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Question 2a

Malevich & 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, Kandinsky Co and the Rothko University, both of which have a financial year ended 31 July 2015. The audits of both clients are being completed and you are reviewing issues which have been raised by the audit seniors.

(a) Kandinsky 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 2015 July 2014
(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:
1. The bank loan was extended in March 2015 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 2016 when $350,000 is due to be paid.

2. Kandinsky 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.

3. The borrowing facilities are due to be reviewed by the bank in April 2016 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.

4. The contingent liability relates to a letter of support which Kandinsky Co has provided to its main supplier of cane sugar which is facing difficult trading conditions.

Required:
In respect of the audit of Kandinsky Co:

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

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