Tag (SQ): Going Concern

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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.

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.

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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  • 10 Marks

AAA – L3 – Q56 – Reporting

Discuss materiality, true and fair concepts, and auditor's report effects for Gifty Goods and Cecilia's Contracts.

56 GG and CC

Described below are situations which have arisen in two unrelated audits and which are considered material.

(1) Gifty Goods

Although you are satisfied that closing inventories this year are fairly stated, the auditor’s report on the previous year’s financial statements was modified due to a restriction on the scope of the audit work in respect of the closing inventory figure. This led to a qualified opinion.

(2) Cecilia’s Contracts

The financial statements disclose the fact that a provision may be required to reduce inventories to their net realisable value if a contract with a major customer, representing 60% of the company’s revenue, is not renewed. A decision on this by the customer is not expected until after the financial statements are due to be signed.

Required

(a) State what is meant by, and explain the relationship between, the concepts of materiality and true and fair.

(b) State, with reasons, the effect on the auditor’s reports of the situations described above.

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  • 20 Marks

AA – L2 – Q37 – Audit of Financial Statements

Describe external auditor's responsibilities and work for going concern assessment. Describe auditor's reports for going concern issues and their circumstances. List considerations for recommending internal controls for cash sales in a garage.

(a) Describe external auditor’s responsibilities and the work that the auditors must perform in relation to an audit client’s ability to continue as a going concern.

(b) Describe the possible auditor’s reports that can be issued where the ability of a company to continue as a going concern status is called into question; your answer should describe the circumstances in which they can be issued.

(c) You have been asked by your client, a garage proprietor, to advise on a system of internal control for cash sales. Set out the points you would take into consideration before giving your recommendations.

 

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  • 20 Marks

AAA – L3 – Q27 – Audit Evidence

Identify audit risks for Asante Motors, a multi-site car retailer with inventory and warranty issues.

Asante Motors (AM) sells motor vehicles and spare parts, and also provides servicing and repairs for vehicles. It operates from eight locations, having expanded recently from just four locations. Each location has a showroom for new and used automobiles, a store for spare parts and a service workshop.

Many of the second-hand vehicles sold by AM are vehicles that have been traded in by customers in part-exchange for a new or newer vehicle. Many used cars are sold for cash.

New cars are imported from a single supplier and are delivered on consignment. AM pays the agreed purchase price plus 2.5% interest four months after delivery. AM has a legal right to return unsold cars to the supplier, but in practice never does so.

New cars are sold with a two-year warranty from the supplier and used cars are sold by AM with a one-year guarantee. All repairs under warranty or guarantee are carried out by AM in its service workshops.

Each location carries a large amount of spare parts in its parts workshops. These operate under the brand name ‘StrongSpares’ and many parts are actually labelled with the StrongSpares brand name. A perpetual inventory system is used, and storekeepers continually check inventories of parts.

The car service workshops try to complete all jobs on the same day that they are started, and are successful in about 80% of cases. Jobs are usually invoiced immediately after completion, and are usually paid for by customers when they come to collect their vehicle.

The senior sales representative at each location is able to use a new car, selected from each consignment delivered from the supplier. These cars are used for business purposes and as demonstration models. They are eventually sold second-hand as ex-demonstration models.

AM purchased the StrongSpares brand name for its parts stores. Senior management believe that the cost of the brand name should not be amortised because they consider that the asset has an indefinite useful life.

AM has recently established an internal audit function, although this has not yet done much work.

Required
Using the information provided, identify and explain the audit risks that will have to be considered and dealt with when planning the final audit of Asante Motors for the financial year just ending.

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  • 20 Marks

AAA – L3 – Q26 – Audit Planning and Risk Analysis

Identify high-risk areas in the audit of Kumasi Playthings, a toy retailer with inventory and management issues.

Kumasi Playthings is a prestigious toy retailer trading from a single urban retail district. The accounts and administration offices are above the shop. The company is the wholly-owned subsidiary of a prominent retail group. Kumasi Playthings is headed by its dynamic managing director, Kofi Mensah, aged 70.

At Kofi Mensah’s insistence, your firm, as local to Kumasi Playthings, has recently been appointed as the auditor. Kumasi Playthings is now the only group company not to be audited by the group auditors.

The following matters have come to light during the preliminary discussions with Kofi Mensah and those members of his staff to whom he has allowed you access:

(1) The parent company wishes Kumasi Playthings to develop operations in a number of out-of-town shopping centres. Kofi Mensah regards this as unacceptable because it would destroy the goodwill and prestige built up over 150 years of quality retailing.

(2) The company has approximately 30,000 lines of inventory. Contrary to group accounting instructions, no physical count is planned for the year end. The company intends to rely on the continuous inventory system which commenced operation in March 20X8. Two major problems have occurred with the system to date. Firstly, a trainee failed to enter all the inventory lines before the system went live. Secondly, due to a dispute with the IT provider, there has been no maintenance service for five months.

(3) Kofi Mensah has just returned from a toy fair at which he placed an order for 50,000 dolls produced by a little-known youth cooperative led by his only niece. The chief buyer is said to be fuming over the incident.

(4) In the year to 31 January 20X8, Kofi Mensah received a bonus of C2m, but you were unable to obtain any information in respect of the calculation and authorization of the bonus. No other director of Kumasi Playthings received a bonus in that year and the next highest paid director received a total emoluments package of C300,000.

(5) There is a dispute with a major supplier over the credit facilities offered to Kumasi Playthings. The supplier manufactures and supplies 30% of Kumasi Playthings’ purchases and claims that Kumasi Playthings has continually exceeded its credit period and that its accounting staff are impatient and incompetent.

(6) The company’s overdraft limit of C2.5m is due for renegotiation in April 20X5.

Required
Identify the potentially high risk areas of the audit.

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  • 15 Marks

AA – L2 – Q21 – Risk Assessment and Internal Control

Explain the meaning of audit risk and its importance to the auditor. Identify risks in auditing Aurum LLC and explain why they need consideration.

21 Golden LLC

Golden LLC designs, manufactures and retails traditional Ghanaian jewellery. Inventory is held at the design warehouse and at three shops. Inventory is also sometimes sent to customers for approval prior to a sale being made. Your firm has been re-appointed as auditors for the year ended 31st December 20X8.

Golden LLC has had a difficult year. A recession has caused a fall in revenue and the future is uncertain. A fourth shop was closed during the year and the premises are still up for sale. The financial director was dismissed half way through the year and is pursuing a claim for unfair dismissal. A replacement has not yet been found.

The managing director is due to retire next year and is likely to require loans he has made to the business to be repaid. Negotiations with the bank in respect of loans to cover these repayments have started.

Required

(a) State what you understand by audit risk and why it is important to the auditor.

(b) Identify the risks arising from the above that will need to be considered when planning the audit of Golden LLC. Explain why these risks need to be considered.

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  • 30 Marks

AA – L2 – Q20 – Risk Assessment and Internal Control

Identify risks associated with auditing ConnectSphere Mobile, a mobile phone service provider with expansion plans. Discuss ethical considerations for accepting the audit of ConnectSphere Mobile, including technical and logistical capabilities. Conclude whether to accept or decline the audit of ConnectSphere Mobile, providing principal reasons.

You are the partner in charge of a four partner firm of Chartered Accountants. Your firm has been invited to tender for the audit of ConnectSphere Mobile for the year ended 31 December 20X8.

ConnectSphere Mobile was established two years ago, and provides a mobile phone service for individuals and business. The system being established by the company comprises:

  • Small portable mobile phones, which allow subscribers (users) to contact or be contacted by any other telephone.
  • The mobile phones can be used within range of a local relay station, which receives calls from and sends calls to the mobile phone.
  • The local relay stations are linked to a central computer which connects the calls to other users. Frequently, this is through a computer’s telephone network.

Currently, the local relay stations cover one large city with a population of about 1,000,000. Within the next year the system will cover all large cities in Zamora with a population of over 250,000. By 20X7, the system will cover all trunk roads and cities with a population of over 100,000. Extending the coverage of the system will involve considerable capital expenditure on new relay stations and require additional borrowings.

The cost of the relay stations and central computer are capitalised and are written off over six years.

The mobile phones are manufactured by other companies and sold through retailers. ConnectSphere Mobile does not sell the phones, but it pays ₵2,000 to the retailer for each phone sold and subscription by the customer to ConnectSphere Mobile. This payment is capitalised in the financial statements of ConnectSphere Mobile and written off over four years.

Subscribers are invoiced monthly with a fixed line rental and a variable call charge. Other operators are charged for the time spent by their customers contacting ConnectSphere Mobile’s subscribers (customers). These charges are logged and calculated by the company’s main computer.

All the shares are owned by three wealthy individuals who are non-executive directors. They will receive a fixed salary. They do not plan to make any further investment in the company.

Establishing the network of relay stations and subscribers will result in the company making losses for at least three years. Current borrowings are about 20% of the shareholders’ funds. Because of the substantial capital expenditure and trading losses, it is expected the company will be highly geared by 20X7.

As the company will not be profitable, the non-executive directors have decided that executive directors should receive a basic salary and a bonus based on the number of subscribers to the system.

The owners plan to float the company on the Zamora Stock Exchange in 20X7. The flotation will involve:

  • issuing new shares to the general public to provide funds for the company; and
  • the three non-executive directors selling some of their shares.

You are aware that ConnectSphere Mobile has a number of very large competitors, each of which has a large number of users and comprehensive coverage (i.e. over 90% of the population are within range of a relay station).

Required:
(a) Consider the risks associated with the audit of ConnectSphere Mobile.
(b) Describe the ethical matters you should consider in deciding whether your audit firm should accept the audit. This should include considering whether your firm has the technical and logistical ability to carry out the audit.
(c) Conclude on whether you would advise your firm to accept or decline the audit, giving your principal reasons for coming to this decision.

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