ACCA AAA ^INT Syllabus E. Completion, Review and Reporting - Audit Opinion - Past Papers ^{2 / 5}

(b) You are responsible for the audit of Basking Co, a large, listed package delivery company. The audit of the financial statements for the year ended 31 July 2017 is nearly complete and you are reviewing the audit working papers. The financial statements recognise revenue of $56,360 million (2016 – $56,245 million), profit for the year of $2,550 million (2016 – $2,630 million) and total assets of $37,546 million (2016 – $38,765 million).

The uncorrected misstatements identified during the audit of Basking Co are described below. The audit engagement partner is holding a meeting with the management team of Basking Co next week, at which the uncorrected misstatements will be discussed.

(1) The accuracy of the depreciation charge was investigated for a sample of motor vehicles with a carrying value of $4·5 million. The investigation revealed that the accounting system had failed to correctly depreciate vehicles acquired during the year. Consequently, depreciation in the sample had been understated, and the carrying value of the vehicles overstated, by $350,000. The total value of all motor vehicles at the year end was $125 million (2016 – $131 million).

(2) In January 2017, the board of Basking Co approved a loan to, Mrs C Angel, who is a key member of the senior management team of the company. The total amount of the loan was $75,000. Following a review of the board minutes, it was discovered that the directors agreed that the amount was clearly trivial and have, therefore, not disclosed the loan in the notes to the financial statements.

(3) During the year Basking Co reduced the value of their provision for customer refunds which is recognised in the financial statements. For the past five years the value of the provision has been calculated based on 7% of one month’s sales, using an average monthly sales value. Management argued that due to improved internal processing systems, such a high rate of provision was no longer necessary and reduced it to 4%. Audit procedures found that refund levels were similar to previous years and there was insufficient evidence at this early stage to confirm whether the new system was more effective or not.

Required:
For each of the matters described above:

(ii) Assuming that management does not adjust the misstatements identified, evaluate the effect of each on the audit opinion.

Note: The total marks will be split equally between each matter. (15 marks)

You are the manager responsible for the audit of Boston Co, a producer of chocolate and confectionery. The audit of the financial statements for the year ended 31 December 2015 is nearly complete and you are reviewing the audit working papers. The financial statements recognise revenue of $76 million, profit before tax for the year of $6·4 million and total assets of $104 million.

The summary of uncorrected misstatements included in Boston Co’s audit working papers, including notes, is shown below. The audit engagement partner is holding a meeting with the management team of Boston Co next week, at which the uncorrected misstatements will be discussed.

(i) During the year Boston Co impaired one of its factories. The carrying value of the assets attributable to the factory as a single, cash-generating unit totalled $3·6 million at the year end. The fair value less costs of disposal and the value in use were estimated to be $3 million and $3·5 million respectively and accordingly the asset was written down by $100,000 to reflect the impairment. Audit procedures revealed that management used growth rates attributable to the company as a whole to estimate value in use. Using growth rates attributable to the factory specifically, the audit team estimated the value in use to be $3·1 million.

(ii) Interest charges of $75,000 relating to a loan taken out during the year to finance the construction of a new manufacturing plant were included in finance charges recognised in profit for the year. The manufacturing plant is due for completion in November 2016.

(iii) One of Boston Co’s largest customers, Cleveland Co, is experiencing financial difficulties. At the year end Cleveland Co owed Boston Co $100,000, against which Boston Co made a 5% specific allowance. Shortly after the year end Cleveland Co paid $30,000 of the outstanding amount due but has since experienced further problems, leading to their primary lender presenting a formal request that Cleveland Co be liquidated. If successful, only secured creditors are likely to receive any reimbursement.

(iv) During the year Boston Co purchased 150,000 shares in Nebraska Co for $4·00 per share. Boston Co classified the investment as a financial asset held at fair value through profit or loss. On 31 December 2015, the shares of Nebraska Co were trading for $4·29. At the year end the carrying value of the investment in Boston Co’s financial statements was $600,000.

Required:
(b) Assuming that management does not adjust any of the misstatements, discuss the effect on the audit opinion and auditor’s report.

The following mark allocation is provided as guidance for this question:
(a) 14 marks
(b) 6 marks

(b) The audit of the new subsidiary, Seurat Sweeteners Co, was performed by a different firm of auditors, Fish Associates. During your review of the communication from Fish Associates, you note that they were unable to obtain sufficient appropriate evidence with regard to the breakdown of research expenses. The total of research costs expensed by Seurat Sweeteners Co during the year was $1·2 million. Fish Associates has issued a qualified audit opinion on the financial statements of Seurat Sweeteners Co due to this inability to obtain sufficient appropriate evidence.

Required:
Comment on the actions which Rockwell & Co should take as the auditor of the Hopper Group, and the implications for the auditor’s report on the Hopper Group financial statements. (6 marks)

You are an audit manager in Taylor & Co, a firm of Chartered Certified Accountants, responsible for the audit of Marr Co, with a year ended 28 February 2014. The draft financial statements recognise profit for the year of $11 million. The audit for the year end is nearing completion, and several matters have been highlighted for your attention by the audit senior, Xi Smith. The matters have been discussed with management and will not be adjusted in the financial statements:

1. In January 2014 a major customer went into administration. There was a balance of $2•5 million owing to Marr Co from this customer at 28 February 2014, which is still included in trade receivables.

2. A court case began in December 2013 involving an ex-employee who is suing Marr Co for unfair dismissal. Lawyers estimate that damages of $50,000 are probable to be paid. The financial statements include a note describing the court case and quantifying the potential damages but no adjustment has been made to include it in the statement of financial position or the statement of profit or loss.

Xi Smith has produced a draft audit report for your review, an extract of which is shown below:

Basis for opinion and disclaimer of opinion

We have performed our audit based on a materiality level of $1•5 million. Our audit procedures have proven conclusively that trade receivables are materially misstated. The finance director of Marr Co, Rita Gilmour, has refused to make an adjustment to write off a significant trade receivables balance. Therefore in our opinion the financial statements of Marr Co are materially misstated and we therefore express a disclaimer of opinion because we do not think they are fairly presented.

Emphasis of Matter paragraph

Marr Co is facing a legal claim for an amount of $50,000 from an ex-employee. In our opinion this amount should be recognised as a provision but it is not included in the statement of financial position. We draw your attention to this breach of the relevant IFRS.

Required:
Critically appraise the proposed auditor’s report of Marr Co for the year ended 28 February 2014.

Note: You are NOT required to re-draft the extracts from the auditor’s report. (12 marks)

You are an audit manager in Taylor & Co, a firm of Chartered Certified Accountants, responsible for the audit of Marr Co, with a year ended 28 February 2014. The draft financial statements recognise profit for the year of $11 million. The audit for the year end is nearing completion, and several matters have been highlighted for your attention by the audit senior, Xi Smith. The matters have been discussed with management and will not be adjusted in the financial statements:

1. In January 2014 a major customer went into administration. There was a balance of $2•5 million owing to Marr Co from this customer at 28 February 2014, which is still included in trade receivables.

2. A court case began in December 2013 involving an ex-employee who is suing Marr Co for unfair dismissal. Lawyers estimate that damages of $50,000 are probable to be paid. The financial statements include a note describing the court case and quantifying the potential damages but no adjustment has been made to include it in the statement of financial position or the statement of profit or loss.

Xi Smith has produced a draft audit report for your review, an extract of which is shown below:

Basis for opinion and disclaimer of opinion

We have performed our audit based on a materiality level of $1•5 million. Our audit procedures have proven conclusively that trade receivables are materially misstated. The finance director of Marr Co, Rita Gilmour, has refused to make an adjustment to write off a significant trade receivables balance. Therefore in our opinion the financial statements of Marr Co are materially misstated and we therefore express a disclaimer of opinion because we do not think they are fairly presented.

Emphasis of Matter paragraph

Marr Co is facing a legal claim for an amount of $50,000 from an ex-employee. In our opinion this amount should be recognised as a provision but it is not included in the statement of financial position. We draw your attention to this breach of the relevant IFRS.

Required:
Critically appraise the proposed auditor’s report of Marr Co for the year ended 28 February 2014.

Note: You are NOT required to re-draft the extracts from the auditor’s report. (12 marks)

You are the manager responsible for the audit of Dylan Co, a listed company, and you are reviewing the working papers of the audit file for the year ended 30 September 2012. The audit senior has left a note for your attention:

‘Dylan Co outsources its entire payroll, invoicing and credit control functions to Hendrix Co. In August 2012, Hendrix Co suffered a computer virus attack on its operating system, resulting in the destruction of its accounting records, including those relating to Dylan Co.

We have therefore been unable to perform the planned audit procedures on payroll, revenue and receivables, all of which are material to the financial statements. Hendrix Co has manually reconstructed the relevant figures as far as possible, and has supplied a written statement to confirm that they are as accurate as possible, given the loss of accounting records.’

Required:

Comment on the actions that should be taken by the auditor, and the implications for the auditor’s report (7 marks)

You are the partner responsible for performing an engagement quality control review on the audit of Snipe Co. You are currently reviewing the audit working papers and draft audit report on the financial statements of Snipe Co for the year ended 31 January 2012. The draft financial statements recognise revenue of $8•5 million, profit before tax of $1 million, and total assets of $175 million.

Snipe Co has in place a defined benefit pension plan for its employees. An actuarial valuation on 31 January 2012 indicated that the plan is in deficit by $10•5 million. The deficit is not recognised in the statement of financial position. An extract from the draft audit report is given below:

Auditor’s opinion

In our opinion, because of the significance of the matter discussed below, the financial statements do not give a true and fair view of the financial position of Snipe Co as at 31 January 2012, and of its financial performance and cash flows for the year then ended in accordance with International Financial Reporting Standards.

Explanation of adverse opinion in relation to pension

The financial statements do not include the company’s pension plan. This deliberate omission contravenes accepted accounting practice and means that the accounts are not properly prepared. 

Required:

Critically appraise the extract from the proposed audit report of Snipe Co for the year ended 31 January 2012.

Note: you are NOT required to re-draft the extract of the audit report. (7 marks)

You are the manager responsible for the audit of Yew Co, a company which designs and develops aircraft engines.

The audit for the year ended 31 July 2011 is nearing completion and the audit senior has left the following file note for your attention:

‘I have just returned from a meeting with the management of Yew Co, and there is a matter I want to bring to your attention. Yew Co’s statement of financial position recognises an intangible asset of $12•5 million in respect of capitalised research and development costs relating to new aircraft engine designs.

However, market research conducted by Yew Co in relation to these new designs indicated that there would be little demand in the near future for such designs. Management has provided written representation that they agree with the results of the market research.

Currently, Yew Co has a cash balance of only $125,000 and members of the management team have expressed concerns that the company is finding it difficult to raise additional finance.

The new aircraft designs have been discussed in the chairman’s statement which is to be published with the financial statements. The discussion states that ‘developments of new engine designs are underway, and we believe that these new designs will become a significant source of income for Yew Co in the next 12 months.’

Yew Co’s draft financial statements include profit before tax of $23 million, and total assets of $210 million.

Yew Co is due to publish its annual report next week, so we need to consider the impact of this matter urgently.’

Required:

You are responsible for answering technical queries from other managers and partners of your firm. An audit partner left the following note on your desk this morning:

(ii) ‘We are auditing Sycamore Co for the first time. The prior period financial statements were audited by another firm. We are aware that the auditor’s report on the prior period was qualified due to a material misstatement of trade receivables. We have obtained sufficient appropriate evidence that the matter giving rise to the misstatement has been resolved and I am happy to issue an unmodified opinion. But should I refer to the prior year modification in this year’s auditor’s report?’

Required:

Respond to the audit partner’s comments. (3 marks)

You are the manager responsible for the audit of Willis Co, a large client of your audit firm, operating in the pharmaceutical industry. The audit work for the year ended 30 August 2010 is nearly complete, and you are reviewing the draft audit report which has been prepared by the audit senior.

You are aware that Willis Co is developing a new drug and has incurred significant research and development costs during the year, most of which have been capitalised as an intangible asset. The asset is recognised at a value of $4•4 million, the total assets recognised on the draft statement of financial position are $55 million, and Willis Co has a draft profit before tax of $3•1 million.

Having reviewed the audit working papers, you are also aware that management has not allowed the audit team access to the results of scientific tests and trials performed on the new drug being developed.

An extract from the draft audit report is shown below.

Basis of opinion (extract)

Evidence available to us in respect of the intangible asset capitalised was limited, because of restrictions imposed on our work by management. As a result of this we have been unable to verify the appropriateness of the amount capitalised, and we are worried that the asset may be overvalued. Because of the significance of the item, and the lack of integrity shown by management, we have been unable to form a view on the financial statements as a whole.

Opinion (extract): Disclaimer on view given by financial statements

Because of the lack of evidence that we could gain over the intangible asset, we are unable to form an opinion as to whether the financial statements are properly prepared in accordance with the relevant financial reporting framework.

Required:

(i) Critically appraise the draft audit report of Willis Co for the year ended 30 August 2010, prepared by the audit senior;

Note: You are NOT required to re-draft the extracts from the audit report. (10 marks)

(ii) Identify and explain any other matters to be considered, and the actions to be taken by the auditor, in respect of the management-imposed limitation on scope. (5 marks)

You are the manager responsible for four audit clients of Axis & Co, a firm of Chartered Certified Accountants. The year end in each case is 30 June 2006.

You are currently reviewing the audit working paper files and the audit seniors’ recommendations for the auditors’ reports. Details are as follows:

(a) Mantis Co is a subsidiary of Cube Co. Serious going concern problems have been noted during this year’s audit. Mantis will be unable to trade for the foreseeable future unless it continues to receive financial support from the parent company. Mantis has received a letter of support (‘comfort letter’) from Cube Co.

The audit senior has suggested that, due to the seriousness of the situation, the audit opinion must at least be qualified ‘except for’. (5 marks)

(b) Lorenze Co has changed its accounting policy for goodwill during the year from amortisation over its estimated useful life to annual impairment testing. No disclosure of this change has been given in the financial statements. The carrying amount of goodwill in the balance sheet as at 30 June 2006 is the same as at 30 June 2005 as management’s impairment test show that it is not impaired.

The audit senior has concluded that a qualification is not required but suggests that attention can be drawn to the change by way of an emphasis of matter paragraph. (6 marks)

(c) The directors’ report of Abrupt Co states that investment property rental forms a major part of revenue. However, a note to the financial statements shows that property rental represents only 1•6% of total revenue for the year. The audit senior is satisfied that the revenue figures are correct.

The audit senior has noted that an unqualified opinion should be given as the audit opinion does not extend to the directors’ report. (4 marks)

(d) Audit work on the after-date bank transactions of Jingle Co has identified a transfer of cash from Bell Co. The audit senior assigned to the audit of Jingle has documented that Jingle’s finance director explained that Bell commenced trading on 7 July 2006, after being set up as a wholly-owned foreign subsidiary of Jingle.

The audit senior has noted that although no other evidence has been obtained an unmodified opinion is appropriate because the matter does not impact on the current year’s financial statements. (5 marks)

Required:

For each situation, comment on the suitability or otherwise of the audit senior’s proposals for the auditors’ reports. Where you disagree, indicate what audit modification (if any) should be given instead.

Note: The mark allocation is shown against each of the four issues.  (20 marks)