ACCA AAA ^INT Syllabus D. Audit of Historical Financial Information - The work of component auditors - Past Papers ^{7 / 8}

You are a manager in Dando & Co, a firm of Chartered Certified Accountants responsible for the audit of the Adams Group. Your firm was appointed as auditor in January 2014, and the audit engagement partner, Joss Dylan, has sent you the following email:

To: Audit manager
From: Joss Dylan
Regarding: Adams Group audit planning

Hello
I need you to begin planning the audit of the Adams Group (the Group). As you know, we have been appointed to audit the Group financial statements, and we have also been appointed to audit the financial statements of the parent company and of all subsidiaries of the Group except for an overseas subsidiary, Lynott Co, which is audited by a local firm, Clapton & Co. All components of the Group have the same year end of 31 May, report under IFRS and in the same currency.

I have provided you with some information about the Group’s general background and activities, and extracts from the draft financial statements. Using this information, you are required to:

b) Explain the matters to be considered, and the procedures to be performed, in respect of planning to use the work of Clapton & Co. (8 marks)

Please present your response as briefing notes for my attention.

Thank you

Attachment:

Background and structure of the Adams Group

The Group operates in the textile industry, buying cotton, silk and other raw materials to manufacture a range of goods including clothing, linen and soft furnishings. Goods are sold under the Adams brand name, which was acquired by Adams Co many years ago and is held at its original cost in the Group statement of financial position. The Group structure and information about each of the components of the Group is shown below:

Ross Co, Lynott Co and Beard Co are all wholly owned, acquired subsidiaries which manufacture different textiles. Adams Co also owns 25% of Stewart Co, a company which is classified as an associate in the Group statement of financial position at a value of $12 million at 31 May 2014. The shares in Stewart Co were acquired in January 2014 for consideration of $11·5 million. Other than this recent investment in Stewart Co, the Group structure has remained unchanged for many years.

Information relevant to each of the subsidiaries:

Ross Co manufactures luxury silk clothing, with almost all of its output sold through approximately 200 department stores. Ross Co’s draft statement of financial position recognises assets of $21·5 million at 31 May 2014. Any silk clothing which has not been sold within 12 months is transferred to Lynott Co, where the silk material is recycled in its manufacturing process.

Lynott Co is located overseas, where it can benefit from low cost labour in its factories. It produces low price fashion clothing for the mass market. A new inventory system was introduced in December 2013 in order to introduce stronger controls over the movement of inventory between factories and stores. Lynott Co is audited by Clapton & Co, and its audit reports in all previous years have been unmodified. Clapton & Co is a small accounting and audit firm, but is a member of an international network of firms. Lynott Co’s draft statement of financial position recognises assets of $24 million at 31 May 2014.

Beard Co manufactures soft furnishings. The company is cash-rich, and surplus cash is invested in a large portfolio of investment properties, which generate rental income. The Group’s accounting policy is to measure investment properties at fair value. Beard Co’s draft statement of financial position recognises assets of $28 million at 31 May 2014, of which investment properties represent $10 million.

Other information:

As part of management’s strategy to increase market share, a bonus scheme has been put in place across the Group under which senior managers will receive a bonus based on an increase in revenue. Adams Co imposes an annual management charge of $800,000 on each of its subsidiaries, with the charge for each financial year payable in the subsequent August.

Extracts from draft Group consolidated financial statements

Required:

Respond to the email from the audit partner. (31 marks)

Note: The split of the mark allocation is shown within the partner’s email. Professional marks will be awarded for the presentation, logical flow and clarity of explanation of the briefing notes. (4 marks) (35 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.

One of the subsidiaries, Exuma Co, is audited by another firm, Jalousie & Co. Your firm has fulfilled the necessary requirements of ISA 600 Special Considerations – Audits of Group Financial Statements (Including the Work of Component Auditors) and is satisfied as to the competence and independence of Jalousie & Co.

You have received from Jalousie & Co the draft audit report on Exuma Co’s financial statements, an extract from which is shown below:

‘Basis for Qualified Opinion (extract)

The company is facing financial damages of $2 million in respect of an on-going court case, more fully explained in note 12 to the financial statements. Management has not recognised a provision but has disclosed the situation as a contingent liability. Under International Financial Reporting Standards, a provision should be made if there is an obligation as a result of a past event, a probable outflow of economic benefit, and a reliable estimate can be made.

Audit evidence concludes that these criteria have been met, and it is our opinion that a provision of $2 million should be recognised. Accordingly, net profit and shareholders’ equity would have been reduced by $2 million if the provision had been recognised.

Qualified Opinion (extract)

In our opinion, except for effects of the matter described in the Basis for Qualified Opinion paragraph, the financial statements give a true and fair view of the financial position of Exuma Co as at 31 March 2011...’

An extract of Note 12 to Exuma Co’s financial statements is shown below:

Note 12 (extract)

The company is the subject of a court case concerning an alleged breach of planning regulations. The plaintiff is claiming compensation of $2 million. The management of Exuma Co, after seeking legal advice, believe that there is only a 20% chance of a successful claim being made against the company.

Figures extracted from the draft financial statements for the year ending 31 March 2011 are as follows:

Required:

Identify and explain the matters that should be considered, and actions that should be taken by the group audit engagement team, in forming an opinion on the consolidated financial statements of the Nassau Group. (10 marks)

You are a senior audit manager in Vegas & Co, responsible for the audit of the Grissom Group, which has been an audit client for several years. The group companies all have a financial year ending 30 June 2010, and you are currently planning the final audit of the consolidated financial statements.

The group’s operations focus on the manufacture and marketing of confectionery and savoury snacks. Information about several matters relevant to the group audit is given below. These matters are all potentially material to the consolidated financial statements. None of the companies in the group are listed.

Grissom Co

This is a non-trading parent company, which wholly owns three subsidiaries – Willows Co, Hodges Co and Brass Co, all of which are involved with the core manufacturing and marketing operations of the group. This year, the directors decided to diversify the group’s activities in order to reduce risk exposure.

Non-controlling interests representing long-term investments have been made in two companies – an internet-based travel agent, and a chain of pet shops. In the consolidated statement of financial position, these investments are accounted for as associates, as Grissom Co is able to exert significant influence over the companies.

As part of their remuneration, the directors of Grissom Co receive a bonus based on the profit before tax of the group. In April 2010, the group finance director resigned from office after a disagreement with the chief executive officer over changes to accounting estimates. A new group finance director is yet to be appointed.

Willows Co

This company manufactures and distributes chocolate bars and cakes. In July 2009, production was relocated to a new, very large factory. One of the conditions of the planning permission for the new factory is that Willows Co must, at the end of the useful life of the factory, dismantle the premises and repair any environmental damage caused to the land on which it is situated.

Hodges Co

This company’s operations involve the manufacture and distribution of packaged nuts and dried fruit. The government paid a grant in November 2009 to Hodges Co, to assist with costs associated with installing new, environmentally friendly, packing lines in its factories. The packing lines must reduce energy use by 25% as part of the conditions of the grant, and they began operating in February 2010.

Brass Co

This company is a new and significant acquisition, purchased in January 2010. It is located overseas, in Chocland, a developing country, and has been purchased to supply cocoa beans, a major ingredient for the goods produced by Willows Co. It is now supplying approximately half of the ingredients used in Willow Co’s manufacturing.

Chocland has not adopted International Financial Reporting Standards, meaning that Brass Co’s financial statements are prepared using local accounting rules. The company uses local currency to measure and present its financial statements.

Further information

Your fi rm audits all components of the group with the exception of Brass Co, which is audited by a small local fi rm, Sidle & Co, based in Chocland. Audit regulations in Chocland are not based on International Standards on Auditing.

Required:

Explain the factors that should be considered, and the procedures that should be performed, in deciding the extent of reliance to be placed on the work of Sidle & Co. (8 marks)