55) PAX CO.
a. It is 1 July 20X5. You are a manager in the audit department of Burty & Co, a firm of Chartered Certified Accountants, responsible for the audit of Pax Co for the year ended 31 March 20X5. Pax Co is an unlisted retail company which is a new audit client of your firm this year. The company’s draft financial statements recognise profit before tax of $2.15 million (20X4 – $1.95 million) and total assets of $13.8 million (20X4 – $12.7million).
The audit is nearly complete and you are reviewing the audit working papers. The audit supervisor has brought the following matters to your attention:
i. Sale and leaseback transaction
On 31 March 20X5, Pax Co sold a property to a leasing company, Hank Co, for its fair value at this date. The property is situated in a sought after area with a high demand for rental properties for retail purposes. Hank Co has assessed the remaining life of the property to be in excess of 50 years, and under the terms of the sales agreement, Pax Co will lease the property back from Hank Co for a period of ten years. Pax Co has treated the transaction as a sale and leaseback transaction in accordance with IFRS® 16 Leases, and derecognised the property in its financial statements and recorded a sale in accordance with IFRS 15 Revenue from Contracts with Customers. (8 marks)
ii. Investment property
Pax Co owns a building which it has used as a warehouse to store inventory. On 1 April 20X4 the building, which had not suffered any historic impairments, had a carrying amount based on depreciated historic cost of $323,000 and a fair value of $348,000. On this date, Pax Co vacated the building and moved the inventory to new larger premises. Management decided to keep the building in order to rent it out as a storage facility to local businesses and to benefit from any increases in property valuations. On 31 March 20X5, the building had not been let and it had a fair value, according to an external valuer, of $353,000. The draft financial statements for the current year recognise the building as an investment property at a carrying amount of $353,000 and include a fair value gain of $30,000 in profit before tax for the year. Since reclassification as an investment property, depreciation has not been charged in relation to the building. (6 marks)
iii. Shopping mall
Pax Co purchased a shopping mall on 1 April 20X3 for $9.5 million. At the date of purchase, the mall was estimated to have a remaining useful life of 20 years and a nil residual value. On 31 March 20X4 following an impairment review, the property was written down to its recoverable amount based on value in use of $8.25 million and an impairment loss of $775,000 was recognised in the statement of profit or loss for the year ended 31 March 20X4.
Pax Co conducted a further impairment review as at 31 March 20X5 which indicated that the property’s recoverable amount, based on value in use, was now $8.85 million. As a result, Pax Co has recognised an impairment reversal of $1.034 million in its profit before tax for the current year. The impairment reversal of $1.034 million has been calculated as its new recoverable amount of $8.85 million less its carrying amount of $7.816 million. The audit supervisor has prepared the following working paper which summarises the accounting transactions in relation to the shopping mall:
Summary of transactions
Date $ million Accounting treatment
1 April 20X3 Cost of asset 9.500
Depreciation (0.475) Depreciation charge for
(9.5m/20 years) the year to 31 March20X4
Impairment (0.775) Impairment loss charged
to profit for the year to
31 March 20X4
31 March 20X4 Year end carrying 8.250
Depreciation (0.434) Depreciation charge for
(8.25m/19 years) the year to 31 March20X5
7.816 Carrying amount prior
to impairment review
Reversal of 1.034 Reversal of impairment
impairment credited to profit for the
year to 31 March 20X5
31 March 20X5 Year end 8.850
Comment on the matters to be considered and explain the audit evidence you would expect to find during your review of the audit working papers in respect of the issues described above.
Note: The split of the mark allocation is shown against each of the issues above.