2 Your firm was appointed as auditor to Indigo Co, an iron and steel corporation, in September 2005. You are the
manager in charge of the audit of the financial statements of Indigo, for the year ending 31 December 2005.
Indigo owns office buildings, a workshop and a substantial stockyard on land that was leased in 1995 for 25 years.
Day-to-day operations are managed by the chief accountant, purchasing manager and workshop supervisor who
report to the managing director.
All iron, steel and other metals are purchased for cash at ‘scrap’ prices determined by the purchasing manager. Scrap
metal is mostly high volume. A weighbridge at the entrance to the stockyard weighs trucks and vans before and after
the scrap metals that they carry are unloaded into the stockyard.
Two furnaces in the workshop melt down the salvageable scrap metal into blocks the size of small bricks that are then
stored in the workshop. These are sold on both credit and cash terms. The furnaces are now 10 years old and have
an estimated useful life of a further 15 years. However, the furnace linings are replaced every four years. An annual
provision is made for 25% of the estimated cost of the next relining. A by-product of the operation of the furnaces is
the production of ‘clinker’. Most of this is sold, for cash, for road surfacing but some is illegally dumped.
Indigo’s operations are subsidised by the local authority as their existence encourages recycling and means that there
is less dumping of metal items. Indigo receives a subsidy calculated at 15% of the market value of metals purchased,
as declared in a quarterly return. The return for the quarter to 31 December 2005 is due to be submitted on
21 January 2006.
Indigo maintains manual inventory records by metal and estimated quality. Indigo counted inventory at 30 November
2005 with the intention of ‘rolling-forward’ the purchasing manager’s valuation as at that date to the year-end
quantities per the manual records. However, you were not aware of this until you visited Indigo yesterday to plan
your year-end procedures.
During yesterday’s tour of Indigo’s premises you saw that:
(i) sheets of aluminium were strewn across fields adjacent to the stockyard after a storm blew them away;
(ii) much of the vast quantity of iron piled up in the stockyard is rusty;
(iii) piles of copper and brass, that can be distinguished with a simple acid test, have been mixed up.
The count sheets show that metal quantities have increased, on average, by a third since last year; the quantity of
aluminium, however, is shown to be three times more. There is no suitably qualified metallurgical expert to value
inventory in the region in which Indigo operates.
The chief accountant disappeared on 1 December, taking the cash book and cash from three days’ sales with him.
The cash book was last posted to the general ledger as at 31 October 2005. The managing director has made an
allegation of fraud against the chief accountant to the police.
The auditor’s report on the financial statements for the year ended 31 December 2004 was unmodified.
Required:
(a) Describe the principal audit procedures to be carried out on the opening balances of the financial statements
of Indigo Co for the year ending 31 December 2005. (6 marks)