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Question 1c

You are an audit manager in Compton & Co, responsible for the audit of the Stow Group (the Group). You are planning the audit of the Group financial statements for the year ending 31 December 2013. The Group’s projected profit before tax for the year is $200 million and projected total assets at 31 December are $2,500 million.

The Group is a car manufacturer. Its operations are divided between a number of subsidiaries, some of which focus on manufacturing and distributing the cars, while others deal mainly with marketing and retail. All components of the Group have the same year end. The Group audit engagement partner, Chad Woodstock, has just sent you the following email.

To: Audit manager
From: Chad Woodstock, audit partner
Subject: The Stow Group – audit planning

Hello

We need to start planning the audit of The Stow Group. Yesterday I met with the Group finance director, Marta Bidford, and we discussed some restructuring of the Group which has taken place this year. A new wholly-owned subsidiary has been acquired – Zennor Co, which is located overseas in Farland. Another subsidiary, Broadway Co, was disposed of.

I have provided you with a summary of issues which I discussed with Marta, and using this information I would like you to prepare briefing notes for my use in which you:

Marta has told me that Zennor Co has a well established internal audit team. She has suggested that we use the internal audit team as much as possible when performing our audit of Zennor Co as this will reduce the audit fee.

The Group audit committee appreciates that with the audit of the new subsidiary there will be some increase in our costs, but has requested that the audit fee for the Group as a whole is not increased from last year’s fee. I have provided you with some information about the internal audit team and in your briefing notes I would like you to:

Discuss how Marta’s suggestion impacts on the planning of the audit of Zennor Co’s and of the Group’s financial statements, and comment on any ethical issue raised. (7 marks)

Thank you.

Acquisition of Zennor Co

In order to expand overseas, the Group acquired 100% of the share capital of Zennor Co on 1 February 2013. Zennor Co is located in Farland, where it owns a chain of car dealerships. Zennor Co’s financial statements are prepared using International Financial Reporting Standards and are measured and presented using the local currency of Farland, the Dingu.

At the present time, the exchange rate is 4 Dingu = $1. Zennor Co has the same year end as the Group, and its projected profit for the year ending 31 December 2013 is 90 million Dingu, with projected assets at the same date of 800 million Dingu.

Zennor Co is supplied with cars from the Group’s manufacturing plant. The cars are sent on cargo ships and take approximately six weeks to reach the main port in Farland, where they are stored until delivered to the dealerships. At today’s date there are cars in transit to Zennor Co with a selling price of $58 million.

A local firm of auditors was engaged by the Group to perform a due diligence review on Zennor Co prior to its acquisition. The Group’s statement of financial position recognises goodwill at acquisition of $60 million.

Compton & Co was appointed as auditor of Zennor Co on 1 March 2013.

Disposal of Broadway Co

On 1 September 2013, the Group disposed of its wholly-owned subsidiary, Broadway Co, for proceeds of $180 million. Broadway Co operated a distribution centre in this country. The Group’s statement of profit or loss includes a profit of $25 million in respect of the disposal.

Broadway Co was acquired by a retail organisation, the Cornwall Group, which wished to bring its distribution operations in house in order to save costs. Compton & Co resigned as auditor to Broadway Co on 15 September 2013 to be replaced by the principal auditor of the Cornwall Group.

Zennor Co – Internal audit team

The internal audit team was established several years ago and is headed up by a qualified accountant, Jo Evesham, who has a lot of experience in designing systems and controls. Jo and her team monitor the effectiveness of operating and financial reporting controls, and report to the board of directors. Zennor Co does not have an audit committee as corporate governance rules in Farland do not require an internal audit function or an audit committee to be established.

During the year, the internal audit team performed several value for money exercises such as reviewing the terms negotiated with suppliers.

Required:

Respond to the instructions in the partner’s email.