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- 20 Marks
Question
You are the manager responsible for four audit clients of Globe & Co, a firm of Chartered Accountants. The year-end in each case is June 30, 2015.
You are currently reviewing the audit working paper files and the audit seniors’ recommendations for the auditors’ reports. Details are as follows:
a. Red Co. Limited is a subsidiary of Yellow Holdings Plc. Serious going concern problems have been noted during this year’s audit. Red will be unable to trade for the foreseeable future unless it continues to receive financial support from the parent company. Red has received a letter of support (‘comfort letter’) from Yellow Holdings Plc.
The audit senior has suggested that due to the seriousness of the situation, the audit opinion must at least be qualified ‘except for’. (5 Marks)
b. Edo Co Plc has changed its accounting policy for goodwill during the year from amortisation over its estimated useful life to annual impairment testing. No disclosure of this change has been given in the financial statements. The carrying amount of goodwill in the statement of financial position as at June 30, 2015, is the same as at June 30, 2014, as management’s impairment test shows that it is not impaired.
The audit senior has concluded that a modification to the opinion is not required but suggests that attention can be drawn to the change by way of an emphasis of matter paragraph. (6 Marks)
c. The directors’ report of Prompt Co Limited states that investment property rental forms a major part of revenue. However, a note to the financial statements shows that property rental represents only 1.6% of total revenue for the year. The audit senior is satisfied that the revenue figures are correct.
The audit senior has noted that an unmodified opinion should be given as the audit opinion does not extend to the directors’ report. (4 Marks)
d. Audit work on the after-date bank transactions of Twinkle Co Limited has identified a transfer of cash from Star Co. Limited. The audit senior assigned to the audit of Twinkle has documented that Twinkle’s finance director explained that Star commenced trading on July 20, 2015, after being set up as a wholly-owned foreign subsidiary of Twinkle.
The audit senior has noted that although no other evidence has been obtained, an unmodified opinion is appropriate because the matter does not impact on the current year’s financial statements. (5 Marks)
Required:
For each situation, comment on the suitability or otherwise of the audit senior’s proposals for the auditors’ reports. Where you disagree, indicate what audit report modification (if any) should be given instead.
Answer
a. Red Co. Limited – Going Concern Issues
Audit Senior’s Proposal:
The audit senior suggests a qualified ‘except for’ opinion due to serious going concern problems, as Red Co. will be unable to trade unless it continues to receive financial support from the parent company, Yellow Holdings Plc.
Comment:
- Suitability of Proposal: The audit senior’s suggestion to issue a qualified opinion is appropriate if the going concern issue is material but the financial statements still present a true and fair view, except for the going concern assumption. A “qualified opinion” or “except for” opinion is appropriate when there is a material uncertainty related to going concern, but the financial statements as a whole are still presented in accordance with the applicable financial reporting framework.
- Alternative: If the financial support from Yellow Holdings Plc is confirmed through the “comfort letter,” the qualification can be related to the going concern issue, stating that the financial support is sufficient to continue the operations in the foreseeable future.
Required Audit Report Modification:
The audit opinion should be qualified with an ‘except for’ statement, addressing the going concern uncertainty, and it should include a clear explanation of the issue, including the comfort letter from the parent company.
b. Edo Co Plc – Change in Accounting Policy for Goodwill
Audit Senior’s Proposal:
The audit senior suggests an emphasis of matter paragraph instead of modifying the opinion for the change in accounting policy regarding goodwill. The change from amortisation to annual impairment testing has not been disclosed.
Comment:
- Suitability of Proposal: The audit senior’s proposal is incorrect. According to IAS 8 (Accounting Policies, Changes in Accounting Estimates and Errors), a change in accounting policy should be disclosed in the financial statements, including the nature of the change, the reasons for it, and its effect on the financial statements. Since the change was not disclosed, a modification of the audit opinion is necessary.
- Alternative: The correct action is to issue a qualified opinion due to the failure to disclose the change in accounting policy. The auditor should state that the financial statements are not in compliance with IAS 8 due to the lack of disclosure of the change in accounting policy.
Required Audit Report Modification:
A qualified opinion should be issued for non-compliance with IAS 8, stating the failure to disclose the change in accounting policy. If the change does not significantly affect the financial statements, it should be highlighted in a ‘qualified opinion’.
c. Prompt Co Limited – Directors’ Report and Revenue
Audit Senior’s Proposal:
The audit senior proposes to issue an unmodified opinion, noting that the issue with the directors’ report does not extend to the audit opinion since it does not affect the financial statements. The discrepancy is related to the directors’ report stating that investment property rental is a major part of revenue, although it only represents 1.6% of total revenue.
Comment:
- Suitability of Proposal: The audit senior’s proposal is appropriate. The auditors’ report is focused on the financial statements, and the discrepancy in the directors’ report is not material to the financial statements themselves. The auditors’ responsibility does not extend to the directors’ report, so no modification of the audit opinion is necessary.
- Alternative: If the directors’ report is misleading or contains a misstatement, the auditor may choose to communicate this to those charged with governance, but it will not require modification of the audit opinion unless it affects the financial statements.
Required Audit Report Modification:
No modification to the audit opinion is required, as the issue pertains to the directors’ report, not the financial statements.
d. Twinkle Co Limited – After-Date Bank Transactions and Subsidiary Setup
Audit Senior’s Proposal:
The audit senior suggests an unmodified opinion because the transfer of cash from Star Co. Limited, a new wholly-owned foreign subsidiary of Twinkle Co. that commenced trading after year-end, does not affect the current year’s financial statements.
Comment:
- Suitability of Proposal: The audit senior’s suggestion is appropriate. The transfer from Star Co. Limited occurred after the balance sheet date (July 20, 2015), and thus does not impact the financial position or results for the year ending June 30, 2015. As long as the transaction is properly disclosed in the financial statements as a subsequent event, no modification to the audit opinion is necessary.
- Alternative: There should be adequate disclosure in the financial statements regarding the post-year-end event (the establishment of the subsidiary and the related transaction) to inform users of the impact of this event on the company’s financial position and operations.
Required Audit Report Modification:
No modification is required to the audit opinion. However, there should be appropriate disclosure in the financial statements regarding the subsequent event and its potential impact.
- Topic: Audit Reporting
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