- 20 Marks
AAA – L3 – Q58- Reporting
Question
Yams Co
The directors of Yams Co have decided that this year, motor vehicles should be depreciated on a reducing balance basis. Previously this has been done on a straight line basis. Profits have fallen by GH₵18,000 as a result.
Required:
Discuss the impact on the auditor’s report, considering materiality and compliance with relevant accounting standards.
Answer:
The relevant figure in terms of materiality is GH₵18,000. This represents 12% of profit before tax, which is above 5%, so the amount is material.
Depreciation of non-current assets is described in IAS 16. A change from one method of depreciation to another is permissible only on the grounds that the new method will give a fairer presentation of the results and of the financial position. Such a change does not, however, constitute a change of accounting policy (IAS 8); it is a change in accounting estimate.
In Yams Co there is nothing to suggest that such a change in accounting estimate is warranted. Furthermore, motor vehicles are a normal class of non-current asset, so it would be highly unusual to change the method of depreciation.
If the directors are unable to give a satisfactory explanation for the change, a modified audit opinion on the grounds of material misstatement would be appropriate. The qualification is only material (and not pervasive) and an ‘except for’ opinion is correct
(b) Plantain Co
A competitor of Plantain Co wrote a damaging article about one of its products. Having consulted its lawyers, Plantain Co has decided to take legal action and is suing the competitor for GH₵500,000. The court case will be heard in September of this year and Plantain Co’s lawyers have informed them that there is an 80% chance of success. As a result, Plantain Co has adjusted its profits upwards by GH₵100,000.
Required:
Discuss the impact on the auditor’s report, considering materiality and compliance with relevant accounting standards.
(c) Papaya Co
On 10 February 20X5, Papaya Co were informed that one of their leading customers had gone into liquidation. At 31 December 20X8, the balance owed was GH₵45,000. The directors thought they had better reflect this in the financial statements so they disclosed this in the notes to the financial statements.
Required:
Discuss the impact on the auditor’s report, considering materiality and compliance with relevant accounting standards.
(d) Melon Co
During the valuation of inventory it was discovered that a line of inventory had been valued under LIFO. This had resulted in a misstatement of GH₵8,000. A further line of inventory was clearly obsolete and should not have been included at all. In the financial statements, this had been included at a valuation of GH₵4,000.
Required:
Discuss the impact on the auditor’s report, considering materiality and compliance with relevant accounting standards.
Answer
(A)
The relevant figure in terms of materiality is GH₵18,000. This represents 12% of profit before tax, which is above 5%, so the amount is material.
Depreciation of non-current assets is described in IAS 16. A change from one method of depreciation to another is permissible only on the grounds that the new method will give a fairer presentation of the results and of the financial position. Such a change does not, however, constitute a change of accounting policy (IAS 8); it is a change in accounting estimate.
In Yams Co there is nothing to suggest that such a change in accounting estimate is warranted. Furthermore, motor vehicles are a normal class of non-current asset, so it would be highly unusual to change the method of depreciation.
If the directors are unable to give a satisfactory explanation for the change, a modified audit opinion on the grounds of material misstatement would be appropriate. The qualification is only material (and not pervasive) and an ‘except for’ opinion is correct. (B)
The relevant figure in terms of materiality is GH₵100,000, which is clearly above 5% threshold. So the amount is material.
Plantain Co is taking one of its competitors to court, so this represents a contingency, as per IAS 37. As Plantain Co is potentially in line to benefit (Plantain Co is making the prosecution) this is a contingent asset. A contingent asset is a possible asset that arises from past events and whose existence will be confirmed by the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the enterprise.
Plantain Co’s lawyers have indicated an 80% chance of success, which, in IAS 37, is ‘probable’. The standard says a probable contingent asset should be disclosed in the notes to the financial statements.
The directors have adjusted the financial statements, which is incorrect. Thus, this is a qualification on the grounds of material misstatement. To adjust the financial statements would result in a reduced profit of GH₵100,000. This clearly has a huge effect on the reported profit. As such a pervasive qualification is appropriate as the adjustment made by the directors renders the financial statements misleading. (C)
The relevant figure is GH₵45,000, which is 38% of profit before tax. So the amount is material.
The fact that a customer went into liquidation on 10 February 20X5 means it is a matter governed by IAS 10 Events after the Reporting Period. Events after the reporting period are those events, both favourable and unfavourable, that occur between the end of the reporting period and the date on which the financial statements are approved for issue. IAS 10 differentiates between adjusting events and non-adjusting events. Adjusting events are those events that provide evidence of conditions that existed as at the end of the reporting period.
The customer had a balance of GH₵45,000 at 31 December 20X8 so this is an adjusting event. Adjusting events should be adjusted in the financial statements, in compliance with IAS 10.
The directors have decided only to include the matter as a note to the financial statements. This would have been the correct treatment if the matter had been a non-adjusting event.
Hence a qualification on the grounds of material misstatement would be correct. Although GH₵45,000 is a large figure, it is not large enough to warrant a pervasive qualification. So a qualified opinion (‘except for …’) would be correct. (D)
The initial misstatement of GH₵8,000 represents 2% of profit before tax, which is not material.
LIFO is not permitted under IAS 2, so normally a qualification on the grounds of disagreement would follow. However, as the figure is less than the materiality threshold it does not matter.
The second misstatement of GH₵4,000 represents only 1% of profit before tax, which is also not material.
Obsolete inventory should be valued at its net realisable value of nil. However, as the figure is less than the materiality threshold it does not matter.
Both misstatements should be added to the list of unadjusted misstatements. Together they represent 3% of profit before tax, which, again, is still less than the standard materiality threshold (that is to say, 5%).
So there is no qualification needed here and the correct audit opinion should be unmodified.
- Tags: Adjusting Events, Auditor’s Report, IAS 10, Liquidation, Material Misstatement, Receivables
- Level: Level 3
- Topic: Reporting
- Uploader: Salamat Hamid