Question 2b
Daley Co is a family owned, unlisted company which imports motor cars. The company buys cars from a variety of car manufacturers for sale to car dealerships and vehicle leasing companies within its own domestic market. Daley Co has been a client of your firm for the last three years and you are the newly appointed audit manager on the audit for the year ended 31 August 20X8. The audit for the current reporting period is nearing completion and you are reviewing the working papers of the going concern section of the audit file.
Extracts from the draft financial statements and other relevant information are given below.
Statement of financial position
| 31 August 20X8 | 31 August 20X7 | |
|---|---|---|
| Draft | Actual | |
| $ million | $ million | |
| Assets | ||
| Non-current assets | ||
| Property, plant and equipment | 13·5 | 14·6 |
13·5 | 14·6 | |
| Current assets | ||
| Inventory | 5·8 | 3·7 |
| Trade receivables | 3·7 | 2·6 |
| Cash at bank and in hand | – | 0·6 |
| 9·5 | 6·9 | |
| Total assets | 23·0 | 21·5 |
| Equity and liabilities | ||
| Equity | ||
| Share capital | 1·0 | 1·0 |
| Retained earnings | 1·3 | 4·7 |
2·3 | 5·7 | |
| Non-current liabilities | ||
| Long-term borrowings | 11·2 | 12·4 |
| Provisions | 3·5 | 0·5 |
14·7 | 12·9 | |
| Current liabilities | ||
| Trade payables | 4·2 | 2·9 |
| Bank overdraft | 1·8 | – |
| 6·0 | 2·9 | |
| Total equity and liabilities | 23·0 | 21·5 |
| 31 August 20X8 | 31 August 20X7 | |
|---|---|---|
| Draft | Actual | |
| $ million | $ million | |
| Revenue | 11·3 | 8·8 |
| Cost of sales | (4·4 ) | (2·9 ) |
| Gross profit | 6·9 | 5·9 |
| Other operating expenses | (9·1 ) | (1·3 ) |
| Operating profit | (2·2 ) | 4·6 |
| Finance costs | (1·5 ) | (0·7 ) |
| Profit before taxation | (3·7 ) | 3·9 |
| Taxation | 0·3 | (1·3 ) |
| Net (loss)/profit for year | (3·4 ) | 2·6 |
You have also ascertained the following information during your review:
1. Daley Co has undergone a period of rapid expansion in recent years and is intending to buy new warehousing facilities in January 20X9 at a cost of $4·3 million.
2. In order to finance the new warehousing facilities, the company is in the process of negotiating new finance from its bankers. The loan application is for an amount of $5 million and is to be repaid over a period of four years.
3. The provision of $3·5 million in this year’s statement of financial position relates to legal actions from five of Daley Co’s largest customers. The actions relate to the claim that the company has sold cars which did not comply with domestic regulations.
4. A major new competitor has moved in to Daley Co’s market in October 20X8.
5. The going concern working papers include a cash flow forecast for the 12 months ending 31 August 20X9.
The cash flow forecast assumes that Daley Co’s revenue will increase by 25% next year and that following the reorganisation of its credit control facility, its customers will pay on average after 60 days. The forecast also assumes that the bank will provide the new finance in January 20X9 and that the company will have a positive cash balance of $1·7 million by 31 August 20X9.
6. The financial statements have been prepared on a going concern basis and make no reference to any significant uncertainties in relation to going concern.
Required:
(b) Explain the audit evidence in respect of the cash flow forecast which you would expect to find in your review of the audit working papers on going concern. (9 marks)