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

by management

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

amount

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

carrying amount

–––––

(6 marks)

Required:

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.

b. It is now 1 September 20X5 and the auditor’s report on Pax Co’s financial statements for the year ended 31 March 20X5 is due to be issued in the next few days.

Following discussions with management, you are satisfied that the sale and leaseback transaction has been treated correctly and that you have gathered sufficient and appropriate audit evidence to support this treatment.

However, management has indicated that they are not willing to make any further adjustments to the financial statements in relation to the investment property or shopping mall and you are now considering the form and content of the auditor’s report in relation to these matters.

Required:

Discuss the implications for the auditor’s report on the basis that no further adjustments have been made to the financial statements in relation to the investment property or shopping mall.

56) INDRA CO.

a. You are the manager responsible for the audit of Indra Co, a listed company specialising in the manufacture and installation of sound-proof partitions for domestic and industrial buildings. You are currently reviewing the draft auditor’s report on the company’s financial statements for the year ended 31 March 20X5. Extracts from the draft auditor’s report are shown below:

Independent auditor’s report to the shareholders and directors of Indra Co

Basis for opinion

We conducted our audit of Indra Co (the Company) in accordance with International Standards on Auditing (ISAs). Our responsibilities under those standards are further described in the auditor’s responsibilities for the audit of the financial statements section of our report. We are independent of the Company in accordance with the ethical requirements which are relevant to our audit of the financial statements in the jurisdiction in which the Company operates, and we have fulfilled our other ethical responsibilities in accordance with these requirements.

We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our opinion.

Opinion

We have audited the financial statements of Indra Co (the Company), which comprise the statement of financial position as at 31 March 20X5, and the statement of comprehensive income, statement of changes in equity and statement of cash flows for the year then ended, and notes to the financial statements, including a summary of significant accounting policies. In our opinion, the accompanying financial statements present fairly, in all material respects, the financial position of the Company as at 31 March 20X5, and of its financial performance and its cash flows for the year then ended in accordance with IFRS® Standards.

Material uncertainty regarding going concern

The Company is financed by a long-term loan from its bankers which is due for redemption in August 20X5. At the date of this auditor’s report, the Company is in the process of renegotiating the loan but has not yet reached a final agreement with its bankers. It is our view that the loan finance is essential to the continued survival of the Company and that at the time of reporting, therefore, the absence of a finalised agreement represents a material uncertainty regarding going concern. The financial statements have been prepared on a going concern basis but do not make any reference to the loan redemption or the ongoing negotiations with the bank. As the external auditor therefore, we are fulfilling our duty by bringing the matter to the attention of users of the financial statements.

Other information

The Company’s principal activity is the manufacture and installation of sound-proof partitions for domestic and industrial buildings. The Company therefore engages in long-term contracts which are incomplete at the reporting date and which are material to its revenue figure. The installation process is complex and significant judgement is applied in assessing the percentage of completeness which is applied to calculate the revenue for the year. The significance of this judgement requires us to disclose the issue as other information which is relevant to the users of the financial statements.

Required:

Critically appraise the extract from the draft auditor’s report for the year ended 31 March 20X5.

Note: You are NOT required to re-draft the extracts from the auditor’s report.

b. Your firm, Edna & Co, has asked you to perform an independent review of the working papers of Katy Co which is a listed entity and has been an audit client of your firm for the last ten years. The audit fieldwork is almost complete and as part of your review, you have been asked to advise the audit team on the drafting of their report to those charged with governance. Katy Co is a discount food retailer which operates 85 stores nationally. The financial statements for the year ended 30 April 20X5 recognise revenue of $247 million (20X4 – $242 million), profit before tax of $14.6 million (20X4 – $14.1 million) and total assets of $535 million (20X4 – $321 million).

After a period of rapid expansion, 20X5 has been a year in which Katy Co has strengthened its existing position within the market and has not acquired any additional stores or businesses. The company’s draft statement of financial position for 20X5 includes a property portfolio of $315 million all of which are legally owned by the entity. In the current year, the company has chosen to adopt a policy of revaluing its property portfolio for the first time and this is reflected in the draft figures for 20X5. The audit work on property, plant and equipment included testing a sample of the revaluations. Edna & Co requested at the planning stage that independent, external valuation reports should be made available to the audit team at the start of the final audit visit. A number of these documents were not available when requested and it took three weeks for them to be received by the audit team. The audit working papers also identify that on review of the non-current asset register, there were four properties with a total carrying amount of $11.1 million which had not yet been revalued and were still recorded at depreciated historic cost.

The audit supervisor’s review of Katy Co’s board minutes identified that the company has renovated car parking facilities at 17 of its stores which has resulted in a significant increase in customer numbers and revenue at each of these locations. The total cost of the renovation work was $13.2 million and has been included in operating expenses for the current year. The audit file includes a working paper recording discussions with management which confirms that capital expenditure authorisation forms had not been completed for this expenditure.

You are aware that your firm had intended to replace the current engagement partner, Bryony Robertson, with Jay Derulo who is Edna & Co’s other specialist in food retail. Unfortunately, Mr Derulo was taken ill earlier in the year and will not now be available until next year’s audit engagement. As a result, 20X5 is the eighth consecutive year in which Bryony Robertson has acted as engagement partner.

Required:

From the information provided above, recommend the matters which should be included in Edna & Co’s report to those charged with governance, and explain the reason for their inclusion.

57) ROBERT CO.

You are the manager responsible for the audit of Robert Co for the year ended 30 September 20X6. During a visit to the team performing the fieldwork, the audit senior shows you a cash flow forecast covering six-month periods to 30 September 20X8 as prepared by management as part of their assessment of the going concern status of the company. The audit senior asks whether any of the forecast cash flows disclosed require any further investigation during the audit fieldwork.

The actual and forecast six-monthly cash flows for Robert Co for the periods ended:

Actual                                      Forecast

31 March             30 Sept  31 March             30 Sept  31 March             30 Sept

20X6                     20X6      20X7                     20X7      20X8                     20X8

$000                     $000      $000                     $000      $000                     $000

Operating cash flows

Receipts from customers   13,935                  14,050   14,300                  14,700   14,950                  15,400

Payments to suppliers        (10,725)               (10,850) (11,050)               (11,400) (11,600)                (12,000)

Salaries                               (1,250)                 (1,300)  (1,275)                 (1,326)  (1,301)                (1,353)

Other operating cash

Payments                            (1,875)                 (1,850)  (1,913)                 (1,887) (1,951)                (1,925)

Other cash flows

Sale of investments            –                           –             –                            –             –                            500

Repayment of J Stefan loan –                         –             –                            –             –                            (500)

Repayment of bank loan   –                           –             –                            –             (1,500)                 –

Receipt of bank loan          –                           –             –                            –             1,500                    –

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

Cash flow for the period    85                         50           62                          87           98                          122

Opening cash                      (275)                     (190)      (140)                     (78)        9                            107

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

Closing cash                       (190)                     (140)      (78)                       9             107                        229

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

The following additional information has been provided in support of the forecasts:

• Receipts from customers and payments to suppliers have been estimated based on detailed sales forecasts prepared by the sales director.
• Salaries and overheads have been estimated as the prior year cost plus general inflation of 2%.
• The bank loan expires on 5 January 20X8. The finance director expects to take out a matching facility with the current lender to pay off the existing debt.
• On 1 October 20X5, the chief executive, Mr J Stefan, gave the company a three-year, interest free loan secured by a fixed charge over the operational assets of Robert Co. The audit team was unaware of this loan prior to obtaining the cash flow forecast.
• The directors plan to sell some investments in listed shares to fund the repayment of the chief executive’s loan. At 30 September 20X6, the investments were carried in the statement of financial position at their fair value of $350,000.

Required:

a) Evaluate the appropriateness of the cash flow forecast prepared by Robert Co and recommend the further audit procedures which should be performed.

b) Comment on the matters to be considered in respect of the loan from Mr J Stefan and recommend the further audit procedures to be performed.

c) Robert Co’s chief executive, Mr Stefan, has requested that the audit engagement partner accompanies him to the meeting with the bank where the matching loan will be discussed. Mr Stefan has hinted that if the partner does not accompany him to the meeting, he will put the audit out to tender.

Identify and discuss the ethical and other professional issues raised by the chief executive’s request, and recommend any actions that should be taken by the audit firm.

58) LUKE CO.

Milan & Co is a firm of Chartered Certified Accountants offering audit and assurance services to a large portfolio of clients. You are a manager in the audit department responsible for the audit of two clients, Luke Co and the Sunway University, both of which have a financial year ended 31 July 20X5. The audits of both clients are being completed and you are reviewing issues which have been raised by the audit seniors.

a. Luke Co is a manufacturer of luxury food items including chocolate and other confectionery which are often sold as gift items individually or in hampers containing a selection of expensive items from the range of products. Due to an economic recession sales of products have fallen sharply this year and measures have been implemented to support the company’s cash flow. You are aware that the company only has $150,000 in cash at the year end.

Extracts from the draft financial statements and other relevant information are given below.

Note    July 20X5             July 20X4

(Draft)             (Actual)

$000                $000

Revenue                                                                                              2,440               3,950

Operating expenses                                                                             (2,100)             (2,800)

Finance charge                                                                                    (520)               (500)

––––––            ––––––

(Loss)/profit before tax                                                                       (180)               650

––––––            ––––––

Total assets                                                                                         10,400             13,500

Long-term liabilities – bank loan                                           1          3,500               3,000

Short-term liabilities – trade payables                                    2          900                  650

Disclosed in notes to financial statements:

Undrawn borrowing facilities                                                3          500                  1,000

Contingent liability                                                                 4          120                  –

Notes:

• The bank loan was extended in March 20X5 by drawing on the borrowing facilities offered by the bank. The loan carries a fixed interest rate and is secured on the company’s property including the head office and manufacturing site. The first repayment of loan capital is due on 30 June 20X6 when $350,000 is due to be paid.
• Luke Co renegotiated its terms of trade with its main supplier of cocoa beans, and extended payment terms from 50 days to 80 days in order to improve working capital.
• The borrowing facilities are due to be reviewed by the bank in April 20X6 and contain covenants including that interest cover is maintained at 2, and the ratio of bank loan to operating profit does not exceed 4:1.
• The contingent liability relates to a letter of support which Luke Co has provided to its main supplier of cane sugar which is facing difficult trading conditions.

Required:

In respect of the audit of Luke Co:

i. Identify and explain the matters which may cast significant doubt on the company’s ability to continue as a going concern. (9 marks)

ii. Recommend the audit procedures to be performed in relation to the going concern matters identified. (6 marks)

b. The Sunway University, a public sector entity, is a small university with approximately 2,000 students, which was established 10 years ago and specialises in vocational study programmes leading to the award of degrees in business, accountancy, finance, law and marketing. The highest performing students achieve a distinction on completing their degree programme, indicating excellence in the knowledge and understanding of their subject. Students pay tuition fees of $10,000 per year, and the degree programme is typically three years long.

The audit work in respect of the year ended 31 July 20X5 is almost complete, but the audit senior has not yet completed the audit work in respect of performance information which is being published with the annual financial statements for the first time this year. It is a requirement in the jurisdiction in which the Sunway University is located that the performance information is audited as part of the external audit.

Details on the performance information are given below:

Performance area        Performance measure                                                 20X5

result

Graduation rate           % of students who complete their degree                   85%

programme

Academic                    % of students achieving a distinction                             20%

performance

Employability            % of students who on graduation                                     65%

obtain graduate level employment

Course satisfaction     % of students who rate their university                         70%

experience as excellent or very good

Required: 

i. Discuss the relevance and measurability of the reported performance information.

ii. Recommend the examination procedures to be used in auditing the performance information.

Note: The total marks will be split equally between each part.

59) BENTLEY CO.

Bentley Co is a family owned, unlisted company which imports motor cars. The company buys cars from a variety of car manufacturers for sale to car dealerships and vehicle leasing companies within its own domestic market. Bentley Co has been a client of your firm for the last three years and you are the newly appointed audit manager on the audit for the year ended 31 August 20X8. The audit for the current reporting period is nearing completion and you are reviewing the working papers of the going concern section of the audit file.

Extracts from the draft financial statements and other relevant information are given below.

Statement of financial position

31 August 20X8                31 August 20X7

Draft                                  Actual

$million                            $million

Assets

Non-current assets

Property, plant and equipment                             13.5                             14.6

––––                            ––––

13.5                             14.6

––––                            ––––

Current assets

Inventory                                                              5.8                               3.7

Trade receivables                                                  3.7                               2.6

Cash at bank and in hand                                      –                                  0.6

––––                            ––––

9.5                               6.9

––––                            ––––

Total assets                                                           23.0                             21.5

––––                            ––––

Equity and liabilities

Equity

Share capital                                                         1.0                               1.0

Retained earnings                                                 1.3                               4.7

––––                            ––––

2.3                               5.7

––––                            ––––

Non-current liabilities

Long-term borrowings                                          11.2                             12.4

Provisions                                                             3.5                               0.5

––––                            ––––

14.7                             12.9

––––                            ––––

Current liabilities

Trade payables                                                          4.2                               2.9

Bank overdraft                                                             1.8                               –

––––                            ––––

6.0                               2.9

––––                            ––––

Total equity and liabilities                                 23.0                             21.5

––––                            ––––

Statement of profit or loss for the year

31 August 20X8                      31 August 20X7

Draft                                        Actual

$million                                  $million

Revenue                                                    11.3                                         8.8

Cost of sales                                              (4.4)                                        (2.9)

––––                                        ––––

Gross profit                                               6.9                                           5.9

Other operating expenses                         (9.1)                                        (1.3)

––––                                        ––––

Operating profit                                        (2.2)                                        4.6

Finance costs                                            (1.5)                                        (0.7)

––––                                        ––––

Profit before taxation                                (3.7)                                        3.9

Taxation                                                    0.3                                           (1.3)

––––                                        ––––

Net (loss)/profit for year                           (3.4)                                        2.6

––––                                        ––––

You have also ascertained the following information during your review:

1. Bentley Co has undergone a period of rapid expansion in recent years and is intending to buy new warehousing facilities in January 20X9 at a cost of $4.3 million.
2. In order to finance the new warehousing facilities, the company is in the process of negotiating new finance from its bankers. The loan application is for an amount of $5 million and is to be repaid over a period of four years.
3. The provision of $3.5 million in this year’s statement of financial position relates to legal actions from five of Bentley Co’s largest customers. The actions relate to the claim that the company has sold cars which did not comply with domestic regulations.
4. A major new competitor has moved in to Bentley Co’s market in October 20X8.
5. The going concern working papers include a cash flow forecast for the 12 months ending 31 August 20X9. The cash flow forecast assumes that Bentley Co’s revenue will increase by 25% next year and that following the reorganisation of its credit control facility, its customers will pay on average after 60 days. The forecast also assumes that the bank will provide the new finance in January 20X9 and that the company will have a positive cash balance of $1.7 million by 31 August 20X9.
6. The financial statements have been prepared on a going concern basis and make no reference to any significant uncertainties in relation to going concern.

Required:

a. Using analytical review where appropriate, evaluate the matters which may cast doubt on Bentley Co’s ability to continue as a going concern.

b. Explain the audit evidence in respect of the cash flow forecast which you would expect to find in your review of the audit working papers on going concern.

You have established through discussions with Bentley Co’s directors that they do not wish to disclose uncertainties over the going concern status of the company in the notes to the financial statements.

Required:

c. Explain the possible reasons why the directors may wish to exclude these disclosures and evaluate the possible implications for the auditor’s report.

60) AVA CO.

a. You are an audit manager in Ava & Co, a firm of Chartered Certified Accountants. The audit of one of your clients, Blake Co, for the year ended 31 May 20X8 is nearly complete and the auditor’s report is due to be issued next week. Blake Co is an unlisted, family owned business which specialises in the service and repair of both commercial and privately owned motor vehicles. The company operates from seven geographically distinct sites, each of which is considered a separate cash generating unit for impairment review purposes. The draft financial statements recognise profit before taxation for the year of $2.3 million and total assets of $22 million.

The schedule of uncorrected misstatements included in Blake Co’s audit working papers and prepared by the audit supervisor is shown below. You are due to attend a meeting with the finance director of Blake Co tomorrow, at which the uncorrected misstatements will be discussed.

                                                 Statement of                          Statement of

                                                  profit or loss                          financial position

Debit               Credit              Debit               Credit

Schedule of uncorrected       $                      $                      $                      $

misstatements:

• Lease of testing

equipment

− lease assets                                                              475,000

− lease liabilities                                                                                475,000

• Legal claim

− contingent assets                                                     1,200,000

− provision for liabilities                                                                    1,200,000

• Asset impairment

− assets                                                                                               85,000

− expenses                  85,000

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

Totals                         85,000             –                      1,675,000             1,760,000

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

• Lease of testing equipment

In the jurisdiction in which Blake Co operates, all motor vehicles over three years old are required to undergo an annual test of vehicle safety and roadworthiness. The annual test requires specialist testing equipment which is inspected by government officials on a regular basis. Following inspection visits in May 20X8, the government inspection report required Blake Co to replace the testing equipment at three of its sites. In order to comply with this requirement, Blake Co has agreed to lease new testing equipment from a leasing company on sixmonth leases. Under the terms of the leases, the company has no option to purchase the equipment. The testing equipment was made available for use by Blake Co at each of the three sites on 31 May 20X8. The client has capitalised leases with a total carrying amount of $625,000 at two of the sites but has elected to take advantage of the IFRS 16 Leases exemption not to capitalise short-term leases at the largest of the three sites. As a result, the present value of the lease payments of $475,000 relating to this site has not been recognised on the company’s statement of financial position. (7 marks)

• Legal claim

A customer of Blake Co successfully sued the company for negligence in April 20X8 after suffering a personal injury at one of its sites. The court awarded the customer $1.2 million in damages and this had not yet been paid as at 31 May 20X8. The audit working papers include a copy of a verified letter dated 25 May 20X8 from an insurance company confirming that the claim is fully covered under Blake Co’s public liability insurance policy. On the basis that the company has no net liability as a result of the claim, the finance director has not recognised any amounts in the financial statements and has not made any disclosures in relation to the matter. (5 marks)

• Asset impairment

During the year, a significant new competitor entered the market place at one of Blake Co’s seven sites. As a result, the site has experienced a decline in market share and revenue. The company has therefore conducted an impairment test on the site’s assets. The company’s working papers for the impairment test have been audited and the following figures have been agreed by the audit team:

Site assets

$

Carrying amount on statement of

financial position as at 31 May 20X8                                                  3.6 million

Value in use                                                                                              2.9 million

Fair value                                                                                                  3.9 million

Related costs of selling the assets:

− Legal costs                                                                                       126,000

− Transaction taxes                                                                             174,000

− Costs of removing the assets                                                           85,000

− Costs of reorganising the business following the asset disposals       96,000

On the basis of the results of these figures, the client has calculated the recoverable amount of the assets as $3.6 million and concluded that the site has not suffered an impairment. No adjustments have therefore been made to the financial statements in this regard. (5 marks)

Required:

Recommend and explain the matters which should be discussed with management in relation to each of the proposed adjustments, including an assessment of their individual impact on the financial statements and on the auditor’s opinion if management does not make the proposed adjustments.

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

b. Your client portfolio as an audit manager at Ava & Co also includes Cam Co which is a listed financial institution offering loans and credit facilities to both commercial and retail customers. You have received an email from the audit supervisor who is currently supervising interim testing on systems and controls in relation to the audit for the year ending 31 October 20X8. The email gives the following details for your consideration:

One of the audit team members, Janette Stott, has provisionally agreed to take out a loan with Cam Co to finance the purchase of a domestic residence. The loan will be secured on the property and the client’s business manager has promised Janette that he will ensure that she gets ‘the very best deal which the bank can offer.’

The payroll manager at Cam Co has asked the audit supervisor if it would be possible for Ava & Co to provide a member of staff on secondment to work in the payroll department. The payroll manager has struggled to recruit a new supervisor for the organisation’s main payroll system and wants to assign a qualified member of the audit firm’s staff for an initial period of six months.

Required:

Comment on the ethical and professional issues raised in respect of the audit of Cam Co and recommend any actions to be taken by the audit firm.

61) CARSON CO.

(a) Carson Co is a new audit client of your firm. You are the manager responsible for the audit of the financial statements for the year ended 31 May 20X1. Carson Co designs and manufactures aircraft engines and spare parts, and is a subsidiary of a multi-national group. There are concerns about the future of the company: against a background of economic recession, sales have been declining, several significant customer contracts have been cancelled unexpectedly, and competition from overseas has damaged the market share previously enjoyed by Carson Co.

Extracts from the draft financial statements are shown below, together with a cash flow forecast for the three months after the year end, which was prepared by Carson Co.

STATEMENT OF FINANCIAL POSITION

Notes   31 May 20X1              31 May 20X0

Draft                            Actual

$m                               $m

Assets

Non-current assets

Intangible assets                                                         1                      200                              180

Property, plant and equipment                                   2                      1,300                           1,200

Deferred tax asset                                                       3                      235                              20

Financial assets                                                                                   25                                35

                                                                                                               1,760                           1,435

Current assets

Inventory                                                                                            1,300                           800

Trade receivables                                                                                2,100                           1,860

                                                                                                               3,400                           2,660

Total assets                                                                                         5,160                           4,095

Equity and liabilities

Equity

Share capital                                                                                       300                              300

Retained earnings                                                                               (525)                           95

                                                                                                                (225)                           395

Non-current liabilities

Long-term borrowings                                                4                      1,900                           1,350

Provisions                                                                   5                      185                              150

                                                                                                             2,085                           1,500

Current liabilities

Short-term borrowings                                               6                     800                              400

Trade payables                                                                                    2,500                           1,800

                                                                                                                3,300                           2,200

Total equity and liabilities                                                                  5,160                           4,095

Notes

1 Intangible assets comprise goodwill on the acquisition of subsidiaries ($80 million), and development costs capitalised on engine development projects ($120 million).

2 Property, plant and equipment includes land and buildings valued at $25 million, over which a fixed charge exists.

3 The deferred tax asset has arisen following several loss-making years suffered by the company. The asset represents the tax benefit of unutilised tax losses carried forward.

4 Long-term borrowings include a debenture due for repayment in July 20X2, and a loan from Carson Co’s parent company due for repayment in December 20X2.

5 Provisions relate to warranties provided to customers.

6 Short-term borrowings comprise an overdraft ($25 million), a short term loan ($60 million) due for repayment in August 20X1, and a bank loan ($715 million) repayable in September 20X1.

ATTACHMENT: CASH FLOW FORECAST FOR THE THREE MONTHS TO 31 AUGUST 20X1

Notes   30 June 20X1  31 July 20X1   31 August 20X1

$m                   $m                   $m

Cash inflows

Cash receipts from customers             1                      175                  195                  220

Loan receipt                                        2                                              150

Government subsidy                           3                                                                      50

Sales of financial assets                                              50

______            ______            ______

Total cash inflows                                                      225                  345                  270

Cash outflows

Operating cash outflows                                             200                  200                  290

Interest payments                                                        40                    40                    40

Loan repayment                                                                                                          60

______            ______            ______

Total cash outflows                                                    240                  240                  390

Net cash flow for the month                                       (15)                 105                  (120)

Opening cash                                                              (25)                 (40)                 65

Closing cash                                                               (40)                 65                    (55)

Notes

This cash flow forecast has been prepared by the management of Carson Co, and is based on the following assumptions.

1 Cash receipts from customers should accelerate given the anticipated improvement in economic conditions. In addition, the company has committed extra resources to the credit control function, in order to speed up collection of overdue debts.

2 The loan expected to be received in July 20X1 is currently being negotiated with our parent company, Burbery Co.

3 The government subsidy will be received once our application has been approved. The subsidy is awarded to companies which operate in areas of high unemployment and it subsidises the wages and salaries paid to staff.

Required

(i) Review the draft statement of financial position and cash flow forecast, and identify and explain any matters which may cast significant doubt on the company’s ability to continue as a going concern (9 marks)

(ii) Design the principal audit procedures to be carried out on the cash flow forecast, and identify any additional information that would be needed in order to carry out these procedures (10 marks)

Note. The split of the mark allocation is shown above.

(b) Given the information provided relating to Carson Co, it is likely that the auditor may conclude on completion of all necessary audit procedures, that the use of the going concern assumption in the financial statements is appropriate, but that a material uncertainty, or several uncertainties, exist regarding the company’s ability to continue as a going concern.

Required

If audit procedures indicate that one or more material uncertainties exist regarding Carson Co’s ability to continue as a going concern, explain the matters that should be considered in forming the audit opinion and the potential impacts on the auditor’s report. (6 marks)

Note. Assume it is 7 June 20X1.

62) COLE CO.

(a) Auditors should accept some of the blame when a company on which they have expressed an unmodified audit opinion subsequently fails, and they should also do more to highlight going concern problems being faced by a company.

Required

Discuss this statement.

(b) You are the manager responsible for the audit of Cole Co, a company which designs and develops aircraft engines. The audit for the year ended 31 July 20X1 is nearing completion and the audit senior has left the following file note for your attention.

‘I have just returned from a meeting with the management of Cole Co, and there is a matter I want to bring to your attention. Cole Co’s statement of financial position recognises an intangible asset of $12.5 million in respect of capitalised research and development costs relating to new aircraft engine designs. However, market research conducted by Cole Co in relation to these new designs indicated that there would be little demand in the near future for such designs. Management has provided written representation that they agree with the results of the market research.

‘Currently, Cole Co has a cash balance of only $125,000 and members of the management team have expressed concerns that the company is finding it difficult to raise additional finance.

‘The new aircraft designs have been discussed in the chairman’s statement which is to be published with the financial statements. The discussion states that ‘developments of new engine designs are underway, and we believe that these new designs will become a significant source of income for Cole Co in the next 12 months.

‘Cole Co’s draft financial statements include profit before tax of $23 million, and total assets of $210 million.

‘Cole Co is due to publish its annual report next week, so we need to consider the impact of this matter urgently.’

Required

Discuss the implications of the audit senior’s file note on the completion of the audit and on the auditor’s report, recommending any further actions that should be taken by the auditor.

(c) You are responsible for answering technical queries from other managers and partners of your firm. An audit partner left the following note on your desk this morning.

(i) ‘I am about to draft the auditor’s report for my client, Chula Co. I am going on holiday tomorrow and want to have the auditor’s report signed and dated before I leave. The only thing outstanding is the written representation from management – I have verbally confirmed the contents with the finance director who agreed to send the representations to the audit manager within the next few days. I presume this is acceptable?’

(ii) ‘We are auditing Chula Co for the first time. The prior period financial statements were audited by another firm. We are aware that the auditor’s opinion on the prior period was qualified due to a material misstatement of trade receivables. We have obtained sufficient appropriate evidence that the matter giving rise to the misstatement has been resolved and I am happy to issue an unmodified opinion. But should I refer to the prior year modification in this year’s auditor’s report?’

Required

Respond to the audit partner’s comments. 

Note. The split of the mark allocation is shown within the question.

63) BAXTER CO.

a. You are an audit manager in Baxter & Co, responsible for the audit of the Damon Group (the Group). You are reviewing the audit working papers for the consolidated financial statements relating to the year ended 31 March 20X8. The Group specialises in the wholesale supply of steel plate and sheet metals. The draft consolidated financial statements recognise revenue of $7,670 million (20X7 – $7,235 million), profit before taxation of $55 million (20X7 – $80 million) and total assets of $1,560 million (20X7 – $1,275 million). Baxter & Co audits all of the individual company financial statements as well as the Group consolidated financial statements. The audit senior has brought the following matters, regarding a number of the Group’s companies, to your attention:

i. Brilly Co

The Group purchased 40% of the share capital and voting rights in Brilly Co on 1 May 20X7. Brilly Co is listed on an alternative stock exchange. The Group has also acquired options to purchase the remaining 60% of the issued shares at a 10% discount on the market value of the shares at the time of exercise. The options are exercisable for 18 months from 1 May 20X8. Brilly Co’s draft financial statements for the year ended 31 March 20X8 recognise revenue of $90 million and a loss before tax of $12 million. The Group’s finance director has equity accounted for Brilly Co as an associate in this year’s group accounts and has included a loss before tax of $4.4 million in the consolidated statement of profit or loss. (7 marks)

ii. Wally Co

Wally Co is a foreign subsidiary whose functional and presentational currency is the same as Damon Co and the remainder of the Group. The subsidiary specialises in the production of stainless steel and holds a significant portfolio of forward commodity options to hedge against fluctuations in raw material prices. The local jurisdiction does not mandate the use of IFRS Standards and the audit senior has noted that Wally Co follows local GAAP, whereby derivatives are disclosed in the notes to the financial statements but are not recognised as assets or liabilities in the statement of financial position. The disclosure note includes details of the maturity and exercise terms of the options and a directors’ valuation stating that they have a total fair value of $6.1 million as at 31 March 20X8. The disclosure note states that all of the derivative contracts were entered into in the last three months of the reporting period and that they required no initial net investment. (6 marks)

Required:

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

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

b. You are also responsible for the audit of the Motgomery Group (the Group), a listed manufacturer of high quality musical instruments, for the year ended 31 March 20X8. The draft financial statements of the Group recognise a loss before tax of $2.2 million (20X7 – loss of $1.5 million) and total assets of $14.1 million (20X7 – $18.3 million). The audit is nearing completion and the audit senior has drafted the auditor’s report which contains the following extract:

Key audit matters

1. Valuation of financial instruments

The Group enters into structured forward contracts to purchase materials used in its manufacturing process. The valuation of these unquoted instruments involves guesswork and is based on internal models developed by the Group’s finance director, Thomas Fitz. Mr Fitz joined the Group in January 20X8 and there is significant measurement uncertainty involved in his valuations as a result of his inexperience. As a result, the valuation of these contracts was significant to our audit.

2. Customer liquidation

Included in receivables shown on the consolidated statement of financial position is an amount of $287,253 from a customer which has ceased trading. On the basis that the Group has no security for this debt, we believe that the Group should make a full provision for impairment of $287,253 thereby reducing profit before taxation for the year and total assets as at 31 March 20X8 by that amount.

Qualified opinion arising from disagreement about accounting treatment

In our opinion, except for the effect on the financial statements of the matter described above, the financial statements have been properly prepared in all material respects in accordance with IFRS Standards.

Emphasis of matter

We draw attention to the loss before tax of $2.2 million for the year ended 31 March 20X8 and that the Group is in breach of loan covenants with its key finance providers. A material uncertainty therefore exists which may cast doubt on the Group’s ability to continue as a going concern. Our opinion is not modified in respect of this matter.

Required:

Critically appraise the extract from the auditor’s report on the consolidated financial statements of the Motgomery Group for the year ended 31 March 20X8.

Note: You are NOT required to re-draft the extract from the auditor’s report.

64) ANWYLL CO.

a. Discuss the three types of misstatement identified in ISA 450 Evaluation of Misstatements Identified During the Audit and comment on why it is important for the auditor to consider the type of misstatement when evaluating their effect on the financial statements and determining the further actions to be taken.

b. You are responsible for the audit of Anwyll Co, a large, listed package delivery company. The audit of the financial statements for the year ended 31 July 20X7 is nearly complete and you are reviewing the audit working papers. The financial statements recognise revenue of $56,360 million (20X6 – $56,245 million), profit for the year of $2,550 million (20X6 – $2,630 million) and total assets of $37,546 million (20X6 – $38,765 million).

The uncorrected misstatements identified during the audit of Anwyll Co are described below. The audit engagement partner is holding a meeting with the management team of Anwyll Co next week, at which the uncorrected misstatements will be discussed.

• The accuracy of the depreciation charge was investigated for a sample of motor vehicles with a carrying value of $4.5 million. The investigation revealed that the accounting system had failed to correctly depreciate vehicles acquired during the year. Consequently, depreciation in the sample had been understated, and the carrying value of the vehicles overstated, by $350,000. The total value of all motor vehicles at the year end was $125 million (20X6 – $131 million).
• In January 20X7, the board of Anwyll Co approved a loan to, Mrs C Angel, who is a key member of the senior management team of the company. The total amount of the loan was $75,000. Following a review of the board minutes, it was discovered that the directors agreed that the amount was clearly trivial and have, therefore, not disclosed the loan in the notes to the financial statements.
• During the year Anwyll Co reduced the value of their provision for customer refunds which is recognised in the financial statements. For the past five years the value of the provision has been calculated based on 7% of one month’s sales, using an average monthly sales value. Management argued that due to improved internal processing systems, such a high rate of provision was no longer necessary and reduced it to 4%. Audit procedures found that refund levels were similar to previous years and there was insufficient evidence at this early stage to confirm whether the new system was more effective or not.

Required:

For each of the matters described above:

1. Explain the matters which should be discussed with management in relation to each of the uncorrected misstatements, and
2. Assuming that management does not adjust the misstatements identified, evaluate the effect of each on the audit opinion.

Note: The total marks will be split equally between each matter.

c. At the start of the year Anwyll Co replaced its computer system with an integrated system. The new system allows for real time tracking of packages once received by Anwyll Co from their customer. As soon as a package is delivered to its final destination the finance system is automatically updated for the revenue and an invoice generated. The audit team have extensively tested the new system and found no deficiencies in relation to the recording of revenue.

Required:

Describe the impact of the above issue, if any, on the auditor’s report in accordance with ISA 701 Communicating Key Audit Matters in the Independent Auditor’s Report.

65) ATHENS CO.

a. In 2019, the IAASB issued three exposure drafts for quality management standards to replace and revise current guidance in the area of quality control.

− Proposed ISA 220 (Revised) Quality Management for an Audit of Financial Statements

− Proposed International Standard on Quality Management (ISQM) 1 Quality Management for Firms that Perform Audits or Reviews of Financial Statements, or Other Assurance or Related Services Engagements

− Proposed ISQM 2 Engagement Quality Reviews.

Required:

Discuss the main objectives and benefits outlined in these exposure drafts on quality management. (6 marks)

You are the manager responsible for the audit of Athens Co, a producer of chocolate and confectionery. The audit of the financial statements for the year ended 31 December 20X5 is nearly complete and you are reviewing the audit working papers. The financial statements recognise revenue of $76 million, profit before tax for the year of $6.4 million and total assets of $104 million.

The summary of uncorrected misstatements included in Athens Co’s audit working papers, including notes, is shown below. The audit engagement partner is holding a meeting with the management team of Athens Co next week, at which the uncorrected misstatements will be discussed.

Statement of profit or loss   Statement of financial position

Debit               Credit                          Debit               Credit

Summary of                           $                      $                                  $                      $

uncorrected

misstatements:

(i) Impairment                         400,000                                                                       400,000

(ii) Borrowing costs                                        75,000                         75,000

(iii) Irrecoverable debt            65,000                                                                         65,000

(iv) Investment                                               43,500                         43,500

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

Totals                                     465,000           118,500                       118,500             465,000

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

(i) During the year Athens Co impaired one of its factories. The carrying value of the assets attributable to the factory as a single, cash-generating unit totalled $3.6 million at the year end. The fair value less costs of disposal and the value in use were estimated to be $3 million and $3.5 million respectively and accordingly the asset was written down by $100,000 to reflect the impairment. Audit procedures revealed that management used growth rates attributable to the company as a whole to estimate value in use. Using growth rates attributable to the factory specifically, the audit team estimated the value in use to be $3.1 million.

(ii) Interest charges of $75,000 relating to a loan taken out during the year to finance the construction of a new manufacturing plant were included in finance charges recognised in profit for the year. The manufacturing plant is due for completion in November 20X6.

(iii) One of Athens Co’s largest customers, Chloe Co, is experiencing financial difficulties. At the year end Chloe Co owed Athens Co $100,000, against which Athens Co made a 5% specific allowance. Shortly after the year end Chloe Co paid $30,000 of the outstanding amount due but has since experienced further problems, leading to their primary lender presenting a formal request that Chloe Co be liquidated. If successful, only secured creditors are likely to receive any reimbursement.

(iv) During the year Athens Co purchased 150,000 shares in Phoebe Co for $4.00 per share. Athens Co classified the investment as a financial asset held at fair value through profit or loss. On 31 December 20X5, the shares of Phoebe Co were trading for $4.29. At the year end the carrying value of the investment in Athens Co’s financial statements was $600,000.

Required:

b. Explain the matters which should be discussed with management in relation to each of the uncorrected misstatements, including an assessment of their individual impact on the financial statements; and

c. Assuming that management does not adjust any of the misstatements, discuss the effect on the audit opinion and auditor’s report.

66) WILLIAM CO.

You are responsible for performing Engagement Quality Control Reviews on selected audit clients of Chrisp & Co, and you are currently performing a review on the audit of the William Group (the Group). The Group manufactures chemicals which are used in a range of industries, with one of the subsidiaries, Lilly Co, specialising in chemical engineering and developing products to be sold by the other Group companies. The Group’s products sell in over 50 countries.

A group structure is shown below, each of the subsidiaries is wholly owned by William Co, the parent company of the Group:

Chrisp & Co is engaged to provide the audit of the Group financial statements and also the audit of Meridith  Co and William Co. Jeremy Co, a new subsidiary, is audited by a local firm of auditors based near the company’s head office. Lilly Co is audited by an unconnected audit firm which specialises in the audit of companies involved with chemical engineering.

The Group’s financial year ended on 31 December 20X6 and the audit is in the completion stage, with the auditor’s report due to be issued in three weeks’ time. The Group’s draft consolidated financial statements recognise profit before tax of $7.5 million and total assets of $130 million.

The notes from your review of the audit working papers are shown below, summarising the issues relevant to each subsidiary.

a. Meridith Co – internal controls and results of controls testing

The Group companies supply each other with various chemical products to be used in the manufacture of chemicals. Audit work performed at the interim stage at Meridith  Co, including walk through procedures and internal control evaluations, concluded that internal controls over intra-group transactions were not effective, and this was documented in the audit file. At the final audit, tests of controls were performed to confirm this to be the case. The tests of controls confirmed that intra-group transactions are not being separately identified in the Group’s accounting system and reconciliations of amounts owed between the subsidiaries are not performed.

The group audit manager has concluded on the audit working papers that ‘as intra-group balances are cancelled on consolidation, this issue has no impact on the Group audit and no further work is necessary’.

As part of the audit approach it was determined that extensive testing would be performed over the internal controls for capital expenditure at Meridith  Co as it was identified during planning that the company had made significant acquisitions of plant and equipment during the year. Following controls testing the internal controls over capital expenditure were evaluated to be effective in Meridith  Co.

The working papers conclude that ‘based on the results of controls testing at Meridith  Co, it is reasonable to assume that controls are effective across the Group’ and substantive procedures on property, plant and equipment in each Group company have been planned and performed in response to this assessment.

b. Jeremy Co – new subsidiary

This subsidiary was acquired on 30 September 20X6 and is audited by Burn & Co. The Group audit strategy contains the following statement in relation to the audit of Jeremy Co: ‘Jeremy Co will only be consolidated for three months and the postacquisition profit for that period to be included in the Group financial statements is $150,000. On that basis, Jeremy Co is immaterial to the Group financial statements and therefore our audit procedures are based on analytical procedures only.’

Other than the analytical procedures performed, there is no documentation in respect of Jeremy Co or its audit firm Burn & Co included in the Group audit working papers.

The draft statement of financial position of Jeremy Co recognises total assets of $30 million.

b. Lilly Co – restriction on international trade

As well as being involved in chemical engineering and supplying chemicals for use by the other Group companies, Lilly Co specialises in producing chemicals which are used in the agricultural sector, and around half of its sales are made internationally.

Lilly Co is audited by Boxglove & Co, and the Group audit working papers contain the necessary evaluations to conclude that an appropriate level of understanding has been obtained in respect of the audit firm.

Boxglove & Co has provided your firm with a summary of key audit findings which includes the following statement: ‘During the year new government environmental regulations have imposed restrictions on international trade in chemicals, with sales to many countries now prohibited.

Our audit work concludes that this does not create a significant going concern risk to Lilly Co, and we have confirmed that all inventories are measured at the lower of cost and net realisable value.’

The Group audit manager has concluded that ‘I am happy that no further work is needed in this area – we can rely on the unmodified audit opinion to be issued by Boxglove & Co. This issue was not identified until it was raised by Boxglove & Co, it has not been mentioned to me by the Group board members, and it has no implications for the consolidated financial statements.’

The draft statement of financial position of Lilly Co recognises total assets of $8 million and the statement of profit or loss recognises profit before tax of $50,000.

The draft consolidated financial statements recognises goodwill in respect of Lilly Co of $3 million (20X5 – $3 million). (7 marks)

Required:

In respect of each of the matters described above:

• Comment on the quality of the planning and performance of the Group audit discussing the quality control and other professional issues raised.
• Recommend any further actions, including relevant audit procedures, to be taken by your firm, prior to finalising the Group auditor’s report.

Note: the split of the mark allocation is shown next to each of the issues above.

d. Additional procedures have now been performed to assess the going concern status of Lilly Co and the group auditor has concluded that there is sufficient doubt to require disclosure of the uncertainty in the financial statements of Lilly Co. The directors of Lilly Co have stated that they do not intend to include any disclosure as they do not want to draw attention to going concern issues in case it causes further problems.

Required:

Discuss the effect of this issue on the auditor’s reports of Lilly Co and the William Group.

67) OLIVIA CO.

You are the manager responsible for the audit of Olivia Co, a jewellery manufacturer and retailer. The final audit for the year ended 31 March 20X7 is nearing completion and you are reviewing the audit working papers. The draft financial statements recognise total assets of $1,919 million (20X6 – $1,889 million), revenue of $1,052 million (20X6 – $997 million) and profit before tax of $107 million (20X6 – $110 million). Three issues from the audit working papers are summarised below:

i) Cost of inventory

Inventory costs include all purchase costs and the costs of conversion of raw materials into finished goods. Conversion costs include direct labour costs and an allocation of production overheads. Direct labour costs are calculated based on the average production time per unit of inventory, which is estimated by the production manager, multiplied by the estimated labour cost per hour, which is calculated using the forecast annual wages of production staff divided by the annual scheduled hours of production. Production overheads are all fixed and are allocated based upon the forecast annual units of production. At the yearend inventory was valued at $21 million (20X6 – $20 million). (6 mark)

ii) Impairment

At the year end management performed an impairment review on its retail outlets, which are a cash generating unit for the purpose of conducting an impairment review. While internet sales grew rapidly during the year, sales from retail outlets declined, prompting the review. At 31 March 20X7 the carrying amount of the assets directly attributable to the retail outlets totalled