• 30 Marks

AAA – May 2023 – L3 – Q1 – Audit Reporting

Evaluate criteria and communication of Key Audit Matters, including actions if none exist.

Romeo and Juliet Plc is an indigenous company incorporated on March 5, 2012. The entity operates in the oil sector of the economy, which has experienced severe income decline over the past years. The global oil prices hit a record low of about $28 per barrel in 2019 and 2020, further plunging the company and the industry into a downward slide in income generation. The company is also affected by foreign exchange difficulties faced by most companies in the country resulting from increased regulation of foreign exchange. Regular cases of oil theft, pipeline vandalism, and insecurity have also affected the operations of major international oil companies, which are the entity’s major customers. As a result of the above, the company recorded the following in its books of account:

  1. Financial losses: The company has made consistent losses from the financial year ended December 31, 2017, to date.
  2. Current liability position: The company’s current liabilities exceeded its current assets.
  3. Negative net operating cash position: The company has maintained a negative net operating cash position from December 31, 2017, to date.

Furthermore, the company’s performance has worsened as a result of a decrease in sales and an increase in expenses.

The largest proportion of the current liabilities is the intercompany borrowings, which accounted for 62% (2020 – 45%) of the total current liability balance. The borrowings stood at N1.5 billion, N1.6 billion, and N2 billion for the financial years ended December 31, 2019, 2020, and 2021, respectively. The finance costs in relation to the borrowings stood at N230 million in the year ended December 31, 2021 (2020- N214 million).

The company has currently defaulted on a number of its contractual obligations with its directors, and there was no directors’ remuneration in the current year due to its continuous loss-making position.

At the pre-audit meeting with management of Romeo and Juliet Plc, your firm (the auditors) were informed that, in the year, the company was involved in a business combination with another oil company. To pay for the cost of acquisition, an additional intercompany loan was obtained because of the poor financial position of the company. In addition, the company’s major investment in an associated company was disposed of. The business acquisition proposal has all necessary regulatory approvals. It was approved at the meeting of the directors and annual general meeting of the company in the previous year and disclosed in the company’s prior year financial statements as business matters.

After the meeting with management, you have started the preparation for the year-end audit, and in compliance with regulatory requirements and auditing standards, a Key Audit Matter should be inserted on the opinion page.

Required:

(a) Evaluate the criteria that will help the engagement team determine what qualifies as a matter requiring significant auditor’s attention and can be classified as a Key Audit Matter. (8 Marks)

(b) Discuss the factors that will determine matters of most significance to be communicated to those charged with governance. (10 Marks)

(c) Discuss the criteria for what must be included in the description of a Key Audit Matter on the audit opinion. (6 Marks)

(d) Evaluate what should be done, assuming that you have determined that there are no Key Audit Matters to be reported in the above scenario. (6 Marks)

(a) Key Audit Matters Criteria

The matters that, in the auditor’s professional judgment, were of most significance in the audit of the financial statements for the current period and can be classified as Key Audit Matters include:

  1. Areas of higher assessed risks of material misstatements or significant risks.
  2. Significant auditor judgments relating to areas in the financial statements that included significant management judgment, including accounting estimates with high estimation uncertainty.
  3. Significant events or transactions that had a significant effect on the financial statements or the audit.
  4. Other matters that require significant auditor attention, such as the implementation of a new IT system.
  5. Matters likely to jeopardize the going concern of the entity, such as persistent revenue decline and continuous business losses.
  6. Matters relating to the auditor’s judgment, such as determining materiality and materiality thresholds.
  7. Changes in the business structure, such as the business combination with another oil company and major investment disposal.
  8. Financing the business through intercompany loans and defaults in contractual obligations to directors.
  9. Significant fraud risks.

(b) Factors Determining Matters of Most Significance for Governance Communication

The factors considered in determining which matters are of most significance to be communicated to those charged with governance include:

  1. Significance of interactions between the auditor, management, and the audit committee.
  2. Importance of the matters for understanding the financial statements as a whole.
  3. Materiality of the matters.
  4. Corrected and uncorrected misstatements related to the matters and their nature.
  5. Complexities in accounting policy, such as subjective policy selection or deviation from industry norms.
  6. Nature and extent of audit function required, such as the involvement of experts.
  7. Difficulties encountered in performing audit procedures and obtaining sufficient audit evidence.
  8. Severe internal control deficiencies.
  9. Inter-relatedness with other matters, such as long-term contracts affecting revenue recognition.
  10. Significant matters requiring the auditor’s attention during the audit.
  11. Areas of higher assessed risks of material misstatements or significant risks identified.
  12. Significant matters requiring both auditor and management judgment, particularly in accounting estimates.
  13. Accounting estimates identified as having high estimation uncertainty.

(c) Description of Key Audit Matters in the Auditor’s Report

The description of the Key Audit Matters in the auditor’s report includes:

  1. Reference to related disclosures in the financial statements (if applicable).
  2. Explanation of why the matter was considered one of the most significant.
  3. Audit evidence obtained in relation to the matter.
  4. Audit conclusion reached on the matter.

(d) Actions When No Key Audit Matters Are Identified

If the auditor determines there are no Key Audit Matters to communicate in the auditor’s report, the following steps should be taken:

  1. Discuss this conclusion with the engagement quality control reviewer.
  2. Communicate this conclusion with those charged with governance.
  3. Include an explanation in the auditor’s report stating that the section is intended to describe matters communicated with those charged with governance based on the auditor’s professional judgment.
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