AUDIT AND ASSURANCE WEEK 11 QUESTION TOPIC: AUDIT REPORT QUESTION 1 You are a manager in the audit department of Nidge & Co, a firm of Chartered Certified Accountants, responsible for the audit of Darren Co, a new audit client operating in the construction industry. Darren Co s financial year ended on 31 January 2015, and the draft financial statements recognize profit before tax of $22 5 million (2014 $20 million) and total assets of $370 million, including cash of $3 million. The company typically works on three construction contracts at a time. The audit is nearly complete and you are reviewing the audit working papers. The audit senior has brought several matters to your attention: (a) Darren Co is working on a major contract relating to the construction of a bridge for Flyover Co. Work started in July 2014, and it is estimated that the contract will be completed in September 2015. The contract price is $20 million, and it is estimated that a profit of $5 million will be made on completion of the contract. The full amount of this profit has been included in the statement of profit or loss for the year ended 31 January 2015.Darren Co s management believes that this accounting treatment is appropriate given that the contract was signed during the financial year, and no problems have arisen in the work carried out so far. (b) A significant contract was completed in September 2014 for Newbuild Co. This contract related to the construction of a 20- mile highway in a remote area. In November 2014, several large cracks appeared in the road surface after a period of unusually heavy rain, and the road had to be shut for ten weeks while repair work was carried out. New build Co paid for these repairs, but has taken legal action against Darren Co to recover the costs incurred of $40 million. Disclosure on this matter has been made in the notes to the financial statements. Audit evidence, including a written statement from Darren Co s lawyers, concludes that there is a possibility, but not a probability, of Darren Co having to settle the amount claimed. STARRY GOLD ACADEMY +2348023428420, +2347038174484, info@starrygoldacademy.com, www.starrygoldacademy.com Page 1
(c) For the first time this year, the financial statements are presented as part of an integrated report. Included in the integrated report are several key performance indicators, one of which states that Darren Co s profit before tax has increased by 20% from the previous year. Discuss the implications of the matters described above on the completion of the audit and on the auditor s report, recommending any further actions which should be taken by the auditor. (d) Write briefly on what you understand by the word AUDIT REPORT and make references on the following terminologies under it, (i)meaning (ii)types (iii)opinion (iv)element of Auditor report. (v)qualified and Unqualified report. (vi)reasons for a Qualification. (vii)subsequent event. (viii)materiality. STARRY GOLD ACADEMY +2348023428420, +2347038174484, info@starrygoldacademy.com, www.starrygoldacademy.com Page 2
QUESTION 2 You are an audit senior of Scarlet & Co and are in the process of reviewing the systems testing completed on the payroll cycle of Bronze Industries Co (Bronze), as well as preparing the audit programmes for the final audit. Bronze operate several chemical processing factories across the country, it manufactures 24 hours a day, seven days a week and employees work a standard shift of eight hours and are paid for hours worked at an hourly rate. Factory employees are paid weekly, with approximately 80% being paid by bank transfer and 20% in cash; the different payment methods are due to employee preferences and Bronze has no plans to change these methods. The administration and sales teams are paid monthly by bank transfer. Factory staff are each issued a sequentially numbered clock card which details their employee number and name. Employees swipe their cards at the beginning and end of the eight-hour shift and this process is not supervised. During the shift employees are entitled to a 30-minute paid break and employees do not need to clock out to access the dining area. Clock card data links into the payroll system, which automatically calculates gross and net pay along with any statutory deductions. The payroll supervisor for each payment run checks on a sample basis some of these calculations to ensure the system is operating effectively. Bronze has a human resources department which is responsible for setting up new permanent employees and leavers. Appointments of temporary staff are made by factory production supervisors. Occasionally overtime is required of factory staff, usually to fill gaps caused by staff holidays. Overtime reports which detail the amount of overtime worked are sent out quarterly by the payroll department to production supervisors for their review. To encourage staff to attend work on time for all shifts Bronze pays a discretionary bonus every six months to factory staff; the production supervisors determine the amounts to be paid. This is communicated in writing by the production supervisors to the payroll department and the bonus is input by a clerk into the system. For employees paid by bank transfer, the payroll manager reviews the list of the payments and agrees to the payroll records prior to authorizing the bank payment. If any changes are required, the payroll manager amends the records. For employees paid in cash, the pay packets are prepared in the payroll department and a clerk distributes them to employees; as she knows most of these individuals she does not require proof of identity. (a) Identify and explain FIVE internal control STRENGTHS in Bronze Industries Co s payroll system. (B) Describe substantive ANALYTICAL PROCEDURES you should perform to confirm Bronze Industries Co s payroll expense. STARRY GOLD ACADEMY +2348023428420, +2347038174484, info@starrygoldacademy.com, www.starrygoldacademy.com Page 3
QUESTION 3 (a) 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. (i) Comment on the actions that should be taken by the auditor, and the implications for the auditor s report; and (ii) Discuss the quality control procedures that should be carried out by the audit firm prior to the audit report being issued. (b) You are also responsible for the audit of Squire Co, a listed company, and you are completing the review of its interim financial statements for the six months ended 31 October 2012. Squire Co is a car manufacturer, and historically has offered a three-year warranty on cars sold. The financial statements for the year ended 30 April 2012 included a warranty provision of $1 5 million and recognized total assets of $27 5 million. You are aware that on 1 July 2012, due to cost cutting measures, Squire Co stopped offering warranties on cars sold. The interim financial statements for the six months ended 31 October 2012 do not recognize any warranty provision. Total assets are $30 million at 31 October 2012. Assess the matters that should be considered in forming a conclusion on Squire Co s interim financial statements, and the implications for the review report. STARRY GOLD ACADEMY +2348023428420, +2347038174484, info@starrygoldacademy.com, www.starrygoldacademy.com Page 4
QUESTION 4 Clarinet Co (Clarinet) is a computer hardware specialist and has been trading for over five years. The company is funded partly through overdrafts and loans and also by several large shareholders; the year end is 30 April 2014. Clarinet has experienced significant growth in previous years; however, in the current year a new competitor, Drums Design Co (Drums), has entered the market and through competitive pricing has gained considerable market share from Clarinet. One of Clarinet s larger customers has stopped trading with them and has moved its business to Drums. In addition, a number of Clarinet s specialist developers have left the company and joined Drums. Clarinet has found it difficult to replace these employees due to the level of their skills and knowledge. Clarinet has just received notification that its main supplier who provides the company with specialist electrical equipment has ceased to trade. Clarinet is looking to develop new products to differentiate itself from the rest of its competitors. It has approached its shareholders to finance this development; however, they declined to invest further in Clarinet. Clarinet s loan is long term and it has met all repayments on time. The overdraft has increased significantly over the year and the directors have informed you that the overdraft facility is due for renewal next month, and they are confident it will be renewed. The directors have produced a cash flow forecast which shows a significantly worsening position over the coming 12 months. They are confident with the new products being developed, and in light of their trading history of significant growth, believe it is unnecessary to make any disclosures in the financial statements regarding going concern. At the year end, Clarinet received notification from one of its customers that the hardware installed by Clarinet for the customers online ordering system has not been operating correctly. As a result, the customer has lost significant revenue and has informed Clarinet that they intend to take legal action against them for loss of earnings. Clarinet has investigated the problem post year end and discovered that other work-in-progress is similarly affected and inventory should be written down. The finance director believes that as this misstatement was identified after the year end, it can be amended in the 2015 financial statements. (a) Describe the procedures the auditors of Clarinet Co should undertake in relation to the uncorrected inventory misstatement identified above. (b) Explain SIX potential indicators that Clarinet Co is not a going concern. (c) Describe the audit procedures which you should perform in assessing whether or not Clarinet Co is a going concern. STARRY GOLD ACADEMY +2348023428420, +2347038174484, info@starrygoldacademy.com, www.starrygoldacademy.com Page 5
(d) The auditors have been informed that Clarinet 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 some going concern disclosures. Describe the impact on the audit report of Clarinet Co if the auditor believes the company is a going concern but that this is subject to a material uncertainty. STARRY GOLD ACADEMY +2348023428420, +2347038174484, info@starrygoldacademy.com, www.starrygoldacademy.com Page 6
QUESTION 5 Mercury Motoring Co (Mercury) specializes in manufacturing engine parts for motor cars and the company has a diverse customer base but seven significant customers. The company s year-end was 30 September 2015.During the year, a number of the company s significant customers have experienced a fall in sales, and consequently they have purchased fewer items from Mercury. As a result, Mercury has paid a number of its suppliers later than usual and some of them have withdrawn credit terms meaning the company must pay cash on delivery. One of Mercury s main suppliers is threatening legal action to recover the sums owing. As a result of the increased level of payables, the company s current ratio has fallen below 1 to 0 9 for the first time. Mercury has produced a cash flow forecast to 30 June 2016 and this shows net cash outflows until May 2016.Mercury has a loan of $2 3 million which is due for repayment in full by 30 September 2016.The finance director has just informed the audit manager that there is a possible change in legislation which will result in one of Mercury s top product lines becoming obsolete as it will not comply with the proposed law. The prepared cash flow forecasts do not reflect this possible event. (a) Explain FIVE potential indicators that Mercury Motoring Co is NOT a going concern. (b) Describe the audit procedures which you should perform in assessing whether or not Mercury Motoring Co is a going concern. STARRY GOLD ACADEMY +2348023428420, +2347038174484, info@starrygoldacademy.com, www.starrygoldacademy.com Page 7