ACCA AAA ^UK Syllabus D. Audit of Historical Financial Information - Procedures for obtaining evidence - Past Papers ^{2 / 9}

You are a manager in the audit department of Pigeon & Co, a firm of Chartered Certified Accountants. You are responsible for the audit of Goldfinch Gas Co, a company which is the main supplier of gas to business and residential customers across the country.

The audit fieldwork for the year ended 30 June 2017 is nearing completion. The draft financial statements recognise profit before tax of $130 million (2016 – $110 million), and total assets of $1,900 million (2016 – $1,878 million).

You are reviewing the audit files and the following matters have been noted for your attention by the audit senior:

(a) Decommissioning provision
A provision of $430 million (2016 – $488 million) is recognised as a long-term liability. The provision is in respect of decommissioning a number of gas production and storage facilities when they are at the end of their useful lives. The estimate of the decommissioning costs has been based on price levels and technology at the reporting date, and discounted to present value using an interest rate of 8% (2016 – 6%). The timing of decommissioning payments is dependent on the estimated useful lives of the facilities but is expected to occur by 2046, with the majority of the provision being utilised between 2025 and 2040.

The accounting policy note discusses the methodology used by management for determining the value of the decommissioning provision and states that this is an area of critical accounting judgements including key areas of estimation uncertainty. The estimate has been made by management. In previous years, a management expert was engaged to provide the estimate but as this was expensive, management decided to produce their own estimate for the year ended 30 June 2017. (10 marks)

Required:
Comment on the matters to be considered, and explain the audit evidence you should expect to find during your file review in respect of each of the issues described above.

You are NOT required to explain the potential impact of the matters on the auditor’s opinion or report.

Note: The split of the mark allocation is shown against each of the issues above.

You are a manager in the audit department of Pigeon & Co, a firm of Chartered Certified Accountants. You are responsible for the audit of Goldfinch Gas Co, a company which is the main supplier of gas to business and residential customers across the country.

The audit fieldwork for the year ended 30 June 2017 is nearing completion. The draft financial statements recognise profit before tax of $130 million (2016 – $110 million), and total assets of $1,900 million (2016 – $1,878 million).

You are reviewing the audit files and the following matters have been noted for your attention by the audit senior:

(b) Depreciation
The draft statement of financial position includes plant and equipment, unrelated to gas production and storage facilities, with a carrying value of $65 million. There was a change in the estimation technique used to determine the depreciation in respect of these assets during the year. Depreciation was previously calculated on a straight line basis over a 10-year useful life, but from 1 July 2016, the useful life has been amended to 15 years. The finance director explained to the audit team that the review of estimated useful life has been made on the basis that the assets are lasting longer than originally anticipated.

The change in depreciation policy has been accounted for as a prior year adjustment, resulting in an increase of $20 million to property, plant and equipment and to retained earnings. The depreciation expense recognised in draft profit for the year to 30 June 2017 is $12 million (2016 – $15 million). (8 marks)

Required:
Comment on the matters to be considered, and explain the audit evidence you should expect to find during your file review in respect of each of the issues described above.

You are NOT required to explain the potential impact of the matters on the auditor’s opinion or report.

Note: The split of the mark allocation is shown against each of the issues above.

You are a manager in the audit department of Pigeon & Co, a firm of Chartered Certified Accountants. You are responsible for the audit of Goldfinch Gas Co, a company which is the main supplier of gas to business and residential customers across the country.

The audit fieldwork for the year ended 30 June 2017 is nearing completion. The draft financial statements recognise profit before tax of $130 million (2016 – $110 million), and total assets of $1,900 million (2016 – $1,878 million).

You are reviewing the audit files and the following matters have been noted for your attention by the audit senior:

(c) Trade receivables
The draft statement of financial position recognises total trade receivables of $450 million (2016 – $390 million).
The audit team has performed substantive analytical procedures on trade receivables with the following results:

Receivables from business customers are generally reviewed for impairment on an individual basis when a customer changes their gas supplier, discontinuing their relationship with the Group. Receivables from residential customers are reviewed for impairment where they are more than 90 days late in paying their bill, or where customers have a history of late payment. Since a new customer billing system was introduced in September 2016, management has exercised additional judgement regarding the appropriate level of allowance for these trade receivables. (7 marks)

Required:
Comment on the matters to be considered, and explain the audit evidence you should expect to find during your file review in respect of each of the issues described above.

You are NOT required to explain the potential impact of the matters on the auditor’s opinion or report.

Note: The split of the mark allocation is shown against each of the issues above.

(a) You are a manager in one of the assurance departments of Leopard & Co, a large firm of Chartered Certified Accountants. You are currently assigned to a due diligence engagement for one of your firm’s audit clients, Cheetah Co, a manufacturer of bespoke furniture. The audit of Cheetah Co is conducted by a team from a different department; you have never been involved in the audit of this client.

The engagement is to conduct a financial and operational due diligence review of Zebra Co, a company which has been identified as a potential acquisition target by Cheetah Co, due to the synergies offered and the potential to expand the existing production facilities. As part of the due diligence review, you have been asked to provide a valuation of Zebra Co’s assets and liabilities and an analysis of the company’s operating profit forecasts. This will assist Cheetah Co in determining an appropriate purchase price for Zebra Co.

During the engagement fieldwork your team identified two matters, which require your further consideration, as follows:

1. While reviewing correspondence with customers in relation to outstanding receivables, one of the team found a letter from a large retailer, for which Zebra Co produces a number of unique products, providing advanced notice that they are not renewing their purchasing agreement when the current one expires. The customer advised that they are switching to a new entrant to the market who is substantially cheaper than Zebra Co. A brief analysis identified that the customer provides, on average, almost 5% of Zebra Co’s annual revenues.

2. Zebra Co owns a piece of land which was given to it as a gift by the local authorities ten years ago. The land surrounds the entrance to the main production premises and is designated as a nature reserve. Restrictions were imposed on the usage of the land which also limit who the owner is able to sell the land to in the future. The land has zero carrying value in the financial statements.

No additional matters have arisen for your consideration. You are also aware that the financial statements for the last ten years have been audited and no modifications have been made to the auditor’s opinion during this period.

Required:

(ii) Recommend the investigation procedures to be performed. (6 marks)

You are the manager responsible for the audit of Thurman Co, a manufacturing company which supplies stainless steel components to a wide range of industries. The company’s financial year ended on 31 July 2016 and you are reviewing the audit work which has been completed on a number of material balances and transactions: assets held for sale, capital expenditure and payroll expenses. A summary of the work which has been performed is given below and in each case the description of the audit work indicates the full extent of the audit procedures carried out by the audit team.

(a) Assets held for sale
Due to the planned disposal of one of Thurman Co’s factory sites, the property and associated assets have been classified as held for sale in the financial statements. A manual journal has been posted by the finance director to reclassify the assets as current assets and to adjust the value of the assets for impairment and reversal of depreciation charged from the date at which the assets met the criteria to be classified as held for sale. The finance director asked the audit senior to check the journal before it was posted on the basis of there being no one with the relevant knowledge to do this at Thurman Co.

The planned disposal was discussed with management. A brief note has been put into the audit working papers stating that in management’s opinion the accounting treatment to classify the factory as held for sale is correct. The manual journal has been arithmetically checked by a different member of the audit team, and the amounts agreed back to the non-current asset register. (9 marks)

Required:
In respect of each of the three matters described above:
(i) Comment on the sufficiency and appropriateness of the audit evidence obtained;
(ii) Recommend further audit procedures to be performed by the audit team; and
(iii) Explain the matters which should be included in a report in accordance with ISA 265 Communicating Deficiencies in Internal Controls to Those Charged with Governance and Management.

Note: The split of the mark allocation is shown against each of the matters above.

You are the manager responsible for the audit of Thurman Co, a manufacturing company which supplies stainless steel components to a wide range of industries. The company’s financial year ended on 31 July 2016 and you are reviewing the audit work which has been completed on a number of material balances and transactions: assets held for sale, capital expenditure and payroll expenses. A summary of the work which has been performed is given below and in each case the description of the audit work indicates the full extent of the audit procedures carried out by the audit team.

(b) Capital expenditure
When auditing the company’s capital expenditure, the audit team selected a material transaction to test and found that key internal controls over capital expenditure were not operating effectively. Authorisation had not been obtained for an order placed for several vehicles, and appropriate segregation of duties over initiating and processing the transaction was not maintained.

The audit team noted details of the internal control deficiencies and updated the systems notes on the permanent audit file to reflect the deficiencies. The audit work completed on this order was to agree the purchase of the vehicles to purchase invoices and to the cash book and bank statement. The rest of the audit work on capital expenditure was completed in accordance with the audit programme. (7 marks)

Required:
In respect of each of the three matters described above:
(i) Comment on the sufficiency and appropriateness of the audit evidence obtained;
(ii) Recommend further audit procedures to be performed by the audit team; and
(iii) Explain the matters which should be included in a report in accordance with ISA 265 Communicating Deficiencies in Internal Controls to Those Charged with Governance and Management.

Note: The split of the mark allocation is shown against each of the matters above.

You are the manager responsible for the audit of Thurman Co, a manufacturing company which supplies stainless steel components to a wide range of industries. The company’s financial year ended on 31 July 2016 and you are reviewing the audit work which has been completed on a number of material balances and transactions: assets held for sale, capital expenditure and payroll expenses. A summary of the work which has been performed is given below and in each case the description of the audit work indicates the full extent of the audit procedures carried out by the audit team.

(c) Payroll expenses
The payroll function is outsourced to Jackson Co, a service organisation which processes all of Thurman Co’s salary expenses. The payroll expenses recognised in the financial statements have been traced back to year-end reports issued by Jackson Co. The audit team has had no direct contact with Jackson Co as the year-end reports were sent to Thurman Co’s finance director who then passed them to the audit team.

Thurman Co employs a few casual workers who are paid in cash at the end of each month and are not entered into the payroll system. The audit team has agreed the cash payment made back to the petty cash records and the amounts involved are considered immaterial. (9 marks)

Required:
In respect of each of the three matters described above:
(i) Comment on the sufficiency and appropriateness of the audit evidence obtained;
(ii) Recommend further audit procedures to be performed by the audit team; and
(iii) Explain the matters which should be included in a report in accordance with ISA 265 Communicating Deficiencies in Internal Controls to Those Charged with Governance and Management.

Note: The split of the mark allocation is shown against each of the matters above.

You are the manager responsible for the audit of Rope Co for the year ended 30 September 2016. During a visit to the team performing the fieldwork, the audit senior shows you a cash flow forecast covering six-month periods to 30 September 2018 as prepared by management as part of their assessment of the going concern status of the company. The audit senior asks whether any of the forecast cash flows disclosed require any further investigation during the audit fieldwork.

The actual and forecast six-monthly cash flows for Rope Co for the periods ended:

The following additional information has been provided in support of the forecasts:

– Receipts from customers and payments to suppliers have been estimated based on detailed sales forecasts prepared by the sales director.

– Salaries and overheads have been estimated as the prior year cost plus general inflation of 2%.

– The bank loan expires on 5 January 2018. The finance director expects to take out a matching facility with the current lender to pay off the existing debt.

– On 1 October 2015, the chief executive, Mr J Stewart, gave the company a three-year, interest free loan secured by a fixed charge over the operational assets of Rope Co. The audit team was unaware of this loan prior to obtaining the cash flow forecast.

– The directors plan to sell some investments in listed shares to fund the repayment of the chief executive’s loan. At 30 September 2016, the investments were carried in the statement of financial position at their fair value of $350,000.

Required:
(a) Evaluate the appropriateness of the cash flow forecast prepared by Rope Co and recommend the further audit procedures which should be performed. (14 marks)

You are the manager responsible for the audit of Rope Co for the year ended 30 September 2016. During a visit to the team performing the fieldwork, the audit senior shows you a cash flow forecast covering six-month periods to 30 September 2018 as prepared by management as part of their assessment of the going concern status of the company. The audit senior asks whether any of the forecast cash flows disclosed require any further investigation during the audit fieldwork.

The actual and forecast six-monthly cash flows for Rope Co for the periods ended:

The following additional information has been provided in support of the forecasts:

– Receipts from customers and payments to suppliers have been estimated based on detailed sales forecasts prepared by the sales director.

– Salaries and overheads have been estimated as the prior year cost plus general inflation of 2%.

– The bank loan expires on 5 January 2018. The finance director expects to take out a matching facility with the current lender to pay off the existing debt.

– On 1 October 2015, the chief executive, Mr J Stewart, gave the company a three-year, interest free loan secured by a fixed charge over the operational assets of Rope Co. The audit team was unaware of this loan prior to obtaining the cash flow forecast.

– The directors plan to sell some investments in listed shares to fund the repayment of the chief executive’s loan. At 30 September 2016, the investments were carried in the statement of financial position at their fair value of $350,000.

Required:
(b) Comment on the matters to be considered in respect of the loan from Mr J Stewart and recommend the further audit procedures to be performed. (6 marks)

You are a manager in Sambora & Co, responsible for the audit of the Jovi Group (the Group), which is listed. The Group’s main activity is steel manufacturing and it comprises a parent company and five subsidiaries. Sambora & Co currently audits all components of the Group.

You are working on the audit of the Group’s financial statements for the year ended 30 June 2012. This morning the audit engagement partner left a note for you:

‘Hello

The audit senior has provided you with the draft consolidated financial statements and accompanying notes which summarise the key audit findings and some background information.

At the planning stage, materiality was initially determined to be $900,000, and was calculated based on the assumption that the Jovi Group is a high risk client due to its listed status. During the audit, a number of issues arose which meant that we needed to revise the materiality level for the financial statements as a whole.

The revised level of materiality is now determined to be $700,000. One of the audit juniors was unsure as to why the materiality level had been revised. There are two matters you need to deal with:

Assess the implications of the key audit findings for the completion of the audit. Your assessment must consider whether the key audit findings indicate a risk of material misstatement. Where the key audit findings refer to audit evidence, you must also consider the adequacy of the audit evidence obtained, but you do not need to recommend further specific procedures. (18 marks)

Thank you’

The Group’s draft consolidated financial statements, with notes referenced to key audit findings, are shown below:

Draft consolidated statement of comprehensive income

Notes: Key audit findings – statement of comprehensive income

1. Revenue has been stable for all components of the Group with the exception of one subsidiary, Copeland Co, which has recognised a 25% decrease in revenue.

2. Operating expenses for the year to June 2012 is shown net of a profit on a property disposal of $2 million. Our evidence includes agreeing the cash receipts to bank statement and sale documentation, and we have confirmed that the property has been removed from the non-current asset register. The audit junior noted when reviewing the sale document, that there is an option to repurchase the property in five years time, but did not discuss the matter with management.

3. The property revaluation relates to the Group’s head office. The audit team have not obtained evidence on the revaluation, as the gain was immaterial based on the initial calculation of materiality.

4. The actuarial loss is attributed to an unexpected stock market crash. The Group’s pension plan is managed by Axle Co – a firm of independent fund managers who maintain the necessary accounting records relating to the plan. Axle Co has supplied written representation as to the value of the defined benefit plan’s assets and liabilities at 30 June 2012. No other audit work has been performed other than to agree the figure from the financial statements to supporting documentation supplied by Axle Co.

Draft consolidated statement of financial position

Notes: Key audit findings – statement of financial position

5. The goodwill relates to each of the subsidiaries in the Group. Management has confirmed in writing that goodwill is stated correctly, and our other audit procedure was to arithmetically check the impairment review conducted by management.

6. The associate is a 30% holding in James Co, purchased to provide investment income. The audit team have not obtained evidence regarding the associate as there is no movement in the amount recognised in the statement of financial position.

7. The assets held for sale relate to a trading division of one of the subsidiaries, which represents one third of that subsidiary’s net assets. The sale of the division was announced in May 2012, and is expected to be complete by 31 December 2012. Audit evidence obtained includes a review of the sales agreement and confirmation from the buyer, obtained in July 2012, that the sale will take place.

8. Two of the Group’s subsidiaries are partly owned by shareholders external to the Group.

9. A loan of $8 million was taken out in October 2011, carrying an interest rate of 2%, payable annually in arrears. The terms of the loan have been confirmed to documentation provided by the bank.

Required:

Respond to the note from the audit engagement partner.