ACCA AA Syllabus E. Review And Reporting - Going Concern Disclosures and Reporting - Past Papers ^{4 / 4}

You are the audit manager of Kiwi & Co and you have been provided with financial statements extracts and the following information about your client, Strawberry Kitchen Designs Co (Strawberry), who is a kitchen manufacturer. The company’s year end is 30 April 2012.

Strawberry has recently been experiencing trading difficulties, as its major customer who owes $0•6m to Strawberry has ceased trading, and it is unlikely any of this will be received. However the balance is included within the financial statements extracts below. The sales director has recently left Strawberry and has yet to be replaced.

The monthly cash flow has shown a net cash outflow for the last two months of the financial year and is forecast as negative for the forthcoming financial year. As a result of this, the company has been slow in paying its suppliers and some are threatening legal action to recover the sums owing.

Due to its financial difficulties, Strawberry missed a loan repayment and, as a result of this breach in the loan covenants, the bank has asked that the loan of $4•8m be repaid in full within six months. The directors have decided that in order to conserve cash, no final dividend will be paid in 2012.

Financial statements extracts for year ended 30 April:

Required

a) Describe the audit procedures that you should perform in assessing whether or not the company is a going concern. (6 marks)

b) Having performed the going concern audit procedures, you have serious concerns in relation to the going concern status of Strawberry. The finance director has informed you that as the cash flow issues are short term he does not propose to make any amendments to the financial statements.

State Kiwi & Co’s responsibility for reporting on going concern to the directors of Strawberry Kitchen Designs Co (2 marks)

Medimade Co is an established pharmaceutical company that has for many years generated 90% of its revenue through the sale of two specific cold and fl u remedies. Medimade has lately seen a real growth in the level of competition that it faces in its market and demand for its products has significantly declined.

To make matters worse, in the past the company has not invested sufficiently in new product development and so has been trying to remedy this by recruiting suitably trained scientific staff, but this has proved more difficult than anticipated.

In addition to recruiting staff the company also needed to invest $2m in plant and machinery. The company wanted to borrow this sum but was unable to agree suitable terms with the bank; therefore it used its overdraft facility, which carried a higher interest rate.

Consequently, some of Medimade’s suppliers have been paid much later than usual and hence some of them have withdrawn credit terms meaning the company must pay cash on delivery. As a result of the above the company’s overdraft balance has grown substantially.

The directors have produced a cash flow forecast and this shows a significantly worsening position over the coming 12 months.

The directors have informed you that the bank overdraft facility is due for renewal next month, but they are confident that it will be renewed.

They also strongly believe that the new products which are being developed will be ready to market soon and hence trading levels will improve and therefore that the company is a going concern. Therefore they do not intend to make any disclosures in the accounts regarding going concern.

Required:

a) Explain the audit procedures that the auditor of Medimade should perform in assessing whether or not the company is a going concern. (6 marks)

The auditors have been informed that Medimade’s bankers will not make a decision on the overdraft facility until after the audit report is completed. The directors have now agreed to include going concern disclosures.

Required:

b) Describe the impact on the audit report of Medimade if the auditor believes the company is a going concern but a material uncertainty exists. (4 marks)

Medimade Co is an established pharmaceutical company that has for many years generated 90% of its revenue through the sale of two specific cold and fl u remedies. Medimade has lately seen a real growth in the level of competition that it faces in its market and demand for its products has significantly declined.

To make matters worse, in the past the company has not invested sufficiently in new product development and so has been trying to remedy this by recruiting suitably trained scientific staff, but this has proved more difficult than anticipated.

In addition to recruiting staff the company also needed to invest $2m in plant and machinery. The company wanted to borrow this sum but was unable to agree suitable terms with the bank; therefore it used its overdraft facility, which carried a higher interest rate.

Consequently, some of Medimade’s suppliers have been paid much later than usual and hence some of them have withdrawn credit terms meaning the company must pay cash on delivery. As a result of the above the company’s overdraft balance has grown substantially.

The directors have produced a cash flow forecast and this shows a significantly worsening position over the coming 12 months.

The directors have informed you that the bank overdraft facility is due for renewal next month, but they are confident that it will be renewed.

They also strongly believe that the new products which are being developed will be ready to market soon and hence trading levels will improve and therefore that the company is a going concern. Therefore they do not intend to make any disclosures in the accounts regarding going concern.

Required:

a) Explain the audit procedures that the auditor of Medimade should perform in assessing whether or not the company is a going concern. (6 marks)

The auditors have been informed that Medimade’s bankers will not make a decision on the overdraft facility until after the audit report is completed. The directors have now agreed to include going concern disclosures.

The auditors have been informed that Medimade’s bankers will not make a decision on the overdraft facility until after the audit report is completed. The directors have now agreed to include going concern disclosures.

Required:

Describe the impact on the audit report of Medimade if the auditor believes the company is a going concern but a material uncertainty exists. (4 marks)

Smithson Co provides scientific services to a wide range of clients. Typical assignments range from testing food for illegal additives to providing forensic analysis on items used to commit crimes to assist law enforcement officers.

The annual audit is nearly complete. As audit senior you have reported to the engagement partner that Smithson is having some financial difficulties. Income has fallen due to the adverse effect of two high-profile court cases, where Smithson’s services to assist the prosecution were found to be in error.

Not only did this provide adverse publicity for Smithson, but a number of clients withdrew their contracts. A senior employee then left Smithson, stating lack of investment in new analysis machines was increasing the risk of incorrect information being provided by the company.

A cash flow forecast prepared internally shows Smithson requiring significant additional cash within the next 12 months to maintain even the current level of services. Smithson’s auditors have been asked to provide a negative assurance report on this forecast.

Required:

Explain the audit procedures the auditor may take where the auditor has decided that Smithson Co is unlikely to be a going concern. (4 marks)