To: Partner

From: CPA
RE: Sweet Temptations Ltd (STL)

Accounting Issues

Acquisition of Gabba Java:

- Issue: STL purchased 100% of the outstanding shares of Grabba Java for $750,000. The issue is
how the acquisition needs to be reported and how the balance sheets need to be consolidated.
- Analysis: As per IFRS 3, STL should recognize goodwill as of the acquisition date measured as the
excess of (a) over (b) below:
a) The aggregate of:
a. Consideration transferred
i. $750,000 paid for the outstanding shares
b. Amount of any NCI interest in Gaba Java
i. $0 = NCI – 100% ownership by STL
b) Net of the acquisition-date amounts of the identifiable assets acquires and liabilities
assumed
a. $0 – fair value of Grabba Java’s fixed assets equal to book value
- Recommendation:
o Goodwill should be measured at $622,750
- Risk : Risk of understating Goodwill
o Assertion: Accuracy & Valuation
o Procedure:
 Examine and review documentation related to share purchase
 Recalculate the A.D and Goodwill based on the financial statements of Graba
Java and information in the share purchase documentation

Audit Planning Memo

OFSL Risk

- Factors increasing Risk:

o STL has recently acquired another company which requires complex accounting
transactions related to set up – increasing the risk of error and thus risk of material
misstatement
o Bookkeeper having an accounting background is not known – increasing risk of error and
this risk of material misstatement
o New financing obtained which requires financial statements – increasing financial
performance pressure and the risk of fraud or error, thus increasing risk of material
misstatement
- Factors decreasing Risk:
o Evans & Rowe, CPAs has been the auditor of STL Since 20X2, they are familiar with the
business operations and controls – decreasing risk of material misstatement
o Stable earnings for the past 3 years – decreasing risk of material misstatement
Overall, the risk at the overall financial statement level can be assessed as being on the higher end as a
result of the new financing obtained as well as the acquisition of a new company.

Approach

Given that the bookkeeper does all of the accounting work there is no segregation of duties. A
Substantive approach should likely be taken and consideration also needs to be given to the audit
approach related to the newly acquired company, Grabba Java. Component materiality will need to be
set with specific audit procedures related to the new subsidiary. A substantive approach involves no
reliance on existent controls.

Materiality

The users of RRI’s financial statements are Meghan and the bank,

- Meghan – concerned with profitability of her company

- Bank – provided financing for the new acquisition and concerned with repayment capabilities

Given that STL is a for profit company both users are concerned with it’s profitability meaning
normalized net income which will be used as the base.

- Adjustments for the gain on sale of the oven is needed - $15,000

- Normalized Net Income before tax = $755,000

The recommended rate for materiality of normalized net income is usually between 3%-7%. Given that
STL has had steady earnings over the past year this indicates that the sensitivity to material
misstatement is not large. As such, 5% of normalized net income is used for the calculation of overall
materiality.

- Overall Materiality = $37,750

Performance materiality is set at 60% of overall materiality. The percentage has been set based on the
fact that the overall financial statement level risk is assessed to be on the higher end.

- Performance materiality = $22,650