SECTION A- This ONE question is compulsory and MUST be attempted
(a) It is 1 July 20X5. You are a manager in the audit department of Charlie & Co, a firm of Chartered Certified Accountants. You are assigned to the audit of Elijah Co which has a financial year ending 30 September 20X5. Elijah Co manages timber plantations, its core business being the management of timber plantations and the production and sale of a range of timber products. It is not currently a listed entity.
The following exhibits, available on the left-hand side of the screen, provide information relevant to the question:
- Partner’s email – an email which you have received from Emmet Green, the audit engagement partner.
- Background information – information relevant to audit planning.
- Notes from meeting – summary of business developments discussed at a recent meeting between the chief finance officer (CFO) and the audit engagement partner.
- Key performance indicators – a summary of financial and non-financial information
- Notes from phone call – a summary of issues raised by the CFO during a discussion with the audit engagement partner.
This information should be used to answer the question requirement within your chosen response option(s).
Exhibit 1: Partner’s Email
To: Audit manager
From: Emmet Green, Audit engagement partner
Subject: Audit planning for Elijah Co
Date: 1 July 20X5
I have provided you with some information which you should use to help you in planning the audit of Elijah Co for the financial year ending 30 September 20X5.
As you know, Elijah Co is a new audit client of our firm. I hope you are looking forward to working on this interesting new client which is the first timber company we have secured as an audit client. You should also be aware that the management team is planning for Elijah Co to achieve a stock market listing within the next two years.
I require you to prepare briefing notes for my own use, in which you:
(a)Evaluate the business risks to be considered in planning the audit of Elijah Co.(10 marks)
(b)Evaluate the audit risks to be considered in planning the audit of Elijah Co.(20 marks)
Note: In relation to the company’s timber plantation asset (referred to in Exhibit 4) you are only required to consider audit risks relating to changes in fair value. Any other relevant audit risks relating to the timber plantation asset will be dealt with separately, later in the planning stage of the audit.
(c)Design the audit procedures to be performed in relation to the change in fair value of the timber plantation asset caused by the recent storms. Your procedures should include those relating to the evaluation of the expert appointed by management and the work they have performed.(6 marks)
(d)Using Exhibit 5, explain the ethical issues and other audit planning implications which arise in relation to the phone call from the company’s chief finance officer, Mark Holt.(10 marks)
Exhibit 2: Background Information
Elijah Co owns and manages several large timber plantations. Approximately 5% of the trees are harvested each year. The company immediately processes the timber which is harvested from felled trees in its own sawmills (a facility where trees are processed into logs and other timber products). The processed timber, which is mainly logs and planks of wood, is then sold to a range of customers including construction companies and furniture manufacturers. Approximately 30% of the timber is exported.
Your firm was appointed as auditor to Elijah Co in March 20X5 following the resignation of the previous auditor, Bear Associates. As part of your firm’s client acceptance procedures, communication was received from Bear Associates indicating that their reason for resignation was due to the retirement of the partner responsible for the audit and that they had no issues to bring to your attention regarding the audit.
Elijah Co has a small internal audit department with two staff who report to the company’s CFO, as the company does not have an audit committee.
Exhibit 3: Notes From Meeting
Meeting date: 10 June 20X5
Attendees: Emmet Green, audit engagement partner
Mark Holt, chief finance officer (CFO)
Mark Holt confirms that Elijah Co applies the requirements of IAS® 41 Agriculture as follows:
- Standing timber, which means trees which are growing in the timber plantation prior tobeing felled, are biological assets, measured at fair value less costs to sell. The change infair value less costs to sell is included in profit or loss for the period in which it arises.
- Felled trees are agricultural produce which are measured at fair value less costs to sellat the point of harvest. Immediately after felling, trees are processed, so that the value offelled trees awaiting processing is minimal at any point in time.
- Processed timber such as logs are measured in accordance with IAS 2 Inventories.
A technical expert from the audit firm has confirmed that the accounting policies outlined above appear appropriate in the context of Elijah Co’s activities.
Elijah Co’s operations are currently all based in its home jurisdiction. However, the board has recently approved the acquisition of several large areas of tropical rainforest in Swellview, a remote developing country. The expansion will allow the company to process new types of timber for which there is significant demand from luxury furniture manufacturers. The acquisition of the areas of the rainforest will cost $25 million and the purchase is due to take place in August 20X5. The cost of $25 million is equivalent to the fair value of the rainforest. Swellview uses the same currency as Elijah Co so the expansion is not creating any foreign exchange risk exposure to the company.
The purchase is being funded through a share issue to existing and new shareholders, who are mainly family members of the Elijah family, who established the company 20 years ago. A share issue was the only option for funding the international expansion as the company is at the limit of its bank borrowing agreement.
An international development agency has agreed to provide a grant of $20 million to assist Elijah Co in its Swellview expansion, on condition that the expansion represents sustainable and ethical business practice.
The grant is provided specifically for training the local workforce and building accommodation for the workforce in a town near to the rainforest.The grant is due to be received in September 20X5 and relevant expenditure will commence in November 20X5. Mark Holt is planning to recognise half of the amount received as income in this year’s financial statements, on the basis that it “will cover some of management’s expenses in planning the international expansion”.
The company is proud to have recently been awarded an industry ‘Gold Standard’ accreditation for its sustainable timber management. To achieve the Gold Standard, which denotes the highest possible level of sustainable timber management and ethical business practice, the company must adhere to a number of strict standards. This includes maintaining the biodiversity of the timber plantation, ensuring that rare species of tree are not harvested, and that animal habitats within the timber plantation are preserved. To maintain the Gold Standard accreditation, one condition is that at least 80% of timber sold must be harvested according to the strict standards set by industry regulators. The Gold Standard applies to all of the company’s activities, including the Swellview expansion.
Contract with Hart Co
The company’s revenue has increased this year, largely due to it signing a significant contract with a new customer, Hart Co. The contract was signed on the basis of Elijah Co receiving the Gold Standard accreditation for its timber.
A group of employees has recently commenced legal action against the company, claiming that breaches of health and safety guidelines regularly take place. The company has made some redundancies this year, which has put pressure on the remaining staff to work harder in order to maintain productivity; the employees are alleging that this has caused an increase in the number of accidents at work, some of which have resulted in fatalities. The company’s management and legal advisors believe that the legal claim, which amounts to $19 million, is unjustified and will not be successful. Mark Holt does not intend to recognise a provision for the claim or make any disclosure in the financial statements in relation to this issue as it is at such an early stage in the legal proceedings.
Use of expert – change in fair value due to recent storms
In the last month, several storms caused damage to some areas of timber plantation. An independent expert has been appointment by management to determine the extent of damage caused and to quantify any financial implications, including determination of the change in fair value of the standing trees which have been damaged by the storm. The expert’s report indicates a large number of trees have been completely destroyed, and many have been badly damaged. Based on the expert’s report, management has determined that a reduction in fair value of $70·5 million should be recognised in respect of the timber plantation asset recognised in the statement of financial position
Exhibit 4: Key Performance Indicators
The information in the table below will be published as part of the Annual Report, in a section titled ‘Key results for the year’, which forms part of management’s commentary on the company’s performance. The financial information is before recognising the change in fair value of the timber plantation caused by the recent storm, and also before accounting for the government grant.
Projected Actual %
30 September 30 September change
Financial key performance indicators: $ million $ million
Revenue 42·5 40·3 +5·5%
Operating profit 22·0 21·0 +4·8%
Profit before tax 6·5 5·0 +30%
Social and environmental key performance indicators:
% timber harvested in line with ‘Gold Standard’ 82% 85%
Number of employees 1,300 1,420
Total staff days lost due to accidents at work 78 65
You are also provided with the following information relating to balances which are extracted from management accounts as at 30 June 20X5:
Total assets – $550 million (20X4 – $545 million)
Timber plantation – $500 million (20X4 – $490 million) – this amount, relating to standing timber, is before accounting for any change in value caused by the recent storms referred to in Exhibit 3.
Inventory – $15·4 million (20X4 – $9·2 million) – the increased level of inventory is explained by management as follows: “In the last two months, industrial action at the country’s ports meant no containers of processed timber could be shipped to our export customers. The missed export sales so far amount to about $2·1 million. We continued to harvest and process timber during this time, leading to an increased level of inventory. The industrial action is ongoing.”
Cash – $4·5 million (20X4 – $6·8 million) – cash levels are depleted this year due to inflationary pressures and demands for higher wages from our employees, which we have met.
Exhibit 5: Notes From Phone Call
Notes from a phone call yesterday between Emmet Green, audit engagement partner and Mark Holt.
Request from Mark Holt
Elijah Co publishes a wide range of non-financial social and environmental Key Performance Indicators (KPIs) as part of the Annual Report, including the three shown as part of Exhibit 4. Mark has asked if our firm can provide assurance on these KPIs as part of performing the annual audit. Mark has suggested that in order to pay for this extra work, the agreed audit fee will be increased by 20%, assuming that the assurance provided on the KPIs is favourable.
Mark informed us that a news report has emerged in Swellview, alleging that Elijah Co paid a government official a sum of $15,000 in order to secure the purchase of tropical rainforest which is taking place next month. Mark wanted to make us aware of the story, which is spreading quickly on social media, and to inform us that these incentive payments are routine business practice in Swellview. He also strongly urged us not to investigate the payment as part of our audit procedures, saying that the amount is insignificant. He suggested that making enquiries regarding the payment might mean more media attention is focussed on the issue, which he is keen to avoid given the company’s plans to obtain a stock market listing within the next two years.
Respond to the instructions in the email from the audit engagement partner.
Note: The split of the mark allocation is shown in Exhibit 1 – Partner’s email.
Professional marks will be awarded for the presentation and logical flow of the briefing notes and the clarity of the explanations provided.