Question 1a i
You are a manager in Maple & Co, responsible for the audit of Oak Co, a listed company. Oak Co manufactures electrical appliances such as televisions and radios, which are then sold to retail outlets. You are aware that during the last year, Oak Co lost several customer contracts to overseas competitors. However, a new division has been created to sell its products directly to individual customers via a new website, which was launched on 1 November 2011.
You are about to commence planning the audit for the year ending 31 December 2011, and you have received an email from Holly Elm, the audit engagement partner.
To: Audit manager
From: Holly Elm, Audit partner
Subject: Oak Co – audit planning
Hello
I would like you to start planning the audit of Oak Co. You need to perform a preliminary analytical review on the financial information and accompanying notes provided by Rowan Birch, the finance director of Oak Co. Using this information and the results of your analytical review, please prepare notes for inclusion in the planning section of the working papers, which identify and explain the principal audit risks to be considered in planning the final audit. Your notes should include any calculations performed. (23 marks)
Thank you.
Financial information provided by Rowan Birch:
Statement of comprehensive income (extract from management accounts)
| note | 11 months to | 11 months to | |
| 30 nov 2011 | 30 nov 2010 | ||
| $'000 | $'000 | ||
| revenue | 25700 | 29300 | |
| cost of sales | -15420 | -15900 | |
| --------- | --------- | ||
| gross profit | 10280 | 13400 | |
| operating expenses | 1 | -6200 | -7750 |
| --------- | --------- | ||
| operating profit | 4080 | 5650 | |
| finance costs | -1500 | -1500 | |
| --------- | --------- | ||
| profit before tax | 2580 | 4150 | |
| --------- | --------- |
| statement of financial position | |||
| note | 30 nov 2011 | 30 nov 2010 | |
| $'000 | $'000 | ||
| assets | |||
| non-current assets | |||
| property plant and equipment | 2,3 | 90000 | 75750 |
| intangible assets | 4 | 1250 | --- |
| --------- | --------- | ||
| 91250 | 75750 | ||
| --------- | --------- | ||
| current assets | |||
| inventory | 1800 | 1715 | |
| trade receivables | 4928 | 4815 | |
| cash and cash equivalent | 100 | 2350 | |
| --------- | --------- | ||
| 6828 | 8880 | ||
| --------- | --------- | ||
| total assets | 98078 | 84630 | |
| ====== | ====== | ||
| equity and liabilities | |||
| equity | |||
| share capital | 20000 | 20000 | |
| revaluation reserve | 3 | 10000 | --- |
| retained earnings | 32278 | 34895 | |
| --------- | --------- | ||
| total equity | 62278 | 54895 | |
| --------- | --------- | ||
| non-current liabilities | |||
| long-term borrowings | 5 | 25000 | 25000 |
| provisions | 6 | 1000 | 1250 |
| finance lease payable | 2 | 5000 | --- |
| --------- | --------- | ||
| 31000 | 26250 | ||
| --------- | --------- | ||
| current liabilities | |||
| bank overdraft | 7 | 1300 | --- |
| trade and other payables | 3500 | 3485 | |
| --------- | --------- | ||
| 4800 | 3485 | ||
| --------- | --------- | ||
| total liabilities | 35800 | 29735 | |
| --------- | --------- | ||
| total equity and liabilities | 98078 | 84630 | |
| ====== | ====== | ||
Notes:
1. Oak Co established an equity-settled share-based payment plan for its executives on 1 January 2011. 250 executives and senior managers have received 100 share options each, which vest on 31 December 2013 if the executive remains in employment at that date, and if Oak Co’s share price increases by 10% per annum. No expense has been recognised this year as Oak Co’s share price has fallen by 5% in the last six months, and so it is felt that the condition relating to the share price will not be met this year end.
2. On 1 July 2011, Oak Co entered into a lease which has been accounted for as a finance lease and
capitalised at $5 million. The leased property is used as the head office for Oak Co’s new website development and sales division. The lease term is for five years and the fair value of the property at the inception of the lease was $20 million.
3. On 30 June 2011 Oak Co’s properties were revalued by an independent expert.
4. A significant amount has been invested in the new website, which is seen as a major strategic development for the company. The website has generated minimal sales since its launch last month, and advertising campaigns are currently being conducted to promote the site.
5. The long-term borrowings are due to be repaid in two equal instalments on 30 September 2012 and 2013. Oak Co is in the process of renegotiating the loan, to extend the repayment dates, and to increase the amount of the loan.
6. The provision relates to product warranties offered by the company.
7. The overdraft limit agreed with Oak Co’s bank is $1•5 million.
Required:
Respond to the email from the audit partner