ACCA AAA ^INT Syllabus D. Audit of Historical Financial Information - Auditing Provisions - Past Papers ^{21 / 41}

You are a manager in Foo & Co, responsible for the audit of Grohl Co, a company which produces circuit boards which are sold to manufacturers of electrical equipment such as computers and mobile phones. It is the first time that you have managed this audit client, taking over from the previous audit manager, Bob Halen, last month.

The audit planning for the year ended 30 November 2012 is about to commence, and you have just received an email from Mia Vai, the audit engagement partner.

To: Audit manager
From: Mia Vai, Audit partner, Foo & Co
Subject: Grohl Co – audit planning

Hello

I am meeting with the other audit partners tomorrow to discuss forthcoming audits and related issues. I understand that you recently had a meeting with Mo Satriani, the finance director of Grohl Co. Using the information from your meeting, I would like you to prepare briefing notes for my use in which you:

Discuss any ethical issues raised, and recommend the relevant actions to be taken by our firm.
(8 marks)

Thank you.

Comments made by Mo Satriani in your meeting

Business overview

Grohl Co’s principal business activity remains the production of circuit boards. One of the key materials used in production is copper wiring, all of which is imported. As a cost cutting measure, in April 2012 a contract with a new overseas supplier was signed, and all of the company’s copper wiring is now supplied under this contract. Purchases are denominated in a foreign currency, but the company does not use forward exchange contracts in relation to its imports of copper wiring.

Grohl Co has two production facilities, one of which produces goods for the export market, and the other produces goods for the domestic market. About half of its goods are exported, but the export market is suffering due to competition from cheaper producers overseas. Most domestic sales are made under contract with approximately 20 customers.

Recent developments

In early November 2012, production was halted for a week at the production facility which supplies the domestic market. A number of customers had returned goods, claiming faults in the circuit boards supplied. On inspection, it was found that the copper used in the circuit boards was corroded and therefore unsuitable for use.

The corrosion is difficult to spot as it cannot be identified by eye, and relies on electrical testing. All customers were contacted immediately and, where necessary, products recalled and replaced. The corroded copper remaining in inventory has been identified and separated from the rest of the copper.

Work has recently started on a new production line which will ensure that Grohl Co meets new regulatory requirements prohibiting the use of certain chemicals, which come into force in March 2013.

In July 2012, a loan of $30 million with an interest rate of 4% was negotiated with Grohl Co’s bank, the main purpose of the loan being to fund the capital expenditure necessary for the new production line. $2•5 million of the loan represents an overdraft which was converted into long-term finance.

Other matters

Several of Grohl Co’s executive directors and the financial controller left in October 2012, to set up a company specialising in the recycling of old electronic equipment. This new company is not considered to be in competition with Grohl Co’s operations. The directors left on good terms, and replacements for the directors have been recruited.

One of Foo & Co’s audit managers, Bob Halen, is being interviewed for the role of financial controller at Grohl Co. Bob is a good candidate for the position, as he developed good knowledge of Grohl Co’s business when he was managing the audit.

At Grohl Co’s most recent board meeting, the audit fee was discussed. The board members expressed concern over the size of the audit fee, given the company’s loss for the year. The board members would like to know whether the audit can be performed on a contingent fee basis.

Financial Information provided by Mo Satriani

Extract from draft statement of comprehensive income for the year ended 30 November 2012

The draft statement of financial position has not yet been prepared, but Mo states that the total assets of Grohl Co at 30 November 2012 are $180 million, and cash at bank is $130,000. Based on draft figures, the company’s current ratio is 1•1, and the quick ratio is 0•8.

You have just received a phone call from Mo Satriani, Grohl Co’s finance director, in which he made the following comments:

‘There is something I forgot to mention in our meeting. Our business insurance covers us for specific occasions when business is interrupted. I put in a claim on 28 November 2012 for $5 million which I have estimated to cover the period when our production was halted due to the problem with the corroded copper. This is not yet recognised in the financial statements, but I want to make an adjustment to recognise the $5 million as a receivable as at 30 November.’

Required:

Comment on the matters that should be considered, and recommend the audit procedures to be performed, in respect of the insurance claim. (8 marks)

You are responsible for the audit of Osprey Co, which has a financial year ended 31 May 2012. The audit engagement partner, Bill Kingfisher, sent you the following email this morning:

To: Audit manager
From: Bill Kingfisher, audit engagement partner, Osprey Co
Regarding: Environmental incident

Hello

Osprey Co’s finance director called me yesterday to explain that unfortunately over the last few weeks, one of its four factories leaked a small amount of toxic chemicals into the atmosphere. The factory’s operations were halted immediately and a decision has been taken to permanently close the site.

Though this is a significant event for the company and will result in relocation and some restructuring of operations, it is not considered to be a threat to its going concern status. Costs of closure of the factory have been estimated to be $1•25 million, which is expected to be material to the financial statements, and a provision has been set up in respect of these costs.

Osprey Co is keen to highlight its previous excellent record on socio-environmental matters. Management is preparing a report to be published with the financial statements which will describe the commitment of the company to socio-environmental matters, and state its target of reducing environmental damage caused by its operations.

The report will contain a selection of targets and key performance indicators to show performance in areas such as energy use, water consumption and employee satisfaction. Our firm may be asked to provide an assurance report on the key performance indicators.

I am asking you to prepare briefing notes for my use in which you:

Recommend the principal audit procedures to be performed in respect of the costs of closure of the factory (6 marks)

Thank you.

Required:

Respond to the partner’s email

Clooney Co is one of the world’s leading leisure travel providers, operating under several brand names to sell package holidays. The company catered for more than 10 million customers in the last 12 months.

Draft figures for the year ended 30 September 2010 show revenue of $3,200 million, profit before tax of $150 million, and total assets of $4,100 million. Clooney Co’s executives earn a bonus based on the profit before tax of the company.

You are the manager responsible for the audit of Clooney Co. The final audit is nearing completion, and the following points have been noted by the audit senior for your attention:

In July 2010, thousands of holiday-makers were left stranded abroad after the company operating the main airline chartered by Clooney Co went into liquidation. The holiday-makers were forced to wait an average of two weeks before they could be returned home using an alternative airline.

They have formed a group which is claiming compensation for the time they were forced to spend abroad, with the total claim amounting to $20 million. The items which the group is claiming compensation for include accommodation and subsistence costs, lost income and distress caused by the situation.

The claim has not been recognised or disclosed in the draft financial statements, as management argues that the full amount payable will be covered by Clooney Co’s insurance.

One part of the company’s activities, operating under the Shelly’s Cruises brand, provides cruise holidays. Due to economic recession, the revenue of the Shelly’s Cruises business segment has fallen by 25% this year, and profit before tax has fallen by 35%.

Shelly’s Cruises contributed $640 million to total revenue in the year to 30 September 2010, and has identifiable assets of $235 million, including several large cruise liners. The Shelly’s Cruises brand is not recognised as an intangible asset, as it has been internally generated.

On 15 November 2010, Clooney Co acquired Craig Co, a company offering adventure holidays for independent travellers. Craig Co represents a significant acquisition, but this has not been referred to in the financial statements.

Required:

Comment on the matters that you should consider, and state the audit evidence you should expect to find in your review of the audit working papers for the year ended September 2010 in respect of the compensation claim. (8 marks)