May 2020 Q3 b(i)
GGC Co. Ltd (GGCL) specialises in manufacturing equipment which can help to reduce toxic emissions in the production of chemicals. The company has grown rapidly over the past eight years and this is partly due to the warranties that the company gives to its customers. It guarantees its products for five years and if problems arise during this period, it undertakes to fix them or provide a replacement.
You are the manager responsible for the audit of GGCL and you are performing the final review stage of the audit and have come across the following issues.
Receivable balance owing from Nhyira Co. Ltd
GGCL has a material receivable balance owed by its customer, Nhyira Co. Ltd. During the year-end audit, your team reviewed the ageing of this balance and found that no payments had been received from Nhyira Co. Ltd for over six months. GGCL would not allow this balance to be circularised. Instead management has assured your team that they will provide a written representation confirming that the balance is recoverable.
Warranty provision
The warranty provision included within the statement of financial position is material. The audit team has performed testing over the calculations and assumptions which are consistent with prior years. The team has requested a written representation from management confirming that the basis and amount of the provision are reasonable. Management is yet to confirm acceptance of this representation.
Required:
b) For each of the two issues above:
i) Discuss the appropriateness of written representations as a form of audit evidence; and (6 marks)
View Solution
Receivables balance owing from Nhyira Co. Ltd
The written representation proposed by management is intended to verify valuation, existence and rights and obligations of a material receivables balance. As management has refused to allow the auditor to circularize the balance and there has been little activity on the account for the past six months then there is very little evidence that has been obtained by the auditor. This representation would constitute entity generated evidence and this is less reliable than auditor generated evidence or evidence from an external source. If related control systems operate effectively then this evidence becomes more reliable. In addition if the representation is written as opposed to oral then this will increase the reliability as an evidence source. Overall this representation is a weak form of evidence, as there were more reliable evidence options available, such as the circularization but this was not undertaken. (3 marks)
Warranty provision
In this case the auditor has performed some testing of the provision in order to obtain auditor generated evidence. The team has tested the calculations and assumptions. None of this is evidence from an external source. The very nature of this provision means that it is difficult for the auditor to obtain a significant amount of reliable evidence as to the level of future warranty claims. Hence the written representation, whilst being an entity generated source of evidence, would still be useful as there are few other alternatives. (3 marks)