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.