AAA March 2019

Question-1

Briefing note

To: Ben Duval, Audit engagement partner for Margot Co

From: Audit manager

Re: Audit planning for Margot Co

Subject: This briefing note includes the evaluation of risk of material misstatement for the purpose of
planning, principal audit procedures for factory impairment and development cost capitalized and
matters to be considered for use of expert and any actions.

(A) Risk of material misstatement

Sales revenue

Online sales has been increased in the year by 90% which is a significant increase. There is a risk that the
revenue is recognized early by the sales portal as the order is placed but not when the performance
obligation has been satisfied, therefore there is risk of overstatement of revenue.

Advertisement

Advertisement cost is 1.8% of total assets hence it is material to the financial statements.

Advertisement costs need to be expensed out in the year they are incurred; however, the finance
director has capitalized the development costs as the intangible asset, this has led to the overstatement
of intangible assets and profits.

New sales portal

A new sales portal with a value of 30,000 has been capitalized which is correctly recognized. The new
sales portal has made the online ordering easier and the discounts of buy ne get one are being offered.
There is a risk that the online sales portal has does not treat discounts correctly or incorrect timing of
revenue is being used which has increased revenue as shown above. The increase in the number of
orders should be verified and checked how many orders has been correctly satisfied.

Research and development

THE Research and development cost of $220,000 is 1.76% of total assets and hence it is material to the
financial statements.

The research cost need to expensed immediately and any development cost should only be capitalized
when it meets the development criteria under IAS 38. Since it is the starting phase, the cost would be
the research cost, therefore there is risk that it has been incorrectly recognized as the intangible assets
which overstates the intangible assets and profits.

ProPack is currently testing prototypes of items which have been developed, with encouraging results.
The testing of prototypes which has been developed need to be capitalized in the cost of asset as it is
part as per IAS 16 cost. There is a risk that if this cost has been expensed it will understate the profits
and assets.

Biological assets

The fruit growing on trees and the harvested agricultural produce are biological assets which were
recognised at fair value of $3·1 million in the 20X8 audited financial statements.

The harvested products of bearer plants are the inventory which need to be recognised at fair value less
costs to sell, hoever the propack co. Recognize these as biological assets and they are still recognised in
the financial statements. These inventories need to be tested for lower of cost and NRV as these
products have very sensitive prices due to the life span and quality.

There is a risk that the inventory is recognized at higher value overstating the profits and assets.

Gearing ratio

The Loan of $375000 was taken which is 3% of total assets.

The gearing ratio of Propack co. Is decreased even though the loan was taken with a material amount,
there is a risk that the loan is incorrectly recognized or not recognized which has decreased the non-
current liabilities

Impairment of plant

The impairment loss should be recognized by the difference of carrying amount and recoverable
amount which is higher of fair value less cost to sell and value in use.

It seems that the fair value less cost to sell has been correctly recognized, however there are mistakes
done when calculating value in use as the value in use is estimated based on the future sales which
could be generated if the damage to the building is repaired and new machinery is put into the factory,
the cashflows should have been calculated based on current condition. Therefore, the impairment has
been incorrectly calculated which has overstated the profits and assets.

Further, the impairment loss needs to be allocated where goodwill needs to be allocated first, there is a
risk that the goodwill is not impaired first which will understate the assets and impairment will be
incorrectly allocated.
New machinery

Propack is buying new machinery, at a total estimated cost of $450,000. This amount has been provided
for within current liabilities, with a corresponding entry accounted for as a prepayment. The purchase of
equipment does not satisfy as liability; therefore, it overstates the current liabilities and assets.

(B) Principal audit procedures

(I) Impairment of factory

1. Confirm the date of damage to the factory that it has been closed since and confirm whether
any other assets and inventory has been damaged.
2. Confirm the carrying amount of factory at the date of damage after deducting any depreciation
to the impairment date.
3. Verify the recoverable amount through quotations or the market value received by the company
for the sale of factory.
4. Ensure the cost of selling the factory has been deducted from the fair value of factory.
5. Discuss with finance director why the value in use has been calculated using the new machine
rather than in the current condition
6. Discuss with finance director to recalculate the value in use using the correct cashflows in the
current condition and verify reasonableness of assumptions
7. Recalculate the impairment loss and confirm the impairment loss is correctly reduced for the
goodwill first.

(ii) Development cost

1. Confirm the purchase of development of online portal through invoices to confirm it is 30,000
2. Discuss with finance director the amortization period used for the online sales portal and
confirm the amortization expense has been expensed.
3. Discuss with finance director why the advertisement cost has been capitalized rather than
charged to pnl.
4. Confirm the amount of $220,000 through invoices to verify the amount
5. Discuss with finance director the treatment of above amount as research or development
expenditure.

(C) Matters to be considered

The biological assets are difficult when determining their value and the Audit firm should test whether
the company have any expertise in valuing the biological assets. It seems that the audit firm is losing this
expertise, therefore they are looking for the experts which can value it.

The value determined by the management is risky as it is generated by management which can include
the biasness in determining the value. Therefore, it needs to be verified through the expert.
The value of biological assets is determined through the age of product, their quality and many things
which are unable to be considered by the audit team. Therefore, it is recommended to use the experts
in determining the value of biological assets which will confirm the amount used in the financial
statements, otherwise the financial statements could be materially misstated as the biological assets are
material to the financial statements.

(D) Audit implications and actions

The propack co. Have used some chemicals which are toxic to humans and they are prohibited in the
country. Therefore, the finance director has violated the laws and regulations. Therefore, when it is
known to the government the propack would be liable for the breach of contract that affects the
financial statements of propack co.

The use of these chemicals are also against the public interest because it harms to customers who uses
the fruits.

When this issue was consulted with the director, the director bribed the person not to talk or whistle
blow, this shows the lack of integrity and professional behavior of director. The director is not faithful
and honest to the auditors and general public.

Actions

The auditor is responsible for the evaluation of any material misstatement in the financial statement
due to any non-compliance. Therefore, the auditor should assess the effect of non-compliance on the
financial statements.

Further, as the issue is in the public interest, the auditor should consult this problem with any institution
and should whistle blow and take appropriate actions.

since the company is family owned, the directors of company are not honest as they bribed to hide the
problem. Therefore, the auditor should be more skeptical and aware to any other issues which can be
possibly happen.

The auditor should also carry out further work on the non compliance of any laws and regulations which
might also be violated.
Question-2

Opinion paragraph

The opinion paragraph comes first before the basis of opinion paragraph that states the reasons of any
modified or unmodified option. However, in this draft audit report, the basis of option praragraph is
stated first.

Further the opinion paragraph should be written as the ‘Unmodified option’ followed by Basis of
unmodified opinion. However, this is not followed.

Ethical requirements

It has been stated that ‘We are independent of the Company in accordance with the ethical
requirements which are relevant to our audit of the financial statements in the jurisdiction in which the
Company operates’ The draft audit report should have included the name/standard of ethical
requirements.

Significant accounting policies

It is correct to state that the underlying financial statements has been audited, however, it is also stated
that the significant accounting policies has been audited. The auditor’s responsibility is to detect and
report any material misstatement in the financial statements, hence the significant accounting policies
are included in audit of FS and no need to write separately.

Audit evidence

The draft report includes that ‘We believe that the audit evidence we have obtained is sufficient and
appropriate to provide a basis for our opinion.’ It seems that the auditor is not sure of their findings and
they are not confident of their opinion. This will create problems for the stakeholders which will read
this report.

Material uncertainty

As per the auditors if bank loan is not succeeded, there is going concern issue and the loan has not been
confirmed but the FS are prepared on going concern assumption. Firstly, it needs to be confirmed that if
the bank loan will not be succeeded than the audit option will need to be modified and adverse option
will be issued.

However, if the there is uncertainty and the loan could be succeeded than no disclosure has been made
which is material and could be pervasive, therefore the opinion should have been modified. Therefore,
wrong option has been stated.
Q-2 (B) Report to those charged with Governance

Documents

A number of revaluation report documents were not available when requested and it took three weeks
for them to be received by the audit team. It should be consulted with management that the audit is
performed as per the audit planning which need to be completed in proper time to maintain the quality.
Therefore, any delay in the report could compromise quality as if there is an issue that could take time
to resolve which is risky.

Revaluation

The properties with carrying amount of $11.1m is 2.15% of total assets and 3.5% of property portfolio
,hence it is material to the financial statements.

As per IAs 16, if there is any revaluation of asset than the whole asset portfolio need to be revalued.
However, in this case four properties with material amount are not revalued which are contrary to the
requirement of accounting standards. Therefore, the auditor should include this matter so that it is
resolved and there is no implication on the audit opinion.

Renovation

The total cost of renovation is 2.5% of total assets and 90% of PBT and hence it is material and pervasive
to the financial statements.

The renovation of assets increases the useful life of asset and hence it is an capital expenditure which
need to be capitalized in the carrying amount of asset but the whole amount has been added as an
expense in the P&L. This materially affects the financial statements, therefore the issue and its
implication on the audit report should also be communicated.

Authorization

The renovation work is material to the financial statements but it has not been authorized, this indicates
that there is a lack of internal controls and this weakness need to be communicated so that the risk of
any possible fraud is reduced and other expenses are authorized properly.
Question- 3 (B)

(I) cash settled share-based payments

Evaluation and difficulties

The share appreciation rights are the liability which need to be revised at each year end with the market
rate of share appreciation right as per IFRS-2. On 28 feb 20X9, the expenditure of $825,000 has been
correctly calculated as far as the estimation is appropriate.

This amount is 1.4% of total assets and 11.1% of PBT, hence material to the financial statements.

The accounting of share appreciation rights has very complex accounting estimation as;

Firstly, the number of employees that will vest is estimated by the management which could be
inappropriate and it was estimated at 1 march 20X8 when they were issues, the employees that would
vest should have been estimated at the each reporting date.

Secondly, the price of SARs is also estimated even though it is calculated by the expert but there is
difficulty in auditing the price as which price should have been set by the expert.

Procedures

1- Review the qualification and experience of the expert used in valuing SARs.

2- Obtain the number of assumptions used by the expert to confirm his work.

3- Recalculate the SARs liability and expense to confirm the amount.

(B) Regulatory penalties

The penalty is 2.25 of totals assets and 17.35 of PBT, hence material to the financial statements.

The penalty seems to be probable and therefore it should be recognized as a non-current liability as it
will be paid over next ten years and at the end of each year, the straight-line expense should be
recorded. However, all of the amount has been expensed in the year which has materially misstated the
financial statements.

There is a difficulty in estimating the amount of the penalty as it is expected by the management but it
has not yet been confirment by regulatory authority, therfore the auditor will have issue in choosing the
amount.

Further, the company is considering to pay over 10 years, which might not be the case or accepted by
the authority.

Procedures

1- Obtain the recent contact with the regulatory authority to confirm the case is pending.
2- Discuss with finance director whether any such breach has been done in the past so that what
amount was paid at that time.

(C) Property development

The property can be converted in to the residential building which will boost its fair value. As per IFRS-13
when calculating fair value, the highest and best use of the property should be taken. It seems that the
highest and best use of the property is converting in to residential building.

When calculating the fair value, the cost needs also to be considered, the total cost here is $1.373m
($1.2+0.173). Therefore, the fair value of the property after converting into residential building is
$3.527m ($4.3-0.173). However, the asset is stated at $4.2m in the financial statements and it has been
overstated by $1.373m

This overstatement is 2.4% of total assets and hence it is material to the financial statements and due to
this FS are materially misstated.

The auditor will find difficulty in determining the highest and best use of the asset, as it could be in the
current condition or after changing it.

Further, the costs that need to paid in order for conversion are also estimated which will need to be
verified and confirmed.