- 30 Marks
AAA – May 2018 – L3 – SA – Q1 – Audit of Complex Entities
Evaluate materiality reassessment, audit findings, and joint audit implications for Honey Group’s financial statements.
Question
You are a manager in Puposola & Company (Chartered Accountants) responsible for the audit of the Honey Group (the Group), a quoted company. The Group’s main activity is steel manufacturing and it comprises of a parent company and three subsidiaries. Your firm currently audits all components of the Group. You are working on the audit of the Group’s financial statements for the year ended June 30, 2017. This morning, the audit engagement partner left a note for you.
“Hello
I have gone through the draft consolidated financial statements and accompanying notes which summarise the key audit findings and some background information.
Although, at the planning stage, materiality was initially determined to be N900,000, and was calculated based on the assumption that Honey Group is a high-risk client due to its listing status. However, due to a number of issues that arose during the audit, there is a need to revise the materiality level for the financial statements as a whole. The revised level of materiality should now be N700,000.
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
| Note | June 30, 2017 Draft (N’000) | June 30, 2016 Actual (N’000) |
|---|---|---|
| Revenue | 98,795 | 103,100 |
| Cost of sales | (75,250) | (74,560) |
| Gross profit | 23,545 | 28,540 |
| Operating expenses | (14,900) | (17,500) |
| Operating profit | 8,645 | 11,040 |
| Share of profit of associate | 1,010 | 900 |
| Finance costs | (380) | (340) |
| Profit before tax | 9,275 | 11,600 |
| Taxation | (3,200) | (3,500) |
| Profit for the year | 6,075 | 8,100 |
| Other comprehensive income for the year, net of tax: | ||
| Gain on property revaluation | 800 | —– |
| Actuarial losses on defined benefit plan | (1,100) | (200) |
| Other comprehensive loss | (300) | (200) |
| Total comprehensive income for the year | 5,775 | 7,900 |
Notes: Key Audit Findings on Statement of Comprehensive Income
- Revenue has been stable for all components of the Group with the exception of one subsidiary, Copesink Company, which witnessed a 25% decrease in revenue.
- Operating expenses for the year to June 2017 is shown net of profit on a property disposal of N2 million. Our evidence includes agreeing the cash receipts to the 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.
- The property revaluation relates to the Group’s head office. The audit team has not obtained evidence on the revaluation, as the gain was immaterial based on the initial calculation of materiality.
- The actuarial loss is attributed to an unexpected stock market crash. The Group’s pension plan is managed by Axial Company, a firm of independent fund managers who maintain the necessary accounting records relating to the plan. Axial Company has supplied written representation as to the value of the defined benefit plan’s assets and liabilities at June 30, 2017. No other audit work has been performed other than to agree the amount reported in the financial statements to supporting documentation supplied by Axial Company.
Draft Consolidated Statement of Financial Position
| Note | June 30, 2017 Draft (N’000) | June 30, 2016 Actual (N’000) |
|---|---|---|
| ASSETS | ||
| Non-current assets | ||
| Property, plant and equipment | 81,800 | 76,300 |
| Goodwill | 5,350 | 5,350 |
| Investment in associate | 4,230 | 4,230 |
| Non-current assets held for sale | 7,800 | – |
| Total non-current assets | 99,180 | 85,880 |
| Current assets | ||
| Inventory | 8,600 | 8,000 |
| Receivables | 8,540 | 7,800 |
| Cash and cash equivalents | 2,100 | 2,420 |
| Total current assets | 19,240 | 18,220 |
| Total assets | 118,420 | 104,100 |
| EQUITY AND LIABILITIES | ||
| Equity | ||
| Share capital | 12,500 | 12,500 |
| Revaluation reserve | 3,300 | 2,500 |
| Retained earnings | 33,600 | 29,400 |
| Non-controlling interest | 4,350 | 4,000 |
| Total equity | 53,750 | 48,400 |
| Non-current liabilities | ||
| Defined benefit pension plan | 10,820 | 9,250 |
| Long-term borrowings | 43,000 | 35,000 |
| Deferred tax | 1,950 | 1,350 |
| Total non-current liabilities | 55,770 | 45,600 |
| Current liabilities | ||
| Trade and other payables | 6,200 | 7,300 |
| Provisions | 2,700 | 2,800 |
| Total current liabilities | 8,900 | 10,100 |
| Total liabilities | 64,670 | 55,700 |
| Total equity and liabilities | 118,420 | 104,100 |
Notes: Key Audit Findings on Statement of Financial Position
- 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.
- The associate is a 30% holding in Jamil Company, purchased to provide investment income. The audit team has not obtained evidence regarding the associate as there is no movement in the amount recognised in the statement of financial position.
- The non-current 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 2017, and is expected to be complete by December 31, 2017. Audit evidence obtained includes a review of the sales agreement and confirmation from the buyer obtained in July 2017, that the sale will take place.
- Two of the Group’s subsidiaries are partly owned by shareholders external to the Group.
- A loan of N8 million was obtained in October 2016 at an interest rate of 2%, payable annually in arrears. The terms of the loan have been confirmed from the loan agreement provided by the bank. There was no repayment of the loan in the books as at prior year end.
Required:
a. Explain why auditors may need to reassess materiality as the audit progresses. (4 Marks)
b. Assess the implications of the key audit findings for the completion of the audit.
Note: 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)
c. Discuss TWO advantages and TWO disadvantages of a joint audit being performed on the financial statements. (8 Marks)
(Total 30 Marks)
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