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Question 4

You are an audit manager in Brearley & Co, responsible for the audit of the Hughes Group (the Group). You are reviewing the audit working papers for the consolidated financial statements relating to the year ended 31 March 2018. The Group specialises in the wholesale supply of steel plate and sheet metals. The draft consolidated financial statements recognise revenue of $7,670 million (2017 – $7,235 million), profit before taxation of $55 million (2017 – $80 million) and total assets of $1,560 million (2017 – $1,275 million). Brearley & Co audits all of the individual company financial statements as well as the Group consolidated financial statements. The audit senior has brought the following matters, regarding a number of the Group’s companies, to your attention:

(a) Dilley Co
The Group purchased 40% of the share capital and voting rights in Dilley Co on 1 May 2017. Dilley Co is listed on an alternative stock exchange. The Group has also acquired options to purchase the remaining 60% of the issued shares at a 10% discount on the market value of the shares at the time of exercise. The options are exercisable for 18 months from 1 May 2018. Dilley Co’s draft financial statements for the year ended 31 March 2018 recognise revenue of $90 million and a loss before tax of $12 million. The Group’s finance director has equity accounted for Dilley Co as an associate in this year’s group accounts and has included a loss before tax of $4·4 million in the consolidated statement of profit or loss. (7 marks)

(b) Willis Co
Willis Co is a foreign subsidiary whose functional and presentational currency is the same as Hughes Co and the remainder of the Group. The subsidiary specialises in the production of stainless steel and holds a significant portfolio of forward commodity options to hedge against fluctuations in raw material prices. The local jurisdiction does not mandate the use of IFRS Standards and the audit senior has noted that Willis Co follows local GAAP, whereby derivatives are disclosed in the notes to the financial statements but are not recognised as assets or liabilities in the statement of financial position. The disclosure note includes details of the maturity and exercise terms of the options and a directors’ valuation stating that they have a total fair value of $6·1 million as at 31 March 2018. The disclosure note states that all of the derivative contracts were entered into in the last three months of the reporting period and that they required no initial net investment. (6 marks)

(c) Knott Co
Knott Co is a long-standing subsidiary in which the Group parent has a direct holding of 80% of the equity and voting rights. Audit work on revenue and receivables at Knott Co has identified sales of aluminium to its parent company in March 2018 with a total sales value of $77 million which have been recorded in the subsidiary’s financial statements. Audit procedures have identified, however, that the receipt of aluminium was not recorded by the parent company until 2 April 2018. The group has made no adjustment for this transaction in the draft consolidated financial statements. Knott Co makes a 10% profit margin on all of its sales of aluminium.  (7 marks)

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