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Question 2a

You are a manager in the audit department of Williams & Co and you are reviewing the audit working papers in relation to the Francis Group (the Group), whose financial year ended on 31 July 2014. Your firm audits all components of the Group, which consists of a parent company and three subsidiaries – Marks Co, Roberts Co and Teapot Co.

The Group manufactures engines which are then supplied to the car industry. The draft consolidated financial statements recognise profit for the year to 31 July 2014 of $23 million (2013 – $33 million) and total assets of $450 million (2013 – $455 million).

Information in respect of three issues has been highlighted for your attention during the file review.

(a) An 80% equity shareholding in Teapot Co was acquired on 1 August 2013. Goodwill on the acquisition of $27 million was calculated at that date and remains recognised as an intangible asset at that value at the year end. The goodwill calculation performed by the Group’s management is shown below:

$’000
Purchase consideration 75,000
Fair value of 20% non-controlling interest 13,000
88,000
Less: Fair value of Teapot Co’s identifiable net assets at acquisition (61,000)
Goodwill
27,000

In determining the fair value of identifiable net assets at acquisition, an upwards fair value adjustment of $300,000 was made to the book value of a property recognised in Teapot Co’s financial statements at a carrying value of $600,000.

A loan of $60 million was taken out on 1 August 2013 to help finance the acquisition. The loan carries an annual interest rate of 6%, with interest payments made annually in arrears. The loan will be repaid in 20 years at a premium of $5 million. (12 marks)

Required:
Comment on the matters to be considered, and explain the audit evidence you should expect to find during your review of the 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.