Question Tag: Audit Recommendations

Pegrace Nigeria Limited (PNL), your audit client, is a national hotel group with substantial cash resources. Its accounting functions are well managed and the group’s accounting policies are rigorously applied. The company’s financial year-end is December 31.

The company has been seeking to acquire a construction company for some time in order to bring in-house the building and refurbishment of hotels and related leisure facilities, like swimming pools, volleyball courts, and restaurants. The management has recently identified Robin Construction Company Limited (RCCL) as a potential target and has urgently requested that you undertake a limited due diligence review.

Further to the preliminary talks between the management of RCCL and PNL, you were provided with the following brief on Robin Construction Company Limited:

1. The Chief Executive, Managing Director, and Finance Director are all family members and major shareholders. The company has an established reputation for quality constructions.
2. Due to a recession in the building business, the company has been operating at its overdraft limit for the last 18 months and has been close to breaching debt obligations on several occasions.
3. Robin’s accounting policies are generally less prudent than those of Pegrace (assets are depreciated over longer estimated useful lives).
4. Contract revenue is recognized on the percentage of completion method, measured by reference to costs incurred to date. Provisions are made for loss-making contracts.
5. The company’s management team includes a qualified and experienced quantity surveyor, whose main responsibilities are:
   • Supervising quarterly physical counts at major construction sites;
   • Comparing costs to date against quarterly rolling budgets; and
   • Determining profits or losses, by contract, at each financial year-end.
6. Labour force is provided under subcontracts. During construction, the regulatory body visited the site and discovered non-compliance with site health and safety regulations.

In February 2021, Robin received a claim that a site on which it built a housing development in Banana Estate was not properly drained and is now sinking. Residents are demanding rectification and asking for payment or damages. Robin has referred the matter to its legal counsel and denied all liability, as the site preparation was subcontracted to Sahara Services Company Limited. No provisions have been made in respect of the claims, nor has any disclosure been made.

The auditor’s report on Robin’s financial statements for the year ended December 31, 2020, was signed, without modification, in March 2021.

Required:

a. Prepare a document to give the explanatory meaning of the term ‘due diligence’ and subsequently discuss items to investigate in a due diligence exercise. (12 Marks)

b. Advise on how to recognize, measure, present, and disclose leases as required by IFRS 16. (8 Marks)