Question1.2 Your audit client, Excelsior Jewellery Ltd, manufactures and sells luxury jewellery through a network of 40 stores in Australia’s major cities. You have verified the production cost of the inventory as $21 million. However, due to a falling Australian dollar and a large increase in the price of gold, the company has estimated that the net realisable value of the inventory is $32 million, and they have revalued the inventory to this amount in their financial statements. Your analysis of the national jewellery market suggests that the inventory could be sold for $32 million. Which type of audit report should you issue? You should issue an audit report with an unmodified audit opinion. You should issue an audit report with a qualified audit opinion. You should issue an audit report with an unmodified audit opinion and a Key Audit Matters section to discuss the difficulties in valuing the inventory. You should issue an audit report with an unmodified audit opinion and an ‘emphasis of matter’ paragraph to discuss the impact of the major increase in inventory valuation on the future profitability of the company. ResetMaximum marks: 1 Flag question undefined

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BlackTom AI · Accepted Answer

The question presents a scenario about how inventory should be measured and how the audit report should reflect any misstatement. Below is a step-by-step analysis of each answer option, with reasoning that differentiates correct from incorrect choices.

Option 1: "You should issue an audit report with an unmodified audit opinion." This would be appropriate only if the financial statements present fairly, in all material respects, in accordance with the applicable financial reporting framework. However, the company has revalued inventory to 32 million when the cost is 21 million. Under the lower of cost and net realisable value (LCNRV) rule in many frameworks (e.g., IAS 2), inventory should be measured at the lower of cost and NRV. Since NRV (32 million) exceeds cost (21 million), the correct measurement should be cost, not NRV. The bookkeeping appears to be overstating inventory by valuing it at NRV rather than cost. That constitutes a potential material misstatement, which would usually require a modification to the audit opinion. Therefore, an unmodified opinion is inappropriate here.

Option 2: "You should issue an audit report with a qualified audit opinion." A qualified opinion is issued when there is a material misstatement or limitation on the scope of the audit that is not pervasive to the financial statements. In this case, valuing inventory at NRV higher than cost appears to be a misstatement of asset value under LCNRV. If that misstatement is material but not pervasive, a qualified opinion is warranted. This option aligns with the idea that the misstatement exists in the inventory valuation rather than in every aspect of the financial statements, leading to a modifying opinion to reflect the misstatement. The reasoning hinges on the misstatement of inventory measurement rather than an outright failure of accounting principles across the board.

Option 3: "You should issue an audit report with an unmodified audit opinion and a Key Audit Matters section to discuss the difficulties in valuing the inventory." A Key Audit Matter (KAM) section is intended for areas that require significant auditor attention during the engagement, often due to complexity or estimation uncertainty. While valuation of inventory can be a KAM, the presence of a misstatement in the measurement (NRV vs. cost) rather than only estimation difficulty does not by itself justify an unmodified opinion with a KAM. If there is a material misstatement, the overall opinion would typically be modified (i.e., not unmodified), even if a KAM is discussed. Therefore, this option is flawed because it combines an unmodified opinion with a misstatement in inventory valuation.

Option 4: "You should issue an audit report with an unmodified audit opinion and an ‘emphasis of matter’ paragraph to discuss the impact of the major increase in inventory valuation on the future profitability of the company." An emphasis of matter paragraph is used to draw attention to a matter appropriately disclosed in the financial statements that, in the auditor’s judgment, is of such importance that it is fundamental to users’ understanding of the financial statements, but does not modify the opinion. Here, the issue is not about a disclosure to future profitability but about the accounting measurement of inventory (NRV vs. cost). Emphasising profitability implications would be inappropriate unless the matter is both material and relates to a disclosure already present; it would still not justify an unmodified opinion if the inventory is misstated according to the LCNRV rule. This makes the option unsuitable.

In summary, among the given choices, option 2 reflects the appropriate response because there appears to be a material misstatement in inventory valuation (recording NRV higher than cost), which would typically necessitate a qualified opinion. The other options either fail to acknowledge the misstatement, propose inappropriate use of KAM or emphasis-of-matter paragraphs without addressing the core measurement issue, or rely on an unmodified opinion when the evidence supports a modification.

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