(a) Explain the concepts of materiality and performance materiality in accordance with ISA 320 Materiality in
Planning and Performing an Audit. (5 marks)
(b) You are the audit senior of Rhino & Co and you are planning the audit of Kangaroo Construction Co (Kangaroo)
for the year ended 31 March 2013. Kangaroo specialises in building houses and provides a five-year building
warranty to its customers. Your audit manager has held a planning meeting with the finance director. He has
provided you with the following notes of his meeting and financial statement extracts:
Kangaroo has had a difficult year; house prices have fallen and, as a result, revenue has dropped. In order to
address this, management has offered significantly extended credit terms to their customers. However, demand
has fallen such that there are still some completed houses in inventory where the selling price may be below
cost. During the year, whilst calculating depreciation, the directors extended the useful lives of plant and
machinery from three years to five years. This reduced the annual depreciation charge.
The directors need to meet a target profit before interest and taxation of $0·5 million in order to be paid their
annual bonus. In addition, to try and improve profits, Kangaroo changed their main material supplier to a cheaper
alternative. This has resulted in some customers claiming on their building warranties for extensive repairs. To
help with operating cash flow, the directors borrowed $1 million from the bank during the year. This is due for
repayment at the end of 2013.
Financial statement extracts for year ended 31 March
Revenue 12·5 15·0
Cost of sales (7·0) (8·0 –––– ––––
Gross profit 5·5 7·0
Operating expenses (5·0) (5·1) –––– ––––
Profit before interest and taxation 0·5 1·9 –––– ––––
Inventory 1·9 1·4
Receivables 3·1 2·0
Cash 0.8 1·9
Trade payables 1·6 1·2
Loan 1·0 –
Using the information above:
(i) Calculate FIVE ratios, for BOTH years, which would assist the audit senior in planning the audit; and
(ii) Using the information provided and the ratios calculated, identify and describe FIVE audit risks and
explain the auditor’s response to each risk in planning the audit of Kangaroo Construction Co.
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