- 20 Marks
Question
Maideline Nigeria Limited manufactures tyres for use by cars, trucks, and trailers. The company is owner-managed, meaning the shareholders are also the directors. On June 1, 2020, the directors decided to wind up the company due to the high cost of operations, the Naira’s depreciation against the US dollar, and the economic impact of COVID-19, which have severely impacted the company’s ability to continue business.
Management notified employees, suppliers, and customers that Maideline would cease all manufacturing activities by September 30. Consequently, all factory workers and most employees in accounts and administration were terminated effective September 30. Remaining employees will face redundancy by November 30. A minimal head office team, including the Company Secretary and some support staff, will remain operational for a few more years until the company winds down completely.
Maideline operated 20 branches and a head office. Of these, 12 branches are located in company-owned buildings, while the remaining 8 operate from leased buildings with lease terms of three to five years. Lease agreements prohibit sub-letting and sale. On adopting IFRS 16, the entity assumed lease renewals at term end, recording lease liabilities and right-of-use assets. A small head office building will remain in use until its lease expires in three years. Maideline accounts for its tangible non-current assets at cost, less depreciation, and has recognized deferred tax assets due to past tax losses and unutilized capital allowances.
All products sold carry a one-year warranty. Until May 31, 2020, the company offered two- and three-year extended warranties, but these were discontinued from March 1, 2020. Maideline distributes products nationally and internationally under three-year agreements and maintains annual supplier contracts. While no distributors or suppliers have pursued legal actions, some are withholding payments, awaiting penalty settlements they claim are due.
Required:
Using the information provided, identify and explain the financial statement risks to be taken into account in planning the final audit of Maideline in respect of the year ended December 31, 2020. (20 Marks)
Answer
1. Going Concern Risks
- Explanation: The directors’ decision to wind up the company due to economic challenges poses a substantial going concern risk. The auditor must assess the appropriateness of preparing financial statements on a going concern basis. Any uncertainty in realizing the carrying values of assets due to discontinued operations should be carefully evaluated and disclosed.
2. Lease Obligations under IFRS 16
- Explanation: Maideline’s leases include non-renewable terms, with leases ranging from three to five years and no option to sub-let. Since the company initially assumed renewals, the lease liabilities and right-of-use assets may need re-evaluation to reflect the decision not to renew leases, impacting asset and liability valuations.
3. Impairment of Non-Current Assets
- Explanation: With plans to discontinue operations, Maideline’s non-current assets, including branch buildings, may be impaired if their value cannot be recovered through continued use. The audit should focus on testing these assets for impairment and ensuring any write-downs to recoverable amounts are reflected accurately.
4. Deferred Tax Asset Realization
- Explanation: The deferred tax assets recognized due to unrelieved tax losses and unutilized capital allowances may no longer be realizable if future taxable profits are not expected. The auditor should assess whether these assets remain valid under IAS 12, given the winding-down plans.
5. Revenue Recognition and Outstanding Receivables
- Explanation: Distributors withholding payments due to anticipated penalty claims pose a risk to receivables’ recoverability. The auditor should assess the adequacy of provisions for doubtful debts and evaluate any adjustments necessary in revenue recognition, ensuring the company has provided for any likely losses.
6. Provisions for Warranty Liabilities
- Explanation: The company has liabilities from one-year warranties and previously offered two- and three-year extended warranties. The audit must verify that provisions are adequate to cover future warranty claims, given that manufacturing has ceased and certain warranties may still be valid post-closure.
7. Obligations Related to Supplier and Distributor Contracts
- Explanation: Although no legal actions have been initiated, there is a potential risk for claims related to the company’s three-year distributor agreements and annual supplier contracts. The auditor should examine potential contingent liabilities and evaluate if provisions are necessary for contract penalties or legal claims.
8. Inventory Valuation
- Explanation: Inventory may need to be valued at net realizable value if the company cannot sell it at usual prices. The auditor should review inventory valuation to ensure that any items unlikely to be sold post-wind-down are properly written down.
9. Financial Statement Presentation and Disclosures
- Explanation: The winding-up process requires clear and accurate disclosures of all related financial statement risks, such as discontinued operations, asset impairments, and going concern uncertainties. The auditor should ensure compliance with IAS 1 regarding adequate presentation and disclosure for stakeholders to understand the company’s position.
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