Question 1

In late October 2019, Mattel said auditors had completed their investigation and had determined that income tax expense was understated by $109 million in the third quarter of 2017 and overstated by $109 million in the fourth quarter of 2017, with no impact for the full year.

The accounting error had to do with Mattel’s ownership of “Thomas & Friends,” an animated children’s show. The error was tied to a $562 million valuation allowance that Mattel created against its deferred tax assets in September 2017. Ultimately, the allowance was reduced by $109 million to lower Mattel’s loss during that quarter.

In addition, Mattel admitted there had been an accounting error and that the internal investigation had found weaknesses in its accounting procedures in October 2019. The company’s chief financial officer, Joe Euteneuer, also announced his departure from the company. A Los Angeles-based PwC partner named Joshua Abrahams, who led the Mattel audit team, has been placed on administrative leave.

(Adapted from cnbc.com, 6 November 2019)

In recent years, we have witnessed numerous accounting scandals, such as Mattel in the U.S., and Toshiba in Japan, which have wavered public confidence in the companies financial reporting process as well as the independence of external auditors.

Required

In the context of Mattel, discuss the needs of the users of financial information as well as the objectives of performing an external audit on the financial statements. Critically discuss the extent that external auditors are truly independent of their clients.

Appropriate and relevant examples and other case studies may be used to justify your arguments.

Question 2

You are the audit senior for Sparkling Ltd, a listed company, and are currently planning the audit for the current financial year ended 31 January 2020. You obtained the following information during a recent visit to the company premises:

You noted that there is a significant increase in revenue and profit compared to the prior year for the first 10 months of the year. You have been informed that this was achieved by attracting new customers by offering extended credit. Customers are now allowed a three-month credit period to pay their debts instead of the one month credit period allowed previously. Due to this change in credit policy, receivables days have increased from SO to 111 days.

In recent months, there have been a number of legal claims brought up by customers due to quality issues with the company’s products. This has also resulted in customers refusing to pay for their purchases of the products. The chief financial officer and purchasing manager were dismissed on 15 August 2019 as a result. Sparkling has managed to hire a replacement purchasing manager but a new chief financial officer can only be appointed after the current financial year ended 31 January 2020. Therefore, the accounts supervisor will be responsible for preparing the financial statements for audit during the interim period.

On 1 June 2019, a new computerized inventory control system which is supposed to record inventory movements and current inventory quantities was installed. Sparkling is proposing to use the inventory quantities on the computer as a basis for the year-end inventory figure rather than perform a full year-end count in previous years. Sparkling has shared with you that test counts have been performed on a monthly basis.

Required

1. Identify and explain SIX 61 audit risks, and the auditor’s response to each risk, in planning the audit of Sparkling Ltd.
   You understand that the new inventory control system has been designed with password controls to help improve the internal control system over inventory.
2. Explain the purpose of password controls.
3. Consider and describe FOUR 141 tests of control you would carry out in order to ensure that the password controls are operating effectively.