22) ZINBLE CO.

Zinble Co is a print supplier to businesses, printing catalogues, leaflets, training manuals and stationery to order. It specialises in using 100% recycled paper in its printing, a fact which is promoted heavily in its advertising.

You are a senior audit manager in Spark & Co, and you have just been placed in charge of the audit of Zinble Co after the manager previously assigned to the audit was moved to another urgent assignment. The audit for the year ended 31 August 20X1 is nearing completion, and the auditor’s report is due to be issued in two weeks’ time. You are currently reviewing a summary of matters for your considering, prepared by the audit senior.

Summary of issues for manager’s attention

Materiality has been determined as follows.

• $800,000 for assets and liabilities
• $250,000 for income and expenses

Issues related to audit work performed:

• Audit work on inventory

Audit procedures performed at the inventory count indicated that printed inventory items with a value of $130,000 were potentially obsolete. These items were mainly out of date training manuals. The finance director, Jacy Laurel, has not written off this inventory as she argues that the paper on which the items are printed can be recycled and used again in future printing orders. However, the items appear not to be recyclable as they are coated in plastic. The junior who performed the audit work on inventory has requested a written representation from management to confirm that the items can be recycled and no further procedures relevant to these items have been performed.

• Audit work on provisions

Zinble Co is involved in a court case with a competitor, Gobble Co, which alleges that a design used in Zinble Co’s printed material copies one of Gobble Co’s designs which are protected under copyright. Our evidence obtained is a verbal confirmation from Zinble Co’s lawyers that a claim of $125,000 has been made against Zinble Co, which is probable to be paid. Jacy Laurel has not made a provision, arguing that it is immaterial. Jacy refused our request to ask the lawyers to confirm their opinion on the matter in writing, saying it is not worth bothering the lawyers again on such a trivial matter.

• Audit work on current assets

Zinble Co made a loan of $6,000 to Jacy Laurel, the finance director, on 30 June 20X1. The amount is recognised as a current asset. The loan carries an interest rate of 4% which we have confirmed to be the market rate for short-term loans and we have concluded that the loan is an arm’s length transaction. Jacy has provided written confirmation that she intends to repay the loan by 31 March 20X2. The only other audit work performed was to agree the cash payment to the cash book. Details of the loan made to Jacy have not been separately disclosed in the financial statements.

Other issues for your attention:

Property revaluations

Zinble Co currently adopts an accounting policy of recognising properties at cost. During the audit of non-current assets Zinble Co’s property manager said that the company is considering a change of accounting policy so that properties would be recognised at fair value from 1 January 20X2.

Non-current asset register

The audit of non-current assets was delayed by a week. We had asked for the non-current asset register reconciliation to be completed by the client prior to commencement of our audit procedures on non-current assets, but it seems that the person responsible for the reconciliation went on holiday having forgotten to prepare the reconciliation. This happened on last year’s audit as well, and the issue was discussed with the audit committee at that time.

Procurement procedures

We found during our testing of trade payables that an approved supplier list is not maintained, and invoices received are not always matched back to goods received notes. This was mentioned to the procurement manager, who said that suppliers are switched fairly often, depending on which supplier is the cheapest, so it would be difficult to maintain an up-to-date approved supplier list.

Financial controller

Mia Fern, Zinble Co’s financial controller, owns a holiday home overseas. It appears that she offered the audit team free use of the holiday home for three weeks after the audit, as a reward for the team’s hard work. She also bought lunch for the audit team on most days.

Required

a. Assess the audit implications of the issues related to audit work performed, that have been raised by the audit senior. Your assessment should consider the sufficiency of evidence obtained, explain any adjustments that may be necessary to the financial statements, and describe the impact on the auditor’s report if these adjustments are not made. You should also recommend any further audit procedures necessary.

b. Explain the matters, arising from the ‘Other issues for your attention’, which should be brought to the attention of the audit committee of Zinble Co.

23) YOMITH CO.

It is 1 July 20X5. You are a manager in the audit department of Bloom & Co, a firm of Chartered Certified Accountants, responsible for the audit of the Yomith Group (the Group), which has a financial year ending 30 September 20X5. The Group, a listed entity, operates in the hospitality sector, running restaurants, coffee shops and hotels.

Bloom & Co audits the Group consolidated financial statements, and the individual financial statements of each Group company. All companies in the Group use IFRS® Standards as their financial reporting framework.

You are provided with the following exhibits:

• An email which you have received from Matt Davis, the Group audit engagement partner.
• Background information about the Group’s current structure and business activities.
• Notes taken at a recent meeting between Matt Davis and the Group finance director.
• Selected financial projections to 30 September 20X5 and comparative financial information.
• Notes taken by Matt Davis during a phone call with a representative of the audit committee.

Required:

Respond to the instructions in the email from the audit engagement partner.

(46 marks)

Note: The split of the mark allocation is shown in the partner’s email (Exhibit 1). Professional marks will be awarded for the presentation and logical flow of the briefing notes and the clarity of the explanations provided. (4 marks)

(Total: 50 marks)

Exhibit 1 – Email from audit engagement partner

To: Audit manager

From: Matt Davis, Group audit engagement partner

Subject: Yomith Group audit planning

Date: 1 July 20X5

Hello

You need to start planning the Yomith Group (the Group) audit, and to help with this I have provided you with some relevant information. I met with the Group finance director yesterday to discuss a number of matters including some recent business developments. I also spoke with a representative from the Group audit committee regarding several issues.

Using all the information provided, I require you to prepare briefing notes for my own use, in which you:

• Evaluate the significant audit risks to be considered in planning the Group audit for the financial year ending 30 September 20X5. Given the planned Group restructuring, you should evaluate audit risks relating to disclosure issues at this stage in the audit planning. (24 marks)
• Identify the additional information which should be requested from management in order to effectively audit the disposal of Good Burgers Co, and explain why this information is required. (4 marks)
• Design the principal audit procedures to be performed in respect of:

1. The classification of the $48 million investment in Spice Co, and
2. The government grant of $20 million received in January 20X5. (8 marks)

• Using the notes from the audit committee phone call in Exhibit 5, discuss any ethical issues relevant to the Group audit, and recommend appropriate actions to be taken by our firm. (10 marks)

Thank you.

Exhibit 2 – Background information about the Group

The Yomith Group is one of the country’s leading hospitality providers. Over the last 15 years, the Group has grown steadily and has a range of successful hospitality brands, each brand being operated by a separate, wholly owned, subsidiary of the Group.

The Group is planning some restructuring, which is discussed in the notes from the client meeting (Exhibit 3). The Group structure shown below is the Group’s existing structure, before any restructuring takes place.

Existing Group structure :

Information about each of the Group companies is given below:

Yomith Co is the parent company of the group, a listed company, which does not trade, and holds the shares in each subsidiary company.

Mondays Coffee Co operates one of the leading coffee shop chains in the country under the ‘Mondays Coffee’ brand. It enjoys a strong market share and operates more than 1,200 coffee shops across the country.

Good Burgers Co operates over 150 fast food restaurants. In recent years, revenue from Good Burgers Co has declined, but it still provides approximately 30% of Group revenue.

Wow Hotels Co is a successful hotel business, with over 75 hotels across the country. The Group acquired Wow Hotels Co three years ago, as part of a growth strategy based on diversification.

Exhibit 3 – Notes from client meeting

Group restructuring

The Group is restructuring, as part of a strategy for continued growth in revenue and profitability. As part of this strategy, the Group is investing $48 million in a newly formed company, Spice Co, representing 50% of the share capital of the company. The remaining 50% shareholding is owned by Dunphys Co, a property development company. The contract behind this investment states that the Group and Dunphys Co will work together to develop six new hotels, all based at the country’s major airports. The investment in Spice Co is likely to take place in August 20X5.

Partly to provide some of the finance needed for the restructuring, and partly because of its declining revenue, the Group is planning to dispose of Good Burgers Co. The board approved this disposal in March 20X5. Vendor’s due diligence has been carried out by Usami & Co, a firm of Chartered Certified Accountants. Usami & Co conducted an independent review of the company’s financial position and future prospects and produced a report on their findings, which is made available to potential buyers. At today’s date, several potential buyers have expressed an interest and the Group expects that the disposal will take place just after the financial year end.

Due to the success of the Wow Hotels brand, the Group plans to expand its hotel offering, and a target company for acquisition has been identified. The Group aims to acquire Valentine Co, which operates the successful Valentine Hotel chain. Negotiations are underway, and it is likely that the acquisition will go ahead in the first quarter of the next financial year. The purchase price has yet to be agreed, but is likely to be around $100 million. Due diligence performed on Valentine Co indicates that the fair value of its identifiable net assets is $85 million.

Mondays Coffee drive-through

The Group has previously trialled 20 drive-through coffee shops situated on busy roads, which offer customers the convenience of purchasing coffee without leaving their cars. This year the Group opened 50 new drive-through coffee shops, open 24 hours a day, seven days a week, which have proven to be extremely popular with customers. The associated capital expenditure recognised in property, plant and equipment was $43 million, which, according to the Group finance director, includes the cost of constructing the coffee shops amounting to $28 million, and the cost of acquiring three-year licences to allow 24-hour trading, at a cost of $15 million. The Group’s accounting policy is to depreciate property over 20 years, and a full year’s worth of depreciation will be charged in the year to 30 September 20X5 in respect of the $43 million capitalised.

According to the Group finance director, the new drive-through coffee shops are projected to account for almost all of the increase in revenue generated from the Mondays Coffee brand in the year. His comment is based on data produced from the management information system which separately records revenue generated from the drive-through coffee shops so that management can assess its performance and determine the return on the $43 million of capital expenditure.

Government grant

The government provides grants to organisations which commit to investing in properties to reduce carbon emissions and energy consumption. Grants are also available to organisations to promote the benefits of recycling to their customers.

In January 20X5, Yomith Co received a grant of $20 million. The only condition attached to the grant is that half of the amount must be used to upgrade existing assets to make them more environmentally friendly. None of the amount received has yet been spent, but it is planned that it will be used to finance capital expenditure across the Group’s property portfolio. The other half of the grant will be used to fund an advertising campaign.

According to the Group finance director, the full $20 million is included within operating profit in the projected Group statement of profit or loss for the year (Exhibit 4).

Exhibit 4 – Selected financial projections

Projected to     Projected to     Actual to         Actual to

30 Sept            30 Sept            30 Sept            30 Sept

20X5               20X5               20X4               20X4

$ million         $ million         $ million         $ million

Subsidiary                         Revenue          Assets              Revenue          Assets

Mondays Coffee Co          155                  200                  110                  160

Good Burgers Co 99                    110                  103                  113

Wow Hotels Co    66                    140                  62                    125

––––                ––––                ––––                ––––

Total                                  320                  450                  275                  398

––––                ––––                ––––                ––––

The table above is based on management information which forms the basis of the segmental reporting disclosed in the notes to the financial statements.

Other financial information for the Group as a whole is given below:

Projected to                             Actual to

30 September 20X5                30 September 20X4

$ million                                 $ million

Operating profit                            76                                            72

Profit before tax                            20                                            18

Total assets                                   475                                          450

Exhibit 5 – Notes from audit committee call

The Group currently has three non-executive directors, who form the Group audit committee. Until January 20X5, there was a fourth non-executive director who was also the financial reporting expert of the Group audit committee. The Group is looking to find a replacement, but is finding it difficult to recruit for this position, and has requested that a senior partner from Bloom & Co become a member of the Group audit committee while a replacement is being sought.

In addition, the Group audit committee is looking to appoint a firm of professional accountants to perform corporate finance work in relation to the planned Group restructuring. The audit committee understands that Bloom & Co cannot provide this nonaudit service as it would create a significant threat to auditor objectivity. However, the audit committee has asked if our firm can recommend another firm to perform the work.

Following the call, the managing partner of Bloom & Co has suggested that the firm recommend Ranger Associates, an unconnected firm, to carry out the work. If Ranger Associates is appointed, Bloom & Co will charge Ranger Associates a referral fee equivalent to 10% of the fee for the corporate finance engagement.

In addition, the audit committee has asked Bloom & Co to work with the Group internal audit team to design internal controls over the part of the accounting system which deals with revenue, and also evaluate the operating effectiveness of the internal controls.

24) FORIOX CO.

You are a manager in Mugg & Co, responsible for the audit of the Foriox Group.

You are planning the audit of the financial statements for the year ending 31 July 20X2.

You are provided with the following exhibits:

1 An email which you have received from Justin Timberlake, the audit engagement partner.

2 Extracts from the permanent audit file.

3 Details of the acquisition of Canary Co including calculation of the goodwill arising on acquisition.

4 Financial information of the Group.

5 Notes from meeting with Steve Crikle, finance director of the Foriox Group.

Required:

Respond to the instructions in the email from the audit engagement partner. (46 marks)

Note: The split of the mark allocation is shown in the partner’s email (Exhibit 1).

Professional marks will be awarded for the presentation and logical flow of the briefing notes and the clarity of the explanations provided. (4 marks)

(Total: 50 marks)

Exhibit 1 – Email from audit engagement partner

To: Audit manager

From: Justin Timberlake, Audit engagement partner

Subject: Foriox Group audit planning

Hello

I have provided you with some information in the form of a number of exhibits which you should use in planning the audit of the Foriox Group (the Group). I held a meeting yesterday with Steve Crikle, the Group finance director and we discussed a number of issues which will impact on the audit planning. One of the issues discussed is the change in group structure due to the acquisition of Canary Co earlier this year. We need to start planning the audits of the three components of the Group, and of the consolidated financial statements.

Using the information in Exhibits 2, 3 and 4, I require you to prepare briefing notes for my use in which you:

(a) Identify and explain the implications of the acquisition of Canary Co for the audit planning of the individual and consolidated financial statements of the Foriox Group. (8 marks)

(b) Evaluate the risks of material misstatement to be considered in the audit planning of the individual and consolidated financial statements of the Foriox Group. (20 marks)

(c) Design the principal audit procedures to be used in the audit of:

(i) Goodwill initially recognised on the acquisition of Canary Co.

(ii) The government grant received by Ox Co. (11 marks)

(d) Using the information provided in Exhibit 5, discuss the ethical and professional issues raised and recommend any actions necessary. (7 marks)

Thank you.

Exhibit 2 – Extracts from the permanent audit file

Fori Co was incorporated 100 years ago. It was founded by Joseph Fori, who established a small pottery making tableware such as dishes, plates and cups. The products quickly grew popular, with one range of products becoming highly sought after when it was used at a royal wedding. The company’s products have retained their popularity over the decades, and the Fori brand enjoys a strong identity and good market share.

Ten years ago, Fori Co made its first acquisition by purchasing 100% of the share capital of Ox Co. Both companies benefited from the newly formed Foriox Group, as Ox Co itself had a strong brand name in the pottery market. The Foriox Group has a history of steady profitability and stable management. Fori Co and Ox Co have a financial year ending 31 July 20X2, and your firm has audited both companies for several years.

Exhibit 3 – Details of the acquisition of Canary Co including calculation of the goodwill arising on acquisition

The most significant event for the Foriox Group this year was the acquisition of Canary Co, which took place on 1 February 20X2. Fori Co purchased all of Canary Co’s equity shares for cash consideration of $125 million, and further contingent consideration of $30 million will be paid on the third anniversary of the acquisition, if the Group’s revenue grows by at least 8% per annum. Fori Co engaged an external provider to perform due diligence on Canary Co, whose report indicated that the fair value of Canary Co’s net assets was estimated to be $110 million at the date of acquisition. Our firm has recently been appointed as auditor of Canary Co for the year ending 30 June 20X2.

Goodwill arising on the acquisition has been calculated as follows:

$ million

Fair value of consideration:

Cash consideration                                                                 125

Contingent consideration                                                        30

––––

155

Less: fair value of identifiable net assets acquired            (110)

––––

Goodwill                                                                                      45

––––

To help finance the acquisition, Fori Co issued loan stock at par on 31 January 20X2, raising cash of $100 million. The loan has a five-year term, and will be repaid at a premium of $20 million. 5% interest is payable annually in arrears. It is Group accounting policy to recognise financial liabilities at amortised cost.

Canary Co manufactures pottery figurines and ornaments. The company is considered a good strategic fit to the Group, as its products are luxury items like those of Fori Co and Ox Co, and its acquisition will enable the Group to diversify into a different market. Approximately 30% of its sales are made online, and it is hoped that online sales can soon be introduced for the rest of the Group’s products. Canary Co has only ever operated as a single company, so this is the first year that it is part of a group of companies.

Exhibit 4 – Financial performance and position of the Group

The Group has performed well this year, with forecast consolidated revenue for the year to 31 July 20X2 of $135 million (20X1 – $125 million), and profit before tax of $8.5 million (20X1 – $8.4 million).

A breakdown of the Group’s forecast revenue and profit is shown below:

Fori Co            Ox Co           Canary Co       Foriox Group

$ million         $ million         $ million         $ million

Revenue                                               69                    50                    16                    135

Profit before tax                                  3.5                   3                      2                     8.5

Note:

Canary Co’s results have been included from 1 February 20X2 (date of acquisition).

Forecast information relates to 1 June – 31 July 20X2.

The forecast consolidated statement of financial position at 31 July 20X2 recognises total assets of $550 million.

Government grant

Ox Co received a grant of $35 million on 1 March 20X2 in relation to redevelopment of its main manufacturing site. The government is providing grants to companies for capital expenditure on environmentally friendly assets. Ox Co has spent $25 million of the amount received on solar panels which generate electricity, and intends to spend the remaining $10 million on upgrading its production and packaging lines.

Other matters

On 1 January 20X2, a new IT system was introduced to Fori Co and Ox Co, with the aim of improving financial reporting controls and to standardise processes across the two companies. Ox Co’s finance director left the company suddenly last week and has not yet been replaced.

Exhibit 5 – Notes from meeting with Steve Crikle, finance director of the Foriox Group

Complaints regarding last year’s audit

Steve Crikle raised concerns about the conduct of the previous audit, stating numerous examples of when he and his staff had been interrupted when they were busy. He stated that he wanted guarantees that this year’s audit will be more efficient, less intrusive and cheaper, otherwise he will seek an alternative auditor. As a result of these complaints, last year’s fee has not been paid.

25) LOMOFY CO.

You are a manager in the audit department of Pluto & Co, a firm of Chartered Certified Accountants. You are responsible for the audit of Lomofy Gas Co, a company which is the main supplier of gas to business and residential customers across the country.

The audit fieldwork for the year ended 30 June 20W7 is nearing completion. The draft financial statements recognise profit before tax of $130 million (20W6 – $110 million), and total assets of $1,900 million (20W6 – $1,878 million).

During the review of the audit files the following matters have been noted for your attention by the audit senior:

• Decommissioning provision

A provision of $430 million (20W6 – $488 million) is recognised as a long-term liability. The provision is in respect of decommissioning a number of gas production and storage facilities when they are at the end of their useful lives. The estimate of the decommissioning costs has been based on price levels and technology at the reporting date, and discounted to present value using an interest rate of 8% (20W6 – 6%). The timing of decommissioning payments is dependent on the estimated useful lives of the facilities but is expected to occur by 20Z6, with the majority of the provision being utilised between 20X5 and 20Z0.

The accounting policy note discusses the methodology used by management for determining the value of the decommissioning provision and states that this is an area of critical accounting judgements including key areas of estimation uncertainty. The estimate has been made by management. In previous years, a management expert was engaged to provide the estimate but as this was expensive, management decided to produce their own estimate for the year ended 30 June 20W7.

b. Depreciation

The draft statement of financial position includes plant and equipment, unrelated to gas production and storage facilities, at a carrying amount of $65 million. There was a change in the estimation technique used to determine the depreciation in respect of these assets during the year. Depreciation was previously calculated on a straight line basis over a 10-year useful life, but from 1 July 20W6, the useful life has been amended to 15 years. The finance director explained to the audit team that the review of estimated useful life has been made on the basis that the assets are lasting longer than originally anticipated.

The change in depreciation policy has been accounted for as a prior year adjustment, resulting in an increase of $20 million to property, plant and equipment and to retained earnings. The depreciation expense recognised in draft profit for the year to 30 June 20W7 is $12 million (20W6 – $15 million).

c. Trade receivables

The draft statement of financial position recognises total trade receivables of $450 million (20W6 – $390 million).

The audit team has performed substantive analytical procedures on trade receivables with the following results:

Receivables collection period:                                                     20W7       20W6

Residential customers                                                           65 days            58 days

Business customers                                                               50 days            55 days

The notes to the financial statements contain the following information relating to trade receivables:                                                                                            20W7             20W6

Trade receivables:                                                                              $ million         $ million

Residential customers                                                                         158                  145

Business customers                                                                             356                  289

Less: allowance for credit losses                                                        (64)                 (44)

Net trade receivables                                                                          450                  390

Receivables from business customers are generally reviewed for impairment on an individual basis when a customer changes their gas supplier, discontinuing their relationship with the Group. Receivables from residential customers are reviewed for impairment where they are more than 90 days late in paying their bill, or where customers have a history of late payment. Since a new customer billing system was introduced in September 20W6, management has exercised additional judgement regarding the appropriate level of allowance for these trade receivables.

(7 marks)

Required

Comment on the matters to be considered, along with an explanation on the audit evidence you should expect to find during your file review in respect of each of the issues described above. You are NOT required to explain the potential impact of the matters on the auditor’s opinion or report.

Note. The split of the mark allocation is shown against each of the issues above.

26) SHOPZO CO.

You are a manager in the audit department of Shag & Co, a firm of Chartered Certified Accountants, and you have just been assigned to the audit of Shopzo Co, a new audit client of your firm, with a financial year ended 31 May 20X5.

You are provided with the following exhibits:

1 An email which you have received from JasonHackett, the audit engagement partner.

2 Notes from my meeting with Len Brennan.

3 Extracts of Shopzo Co’s draft financial statements and results of the preliminary analytical review procedures performed by one of the audit seniors.

Required:

Respond to the instructions in the email from the audit engagement partner. (46 marks)

Note: The split of the mark allocation is shown in the partner’s email (Exhibit 1).

Professional marks will be awarded for the presentation and logical flow of the briefing notes and the clarity of the explanations provided. (4 marks) (Total: 50 marks)

Exhibit 1 – Email from audit engagement partner

To: Audit manager

From: JasonHackett, Audit engagement partner

Regarding: Shopzo Co audit planning

Hello

I have provided you with some information in the form of a number of exhibits which you should use in planning the audit of Shopzo Co. I held a meeting yesterday with the company’s finance director, Len Brennan, and we discussed a number of issues which will impact on the audit planning.

Using the information provided, I require you to prepare briefing notes for my use in which you:

(a) Discuss the matters specific to the planning of an initial audit engagement which should be considered in developing the audit strategy. (6 marks)

(b) (i) Evaluate the audit risks to be considered in planning the audit of Shopzo Co. (20 marks)

(ii) Recommend the additional information which would be relevant in the evaluation of audit risk. (5 marks)

(c) Design the principal audit procedures to be used in the audit of:

(i) The portfolio of short-term investments, and

(ii) The earnings per share figure. (10 marks)

(d) Identify and discuss the relevant ethical and professional issues raised if your firm performs the audit of both Shopzo Co and Rachel Co and recommend any actions necessary. (5 marks)

Thank you.

Exhibit 2 – Notes from meeting with Len Brennan

Shopzo Co is a newly listed company which designs, develops and publishes computer games including many highly successful games which have won industry awards. The company has grown rapidly in the last few years. Shopzo Co was formed ten years ago by Dougal Doyle, a graduate in multimedia computing. In the last two years the company invested $100 million in creating games designed to appeal to a broad, global audience and sales are now made in over 60 countries. The software used in the computer games is developed in this country, but the manufacture of the physical product takes place overseas.

Computer games are largely sold through retail outlets, but approximately 25% of Shopzo Co’s revenue is generated through sales made on the company’s website. In some countries Shopzo Co’s products are distributed under licences which give the licence holder the exclusive right to sell the products in that country. The cost of each licence to the distributor depends on the estimated sales in the country to which it relates, and licences last for an average of five years. The income which Shopzo Co receives from the sale of a licence is deferred over the period of the licence. At 31 May 20X5 the total amount of deferred income recognised in Shopzo Co’s statement of financial position is $18 million.

As part of a five-year strategic plan, Shopzo Co obtained a stock market listing in December 20X4. The listing and related share issue raised a significant amount of finance, and many shares are held by institutional investors. Dougal Doyle retains a 20% equity shareholding, and a further 10% of the company’s shares are held by his family members.

Despite being listed, the company does not have an internal audit department, and there is only one non-executive director on the board. These issues are explained in the company’s annual report, as required by the applicable corporate governance code.

Recently, a small treasury management function was established to manage the company’s foreign currency transactions, which include forward exchange currency contracts. The treasury management function also deals with short-term investments. In January 20X5, cash of $8 million was invested in a portfolio of equity shares held in listed companies, which is to be held in the short term as a speculative investment. The shares are recognised as a financial asset at cost of $8 million in the draft statement of financial position. The fair value of the shares at 31 May 20X5 is $6 million.

As a listed company, Shopzo Co is required to disclose its earnings per share figure. Dougal Doyle would like this to be based on an adjusted earnings figure which does not include depreciation or amortisation expenses.

The previous auditors of Shopzo Co, a small firm called Crilly & Co, resigned in September 20X4. The audit opinion on the financial statements for the year ended 31 May 20X4 was unmodified.

Len Brennan commented on growing competition in the computer games industry. One rapidly expanding competitor, Rachel Co, was specifically referred to. You are aware that your firm recently acquired another accountancy firm and that Rachel Co is one of their clients. It is hoped that the audit of Rachel Co will be transferred to your department to take advantage of your specialism in this industry.

Exhibit 3 – Extract of draft financial statements and results of preliminary analytical review

Statement of profit or loss (extract)

Year to 31 May 20X5             Year to 31 May 20X4             % change

Draft                                        Actual

$000                                        $000

Revenue                      98,000                                     67,000                               46.3% increase

Gross profit                 65,000                                     40,000                               62.5% increase

Operating profit          12,000                                     9,200                                 30.4% increase

Finance charge            4,000                                       3,800                                 5.3% increase

Profit before tax          8,000                                       5,400                                 48.1% increase

Earnings per share      89.6 cents per share                –

Note: Earnings per share has been calculated as follows:

$000

Profit before tax                                                          8,000

Add: Depreciation                                                      1,100

Amortisation                                                               6,000

––––––

Adjusted profit before tax                                           15,100

––––––

Adjusted profit before tax                                           15,100,000

––––––––––

Number of equity shares at 31 May 20X5                 16,850,000 = 89.6 cents per share

Statement of financial position (extract)

31 May 20X5              31 May 20X4

Draft                            Actual

$000                            $000                            % change

Non-currentassets:
Intangible assets – development costs 58,000                        35,000                   65.7% increase

Total assets                                                 134,000                       105,000                 27.6% increase

27) CRIKLE CO.

You are a manager in the audit department of Catt & Co, a firm of Chartered Certified Accountants, responsible for the audit of the Crikle Group (the Group), which has a financial year ending 31 December 20X8. Your firm is appointed to audit the parent company, Crikle Co, and all of its subsidiaries, with the exception of Jinx Co, a newly acquired subsidiary located in a foreign country which is audited by a local firm of auditors, Sparrow Associates.

All companies in the Group report using IFRS® Standards as the applicable financial reporting framework and have the same financial year end.

You are provided with the following exhibits:

1 An email which you have received from Maya Crag, the audit engagement partner.

2 Background information about the Group including a request from the Group finance director in respect of a non-audit engagement.

3 Extracts from the Group financial statements projected to 31 December 20X8 and comparatives, extracted from the management accounts, and accompanying explanatory notes. 4 Management’s determination of the goodwill arising on the acquisition of Jinx Co.

5 An extract from the audit strategy document prepared by Sparrow Associates relating to Jinx Co.

Required:

Respond to the instructions in the email from the audit engagement partner. (46 marks)

Note: The split of the mark allocation is shown in the partner’s email (Exhibit 1).

Professional marks will be awarded for the presentation and logical flow of the briefing notes and the clarity of the explanations provided. (4 marks) (Total: 50 marks)

Exhibit 1 – Email from audit engagement partner

To: Audit manager

From: Maya Crag, Audit engagement partner

Subject: Audit planning for the Crikle Group

Hello

I have provided you with some information in the form of a number of exhibits which you should use in planning the audit of the Crikle Group (the Group). I held a meeting yesterday with the Group finance director and representatives from the Group audit committee, and we discussed a number of issues which will impact on the audit planning.

Using the information provided, I require you to prepare briefing notes for my use in which you:

(a) Evaluate the audit risks to be considered, inorder to plan the Group audit. Use analytical procedures to assist in identifying audit risks. You are not required to consider audit risks relating to disclosure, as these will be planned for later in the audit process. (24 marks)

(b) Design the principal audit procedures to be used in the audit of the goodwill arising on the acquisition of Jinx Co. Management’s calculation of the goodwill is shown in Exhibit 4. You do not need to consider the procedures relating to impairment testing, or to foreign currency retranslation, as these will be planned later in the audit. (6 marks)

(c) Using the information provided in Exhibit 5, evaluate the extract of the audit strategy prepared by Sparrow Associates in respect of their audit of Jinx Co and discuss any implications for the Group audit. (10 marks)

(d) After considering the request in Exhibit 2 from the Group finance director in respect of our firm providing advice on the Group’s integrated report, discuss the ethical and professional implications of this request, recommending any further actions which should be taken by our firm. (6 marks)

Thank you.

Exhibit 2 – Background information about the Group and request from Group finance director Group operational activities

The Group, which is a listed entity, operates in distribution, supply chain and logistics management. Its operations are worldwide, spanning more than 200 countries. The Group’s strategy is to strengthen its market share and grow revenue in a sustainable manner by expansion into emerging markets. There are over 50 subsidiaries in the Group, many of which are international. There are three main business divisions: post and parcel delivery, commercial freight and supply chain management, each of which historically has provided approximately one-third of the Group’s revenue.

A fourth business division which focuses purely on providing distribution channels for the oil and coal sector was established two years ago, and in 20X8 began to grow quite rapidly. It is forecast to provide 12% of the Group’s revenue this year, growing to 15% in 20X9. This division is performing particularly well in developing economies.

In recent years, revenue has grown steadily, based mainly on growth in some locations where e-commerce is rapidly developing. This year, revenue is projected to decline slightly, which the Group attributes to increased competition, as a new distribution company has taken some of the Group’s market share in a number of countries. However, the Group management team is confident that this is a short-term drop in revenue, and forecasts a return to growth in 20X9.

Innovation

The Group has invested in automating its warehousing facilities, and while it still employs more than 250,000 staff, many manual warehouse jobs are now performed by robots. Approximately 5,000 staff were made redundant early in this financial year due to automation of their work. Other innovations include increased use of automated loading and unloading of vehicles, and improvements in the technology used to monitor and manage inventory levels.

Integrated reporting

The Group is proud of this innovation and is keen to highlight these technological developments in its integrated report. The Group finance director has been asked to lead a project tasked with producing the Group’s first integrated report. The finance director has sent the following request to the audit engagement partner:

‘We would like your firm to assist us in developing our integrated report, and to provide assurance on it, as we believe this will enhance the credibility of the information it contains. Specifically, we would like your input into the choice of key performance indicators which should be presented, how to present them, and how they should be reconciled, where relevant, to financial information from the audited financial statements.’

The publication of an integrated report is not a requirement in the jurisdiction in which the Group is headquartered, but there is a growing pressure from stakeholders for an integrated report to be produced by listed reporting entities.

If Catt & Co accepts the engagement in relation to the Group’s integrated report, the work would be performed by a team separate from the audit team.

Exhibit 3 – Extract from consolidated financial statements

Statement of financial position

                                                          Note               As at 31 December    As at 31 December 

                                                                                        20X8                           20X7

                                                                                   Projected                         Actual

$ million                                 $ million

Non-current assets

Goodwill                                             1                                  1,100                           970

Other intangible assets                        2                                  200                              170

Property, plant and equipment                                               657                              600

Other investments                                                                   85                                100

–––––                          –––––

Total non-current assets                                                          2,042                           1,840

–––––                          –––––

Current assets                                                                       1,450                           1,420

–––––                          –––––

Total assets                                                                            3,492                           3,260

–––––                          –––––

Equity and liabilities

Equity

Share capital                                       3                                  1,250                           1,150

Retained earnings                                                                   840                              780

Other components of equity                                                   130                              140

Non-controlling interest                                                         25                                23

–––––                          –––––

2,245                           2,093

–––––                          –––––

Non-current liabilities                        4                                  650                              620

Current liabilities                                                                    597                              547

–––––                          –––––

Total equity and liabilities                                                   3,492                           3,260

–––––                          –––––

Statement of profit or loss

                                                 Note                Year to                       Year to

                                                                       31 December 20X8    31 December 20X7

                                                                         Projected                    Actual

$ million                     $ million

Revenue                                  5                      5,770                           5,990

Other operating income          6                      120                              80

Operating expenses                 7                      (5,540)                        (5,800)

–––––                          –––––

Operating profit                                              350                              270

Finance charges                                              (28)                             (30)

–––––                          –––––

Profit before tax                                              322                              240

Tax expense                                                    (64)                             (60)

–––––                          –––––

Profit for the year                                         258                              180

–––––                          –––––

Notes to the extracts from financial statements

Goodwill

• Goodwill relates to the Group’s subsidiaries, and is tested for impairment on an annual basis. Management will conduct the annual impairment review in December 20X8, but it is anticipated that no impairment will need to be recognised this year due to anticipated growth in revenue which is forecast for the next two years. In March 20X8, the Group acquired an 80% controlling shareholding in Jinx Co, a listed company located in a foreign country, for consideration of $351 million. Management’s determination of the goodwill arising on this acquisition is shown in Exhibit 4.

Other intangible assets

• Other intangible assets relates mostly to software and other technological development costs. During the year $35 million was spent on developing a new IT system for dealing with customer enquiries and processing customer orders. A further $20 million was spent on research and development into robots being used in warehouses, and $5 million on developing new accounting software. These costs have been capitalised as intangible assets and are all being amortised over a 15-year useful life.

Equity and non-current liabilities

• A share issue in July 20X8 raised cash of $100 million, which was used to fund capital expenditure.
• Non-current liabilities includes borrowings of $550 million (20X7 – $500 million) and provisions of $100 million (20X7 – $120 million). Changes in financing during the year have impacted on the Group’s weighted average cost of capital. Information from the Group’s treasury management team suggests that the weighted average cost of capital is currently 10%.

Financial performance

• Revenue has decreased by 3.7% over the year, due to a new competitor in the market taking some of the Group’s market share.
• Other operating income comprises the following items:

                                                                                                      20X8         20X7

$ million               $ million

Reversal of provisions                                                                  60                    40

Reversal of impairment losses on receivables and other assets   30                    20

Foreign currency gains                                                                 28                    23

Profit/(loss) on disposal of non-current assets                             2                      (3)

––––                ––––

Total                                                                                              120                  80

––––                ––––

• Operating expenses includes the following items:

                                                                                                      20X8         20X7

$ million               $ million

Staff costs                                                                                     3,650         3,610

Cost of raw materials, consumables and supplies                        1,725         1,780

Depreciation, amortisation and impairment                                 145                  140

Other operating expenses                                                             20                    270

–––––              –––––

Total                                                                                              5,540         5,800

–––––             –––––

Exhibit 4 – Determination of goodwill on the acquisition of Jinx Co

Note                $ million

Cash consideration – paid 1 March 20X8                                                            80

Contingent consideration                                                              1                      271

––––

Total consideration                                                                                               351

Fair value of non-controlling interest                                           2                      49

––––

400

Less: Fair value of identifiable net assets                                     3                (300)

––––

Goodwill                                                                                                               100

––––

Notes:

• The contingent consideration will be payable four years after the acquisition date and is calculated based on a payment of $525 million, only payable if Jinx Co reaches revenue and profit targets outlined in the purchase documentation. The amount included in the goodwill calculation has been discounted to present value using a discount factor based on an 18% interest rate.
• The non-controlling interest is measured at fair value, the amount being based on Jinx Co’s share price on 1 March 20X8.
• The assets and liabilities acquired and their fair values were determined by an independent firm of Chartered Certified Accountants, Sinder & Co, who was engaged by the Group to perform due diligence on Jinx Co prior to the acquisition taking place. A fair value uplift of $12 million was made in relation to property, plant and equipment.

Exhibit 5 – Extract from audit strategy – prepared by Sparrow Associates in respect of the audit of Jinx Co

The two points below are an extract from the audit strategy. Other sections of the audit strategy, including the audit risk assessment, have been reviewed by the Group audit team and are considered to be satisfactory. Jinx Co is projected to be loss making this year, and the Group audit team is confident that sufficient procedures on going concern have been planned for.

INT & UK: Controls effectiveness

We will place reliance on internal controls, which will reduce the amount of substantive testing which needs to be performed. This is justified on the grounds that in the previous year’s audit, controls were tested and found to be highly effective. We do not plan to re-test the controls, as according to management there have been no changes in systems or the control environment during the year.

INT: Internal audit

Jinx Co has offered the services of its internal audit team to help perform audit procedures. We are planning to use the internal auditors to complete the audit work in respect of trade receivables, as they have performed work on this area during the year. It will be efficient for them to perform and conclude on the relevant audit procedures, including the trade receivables circularisation, and evaluation of the allowance for trade receivables, which we will instruct them to carry out.

UK: Valuation of pension plan

Jinx Co has a defined benefit pension plan in place for its employees. The draft financial statements recognise a non-current liability of £11 million in relation to plan assets with a value of £38 million, and plan liabilities valued at £49 million. In previous years the pension plan has been valued by an external valuer, and in 20X7 a net deficit of £3 million was recognised in non-current liabilities. However, this year the valuation has been performed by one of Sparrow Associates’ partners, who is a qualified actuary. The fee for providing this valuation was £35,000. It is expected that the audit fee will be £600,000 and fees for other audit-related services will be in the region of £100,000.

28) CRIGG CO.

You are a manager in the audit department of Hagrett & Co, a firm of Chartered Certified Accountants, responsible for the audit of several companies and for evaluating the acceptance decisions in respect of potential new audit clients.

One of your audit clients is Crigg Sports Co, which operates a chain of sport and leisure centres across the country. The company has a financial year ending 28 February 20X9, and you are about to start planning the audit. Bella Cross, the audit engagement partner, met with the company’s finance director last week to discuss business developments in the year and recent financial performance.

In addition, Bella has been approached by Harry Fitt, the managing director of Fitt Gyms Co. Harry has enquired regarding whether Hagrett & Co can provide the company with an audit or limited assurance review, and Bella would like you to evaluate this request. Hagrett & Co already provides a payroll service to Fitt Gyms Co and has assisted Harry with his personal tax planning in the past. Harry also has a suspicion that several employees are carrying out a fraud at the company, and he has asked whether an audit or limited assurance review would have alerted him earlier to the situation.

You are provided with the following exhibits:

1 An email you have received from Bella Cross, in respect of both Crigg Sports Co and Fitt Gyms Co.

2 Notes of a meeting which Bella held recently with the finance director of Crigg Sports Co.

3 Extracts from the latest management accounts of Crigg Sports Co.

4 Notes of a telephone conversation which Bella had yesterday with Harry Fitt, managing director of Fitt Gyms Co.

Required:

Respond to the requirements in the email from the audit engagement partner. (46 marks)

Note: The split of the mark allocation is shown in the partner’s email (Exhibit 1).

Professional marks will be awarded for the presentation and logical flow of the briefing notes and the clarity of the explanations provided. (4 marks)

(Total: 50 marks)

Exhibit 1 – Email from audit engagement partner

To: Audit manager

From: Bella Cross, Audit engagement partner for Crigg Sports Co

Subject: Audit planning for Crigg Sports Co, and evaluation of accepting Fitt Gyms Co as a potential audit client

Hello

I have provided you with some information in the form of a number of exhibits which you should use to help you with planning the audit of Crigg Sports Co for the financial year ending 28 February 20X9.

Using the information provided in Exhibits 2 and 3, I require you to prepare briefing notes for my own use, in which you:

(a) Inorder to plan the company’s audit, evaluate the business risks to be considered (8 marks)

(b) Evaluate the risks of material misstatement to be considered for the purpose of developing the audit strategy and audit plan. (18 marks)

(c) Design the principal audit procedures to be used in the audit of the grant received from the government in September 20X8. (6 marks)

In Exhibit 4, I have also provided you with some information relating to Fitt Gyms Co. In respect of this, in your briefing notes you should also:

(d) Evaluate the matters to be considered in deciding whether to accept an engagement to provide Fitt Gyms Co with an audit or limited assurance review. (8 marks)

(e) In relation to the suspicion of fraud being carried out at Fitt Gyms Co:

Discuss whether an audit or limited assurance review of financial statements in previous years could have uncovered the fraud. (6 marks)

Thank you.

Exhibit 2 – Notes of a meeting held on 30 November 20X8

Meeting attendees:

Bella Cross, audit engagement partner, Hagrett & Co

Aneta Bay, finance director, Crigg Sports Co

Business background

Crigg Sports Co operates 30 sport and leisure centres around the country. Each centre has a large gym and a swimming pool, and many also have tennis and badminton courts. Given the nature of the company’s operations, it has to comply with health and safety regulations set by the national regulatory body, and its facilities are inspected regularly to ensure that all regulations are being followed, and for the company to retain its operating licence.

The company is not listed and therefore does not need to comply with local corporate governance regulations. However, the company’s chief operating officer and chairman consider it good practice to have independent input to the board, and there are two non-executive directors. One of the non-executive directors is a leisure industry expert who was chairman of a rival company, Lyre Leisure Co, for ten years.

The second non-executive director is an academic who specialises in organisational behaviour and who has written several books on performance management in the sport and leisure industry.

The company’s board has approved a plan to expand through acquiring other leisure and sport facility providers. The strategy is not likely to be implemented for another two years, when the board would like the first acquisition to take place. However, potential target companies will be identified in the next 12 to 18 months. Ultimately, the board would like to seek a flotation of the company within five years, and they consider that expanding the company would improve profits and make a stock exchange listing more feasible.

Crigg Sports Co has a small internal audit department with two staff who report to the finance director, as the board does not have an audit committee.

The company offers a membership scheme whereby, for an annual subscription, members can use the facilities at any of the centres. Customers who are not members can pay to access a centre for a day under the company’s ‘pay as you go’ plan. The membership scheme accounts for approximately 85% of the company’s revenue, with the remaining revenue resulting from ‘pay as you go’ sales.

Business developments in the year

The industry is competitive and the company’s strategy is to encourage customers to renew their membership and to attract new members by offering a range of new activities. According to the finance director, a successful initiative which started in March 20X8 is the ‘Healthy Kids’ campaign; this offers children two hours coaching per week in a range of sports including swimming and tennis. This coaching is provided free as part of their parents’ membership, and it has proved to be very successful – the finance director estimates that it has led to 3,000 new members since it was launched.

In June 20X8, the company opened a new coastal sport and leisure centre which, as well as offering the usual facilities, also has a scuba diving centre and offers other water sports facilities. An investment of $12 million was also made in new gym equipment across all centres, to ensure that the company offers the most modern facilities to its customers.

An advertising campaign has been launched, to promote the company brand generally, and to make customers aware of the investments in the facilities which have been made. As part of this campaign, the company paid $1 million to a famous athlete to endorse the company for a period of two years. The athlete will appear at the opening of the new coastal sports centre and has agreed to feature in poster advertisements for the next two years.

Crigg Sports Co is also involved with a government initiative to help unemployed people have access to sport facilities. The company received a grant of $2 million in September 20X8, under the terms of which it allows unemployed people three hours of free access to its facilities per month. By the end of November, 33,900 free hours of facility use have been provided under this scheme. The government intends the initiative to run for three years, to promote long-term health of participants.

A new data management system has been introduced, which integrates membership information with accounting software. This allows more efficient management of the customer database which is used extensively for marketing purposes, as well as providing more timely information on financial performance to management. Data from the previous system was transferred to the new system in July 20X8, and the two systems ran in parallel for two months while training was given to staff and the new system was monitored.

One feature of the new system is that it records and reports on the free hours of access provided to unemployed people, which the company has to report on a monthly basis to the government.

Exhibit 3 – Extracts from management accounts of Crigg Sports Co

Note                Based on                     Based on

projected figures         audited figures

to 28 February            to 28 February

20X9                           20X8

Revenue                                              1                      $53 million                 $45 million

Income from government grant          2                      $2 million                   –

Operating margin                                3                      15%                             10.7%

Profit before tax                                                          $6.9 million                $4.6 million

Capital expenditure and                      4                      $32 million                 $20 million

associated borrowings

Cash                                                                            $1.4 million                $5.6 million

Total assets                                                                 $130 million               $110 million

Number of sport and leisure centres   5                      20                                18

Number of members                           6                      38,000                         33,800

Number of ‘pay as you go’ entry tickets sold            108,000                       102,600

Notes

• Revenue is forecast to increase significantly this year. This is largely due to the success of the advertising campaign featuring the celebrity athlete and the ‘Healthy Kids’ programme (referred to in Exhibit 2).
• The grant received of $2 million, the details of which are explained in Exhibit 2, has been recognised in full as income for the year.
• The company’s operating expenses includes the following items:

20X9                           20X8

$000                            $000

Staff costs                                                       15,300                         14,300

Marketing                                                       8,500                          8,500

Maintenance and repairs of facilities             5,500                           5,300

• Capital expenditure was mostly financed through borrowings. On 1 March 20X8, a tenyear $30 million loan was received from the company’s bank. The loan does not bear interest and is repayable at par value of $34 million. As well as the bank loan, a loan of $1 million was advanced to the company from its managing director, Bob Glider, on 1 July 20X8. The terms of this loan include 3% interest paid to Bob annually in arrears, and the capital will be repaid in seven years’ time in 20Y5.
• Two new sport and leisure centres were opened this year. As well as the coastal sport and leisure centre (referred to in Exhibit 2), a new centre was opened in an affluent urban area in the capital city.
• 6 The management information system shows that members visit a sport and leisure centre on average three times per week.

Exhibit 4 – Notes of a telephone conversation between Bella Cross and Harry Fitt, managing director of Fitt Gyms Co

Notes taken by Bella Cross:

Harry Fitt phoned me this morning to discuss developments at Fitt Gyms Co and to enquire whether our firm could carry out either an audit of the company’s financial statements, or a limited assurance review of them. This would be the first time that the financial statements have been subject to audit or limited assurance review.

Business background

The company was founded by Harry in 20X5, and since that time our firm has provided a payroll service for the company’s staff, which now number 35 employees working in the company’s four gyms, all located in urban areas. We have also provided Harry with advice on his personal tax position and financial planning in respect of his retirement, as he wants to sell the company in a few years’ time. Harry runs the company with his son, Steve, who is a qualified personal trainer, and with his daughter, Siobhan, who is the marketing director. The company employs one accountant who prepares the management and financial accounts and who deals with customer memberships.

The company has grown quite rapidly in the last year, with revenue of $8 million for the financial year to 30 September 20X8, and with total assets of approximately $5.5 million. The comparative figures for 20X7 were revenue of $6.5 million and total assets of $4.8 million.

Loan application

Harry thinks that it will be difficult to attract more members for his gyms in existing locations, and would like the company to expand by constructing a new gym. He has discussed a loan of $4 million with the company’s bank to fund the necessary capital expenditure. The bank manager has asked for the company’s financial statements for the year to 30 September 20X8 and comparative information, and has also requested a cash flow and profit forecast for the next three years in order to make a lending decision within the next two months.

Harry has asked whether a representative of the firm can attend a meeting with Harry and the company’s bank manager, to support the loan application and answer questions from the bank manager, assuming that we are engaged to perform either an audit or a limited assurance review on the financial statements.

Suspected fraud

Harry mentioned that one of the reasons he would like an audit or limited assurance review of the financial statements is because he has noticed some unusual trends in the company’s financial information. This has led him to suspect that several employees are carrying out a fraud. Each gym has a small shop selling gym wear and a café, where customers can buy light meals, drinks and snacks.

Harry has noticed that the cash receipts from sales in the shops and cafés have reduced significantly in the last year, however, there has been no reduction in purchases from suppliers. As a consequence, the gross margin for these sales as reported in the management accounts has fallen from 32% to 26%. This indicated to him that staff members could be giving away items for free to customers, or they could be taking inventories from the shops and cafés for their personal use or to sell.

The shops and cafés keep a relatively small amount of inventory which is replenished on a regular basis. Until this year, sales in the shops represented approximately 5%, and café sales represented approximately 8% of the company’s revenue. The figures for this year are 3% and 6% respectively.

Harry wonders whether the potential fraud would have been uncovered earlier, had the financial statements been subject to audit or limited assurance review in previous years.

29) AZRAIL CO.

a. You are a manager in the audit department of Calebs & Co and you are reviewing the audit working papers in relation to the Azrail Group (the Group), whose financial year ended on 31 July 20X4. Your firm audits all components of the Group, which consists of a parent company and three subsidiaries – Mitchs Co, Rosss Co and Tuck Co.

The Group manufactures engines which are then supplied to the car industry. The draft consolidated financial statements recognise profit for the year to 31 July 20X4 of $23 million (20X3 – $33 million) and total assets of $450 million (20X3 – $455 million).

Information in respect of three issues has been highlighted for your attention during the file review.

i. Goodwill

An 80% equity shareholding in Tuck Co was acquired on 1 August 20X3. Goodwill on the acquisition of $27 million was calculated at that date and remains recognised as an intangible asset at that value at the year end.

The goodwill calculation performed by the Group’s management is shown below:

$000

Purchase consideration                                                                       75,000

Fair value of 20% non-controlling interest                                        13,000

–––––––

88,000

Less:

Fair value of Tuck Co’s identifiable net assets at acquisition            (61,000)

–––––––

Goodwill                                                                                             27,000

–––––––

In determining the fair value of identifiable net assets at acquisition, an upwards fair value adjustment of $300,000 was made to the book value of a property recognised in Tuck Co’s financial statements at a carrying value of $600,000.

(9 marks)

ii. Property complex

In September 20X4, a natural disaster caused severe damage to the property complex housing the Group’s head office and main manufacturing site. For health and safety reasons, a decision was made to demolish the property complex. The demolition took place three weeks after the damage was caused. The property had a carrying value of $16 million at 31 July 20X4.

A contingent asset of $18 million has been recognised as a current asset and as deferred income in the Group statement of financial position at 31 July 20X4, representing the amount claimed under the Group’s insurance policy in respect of the disaster. (6 marks)

iii. Inter-company trading

Mitchs Co supplies some of the components used by Rosss Co in its manufacturing process. At the year-end, an intercompany receivable of $20 million is recognised in Mitchs Co’s financial statements. Rosss Co’s financial statements include a corresponding intercompany payables balance of $20 million and inventory supplied from Mitchs Co valued at $50 million. (5 marks)

Required:

Comment on the matters to be considered, and explain the audit evidence you should expect to find during your review of the audit working papers in respect of each of the issues described above.

b. Azrail Group has recently received correspondence from their insurance company informing them that the insurance claim has been rejected as the insurance policy had expired and not been renewed at the date the disaster occurred. The going concern status is not considered to be affected as the Group has sufficient assets to acquire a new head office and continue trading. The directors have refused to remove the contingent asset.

Required:

Discuss the implications of the matter described above on the auditor’s report, recommending any further actions which should be taken by the auditor.

30) THUNDERMAN CO.

You are the manager responsible for the audit of Thunderman Co, a manufacturing company which supplies stainless steel components to a wide range of industries. The company’s financial year ended on 31 July 20X6 and you are reviewing the audit work which has been completed on a number of material balances and transactions: assets held for sale, capital expenditure and payroll expenses. A summary of the work which has been performed is given below and in each case the description of the audit work indicates the full extent of the audit procedures carried out by the audit team.

• Assets held for sale

Due to the planned disposal of one of Thunderman Co’s factory sites, the property and associated assets have been classified as held for sale in the financial statements. A manual journal has been posted by the finance director to reclassify the assets as current assets and to adjust the value of the assets for impairment and reversal of depreciation charged from the date at which the assets met the criteria to be classified as held for sale. The finance director asked the audit senior to check the journal before it was posted on the basis of there being no one with the relevant knowledge to do this at Thunderman Co.

The planned disposal was discussed with management. A brief note has been put into the audit working papers stating that in management’s opinion the accounting treatment to classify the factory as held for sale is correct. The manual journal has been arithmetically checked by a different member of the audit team, and the amounts agreed back to the non-current asset register. (9 marks)

• Capital expenditure

When auditing the company’s capital expenditure, the audit team selected a material transaction to test and found that key internal controls over capital expenditure were not operating effectively. Authorisation had not been obtained for an order placed for several vehicles, and appropriate segregation of duties over initiating and processing the transaction was not maintained.

The audit team noted details of the internal control deficiencies and updated the systems notes on the permanent audit file to reflect the deficiencies. The audit work completed on this order was to agree the purchase of the vehicles to purchase invoices and to the cash book and bank statement. The rest of the audit work on capital expenditure was completed in accordance with the audit programme. (7 marks)

• Payroll expenses

The payroll function is outsourced to Max Co, a service organisation which processes all of Thunderman Co’s salary expenses. The payroll expenses recognised in the financial statements have been traced back to year-end reports issued by Max Co. The audit team has had no direct contact with Max Co as the year-end reports were sent to Thunderman Co’s finance director who then passed them to the audit team.

Thunderman Co employs a few casual workers who are paid in cash at the end of each month and are not entered into the payroll system. The audit team has agreed the cash payment made back to the petty cash records and the amounts involved are considered immaterial. (9 marks)

Required:

In respect of each of the three matters described above:

1. Comment on the sufficiency and appropriateness of the audit evidence obtained
2. Recommend further audit procedures to be performed by the audit team, and
3. Explain the matters which should be included in a report in accordance with ISA 265 Communicating Deficiencies in Internal Controls to Those Charged with Governance and Management.

Note: The split of the mark allocation is shown against each of the matters above.

31) LYMO CO.

The Lymo Communications Group (LCG) is an audit client of your firm, Nito & Co, with a financial year ending 31 December 20X6. You are the manager assigned to the forthcoming audit. LCG is one of Nito & Co’s largest audit clients.

You are provided with the following exhibits:

1 An email which you have received from Antonio Saga, the audit engagement partner.

2 Notes from meeting with the finance director.

3 Extracts from the latest report of the internal audit department.

4 Extracts from latest management accounts.

Required:

Respond to the instructions in the email from the audit engagement partner. (46 marks)

Note: The split of the mark allocation is shown in the partner’s email (Exhibit 1).

Professional marks will be awarded for the presentation and logical flow of the briefing notes and the clarity of the explanations provided. (4 marks)

(Total: 50 marks)

Exhibit 1 – Email from audit engagement partner

To: Audit engagement manager

From: Antonio Saga, audit engagement partner

Subject: LCG audit planning

Hello

I have provided you with some information in the form of a number of exhibits which you should use in planning the audit of Lymo Communications Group (LCG). I held a meeting yesterday with the Group finance director regarding the forthcoming audit. We also discussed the possibility of using the Group’s internal audit team to improve audit efficiency.

Using the information provided, I require you to prepare briefing notes for my use in which you:

(a) Evaluate the relevant audit risks to plan the final audit of LCG. (18 marks)

(b) Recommend the additional information, relevant in the evaluation of audit risk. (5 marks)

(c) Discuss the matters to be considered in determining the assistance which could be provided by, and the amount of reliance, if any, which can be placed on the work of LCG’s internal audit department. (7 marks)

(d) Design the principal audit procedures to be conducted in the audit of:

(i) The classification of the 50% equity shareholding in WTC as a joint venture, and

(ii) The measurement of the intangible asset recognised in respect of the licence to operate in Nearland. (10 marks)

(e)Discuss the advantages and disadvantages of a joint audit if the acquisition of the company in Neverland goes ahead. (6 marks)

Thank you.

Exhibit 2 – Notes from meeting with finance director

LCG is a listed entity, one of the largest telecommunications providers in the country and is seeking to expand internationally. LCG also provides broadband and fixed telephone line services. One of LCG’s strategic aims is to expand internationally, either by acquiring existing telecommunications providers in other countries, or by purchasing licences to operate in foreign countries. LCG has identified a telecommunications company located overseas in Neverland. The Group’s audit committee has suggested that once the acquisition is complete, due to the distant location of the company, a joint audit could be performed with the target company’s current auditors.

In March 20X6, LCG purchased a 50% equity shareholding in William Telecoms Co (WTC), a company operating in several countries where LCG previously had no interests. The other 50% is held by Wall Communications Co. The cost of the 50% equity shareholding was $45 million. LCG is planning to account for its investment in WTC as a joint venture in the Group financial statements.

On 1 January 20X5, LCG purchased a licence to operate in Nearland, a rapidly expanding economy, at a cost of $65 million. The licence lasts for 10 years from the date that it was purchased. Since purchasing the licence, LCG has established its network coverage in Nearland and the network became operational on 1 July 20X6. The licence was recognised as an intangible asset at cost in the Group statement of financial position at 31 December 20X5. Since the network became operational, customer demand has been less than anticipated due to a competitor offering a special deal to its existing customers to encourage them not to change providers.

Most of LCG’s mobile phone customers sign a contract under which they pay a fixed amount each month to use LCG’s mobile network, paying extra if they exceed the agreed data usage and airtime limits. The contract also allows connection to a fixed landline and internet access using broadband connection and most contracts run for two or three years.

In order to extend its broadband services, LCG has started to purchase network capacity from third party companies. LCG enters a fixed-term contract to use a specified amount of the seller’s network capacity, with the seller determining which of its network assets are used by LCG in supplying network services to its customers. In the first six months of 20X6, LCG purchased $17.8 million of network capacity from a range of suppliers, with the contract periods varying from twelve months to three years. The cost has been capitalised as an intangible asset.

Exhibit 3 – Extracts from the latest report of the internal audit department

LCG has a well-established internal audit department which is tasked with a range of activities including providing assurance to management over internal controls and assisting the Group’s risk management team. The internal audit department is managed by Jules Winfield, a qualified accountant with many years’ experience. An extract from the executive summary of the latest internal audit report to the Group finance director is shown below:

‘We are pleased to report that LCG’s internal controls are working well and there have been no significant changes to systems and controls during the year. As a result of our testing of controls we uncovered only two financial irregularities which related to:

• Failure to obtain appropriate authorisation and approval of senior management expense claims, such as travel and other reimbursements. The unsubstantiated expense claims amounted to $575,000.
• Inadequate access controls over the Group’s IT systems which resulted in a payroll fraud amounting to $750,000.’

Exhibit 4 – Extracts from latest management accounts

                                        8 months to            Audited financial statements to

                                    31 August 20X6                     31 December 20X5

$ million                                 $ million

Revenue:

Europe                                    106                                          102

Americas                                 30                                            68

South East Asia                      33                                            30

India                                        29                                            20

––––                                        ––––

Total                                        198                                          220

––––                                        ––––

                                        At 31 August 20X6                At 31 December 20X5

$ million                                 $ million

Total assets                             598                                          565

32) WOPNO CO.

a. The IAASB published ISA 540 (Revised) Auditing Accounting Estimates and Related Disclosures (ISA-540 Revised) standard. The revised standard states that the auditor must obtain sufficient appropriate audit evidence to evaluate whether accounting estimates and related disclosures are reasonable in the context of the applicable financial reporting framework, or are misstated. ISA-540 Revised includes enhanced requirements for risk assessment procedures and the auditor’s work effort in responding to the assessed risks of material misstatement to support this evaluation.

Required:

Provide an explanation as to why accounting estimates are considered to be a source of high audit risk and discuss the reasons for the revision of ISA-540 commenting on its requirement for an enhanced risk assessment in relation to the audit of accounting estimates.

b. You are the manager responsible for the audit of Wopno Co, a listed entity whose principal activity is the operation of a regional railway network. The audit for the year ended 28 February 20X9 is the first year your firm has audited Wopno Co. The draft financial statements recognise total assets of $58 million and profit before tax of $7.4 million. The detailed audit fieldwork has started and the audit supervisor has brought the following matters to your attention in relation to the testing of key accounting estimates:

(i) Cash-settled share-based payment scheme

On 1 March 20X8, Wopno Co granted 550,000 share appreciation rights to 55 executives and senior employees of the company with each eligible member of staff receiving 10,000 of the rights. The fair value of the rights was estimated on 28 February 20X9 by an external expert using an options pricing model at $4.50 each. Wopno Co prides itself on good employee relations and the senior management team has estimated that all 55 staff will qualify for the rights when they vest three years after the granting of the rights on 1 March 20X8. The company has recognised a straight line expense in this year’s draft accounts of $825,000.

(ii) Regulatory penalties

Wopno Co has been subject to a review by the national railways regulator following a complaint from a member of staff with safety concerns. The regulator identified breaches in safety regulations and issued a penalty notice on 30 September 20X8. Wopno Co has appealed against the initial penalty payable. Negotiations with the regulator are still ongoing and the amount payable has not yet been finalised. Wopno Co currently estimates that the total penalty payable as a result of the breach will be $1.3 million which it expects to repay in equal annual instalments over the next ten years with the first payment falling due on 1 March 20X9. The company’s draft statement of profit or loss for the current year recognises an expense of $1.3 million and the draft statement of financial position includes a liability for the same amount.

(iii) Property development

Wopno Co owns an industrial property which it has historically used as a maintenance depot for its engines and carriages. The company has an accounting policy of revaluing its properties to fair value and at the interim audit it was noted that the depot was recorded at a carrying amount of $2.5 million in the non-current asset register. During the first week of the audit fieldwork, the audit supervisor identified a year-end journal which has uplifted the depot to a fair value of $4.9 million in this year’s statement of financial position as at 28 February 20X9. Management has advised that this represents the estimated sales value of the building following Wopno Co’s plan to develop the building as a residential property. The client has confirmed that the property is suitable for conversion into residential apartments at an estimated cost of $1.2 million and has negotiated secured finance for the development with their bank. The development will be subject to the payment of fees to the local council’s building regulator of $173,000.

Required:

i. Evaluate the accounting treatments of the Client and the difficulties which you might encounter when auditing each of the accounting estimates described above; and

ii. Design the audit procedures which should now be performed to gather sufficient and appropriate audit evidence.

Note: The split of the mark allocation is shown against each of the issues above.