,000,000
Total current liabilities 4,160,000
Notes Receivable 2,000,000
Long term debt 12,000,000
Inventory 12,000,000
Total liabilities 16,160,000
Total current assets 20,000,000
Stockholders’ Equity
Equipment and Machinery 22,000,000
Preferred stock (4,000,000 shares
Buildings and other property 25,000,000 @L.E 10) 40,000,000
Common stock (10,000,000
Land 15,000,000 @ shares at L.E 1) 10,000,000
Retained earnings 15,840,000

Total stockholders’ equity 65,840,000

Total fixed assets 62,000,000

Total liabilities &

Total assets 82,000,000 Stockholders’ equity 82,000,000

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 Faculty of Management Technology
Auditing and Assurance services
WS 2017

The Holding Company for Textile Manufacturing

Income Statement
For the period ended December 31st, 2017

Sales 33,000,000
Less: Sales Return and Allowances (3,000,000)
Net Sales 30,000,000
Less: Cost of goods sold (12,000,000)
Gross Margin 18,000,000
Less Operating expenses:
Salaries Expense (2,000,000)
Maintenance Expense (1,500.000)
Depreciation Expense (200,000)

Total Operating Expenses (3,700,000)

Net operating income 14,300,000

Less: Net loss from discontinued operations (700,000)

Net income before interest and taxes 13,600,000

Less: Interest expenses on long term debt (1,300,000)

Net income before tax 12,300,000

Less: tax expense (2,460,000)

Net income after tax 9,840,000

If you know that:

Sherif Mostafa is an auditor, who works for “The Professional Audit Advisors”
CPA Firm. Sherif is certified public accountant who has graduated from the faculty of
commerce 8 years ago; he is a highly qualified with 7 years of experience in auditing and
management advisory services. He has completed his professional education and earned
the CPA certificate 2 years ago and currently he is holding the post of “audit partner” in
the audit firm.

On December 31st 2016, he was assigned to audit “The Holding Company for
Textile Manufacturing”, which is a publicly listed company in the CASE (Cairo and
Alexandria Stock Exchange). The company was established in 1990 and had become one
of the top and most traded companies in the stock market. Such a company has been
audited by “The Professional Audit Advisors” for more than 10 years now; however it
was the first time for Sherif to audit such a company.

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 Faculty of Management Technology
Auditing and Assurance services
WS 2017

Due to such a long term relationship, the staff from both companies developed
strong personal relationships as well as some current financial positions’ holders in the
“The Holding Company for Textile Manufacturing” was ex-audit staff in “The
Professional Audit Advisors” CPA Firm. Sherif had heard a lot about the company’s
CFO and CEO high performance as they were his old colleagues at university, as well as
they usually have been cooperative with Sherif’s partners on previous engagements in
which they usually had received clean opinion.

The audit was to start in the mid of January 2016, for the financial year that will
end December 31st, 2016. Before conducting the audit Sherif had to start his audit plan by
assessing the acceptable audit risk and the planned detection for each segment to be
audited and then to start determining the materiality level.

Sherif had to assess the internal control system of the client company by starting
touring the production and manufacturing sites, where he found a large number of
machines to be obsolete as they weren’t operating like others and they produced defects
in the cloth produced by them. He also found that the five warehouses where inventory is
located, each is under the supervision of only one employee who is also responsible for
physical counting which is done every quarter, and he is the same person responsible for
fulfilling the sales order as well as for shipping the goods to the wholesalers.

After assessing the risk, Sherif started to assess the preliminary judgment about
materiality, which was assessed as 5% of the total assets. Sherif will focus in his audit on
auditing four important figures, cash, machinery, sales and inventory and long term
debt; and the following was revealed out during the audit:

a) While re-calculating a sample of invoices whose value is L.E 3000,000 a sales

invoice of L.E 100,000 was failed to be recorded.
b) During inspection of the production site area, it was found that machinery with
L.E 50,000 worth was found to be obsolete out of equipment and machinery
worth L.E 2000,000 but that was not reflected in the net value of machinery stated
in the balance sheet.
c) Out of the cash recorded was also revealed that a theft of L.E 500,000 took place,
however the theft was not disclosed in the footnotes. It was suggested through the
police investigation report, that the theft might have been resulting from some of
the employees working in the company as there was no signs of external attacks.
d) Of a sample of L.E 2,000,000 worth inventory 2% of it was wrongly overstated
above its cost value.

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 Faculty of Management Technology
Auditing and Assurance services
WS 2017
e) After some discussions with the credit manager of the company, it was found that
L.E 1000,000 of the long term debt was recorded as other short term liabilities in
order to improve the debt to equity ratios.

Required:

1. For each of the previous cases (a-e) determine the audit assertion that should have
been supported
2. For each of the previous cases (a-e) , determine the suitable audit objective the
auditor wanted to satisfy
3. For each of the previous cases (a-e), determine the type of audit evidence that was
used by Sherif
4. Identify any control weakness that Sherif would have assessed throughout his
work.
5. Identify the degree of inherent risk as well as the acceptable audit risk (i.e.
high/low) based on any inherent risk factor that the Sherif might have assessed.
6. Based on your own analysis should Sherif have any doubts about the ability of the
company to continue in the future if you knew that the industry benchmark
acceptable liquidity ratio is 3 times for the current ratio, 2 times for the quick ratio
and 15 % for the long term debt to equity ratio?
7. In your opinion, does Sherif finds that the financial statements as acceptable?
(NB: the sampling error is 10% of the direct projection)
8. Now what is the suitable audit report that should be issued? Why?
9. According to the Sarbanes Oxley Act for the year 2002, it was enforced a new law
in the USA that required the every publicly held corporation to change its audit
firm to another one after a period of five years. What do you think the advantages
and disadvantages of such a law for auditors or for the auditing profession?