PAA 5 – 2

36. During the final audit, the finance director has informed the audit team that Sunflower Co’s bankers will not make a decision on the renewal of the overdraft facility until after the auditor’s report is signed. The audit engagement partner is satisfied that the use of the going concern basis is appropriate.

The directors have agreed to include some brief going concern disclosures in the draft financial statements and the audit team still have to assess the adequacy of these disclosures.

Required:

Discuss the issue and describe the impact on the auditor’s report of Sunflower Co of adequate AND inadequate going concern disclosure.

37. Rabbit Co manufactures chemicals and has a factory and four offsite storage locations for finished goods. Rabbit Co’s year end was 30 April 20X3. The final audit is almost complete and the financial statements and auditor’s report are due to be signed next week. Revenue for the year is $55 million and profit before taxation is $5.6 million.

The following two events have occurred subsequent to the year end. No amendments or disclosures have been made in the financial statements.

Event 1 – Defective chemicals

Rabbit Co undertakes extensive quality control checks prior to the dispatch of any chemicals. Testing on 3 May 20X3 found that a batch of chemicals produced in April was defective. The cost of this batch was $0.85 million. In its current condition it can be sold at a scrap value of $0.1 million. The costs of correcting the defect are too significant for Rabbit Co’s management to consider this an alternative option.

Event 2 – Explosion

An explosion occurred at the smallest of the four offsite storage locations on 20 May 20X3. This resulted in some damage to inventory and property, plant and equipment. Rabbit Co’s management have investigated the cause of the explosion and believe that they are unlikely to be able to claim on their insurance. Management of Rabbit Co has estimated that the value of damaged inventory and property, plant and equipment was $0.9 million and it now has no scrap value.

Required:

(a) For each of the two events above:

(i) Explain whether the financial statements require amendment; and

(ii) Describe audit procedures that should be performed in order to form a conclusion on any required amendment.

Note. The total marks will be split equally between each event.

(b) The directors do not wish to make any amendments or disclosures to the financial statements for the explosion (Event 2).

Required

Explain the impact on the auditor’s report should this issue remain unresolved.

38. A few months have now passed and the audit team is performing the audit fieldwork including the audit procedures which you recommended over the redundancy provision. The team has calculated that the necessary provision should amount to $305,000. The finance director is not willing to adjust the draft financial statements.

Required:

Discuss the issue and describe the impact on the auditor’s report, if any, should this issue remain unresolved.

39. During the audit, the team discovers that the intangible assets balance includes $440,000 related to one of the nine new health and beauty products development projects, which does not meet the criteria for capitalisation. As this project is ongoing, the finance director has suggested that no adjustment is made in the 20X8 financial statements. She is confident that the project will meet the criteria for capitalisation in 20X9.

Required:

Discuss the issue and describe the impact on the auditor’s report, if any, should this issue remain unresolved.

40. The finance director of Spider Spirals Co has informed you that he is not proposing to make an adjustment for the trade payables payment run made on 3 November, as the total payment of $490,000 would only require a change to trade payables and the bank overdraft, both of which are current liabilities.

Required:

Discuss the issue and describe the impact on the auditor’s report, if any, should this issue remain unresolved.

41. A member of your audit team has asked for information on ISA 701 Communicating Key Audit Matters in the Independent Auditor’s Report as she has heard this standard is applicable to listed clients such as Airsoft Co.

Required:

(a) Identify what a key audit matter (KAM) is and explain how the auditor determines and communicates KAM.

42. Science Motoring Co (Science) specialises in manufacturing engine parts for motor cars and the company has a diverse customer base but seven significant customers. The company’s year-end was 30 September 2015.

During the year, a number of the company’s significant customers have experienced a fall in sales, and consequently they have purchased fewer items from Science. As a result, Science has paid a number of its suppliers later than usual and some of them have withdrawn credit terms meaning the company must pay cash on delivery. One of Science’s main suppliers is threatening legal action to recover the sums owing. As a result of the increased level of payables, the company’s current ratio has fallen below 1 to 0·9 for the first time.

Science has produced a cash flow forecast to 30 June 2016 and this shows net cash outflows until May 2016. Science has a loan of $2·3 million which is due for repayment in full by 30 September 2016. The finance director has just informed the audit manager that there is a possible change in legislation which will result in one of Science’s top product lines becoming obsolete as it will not comply with the proposed law. The prepared cash flow forecasts do not reflect this possible event.

Required:

(a) Explain FIVE potential indicators that Science Motoring Co is NOT a going concern.

(b) Describe the audit procedures which you should perform in assessing whether or not Science Motoring Co is a going concern.

43. ISA 700 Forming an Opinion and Reporting on Financial Statements requires auditors to produce an audit report. This report should contain a number of consistent elements so that users are able to understand what the audit report means.

Required:

Describe FOUR elements of an unmodified auditor’s report and for each explain why they are included.

44. During the audit, your team has identified an error in the valuation of work in progress, as a number of the assumptions contain out of date information. The directors of Jacktree have indicated that they do not wish to amend the financial statements.

Required:

Explain the steps Pumpkin & Co should now take and the impact on the audit report in relation to the directors’ refusal to amend the financial statements.