Week 10 – Audit Reports
Assume you are an auditor and you are facing the following separate circumstances, the effects of all the items below are material:
1. The provision for stock is inadequate.
2. A retailer values inventory at sales price less an allowance for sales margin.
3. A manufacturing company is cu
ently negotiating with the bank an extension of a loan facility that is due for repayment shortly after the AGM; without this refinancing the business will not be able to continue operations.
4. A significant proportion of a retailer’s sales are on a cash basis and inadequate records have been maintained; there are no audit tests that can be done to satisfy yourself that the cash sales are accurate.
5. Management have excluded from the financial report the necessary disclosures in relation to a contingent liability.
6. The company that runs a dairy farm has prepared the financial report on a going concern basis; shortly after the year end the company’s contract with a major supermarket was cancelled. Without this customer you expect the business to cease trading within six months and it is unlikely that the company will be able to secure any new contracts in that time.
7. The directors of a construction company refuse to give you access to reports produced by an independent quantity surveyor in relation to the value of work done on some of their construction projects.
8. A wholesaler has a policy of including all of its buildings in the balance sheet at cost less depreciation. You establish that one of the warehouses included in the balance sheet at a value of $20m has an actual market value of $23m.
9. A client changes its method of accounting for the cost of inventories from FIFO to weighted average cost. The auditor agrees with the change, although it has a material effect on the financial report and has not been disclosed.
REQUIRED
Indicate the effect of the above circumstances on your auditor’s report if management were to refuse to make any changes you feel necessary in order that the financial report gives a true and fair view.
Solution
1. This is a disagreement with management. The audit report would be qualified if the issue is material but not extreme, or an adverse opinion in extreme cases.
2. This is an acceptable method of valuing inventory at cost and therefore an unmodified opinion can be given.
3. If the matter of loan negotiations is not adequately disclosed, then this constitutes a disagreement with management, and the report would be qualified or an adverse opinion, depending on the circumstances. If the matter of the loan negotiations is adequately disclosed, an emphasis of a matter is added.
4. This is a scope limitation. The audit report would be qualified or a disclaimer, depending on the circumstances.
5. This is a disagreement with management and a qualified opinion is necessary, refer to 1 above.
6. It appears that it is highly likely that the business will not continue to trade and therefore the financial report should not be prepared on a going concern basis; some alternative such as a
eak-up basis would be appropriate. This gives rise to an adverse audit opinion.
7. This is a scope limitation. Refer answer 4 above.
8. The policy is to include buildings at cost less depreciation and therefore the accounts do not need to be changed to include the market value of the property. An unmodified opinion is appropriate.
9. A qualified auditor’s opinion would be issued because of the disagreement with those charged with governance regarding the lack of disclosure of the change in accounting policy. The amount involved is material but not pervasive; therefore, a qualified rather than an adverse opinion will be issued.
Week 8 – Substantive Tests and related assertions
9.29 You are the audit senior at Chan & Associates and have been assigned to the audit of shareholders' equity of Galaxy Ltd (Galaxy), a large publicly listed company. Galaxy uses the services of an independent share registry office to maintain detailed records of their shareholders.
As part of your preliminary review you have discovered the following information:
· One month before year end, Galaxy made a large share issue, which was 80 % subscribed
· Prior to the new share issue, Galaxy declared a dividend to its existing shareholders. This dividend remains unpaid at year end.
REQUIRED
a) Explain the audit procedures that you would undertake in order to obtain sufficient appropriate audit evidence in respect of the share issue and dividend.
Solution:
9.29 Share issue
The key assertions are completeness of the account balance and the assertions about presentation and disclosure. Accounting standards require detailed disclosure of movements in share capital and the auditor must ensure that all relevant details have been disclosed. Procedures that could be used to obtain this information include:
· confirmation of details and subscription rates with the share registry service
· review of minutes of directors’ meetings with details of the share issue
· review of any prospectus issued in relation to the share issue.
Dividend payment
The key assertions are:
· Occu
ence – Dividends are paid to shareholders that exist
· Completeness – Dividends payable are recorded
· Accuracy – Dividends payable are accurately recorded
The amount of dividend due should be equal to the dividend declared per share multiplied by the number of shareholders entitled to the dividend. The auditor therefore needs evidence of the dividend declared and the number of shareholders.
· Evidence as to the rate of dividend can be obtained from a review of the minutes of directors meetings.
· Details of entitled shareholders could be obtained from the share registry service. The auditor might also confirm entitlement to the dividend by reviewing the memorandum and articles of incorporation.
Week 9 – Subsequent events/post-audit discovery of facts
The financial year of Hadrian Ltd ended on 30 June 2015. Your auditor’s report was signed on 25 August and the financial statements were issued on 10 September. Listed below are events that occu
ed or were discovered after the end of the financial year. Assume that each has a material effect on the financial statements.
1. 1 August — A lawsuit was filed against Hadrian for damages that allegedly occu
ed before 30 June. In the opinion of Hadrian’s lawyers, there is a danger of a significant loss.
2. 15 August — You discovered that MacTavish, a debtor of Hadrian went bankrupt on 10 August. The most recent sale had taken place on 25 May and no transactions had occu
ed since that date.
3. 17 August – Determination by the ATO of additional income tax due for a prior year.
4. 19 August - Filing of a Competition and Consumer Act 2010 action against the company.
5. 20 August - Declaration of a bonus issue of ordinary shares.
6. 23 August - Sale of a fixed asset at a substantial profit.
7. 1 September — You discovered that a legal action commenced against Hadrian in relation to a faulty product sold in May 2015.
8. 15 September — A fire burnt down one of Hadrian’s warehouses, resulting in a loss of 30% of the inventory that was on hand at that date.
9. 30 September — You discovered that Spo
an, a debtor of Hadrian, went bankrupt on 15 July. Sales to Spo
an were all made before the end of the year.
10. 30 September — You discovered that Haggis, a debtor of Hadrian, went bankrupt on 25 September. The sale had taken place before the end of the year, but the amount had appeared collectable at the date on which the auditor’s report was signed.
REQUIRED
(a) Indicate your responsibilities for each of the above events.
(b) Indicate the type of disclosure (if any) you would recommend in relation to each of the six events. You can choose from any of the following:
A. Adjust the financial statements
B. Disclose in the Notes to the Financial report
C. Request that the client recall the financial report for revision
D. No action is required
Solution:
1.
(a) The auditor has a responsibility for identifying and evaluating events up until the date of the audit report.
(b) This is a subsequent event that should be disclosed by way of a note to the financial report. It is an event that occu
ed before the end of the financial year, however it is disclosed by way of a note because the amount of the lawsuit is uncertain at the date of signing the audit report.
2.
(a) The auditor has a responsibility for identifying and evaluating events up until the date of the audit report.
(b) This is a subsequent event affecting the value of a debtor's balance at year-end that will require adjustment to the provision for doubtful debts (unless it has already been included).
3.
(a) This is a subsequent event occu
ing before the date of the audit report. The auditor has a responsibility for identifying and evaluating events up until the date of the audit report.
(b) An additional tax assessment could be uncovered by examining subsequent cash disbursements, review of the minutes of the board of directors or shareholders, examining internal revenue agent reports for all expenses not cleared by the ATO, requesting letters from lawyers near the end of the fieldwork, and through discussions with management.
The tax assessment should be accrued as a tax expense and a liability for the year under audit and clearly disclosed if the amount is material. If the tax assessment is accrued and adequately disclosed, no audit report modification is necessary, otherwise a qualified audit opinion should be issues if the matter is material.
4.
(a) This is a subsequent event occu
ing before the date of the audit report. The auditor has a responsibility for identifying and evaluating events up until the date of the audit report.
(b) The antitrust suit may have been uncovered through inquiries of the client, the management representation letter, or letters from the client’s legal counsel.
The antitrust suit should be disclosed in a footnote.
If the antitrust suit is appropriately disclosed then no modification is necessary, otherwise a qualified opinion should be issued.
5.
(a) This is a subsequent event occu
ing before the date of the audit report. The auditor has a responsibility for identifying and evaluating events up until the date of the audit report.
(b) The declaration of a share dividend subsequent to the balance sheet date could be uncovered by reading the minutes of the board of directors or shareholders subsequent to the balance sheet date, by confirmation with the independent share registrar, or through discussion with management.
The share dividend should be disclosed in a footnote, including the date of declaration, the percent of the share dividend and the effect on issued shares, capital share, paid-in capital and retained earnings.
No audit report modification is necessary, unless it is not disclosed in which case a qualified audit