Overall F/S level (OFSL) risk (What & Why?

3x)

Factors that impact the risk of material misstatement (RMM) at the OFSL:

 Accounting issues that require judgement and use of estimates, including revenue recognition for new projects
and impairment of inventory and long-lived assets  complex and more likely to result in errors  ↑ risk
 Increase borrowing from bank, bank increased exposure and it is likely to place higher reliance on F/S  bias for
mgmt to manipulate the financial results to meet bank’s covenants  ↑ risk
 Hired a new part-time bookkeeper in the year who has been identified as having weak technical knowledge
o Bookkeeper’s lack of familiarity with both the company and complex financial reporting, limited hours
available to complete the bookkeeping tasks  potential to result in increased errors  ↑ risk
 Joan is less involved in day-to-day operation as she has had to take on outside employment  decrease in
oversight, increases the likelihood of fraud and errors going unidentified  ↑ risk
 Has been client for several years, familiar with the owner-operated business and issues it typically faces  ↓risk
 Due to the reasons above, the OFSL risk is set as high for this engagement

Materiality

Main user of F/S: bank  concern whether PPI can make the pmt on the LOC
Income is a proxy for cash flow and is therefore a good indication of whether PPI will be able to repay the loan.

As PPI remains profitable, a materiality based on pre-tax net income from continuing operations would be
appropriate.

Note 1 – the amount is non-recurring and would be normalized for purposes of materiality
Note 2 – adjustment for net revenue recognition related to plants not yet sold

Due to the anticipated sensitivity of the bank to changes in the F/S, materiality should be set at 5%, $525.

Approach

Review engagement  obtain limited assurance through inquiry and analytical procedures to enable auditor to
conclude that nothing has come to our attention that causes us to believe that F/S are not prepared in all material
respects, in accordance with ASPE.
Issue

There are some indications of the impairment – low quality of soil and too shady.
The issue is whether the carrying amount of the land and greenhouse should be written down.

Handbook and Analysis

ASPE 3063.09 – A long-lived asset shall be tested for recoverability whenever events or changes in circumstances indicate
that its carrying amount may not be recoverable.

 The garden did not live up with the expectation of the tenants, low quality of soil and too shady

ASPE 3063.12 – For purposes of recognition and measurement of an impairment loss, a long-lived asset shall be grouped
with other assets and liabilities to form an asset group at the lowest level for which identifiable cash flows are largely
independent of the cash flows of other assets and liabilities.

 Given the greenhouse cannot generate the cash on its own, thus, the land and greenhouse should be grouped
together in assessing the impairment

The carrying amount of a long-lived asset is not recoverable if the carrying amount exceeds the sum of the
undiscounted cash flows expected to result from its use and eventual disposition (recoverable amount).

Carrying amount > recoverable amount  Impairment – written down to fair value
Impairment loss = Carrying amount – Fair value (ASPE)

IFRS – Recoverable amount

Higher of:

1) asset’s fair value less costs of disposal

2) asset’s value in use

Impairment loss = carrying value - recoverable amount

Recommendation

Written down the asset to $50K  impairment of $35K

land remain $50K & greenhouse written down to nil

Impairment loss 35K

Assets 35K

No impact on current ration covenant

Issue

Recognized revenue when the inventory has been set aside and has not been planted yet.
The issue is whether the revenue associated with this contract should be recognized in 20X2 F/S.

Handbook and Analysis

ASPE 3400.04 -.06 revenue should be recognized when the following criteria have been met:

1) Ultimate collection is reasonably assured

Largest commercial customer – no indication that there will be an issue with collection
2) Performance – transfer of significant risks and rewards
Shrubs have not been planted or delivered. Also, the client has not inspected the goods and has indicated that
he wishes to do so. There is an uncertainty around customer acceptance, thus, the risks and rewards of
ownership likely have not transferred.
3) Reasonable assurance regarding measurement of revenue
The agreed-upon price is $27,000, no indication that there will be an issue

Recommendation

As PPI still holds the shrubs, thus, the risks and rewards have not transferred to Total Tower.
The revenue should not be recognized until the shrubs are planted and accepted by the customer.

 Decrease in net income by the amount of the gross profit $13K ($27K - $14K = $13K)
 Increase in inventory of $14K
 Decreases in AR $27K
 Negative impact on the current ratio covenant

Issue

PPI includes $12K of inventory that has been banned by the municipality at the year end.
The issue is whether a write-down of those inventories is required.

Handbook and Analysis

ASPE 3031.09 – Inventories shall be measured at the lower of cost and net realizable value.

 NRV of those banned products is nil as those pesticides and weed killers must be disposed and unable to re-sold.
o As NRV is the lower, the value of inventory should be written down.

Recommendation

Write off the affected pesticides and weed killers entirely  Dr. Loss on inventory write-off Cr. Inventory $12K
 decrease inventory and net income by $12K  negative impact on current ratio covenant