ACCA AAA ^UK Syllabus D. Audit of Historical Financial Information - Planning a group audit - Past Papers ^{2 / 8}

You are responsible for performing Engagement Quality Control Reviews on selected audit clients of Crocus & Co, and you are currently performing a review on the audit of the Magnolia Group (the Group). The Group manufactures chemicals which are used in a range of industries, with one of the subsidiaries, Daisy Co, specialising in chemical engineering and developing products to be sold by the other Group companies. The Group’s products sell in over 50 countries.

A group structure is shown below, each of the subsidiaries is wholly owned by Magnolia Co, the parent company of the Group:

Crocus & Co is engaged to provide the audit of the Group financial statements and also the audit of Hyacinth Co and Magnolia Co. Geranium Co, a new subsidiary, is audited by a local firm of auditors based near the company’s head office. Daisy Co is audited by an unconnected audit firm which specialises in the audit of companies involved with chemical engineering.

The Group’s financial year ended on 31 December 2016 and the audit is in the completion stage, with the auditor’s report due to be issued in three weeks’ time. The Group’s draft consolidated financial statements recognise profit before tax of $7·5 million and total assets of $130 million.

The notes from your review of the audit working papers are shown below, summarising the issues relevant to each subsidiary.

(a) Hyacinth Co – internal controls and results of controls testing
The Group companies supply each other with various chemical products to be used in the manufacture of chemicals. Audit work performed at the interim stage at Hyacinth Co, including walk through procedures and internal control evaluations, concluded that internal controls over intra-group transactions were not effective, and this was documented in the audit file. At the final audit, tests of controls were performed to  confirm this to be the case. The tests of controls confirmed that intra-group transactions are not being separately identified in the Group’s accounting system and reconciliations of amounts owed between the subsidiaries are not performed.

The group audit manager has concluded on the audit working papers that ‘as intra-group balances are cancelled on consolidation, this issue has no impact on the Group audit and no further work is necessary’.

As part of the audit approach it was determined that extensive testing would be performed over the internal controls for capital expenditure at Hyacinth Co as it was identified during planning that the company had made significant acquisitions of plant and equipment during the year. Following controls testing the internal controls over capital expenditure were evaluated to be effective in Hyacinth Co.

The working papers conclude that ‘based on the results of controls testing at Hyacinth Co, it is reasonable to assume that controls are effective across the Group’ and substantive procedures on property, plant and equipment in each Group company have been planned and performed in response to this assessment. (9 marks)

Required:
In respect of each of the matters described above:

(ii) Recommend any further actions, including relevant audit procedures, to be taken by your firm, prior to finalising the Group auditor’s report.

Note: the split of the mark allocation is shown next to each of the issues above.

You are responsible for performing Engagement Quality Control Reviews on selected audit clients of Crocus & Co, and you are currently performing a review on the audit of the Magnolia Group (the Group). The Group manufactures chemicals which are used in a range of industries, with one of the subsidiaries, Daisy Co, specialising in chemical engineering and developing products to be sold by the other Group companies. The Group’s products sell in over 50 countries.

A group structure is shown below, each of the subsidiaries is wholly owned by Magnolia Co, the parent company of the Group:

Crocus & Co is engaged to provide the audit of the Group financial statements and also the audit of Hyacinth Co and Magnolia Co. Geranium Co, a new subsidiary, is audited by a local firm of auditors based near the company’s head office. Daisy Co is audited by an unconnected audit firm which specialises in the audit of companies involved with chemical engineering.

The Group’s financial year ended on 31 December 2016 and the audit is in the completion stage, with the auditor’s report due to be issued in three weeks’ time. The Group’s draft consolidated financial statements recognise profit before tax of $7·5 million and total assets of $130 million.

The notes from your review of the audit working papers are shown below, summarising the issues relevant to each subsidiary.

(b) Geranium Co – new subsidiary
This subsidiary was acquired on 30 September 2016 and is audited by Fern & Co. The Group audit strategy contains the following statement in relation to the audit of Geranium Co: ‘Geranium Co will only be consolidated for three months and the post-acquisition profit for that period to be included in the Group financial statements is $150,000. On that basis, Geranium Co is immaterial to the Group financial statements and therefore our audit procedures are based on analytical procedures only.’

Other than the analytical procedures performed, there is no documentation in respect of Geranium Co or its audit firm Fern & Co included in the Group audit working papers.

The draft statement of financial position of Geranium Co recognises total assets of $30 million. (7 marks)

Required:
In respect of each of the matters described above:

(ii) Recommend any further actions, including relevant audit procedures, to be taken by your firm, prior to finalising the Group auditor’s report.

Note: the split of the mark allocation is shown next to each of the issues above.

You are responsible for performing Engagement Quality Control Reviews on selected audit clients of Crocus & Co, and you are currently performing a review on the audit of the Magnolia Group (the Group). The Group manufactures chemicals which are used in a range of industries, with one of the subsidiaries, Daisy Co, specialising in chemical engineering and developing products to be sold by the other Group companies. The Group’s products sell in over 50 countries.

A group structure is shown below, each of the subsidiaries is wholly owned by Magnolia Co, the parent company of the Group:

Crocus & Co is engaged to provide the audit of the Group financial statements and also the audit of Hyacinth Co and Magnolia Co. Geranium Co, a new subsidiary, is audited by a local firm of auditors based near the company’s head office. Daisy Co is audited by an unconnected audit firm which specialises in the audit of companies involved with chemical engineering.

The Group’s financial year ended on 31 December 2016 and the audit is in the completion stage, with the auditor’s report due to be issued in three weeks’ time. The Group’s draft consolidated financial statements recognise profit before tax of $7·5 million and total assets of $130 million.

The notes from your review of the audit working papers are shown below, summarising the issues relevant to each subsidiary.

(c) Daisy Co – restriction on international trade
As well as being involved in chemical engineering and supplying chemicals for use by the other Group companies, Daisy Co specialises in producing chemicals which are used in the agricultural sector, and around half of its sales are made internationally.

Daisy Co is audited by Foxglove & Co, and the Group audit working papers contain the necessary evaluations to conclude that an appropriate level of understanding has been obtained in respect of the audit firm.

Foxglove & Co has provided your firm with a summary of key audit findings which includes the following statement: ‘During the year new government environmental regulations have imposed restrictions on international trade in chemicals, with sales to many countries now prohibited. Our audit work concludes that this does not create a significant going concern risk to Daisy Co, and we have confirmed that all inventories are measured at the lower of cost and net realisable value.’

The Group audit manager has concluded that ‘I am happy that no further work is needed in this area – we can rely on the unmodified audit opinion to be issued by Foxglove & Co. This issue was not identified until it was raised by Foxglove & Co, it has not been mentioned to me by the Group board members, and it has no implications for the consolidated financial statements.’

The draft statement of financial position of Daisy Co recognises total assets of $8 million and the statement of profit or loss recognises profit before tax of $50,000.

The draft consolidated financial statements recognises goodwill in respect of Daisy Co of $3 million (2015 – $3 million). (9 marks)

Required:
In respect of each of the matters described above:

(ii) Recommend any further actions, including relevant audit procedures, to be taken by your firm, prior to finalising the Group auditor’s report.

Note: the split of the mark allocation is shown next to each of the issues above.

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:

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.

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.

(c) Marks Co supplies some of the components used by Roberts Co in its manufacturing process. At the year end, an intercompany receivable of $20 million is recognised in Marks Co’s financial statements. Roberts Co’s financial statements include a corresponding intercompany payables balance of $20 million and inventory supplied from Marks Co valued at $50 million. (6 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.

You are the manager responsible for the audit of the Poodle Group (the Group) and you are completing the audit of the consolidated financial statements for the year ended 31 March 2013.

The draft consolidated financial statements recognise revenue of $18 million (2012 – $17 million), profit before tax of $2 million (2012 – $3 million) and total assets of $58 million (2012 – $59 million).

Your firm audits all of the components of the Group, apart from an overseas subsidiary, Toy Co, which is audited by a small local firm of accountants and auditors.

The audit senior has left a file note for your attention. You are aware that the Group’s annual report and financial statements are due to be released next week, and the Group is very reluctant to make any adjustments in respect of the matters described.

(a) Toy Co

The component auditors of Toy Co, the overseas subsidiary, have been instructed to provide the Group audit team with details of a court case which is ongoing. An ex-employee is suing Toy Co for unfair dismissal and has claimed $500,000 damages against the company.

To comply with local legislation, Toy Co’s individual financial statements are prepared using a local financial reporting framework. Under that local financial reporting framework, a provision is only recognised if a cash outflow is virtually certain to arise.

The component auditors obtained verbal confirmation from Toy Co’s legal advisors that the damages are probable, but not virtually certain to be paid, and no provision has been recognised in either the individual or consolidated financial statements. No other audit evidence has been obtained by the component auditors. (7 marks)

(b) Trade receivable

On 1 June 2013, a notice was received from administrators dealing with the winding up of Terrier Co, following its insolvency. The notice stated that the company should be in a position to pay approximately 10% of the amounts owed to its trade payables. Poodle Co, the parent company of the Group, includes a balance of  $1•6 million owed by Terrier Co in its trade receivables. (7 marks)

(c) Chairman’s statement

The draft chairman’s statement, to be included in the Group’s annual report, was received yesterday. The chairman comments on the performance of the Group, stating that he is pleased that revenue has increased by 20% in the year. (6 marks)

Required:

In respect of each of the matters described:

(i) Assess the implications for the completion of the Group audit, explaining any adjustments that may be necessary to the consolidated financial statements, and recommending any further procedures necessary; and

(ii) Describe the impact on the Group audit report if these adjustments are not made.

Note: The split of the mark allocation is shown above against each of the parts.

You are a manager in Magpie & Co, responsible for the audit of the CS Group. An extract from the permanent audit file describing the CS Group’s history and operations is shown below:

Permanent file (extract)

Crow Co was incorporated 100 years ago. It was founded by Joseph Crow, who established a small pottery making tableware such as dishes, plates and cups. The products quickly grew popular, with one range of products becoming highly sought after when it was used at a royal wedding.

The company’s products have retained their popularity over the decades, and the Crow brand enjoys a strong identity and good market share.

Ten years ago, Crow Co made its first acquisition by purchasing 100% of the share capital of Starling Co. Both companies benefited from the newly formed CS Group, as Starling Co itself had a strong brand name in the pottery market. The CS Group has a history of steady profitability and stable management.

Crow Co and Starling Co have a financial year ending 31 July 2012, and your firm has audited both companies for several years.

(a) You have received an email from Jo Daw, the audit engagement partner:

To: Audit manager

Hello

I have just been to a meeting with Steve Eagle, the finance director of the CS Group. We were discussing recent events which will have a bearing on our forthcoming audit, and my notes from the meeting are attached to this email. One of the issues discussed is the change in group structure due to the acquisition of Canary Co earlier this year.

Our firm has been appointed as auditor of Canary Co, which has a year ending 30 June 2012, and the terms of the engagement have been agreed with the client. We need to start planning the audits of the three components of the Group, and of the consolidated financial statements.

Using the attached information, you are required to:

(i) Identify and explain the implications of the acquisition of Canary Co for the audit planning of the individual and consolidated financial statements of the CS Group; (8 marks)

(ii) Evaluate the risks of material misstatement to be considered in the audit planning of the individual and consolidated financial statements of the CS Group; and (18 marks)

(iii) Recommend the principal audit procedures to be performed in respect of the goodwill initially recognised on the acquisition of Canary Co. (5 marks)

Thank you.

Acquisition of Canary Co

The most significant event for the CS Group this year was the acquisition of Canary Co, which took place on 1 February 2012. Crow Co purchased all of Canary Co’s equity shares for cash consideration of $125 million, and further contingent consideration of $30 million will be paid on the third anniversary of the acquisition, if the Group’s revenue grows by at least 8% per annum.

Crow Co engaged an external provider to perform due diligence on Canary Co, whose report indicated that the fair value of Canary Co’s net assets was estimated to be $110 million at the date of acquisition. Goodwill arising on the acquisition has been calculated as follows:

To help finance the acquisition, Crow Co issued loan stock at par on 31 January 2012, raising cash of $100 million. The loan has a five-year term, and will be repaid at a premium of $20 million. 5% interest is payable annually in arrears. It is Group accounting policy to recognise financial liabilities at amortised cost.

Canary Co manufactures pottery figurines and ornaments. The company is considered a good strategic fit to the Group, as its products are luxury items like those of Crow Co and Starling Co, and its acquisition will enable the Group to diversify into a different market.

Approximately 30% of its sales are made online, and it is hoped that online sales can soon be introduced for the rest of the Group’s products. Canary Co has only ever operated as a single company, so this is the first year that it is part of a group of companies.

Financial performance and position

The Group has performed well this year, with forecast consolidated revenue for the year to 31 July 2012 of $135 million (2011 – $125 million), and profit before tax of $8•5 million (2011 – $8•4 million). A breakdown of the Group’s forecast revenue and profit is shown below:

Note: Canary Co’s results have been included from 1 February 2012 (date of acquisition), and forecast up to 31 July 2012, the CS Group’s financial year end.

The forecast consolidated statement of financial position at 31 July 2012 recognises total assets of $550 million.

Other matters

Starling Co received a grant of $35 million on 1 March 2012 in relation to redevelopment of its main manufacturing site. The government is providing grants to companies for capital expenditure on environmentally friendly assets.

Starling Co has spent $25 million of the amount received on solar panels which generate electricity, and intends to spend the remaining $10 million on upgrading its production and packaging lines.

On 1 January 2012, a new IT system was introduced to Crow Co and Starling Co, with the aim of improving financial reporting controls and to standardise processes across the two companies. Unfortunately, Starling Co’s finance director left the company last week.

Required:

Respond to the email from the partner.

(b) Magpie & Co’s ethics partner, Robin Finch, leaves a note on your desk:

‘I have just had a conversation with Steve Eagle concerning the CS Group. He would like the audit engagement partner to attend the CS Group’s board meetings on a monthly basis so that our firm can be made aware of any issues relating to the audit as soon as possible.

Also, Steve asked if one of our audit managers could be seconded to Starling Co in temporary replacement of its finance director who recently left, and asked for our help in recruiting a permanent replacement. Please provide me with a response to Steve which evaluates the ethical implications of his requests.’

Required:

Respond to the note from the partner. (6 marks)

You are the manager responsible for the audit of the Nassau Group, which comprises a parent company and six subsidiaries. The audit of all individual companies’ financial statements is almost complete, and you are currently carrying out the audit of the consolidated financial statements.

A trainee accountant, Jo Castries, is assigned to your audit team. This is the first group audit that Jo has worked on. Jo made the following comment regarding the group audit:

‘I understand that in a group audit engagement, one of the requirements is to design and perform audit procedures on the consolidation process. Please explain to me the principal audit procedures that are performed on the consolidation process.’

Required:

Respond to the trainee accountant’s question. (8 marks)

You are an audit manager in Ribi & Co, a firm of Chartered Certified Accountants. One of your audit clients Beeski Co provides satellite broadcasting services in a rapidly growing market.

In November 2005 Beeski purchased Xstatic Co, a competitor group of companies. Significant revenue, cost and capital expenditure synergies are expected as the operations of Beeski and Xstatic are being combined into one group of companies.

The following financial and operating information consolidates the results of the enlarged Beeski group:

In August 2006 Beeski purchased MTbox Co, a large cable communications provider in India, where your firm has no representation. The financial statements of MTbox for the year ending 30 September 2006 will continue to be audited by a local firm of Chartered Certified Accountants.

MTbox’s activities have not been reflected in the above estimated results of the group. Beeski is committed to introducing its corporate image into India.

In order to sustain growth, significant costs are expected to be incurred as operations are expanded, networks upgraded and new products and services introduced.

Required:

Explain what effect the acquisitions will have on the planning of Ribi & Co’s audit of the consolidated financial statements of Beeski Co for the year ending 30 September 2006. (10 marks)