Tag (SQ): Financial Distress
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- 15 Marks
AAA – L3 – Q60 – Evaluation and review
Identify further information needed to assess Jemila Foods' going concern status due to supplier financial difficulties.
Question
Jemila Foods has been in existence, importing foodstuffs such as rice, for a number of years. The managing director had built up the business using contacts he already had in the industry. The company imports only one brand of food which is manufactured exclusively by one company which is based in Bharat. The food is distributed via ‘shops within shops’ at 20 branches of a well-known store. Under this minimum annual payment of $10,000 per store.
The audit is nearing completion but you have just heard that the Bharat manufacturer is facing serious financial difficulties and that supplies have ceased.
Required:
(a) Set out the further information the auditor would require before reaching his audit opinion. (b) Set out the possible forms of report that the auditor may issue.
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- 10 Marks
AAA – L3 – Q59 – Going Concern
Identify factors indicating that a company may not be a going concern.
Question
You are responsible for the audit of Asante Co, a limited liability company, for the year ended 31 December 20X8. The principal activity of Asante Co is the provision of high-quality packaging services for manufacturing companies. The company was established 3 years ago and has significantly exceeded its growth targets in each subsequent year.
Historically, the packaging process was labour-intensive, but in September 20X8, in an effort to reduce labour costs and increase efficiency, the company invested in an enhanced automated packing system. The investment was funded by a loan repayable in monthly instalments over four years. The loan covenant agreement includes a covenant specifying that the company’s debt:equity ratio should not exceed 1:1.
A comparison of the draft financial statements for the year ended 31 December 20X8 with the previous year indicates a significant increase in revenue with a small increase in profitability. The company is currently trading in excess of its overdraft limit and is negotiating an increase in its facility with the bank. Management has prepared, in support of its negotiations, profit and cash flow forecasts based on the assumptions that the anticipated increase in efficiency and reduction in labour costs will be achieved.
The company struggles to meet the weekly wage bill and has fallen behind with its payments to the taxation authorities. It has also failed to comply with the terms of the lease in respect of the factory premises and has not paid the last 3 months’ instalments.
Required:
(a) Identify, and explain, from the information provided above, factors which indicate that Asante Co may not be a going concern. (b) Outline the matters to which you would direct your attention in the period after the end of the reporting period in order to determine whether Asante Co can continue as a going concern for the foreseeable future.
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