Corporate Reporting – Advanced Level November 2022

MARK PLAN AND EXAMINER’S COMMENTARY

This report includes:

• a summary of the scenario and requirements for each question
• the technical and skills marks available for each part of the requirement
• a description of how skills should be demonstrated
• detailed points for a full answer
• examiner’s commentary on candidates’ performance

The information set out below was that used to mark the questions. Markers were encouraged to use
discretion and to award partial marks where a point was either not explained fully or made by
implication.

Question 1 solution

Scenario

The candidate is an audit senior working for FST LLP, a firm of ICAEW Chartered Accountants. FST
is the statutory auditor of Litesafe for the year ended 30 June 2022.

The candidate is provided with Advance Information about Litesafe Ltd which comprises:

(1) The scenario and three Exhibits (A,B and C); and

(2) The nominal ledger data for Litesafe for the 11 months ended 31 May 2022, contained within the
data analytics software.

The audit issues identified in the Advance Information document relate to revenue recognition and the
recognition of an intangible. Extracts are provided from board meeting minutes.

In the Advance Information an audit senior, Ali Bashir has prepared analysis of the cost of sales and
gross profit for the company in total for the 11 months to 31 May 2022. The analysis shows a similar
GP% in comparison with the prior year. The audit senior identifies inventory, trade payables and
revenue as areas of audit risk.

The candidate has the opportunity to interrogate the data analytics software before the examination to
familiarise themselves with how the GP schedule in the Advance Information has been prepared
using the data analytics software.

Candidates should identify the potential earnings management motivated by the future listing and the
CEO’s bonus. Profits are being delayed to future accounting periods.

In the examination, the candidate is required to:

1. In relation to total gross profit before payroll expenses for the year ended 30 June 2022:

a. Update and complete Ali’s analysis of total gross profit before payroll expenses (Advance
Information: Exhibit C) to include the results for Litesafe for the full year ended 30 June 2022.

b. Perform preliminary analytical procedures on total gross profit before payroll expenses using
your calculation in 1 a) and other relevant information. As part of your procedures, you should
identify and explain patterns shown in the data analytics software. Identify any specific
unusual transactions in June 2022 which have had a material effect on gross profit before
payroll expenses.

2. For the analysis of Air Lamps prepared by the audit assistant (Exhibit 1):

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a) explain the appropriate financial reporting treatment of the contract with FM and prepare
correcting journal entries; and
b) recalculate the gross profit margin for Air Lamps.

3. For the analysis of Head Torches prepared by the audit assistant (Exhibit 2):

a) explain the appropriate financial reporting treatment of the shares issued to KTY and prepare
correcting journal entries; and
b) recalculate the gross profit margin for Head Torches.

4. Set out and explain the appropriate financial reporting treatment for the SPOT intangible asset
(Exhibit 3) in Litesafe’s financial statements for the year ended 30 June 2022. Prepare a
correcting journal entry.

5. Identify and justify the three specific audit risks that you consider to be most significant in our
audit of Litesafe for the year ended 30 June 2022.

Requirements Total Skills assessed

Marks
1. In relation to total gross profit before
payroll expenses for the year ended 30 June
2022:
a) Update and complete Ali’s analysis of total
gross profit before payroll expenses
(Advance Information: Exhibit C) to include
the results for Litesafe for the full year ended
30 June 2022.
b) Perform preliminary analytical procedures
on total gross profit before payroll expenses
using your calculation in 1a) and other
relevant information. As part of your
procedures, identify and explain patterns
shown in the data analytics software. Identify
any specific unusual transactions in June
2022 which have had a material effect on
gross profit before payroll expenses.
12 • Assimilate and demonstrate
understanding of a large amount of
complex information.
• Operate to a brief in structured
situations
• Use the data to prepare analysis of
GP and explain movements
• Identify key transactions and explain
significance
• Apply the concept of materiality
• Use the data to identify trends - and
unusual patterns (e.g., October
purchases and decline in revenue in
final three months)
• Identify the incentive for and
incidence of creative accounting
• Assimilate data from various sources
& data types in making decisions

2. For the analysis of Air Lamps prepared by 9 • Recommend appropriate financial

the audit assistant (Exhibit 1):
a) Explain the appropriate financial reporting
treatment of the contract with FM and
prepare correcting journal entries; and
b) Recalculate the gross profit margin for Air
Lamps
reporting treatments for the contract
by applying IFRS 15 to the scenario
• Use the data & information to prepare
a revised GP calculation
• Identify the incentive for and
incidence of creative accounting –
delaying revenue to future accounting
periods

3. For the analysis of Head Torches 6 • Recommend appropriate financial

prepared by the audit assistant (Exhibit 2): reporting treatments for the contract
by applying IFRS 2 to the scenario
a) Explain the appropriate financial reporting • Use the data & information to prepare
treatment of the shares issued to KTY and a revised GP calculation
prepare correcting journal entries; and
b) Recalculate the gross profit margin for
Head Torches.

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4. Set out and explain the appropriate
financial reporting treatment for the SPOT
intangible asset (Exhibit 3) in Litesafe’s
financial statements for the year ended 30
June 2022. Prepare any correcting journal
entries.
6 • Use and analyse the data &
information given to support
requirement
• Access the data to identify the
intangible amortisation charge
• Relate various parts of the question to
identify critical factors
• Use technical knowledge of IAS 38 to
recalculate the intangible amortisation
and recommend a correcting journal
adjustment.

5. Identify and justify the three specific audit
risks that you consider to be most significant
in FST’s audit of Litesafe for the year ended
30 June 2022.
9 • Apply technical knowledge of financial
reporting to determine the key risks
• Apply professional scepticism to
justify the key risks
• Critically review and identify the audit
risks
• Prioritise key issues
• Apply the concept of materiality

42

1) In relation to total gross profit before payroll expenses for the year ended 30 June 2022:

• Update and complete Ali’s analysis of total gross profit before payroll expenses (Advance
Information: Exhibit C) to include the results for Litesafe for the full year ended 30 June 2022.
• Perform preliminary analytical procedures on total gross profit before payroll expenses using
your calculation in (1) and other relevant information. As part of your procedures, you should
identify and explain patterns shown in the data analytics software. Identify any specific
unusual transactions in June 2022 which have had a material effect on gross profit before
payroll expenses.

Total gross profit before payroll expenses

Year ended Prior year Fieldwork

30 June 30 June
2021 2022
£000 £000
Revenue
Total of account codes 051002 to 052099 29,925 26,035 13%↓

Purchases
Total of account codes 051002 to 052099 15,137 10,600 30%↓

(Increase) / decrease in inventory

Total of account codes 122002 to 122099 (3,982) 137 1.2%↓
Cost of sales (11,154) (10,737)

Gross profit before wages 18,770 15,298

62.7% 58.8%

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Analytical procedures on total gross profit before payroll expenses

Revenue has fallen by 13% with a decline in the final three months of the year. In absolute terms this
represents a fall in revenue of £3.89 million.

January and March 2022 indicate the highest revenue months and as identified in the Advance
Information, there is a fall in revenue for the months of April and May. Most revenue accounts indicate
a decline in revenue compared to the previous year, although there are exceptions. For example
051080 - Turnover FG LL/kits and 051090 Turnover FG fans. Although the heat map identifies some
large transactions posted to revenue (Transaction IDs 217145, 219542, 220782) there is no indication
that these are unusual and the credits are made across many revenue lines.

Purchases have fallen by 30% however, inventory has fallen by £137,000 or 1.3% year on year. In the
11 month data, inventory had increased by £555,000 from 30 June 2021 meaning that there has been
a decrease in inventory of 700k in the month of June 2022.

Gross profit margin has fallen by 3.9% compared with the year ended 30 June 2021. At May 2022 the
gross profit was 62.5% .

Using the heat map filtered for cost of sales identifies two unusual transactions in June 2022;

See transaction ID 223775 in June 2022 for £1,070,981 a large inventory allowance - which
decreases the GP and GP%.

See transaction ID 223773 Fair value of goods – share transaction with KTY in June 2022 for
£400,000 which increases the GP and the GP%

Both transactions require further investigation and explanation from management.

The Advance Information suggests the decline in revenue is caused by a major machine overhaul
which slowed down production and customers were asked to delay their orders until the next financial
year – this explanation should be treated with scepticism and investigated as June revenue has also
not recovered and the company is holding significant amounts of inventory. The delaying of revenue
could be indicative of earnings management by Giselle to ensure that she reaches bonus targets in
the year ended 30 June 2023 and 24 and to provide a smooth growth in profits.

The explanation for the decline in revenue in the final three months should be investigated and the
preliminary analytical procedures indicate that detailed cut off procedures should be performed.

The Advance Information identifies changes to future regulation. This could impact on the net
realisable value of Litesafe’s inventory and further audit procedures are required to substantiate the
inventory allowance.

Inventory

Prior year Fieldwork Increase/(decrease) % increase/(decrease)

30 June 2021 at 30 June 2022 in inventory
£000 £000 £000

Total of 11,673 11,536 (137) 1.2%

account codes
651009 to
651099

Inventory has fallen by £137,000 as noted above. There is no significant variation in the closing
inventory each month. This suggests that the company holds high levels of base inventory. However
there are significant changes in individual inventory accounts

The following inventory accounts have changed by more than audit materiality:

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Account Revised Current %

Code Account Description prior year year Difference change
651030 STOCK LEAD LAMP 1,245,083.97 918,901 -326,183 -26%
651040 STOCK LL/LINKEX 1,660,528.29 1,006,636 -653,893 -39%
651050 STOCK LL/FLOODLITE 897,808.26 1,460,665 562,857 63%
STOCK NEW
651053 HANDLAMP 670,431.36 981,378 310,947 46%
651054 STOCK HANDLAMP 917,040.57 724,521 -192,520 -21%
651055 STOCK CHARGER 150,071.61 0 -150,072 -100%
STOCK
651070 LL/ACCESSORIES 540,743.07 830,787 290,043 54%
651074 STOCK MINI / MICRO 468,419.73 268,996 -199,424 -43%
651090 STOCK FANS 0.00 355,624 355,624 100%

Comparing inventory by account shows that many inventory accounts have changed by amounts in
excess of £150k materiality – see accounts identified above.

There are two accounts with zero balances, 651055 Stock charger and 651099 Stock packaging and
sundry.

Using explore to drill down into these accounts identifies that the inventory allowance identified above
(Transaction ID 223 775) reduces these balances to show zero inventory.

Using the metrics module “inventory and production” shows that inventory days are 392.6 – this
suggests that the company has over 14 months of inventory and places Litesafe at the top of the
range for companies in this industry.

Inventory days are high which brings into question inventory obsolescence. FST should challenge
management over why this ratio is so high especially as revenue has fallen in 2022 Is this is a
permanent contraction in Litesafe’s market and Litesafe has not matched this contraction by reducing
production ie is the company over producing for inventory? FST has already recognised a material
inventory allowance which reduces some accounts to zero and further audit procedures are required
to explain the validity of this adjustment.

Using Explore to compare movements for purchases and revenue identifies that high levels of
purchases in October 2021 are not matched by high sales figures.

Purchases compared with sale of goods

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Tutorial note: The graphs cannot be reproduced in the exam - candidates should describe the
unusual pattern in the data.

Examining the stacked bar chart for purchases indicates that October 2021 is an outlier month,
showing significantly higher purchases in comparison with other months. Using the explore module to
identify the transactions in October 2021 shows two very large purchase transactions in excess of
£600k which require further investigation – see below.

This pattern is not matched by an increase in revenue. The highest revenue is in March 2022 which is
followed by a decline on revenue in the final three months of the year.

• Key transactions

1) Transaction ID 215381 for £683,922 posted by Edith Ring on 4/10/2021. This transaction
Credits Purchase ledger control and debits the purchases accounts for 101024
Mini/Micro,101022 Head torches and 101025 Midi.

2) Transaction ID 215390 £614048 again posted by Edith on 4/10/2021. This transaction also
credits Purchase ledger control and debits the purchases accounts for 101024
Mini/Micro,101022 Head torches and 101025 Midi.

These two transactions represent £1.297k and over 50% of the purchases for the month – they are
also discoverable using the heat map – these are key transactions which should be investigated.

3) Transaction ID 223 775 - inventory allowance in June 2022. This transaction is significant
because of its size. It is also posted in August 2022 (after the year end) and the amounts are
round sums.

Account Debit Credit Effective date Document Journal User id Created

code type description date
Statement of financial
position
651009 STOCK 281,000 30/6/2022 MANUAL General E Ring 10/8/2022 at
RECHARGE inventory 9:40
ABLE provision
TORCH

651040 STOCK 501000 30/6/2022 MANUAL General E Ring 10/8/2022 at

LL/LINKEX inventory 9:40
provision
651052 STOCK AIR 105000 30/6/2022 MANUAL General E Ring 10/8/2022 at
LAMP inventory 9:40
provision
651055 STOCK 147620 30/6/2022 MANUAL General E Ring 10/8/2022 at
CHARGER inventory 9:40
provision
651099 STOCK 36271 30/6/2022 MANUAL General E Ring 10/8/2022 at
PACKAGIN inventory 9:40
G& provision
SUNDRY

Profit or loss accounts

CLOSING 281,000 30/6/2022 MANUAL General E Ring 10/8/2022 at
STOCK inventory 9:40
RECHARGE provision
ABLE
122009 TORCH
CLOSING 501000 30/6/2022 MANUAL General E Ring 10/8/2022 at
STOCK inventory 9:40
122040 LL/LINKEX provision
CLOSING 105000 30/6/2022 MANUAL General E Ring 10/8/2022 at
STOCK AIR inventory 9:40
122002 LAMP provision

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CLOSING 147620 30/6/2022 MANUAL General E Ring 10/8/2022 at

STOCK inventory 9:40
122005 CHARGER provision
CLOSING 36271 30/6/2022 MANUAL General E Ring 10/8/2022 at
STOCK inventory 9:40
PACKAGIN provision
G&
122099 SUNDRY

4) Transaction ID 223 773 Head torches Share based payment in Month 12 – this transaction is
significant because of its size relative to materiality. It is also for a round sum amount and has
been processed after the departure of the FD by Edith Ring.

ACCOUNT CODE £ debit £ EFFECTIVE DOCUMENT JOURNAL USER Created

Credit DATE TYPE DESCRIPTION ID date
AMOUNT
651022 STOCK 400,000 30/6/2022 MANUAL Fair value of E Ring 25/9/2022
HEAD goods - share 20:24
TORCH transaction with
KTY
122022 CLOSING 400,000 30/6/2022 MANUAL Fair value of E Ring 25/9/2022
STOCK goods - share 20:24
HEAD transaction with
TORCH KTY

2) In relation to the analysis of Air Lamps prepared by the audit assistant (Exhibit 1):

• explain the appropriate financial reporting treatment of the contract with FM and prepare
correcting journal entries; and

Financial reporting treatment of Furgus Mining Contract

The contract has two elements:

• The supply of Air Lamps

• The installation.

Supply of Air Lamps

Litesafe has promised goods and services in the contract comprising of a) supply of Air lamps and b)
installation.

To determine whether the supply of lamps and the installation are separable Litesafe needs to apply
the criteria in IFRS 15.

FM can benefit from the lamps on their own either by using then for the installation in the tunnel or by
reselling. The lamps are operable without any further modification. Litesafe has already carried out
modifications to the lamps to ensure that they can be installed in tunnels. The lamps can be used not
just by FM but in any tunnel environment.

With respect to the installation service. Litesafe is acting as principal in the service.

Litesafe has promised to deliver and install the equipment but would be able to fulfil the delivery
without completing the installation. Although FM can only benefit from the Air Lamps once they are
installed, the combined output of the sale of the lamps and installation are separate. The conclusion is
that Litesafe is not providing an integrated service and the two elements have separate performance
obligations. We would need to confirm the payment terms to the contract to ensure that Litesafe can
receive payment for delivery without installation as each delivery and each installation could be
separate performance obligations. .

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The sale of the lamps should be recognised on delivery because it is at this point that FM has control
of the goods.

Litesafe has invoiced for lamps and installation after the completion of a km of installation. If the
installation is regarded as a separate performance obligation, we would need to confirm the basis on
which it is invoiced – after each km or on a percentage completion basis. Given that FM cannot
benefit from the tunnel until it is complete, there is an argument to support not recognising revenue in
respect of the lights installed by the year end. However, there is an argument for saying this second
performance obligation (installation) could be recognised over time. According to IFRS 15 para 36 -
part (b) the installation is creating/enhancing an asset that a customer controls. There is no alternative
use to Litesafe for this tunnel installation, so it appears to also meet part c) of IFRS 15 para 36.
Therefore an amount for installation revenue could be recognised for the installation of 200m/15km.
As this is only 1.3% it is not material and would only represent revenue of £60k.

Therefore, Litesafe should recognise the revenue from the sale of the the first consignment of 4,750
modified Air Lamps with a sales value of £950,000. This should be included in revenue for the year
ended 30 June 2022. And the cost of the 4,350 lamps (£174,000) stored in FM’s warehouse at 30
June 2022 should be removed from Litesafe’s closing inventory.

If revenue is not recognised in respect of the installation of 200m of tunnel lighting, Litesafe should
consider a WIP adjustment. (Given that 400 lamps had been installed by 30 June 2022,
approximately 200 metres of the tunnel has been completed. 1 km of tunnel x 400/2000 lamps = 200
metres). Further information is required to determine this adjustment.

Correcting journal
£
Debit Accrued income 950,000
Credit Revenue 950,000
Debit cost of sales 174,000
Credit closing inventory of air lamps 174,000

Being journal to include revenue for 4,750 lamps and remove cost from inventory

The impact of this journal is to increase profit for the year by £776,000 and reduce profit in the year
ending 30.6.2023 by the same amount.

• recalculate the gross profit percentage for Air Lamps.

£000
Revenue 1952 + 950 2,902
Cost of sales 843 +174 (1,017)
Gross profit 1,885
65%

The gross profit increases after this adjustment but is still below 2021 level. From the above analytical
procedures I have identified that the cost of sales includes an inventory allowance in respect of air
lamps for £105,000 which may be over or understated. Further procedures are required to ensure that
cut off of purchases is correct for this account and the inventory allowance is an appropriate
adjustment to reflect the lower of cost and NRV of air lamps in inventory.

(3) In relation to the analysis of Head Torches prepared by the audit assistant (Exhibit 2):
• explain the appropriate financial reporting treatment of the shares issued to KTY and prepare
correcting journal entries; and

Shares issued to KTY Ltd

This is a transaction with a third party where goods are exchanged for shares in Litesafe. The fair
value of the goods can be measured reliably and therefore the ‘direct method’ as described in IFRS 2
should be used to record a cost for the purchase of the goods.

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Examining account 122022 Closing inventory of Head Torches in June 2022 shows transaction ID
Transaction ID 223773 for £400,000. Edith has correctly included the goods in inventory but has not
included a cost in purchases.

Correcting journal
£
Debit 101022 Purchases Head Torch 400,000
Credit Issued shares 4,000
Credit Share premium 396,000

• recalculate the gross profit percentage for Head Torches.

£000
Revenue 2,159
Cost of sales 320 + 400 (720)
1,439
67%

After including the adjustment, the gross profit percentage decreases and is closer to the GP % for the
previous year.

(4) In relation to the SPOT intangible asset (Exhibit 3), set out and explain the appropriate financial
reporting treatment in Litesafe’s financial statements for the year ended 30 June 2022. Prepare a
correcting journal entry.

Cost

From examining the Intangible account (Account code 61080) in the DAS, there are two transactions
which should be investigated to establish whether these form part of the cost of the intangible asset :

• Transaction ID 223703 for £105k described as an accrual for heat and light posted by Martin
Chan

• Transaction ID 222019 for £45k

Transaction ID 223774 represents the amortisation charge of £232,750. The detail of the working is
shown in the Journal description.

ACCOUNT Debit Credit EFFECTIVE DOCUM JOURNAL DESCRIPTION USE Created

CODE AMOUN DATE ENT R ID date
T TYPE
601080 SPOT 232,750 30/6/2022 MANUA Cost £1,470,000 x E 10/8/202
intangible L £950,000 (4,750 lamps x Ring 2 at 9:30
asset £200)/£6,000,000 (total
FM contract value)

257512 Write offs 232,750 30/6/2022 MANUA Cost £1,470,000 x E 10/8/202

L £950,000 (4,750 lamps x Ring 2 at 9:30
£200/£6,000,000 (total FM
contract value

The amortisation charge is incorrect in a number of respects:

First the calculation assumes a zero residual value - It would be incorrect to assume a zero residual
value in this instance as there is evidence of an active market for the asset at the end if its useful life –
Martin Chan commissioned an external valuation expert who confirmed a residual value of £500,000
based on an estimated useful life of three years.

Second, Edith has measured the amortisation according to items delivered as a proxy for revenue.
Litesafe has not recognised the revenue in the correct financial year but even if it had, there is a

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rebuttable presumption that revenue cannot be used (IAS38 para 98A) but units of production can be
used as an alternative to time (IAS38 para98). The appropriate method is to amortise the cost over
time. The intangible is not specific to the FM contract but is a process which can be applied to lamps
for sales to any mining company.

The amortisation charge should be calculated on the cost less residual value and amortised over 3
years from the date when the SPOT process was first introduced - ie 1 April 2022

Finally the amortisation charge has been calculated on a cost figure of £1,470k – There are two further
amounts noted above which may be part of the total and need further investigation.

Revised calculation

Cost £1,470,000 less residual value £500,000 = 970,000 x 4 months / 36 months = £107,777

Correcting journal
£
Debit 601080 Goodwill (SOFP) 124,973
Credit 257512 Goodwill write off 107,777 – 124,973
232,750 = 124,973

(5) Identify and justify the three specific audit risks that you consider to be most significant in our audit
of Litesafe for the year ended 30 June 2022.

Audit risk that revenue may be understated in particular there is a decline in revenue in last three
months

Revenue has declined and in particular revenue in the last three months has fallen dramatically.

The directors’ meeting refers to customers delaying orders to July 2022 as an explanation for the
decline in revenue – this needs to be followed up as the company may be offering incentives for
customers to order in the next financial year to increase profit before the listing in June 2025. If this
were the case, an increase in inventory at 30 June 2022 could have been expected which has not
happened. Inventory has fallen in the month of June.

A specific revenue recognition issue has arisen with the FM contract. See above – which may indicate
that there are other errors in revenue recognition.

Audit risk that inventory may be understated– in particular the inclusion of a large round sum
inventory allowance in June 2022

The inventory allowance represents a key audit risk that inventory is understated.

The audit risk arises because there is pressure from the CEO Melissa Grange to ensure a smooth
trend of profits in the next two years prior to the listing and using an inventory allowance enables
profits next year to be generated by releasing the allowance.

(Analytical procedures also indicate that inventory days are high, despite the inclusion of the inventory
allowance, there is a risk of overstatement of inventory. This could also be identified as an audit risk
and justified).

Audit risk that trade payables and purchases may be understated

Trade payables have fallen significantly compared to the year ended 30 June 2021 – The audit risk
arises from an unusual transaction involving a supplier KTY. There may be other transactions of this
nature which have been undertaken and incorrectly recorded.

Note: Other key risks explained and justified were also acceptable.

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Examiners’ comments

1.1 Analytical procedures

The gross profit calculation was often done well. The main mistake was assuming that the
inventory had increased over the period instead of reduced. Weaker candidates did not answer
the question asked and produced a net profit schedule and highlighted dividend payments.

The analytical procedures saw students cover the fundamental changes in revenue and
purchases well, linking it back to the specifics in the scenario.

Candidates who scored well were able to discuss issues that affected gross profit (revenue
decreases etc) and highlighted the transactions in June that would have influenced the year on
year movements; namely the inventory allowances and the share-based payments. Candidates
who did this would often easily scored maximum marks.

The majority who accessed the DAS, identified the two key transactions; the inventory allowance
and the share based payment. There was limited use of the metrics module to identify inventory
days.
Weaker candidates spent time discussing transactions that were not relevant to the gross profit
(eg payroll and dividends).

• Common mistakes included:

•
o Restating net profit rather than gross profit as asked
o Showing a lack of understanding of how the movement of inventory and purchase
figures combine to give cost of sales
o Failing to identify the two very obvious entries in inventory
o Including superfluous information about tax, dividends, operating expenses etc
o Highlighting as unusual normal transactions eg accruing for GRNI and recording
payments of purchase invoices.

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1.2 Explain the appropriate financial reporting treatment:

- For the FM contract

- For the shares to KTY
- SPOT intangibles

Many candidates provided good answers to the first two scenarios, correctly identifying the revenue
recognition issues and the direct method share-based payment.

Some candidates failed to appreciate the scenario and stated that the revenue recognised post year
end needed to be reversed – as no entries had been made for this, there was nothing to reverse.
Those candidates who identified only one PO were still able to score a reasonable mark if they then
followed through that conclusion.

With respect to the share based payment, some candidates demonstrated a poor understanding of
how the inventory and purchases balances feed into the calculation of GP. The key to this scenario
was recognising that the inventory was correct but that the transaction had not been reflected in
purchases.

The SPOT intangible issue was often answered well with many candidates finding the entries which
had been made and critiquing them.

A minority failed to access the DAS where the details in respect of capitalised costs and amortisation
method could be unearthed.

Even more disconcerting were the number of candidates illustrating poor knowledge of basic
accounting concepts. Weaker candidates tried to revalue the intangible to the residual value rather
than appreciating its role within the calculation of amortisation charges.

1.3 Three key audit risks

Many candidates scored well on this element of the question. Those who did so clearly identified a risk,
specified over or understatement, used information from the question to justify and explain why the risk
had arisen and backed up their analysis with information taken from DAS and the scenario.

Many candidates identified the future AIM listing creating the risks of suppression of revenue,
overstatement of costs and understatement of amortisation. Sometimes candidates would highlight the
listing/bonus as a separate risk rather than the cause /motivation to misstate the financial statement
figures.

Answers which scored less well:

• focussed wholly on the FR issues covered in 1.2 and simply turned the error found into risks rather
than using them as examples for wider risks identified
• set out a list of observations and did not identify risks
• muddled together risks of under and overstatement or used inappropriate examples to support the
points being made
• focussed wholly on inherent, general risks rather than also including risks to specific balances within
the financial statements
• discussed general business risks using details derived from the scenario but not applied to the
audit.

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Question 2

Scenario

AZT Ltd was incorporated on 31 March 2021 and its main activity is investing in companies with
potential growth. It has a 30 September year end.

On the last day of its previous year end it invested in Greenlang which has a functional currency of €.
Therefore, the previous year financial statements include the consolidation adjustments for
Greenlang.

On 1 October 2021, at the beginning of the financial year, AZT Ltd entered into a lease with
Greenlang for a property which it uses as its UK training centre. In Greenlang’s financial statements it
has correctly recognised the property as a right of use asset and a liability. From AZT’s perspective,
the lessor, this is an operating lease.

The candidate is then provided with a consolidation schedule for the current year end 30 September
2022. The consolidation schedule is incorrect because:

1. The intra group adjustment for the lease has not been made – so the property is in PPE and
included as a right of use assets and liability.
2. The wrong FX rate has been used to translate Greenlang’s profit or loss
3. The goodwill figure is the same as the previous year and has not been translated at closing
rate.
4. The fair value adjustments are also at the opening rate and should be at the closing rate.
5. There has not been any adjustment for subsequent measurement of the fair value of the
brand.

Specifically the candidate is required to:

(1) For AZT Ltd’s lease of property to Greenlang (Exhibit 3), explain the financial reporting
treatment in the individual financial statements of AZT Ltd for the year ended 30 September
2022. Set out any additional information you require.

(2) Using all available information and taking into account any adjustments from (1) above:

a) Identify and explain any errors or omissions in the draft consolidation schedule prepared
by the newly-appointed AZT group financial controller (Exhibit 1). Set out and explain the
correct financial reporting treatment and identify adjustments required to the AZT
consolidated financial statements for the year ended 30 September 2022.

You are not required to redraft the consolidation schedules for the AZT Group.

b) Prepare a revised calculation of goodwill and a consolidated statement of financial

position as at 30 September 2022 for the AZT Group including your adjustments.

Page 13 of 29
@ICAEW

Requirements
(1) For AZT Ltd’s lease of property to
Greenlang (Exhibit 3), explain the
financial reporting treatment in the
individual financial statements of
AZT Ltd for the year ended 30
September 2022. Set out any
additional information you require.
(2) Using all available information
and taking into account any
adjustments from (1) above:
a) Identify and explain any
errors or omissions in the
draft consolidation schedule
prepared by the newly-
appointed AZT group financial
controller (Exhibit 1). Set out
and explain the correct
financial reporting treatment
and identify adjustments
required to the AZT
consolidated financial
statements for the year ended
30 September 2022.
You are not required to
redraft the consolidation
schedules for the AZT Group.
b) Prepare a revised calculation of
goodwill and a consolidated
statement of financial position as
at 30 September 2022 for the AZT
Group including your adjustments.
For AZT Ltd’s lease to Greenlang (Exhibit 3), explain the financial reporting treatment in the
individual financial statements of AZT Ltd for the year ended 30 September 2022. Set out any
additional information you require.
Lease to Greenlang - Lessor accounting:
- AZT is the lessor in this transaction so lessor accounting is relevant.
@ICAEW
Corporate Reporting – Advanced Level November 2022
Marks Skills assessed
8 • Assimilate and demonstrate
understanding of a large amount of
complex information.
• Evaluate, using judgement and
scepticism, the appropriate accounting
treatments for the lessor
• Appreciate the different perspectives of
lessee and lessor
• Demonstrate an understanding of
different perspectives, analysing &
interpreting related problems &
situations from alternative given stances
• Recommend appropriate accounting
adjustments in the form of journal
12 • Draw upon technical & professional
knowledge learnt to analyse issues
• Assimilate data from different sources &
data types in making decisions
(consolidation schedule and previous
years working paper)
• Assess, evaluating & managing
information provided in multiple sources
• Conduct critiques: critically reviewing
situations & problems
8 • Assimilate information and adjustments
to prepare the statement of financial
position
28
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 Corporate Reporting – Advanced Level November 2022

- Under lessor accounting there is still a distinction between an operating lease and a finance lease.

- To determine what type of lease it is, the risks and rewards of ownership need to be considered. In this
case, the lease is for only 5 years for a building which has a 50-year life (the life of the land is likely
longer and indefinite). The risks and rewards of ownership, including the possibility of future periods
when the building is empty remain with AZT, as does the cost of repairs and buildings insurance.
Management should provide HV with a copy of lease to confirm terms and consider any other relevant
conditions.

- The lease is therefore to be treated as an operating lease.

- The property should continue to be recognised as an asset that is leased out in the AZT individual
company financial statements by way of an operating lease and to be depreciated (subject to further
consideration of its status as an investment property and the related accounting policy decisions – see
below)

- The rental income should be recognised on a straight-line basis

- Rental income for the year is €220,000. This was received on the first day of the year when the
exchange rate was £1: €1.1 – hence we would expect to see rental income of £200k in AZT Ltd’s P&L
account. This has been recognised correctly.

Investment property considerations:

- The other relevant point to consider is whether the property leased to Greenlang should be classified
as an investment property under IAS40.

- IAS 40 states that an investment property is land and buildings or both held by the entity to earn
rentals. That appears to be the case as AZT has decided to lease out the property as it has no need for
it for its own use. At the commencement of the lease to Greenlang on 1 October 2021, in the individual
financial statements of AZT Ltd, the property should have been transferred to investment property.
More information on when the decision to rent out the property is needed because if the decision had
been made in previous financial period, this would result in an error of classification in the prior year
accounts.

- At 1 October 2021, the carrying amount was £3.2m – (£2.2m/50 years x 6/12 months) = £3.178m

- That is the case even though the property is leased to another group company – it is still an investment
property from the entity’s own perspective although an owner-occupied property from a group
perspective (see further consideration of group entries needed in (3) below.

- An investment property should initially be recorded at cost (as is the case here) and then the entity has
a choice whether to measure it using the cost model or the fair value model. AZT appears to have
chosen the cost model but that may be by default rather than a conscious choice and so should be
discussed further.

- If the fair value model had been chosen then the property would have been revalued at the date of
transfer with the gain going to OCI. Depreciation would then cease and future changes in fair value
would go to the P&L account.

Under the cost model, the property will continue to be depreciated (as the company has done) and so
its carrying amount of £3.2m – (£2.2m/50 years x 18/12 months) = £3.134m is the balance that should
be described as an investment property at 30 September 2022.

Additional information

Copy of lease to confirm terms and consider any other relevant conditions.
Accounting policy for Investment property
Information on when the decision to rent out the property was taken

Page 15 of 29
@ICAEW
 Corporate Reporting – Advanced Level November 2022

(2) Using all available information and taking into account any adjustments from (1) above:

a. Identify and explain any errors or omissions in the draft consolidation schedule prepared
by the newly-appointed AZT group financial controller (Exhibit 1). Set out and explain the
correct financial reporting treatment and identify adjustments required to the AZT
consolidated financial statements for the year ended 30 September 2022.

You are not required to redraft the consolidation schedules for the AZT Group.

Omission = No adjustments included for the lease in Exhibit 3

The AZT column in the schedules does not include any of the adjustments arising from the financial
reporting issues for the lease. The balances in respect of the right of use asset and liability lease included in
the Greenlang statement of financial position will cancel on consolidation - the property is recognised within
PPE in the consolidated financial statements of the group

Working 1 Correct FR treatment in consolidated financial statements

The building should be shown as PPE in the consolidated financial statements at its carrying amount of
£3,134k

The right of use asset of 683k and the liability 702k cancels with the depreciation charge (€196/1.125)
£174k and interest charge (€46/1.125) £41k and the rent (€220/1.125) 196 (AZT recognised rent at date of
receipt – the exchange difference has been left in the parent company profit or loss). .

£000
Debit liability 702
Credit asset 683
Credit profit or loss 174+41-196 19

Error – incorrect FX rates used to translate the subsidiary -Greenlang

The FX rates used to translate Greenlang’s balances are incorrect. The statement of financial position is
largely correct in that it is translated at the closing rate but the SPL should have been translated at the
average rate for the year - £1:€1.125

This will give rise to the following adjustments to the figures consolidated:

Working 2
Year ended 30 September 2022 Greenlang Greenlang Greenlang Diff.
Statement of comprehensive income Euro 000 £'000 £'000 £'000
At closing At average
rate rate
£1 = €1.15 £1 = €1.125
Revenue 23,901 20,783 21,245
Cost of sales -20,786 -18,075 -18,476
Gross profit 3,115 2,708 2,769
Operating expenses -2,383 -2,072 -2,118
Operating profit 732 636 651
Finance costs -60 -52 -53
Profit before tax 672 584 598
Tax -168 -146 -149
Profit after taxation 504 438 449 9

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@ICAEW
 Corporate Reporting – Advanced Level November 2022

The above FX difference will be included in the foreign exchange reserve on consolidation.

Opening goodwill calculation:

Error: Goodwill has not been translated to closing rate at the year end and adjustments for subsequent
measurement of the brand have not been included.

The financial controller has booked the adjustment to reflect the goodwill as recorded in the prior year
financial statements and reinstated the fair value adjustments.

However, goodwill is treated as an asset of Greenlang and should be retranslated at the closing rate each
year.

A movement to the foreign exchange reserve is required for:

Working 3

The revaluation of the opening Goodwill valuation :

Goodwill 755 HR 1.10 686

755 CR 1.15 657
29
Also, the fair value adjustments should be brought in at closing rate and adjusted to the foreign currency
reserve:

Working 4

€000 £0
Land 2000 HR 1.10 1818
2000 CR 1.15 1739
79
Brand 540 HR 1.10 491
540 CR 1.15 470
21
Deferred tax -483 HR 1.10 -439
-483 CR 1.15 -420
-19
81

Omission – Subsequent adjustment to fair value of the brand has not been made

There is a further adjustment to make as the calculation of goodwill was based on a provisional value for the
net assets (which can be adjusted up to 12 months after the acquisition)

The effect is as follows:

Subsequent measurement of fair value for brand

Working 5

The adjustment to the brand valuation as at the acquisition date should be accounted for as if its fair value
had been recognised from that date. The increase in value is €670 - €540 = €130 at closing rate of £1 =
€1.15 = £113k. This higher net asset value reduces goodwill. This will also impact on the deferred tax
adjustment made in respect of the fair value adjustments to goodwill.

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@ICAEW
 Corporate Reporting – Advanced Level November 2022

£000
Debit Brand 113
Credit Goodwill 113

Debit Goodwill 21
Credit Deferred tax 113 x 19% 21

Working 6

The brand value of €670k should be amortised over its useful life of 10 years with the charge of €67k
(£60k) going to PorL account. This will also affect the deferred tax liability.

£000
Debit Consolidated profit or loss 60
Credit Brand 60

Credit profit or loss 60 x 19% 11

Debit Deferred tax 11

The carrying amount of the brand at the year-end will be €670k - €67k = €603k translated at the year-end
rate of £1 = €1.15 = £523k – see part 2b) below - statement of financial position below.

b) Prepare a revised calculation of goodwill and a consolidated statement of financial position as

at 30 September 2022 for the AZT Group including your adjustments.

Goodwill €000

Net assets, as reported by Greenlang at 30.9.2021 2,908

Add:
Fair value adjustments recorded on consolidation:
Land 2,000
Recognition of Greenlang brand – revised per expert valuer 670
Less:
Revised deferred tax adjustment
2,000 + 670 = 2670 x 19% (AZT’s tax rate) (507)
Revised fair value of net assets at 30 September 2021 5,071

Cash consideration paid on 30 September 2021 5,720

Less: Revised fair value of net assets at 30 September 2021 (5,071)

Goodwill acquired in business combination 649

£000
Translated to £ at £1: €1.15 564

Page 18 of 29
@ICAEW
 Corporate Reporting – Advanced Level November 2022

Revised consolidated statement of financial position as at 30 September 2022 for the AZT Group

Consolidated Consolidated
AZT Group AZT Group
Per question revised
£000 £000

Assets
PPE
14214 - 79 FV adjustment to
closing rate (W4)
14,214 14,135

Intangible asset
- Greenlang brand
- see W5 and W6 above 491 523

Right of use asset – W1

(Eliminates on consolidation) 683 -

Goodwill on consolidation of
Greenlang – see above 686 564

Current assets unchanged 8,331 8331

Total assets
24,405 23,553

Equity
Ordinary shares - £1 each
15,500 15,500

Retained earnings (886k W1 - 9

W2+19 adjustments for lease
W6 - 60 Brand amortisation
Deferred tax +11 886 847

Foreign currency reserve

(134) (236)

16,252 16,111
Liabilities
Lease liability
(Eliminates on consolidation) 702 -
Deferred tax
Per revised goodwill 507 @ 1.15
W6 -11 brand amortisation 439 430

Other liabilities unchanged 7,012 7,012

8,153 7,442

Total equity and liabilities 24,405 23,553

Page 19 of 29
@ICAEW
 Corporate Reporting – Advanced Level November 2022

Examiners’ comments

2.1 Lease

Answers to this element of the question were very variable with some candidates scoring full
marks and others very little.

Those who did well focussed wholly on the treatment in AZT and used the information in the
question to recognise that that the question was about lessor accounting and the classification of
the PPE.

Those who scored poorly:

o Stated that the treatment in AZT needed to mirror that in its subsidiary

o Simply reproduced calculations for the lease already given in the question

Another common mistake was using the ROU asset valuation as the FV for AZT on transfer to an
investment asset.

A significant majority identified the investment property issue and were able to achieve good
marks

Most candidate gained marks for identifying additional information requirements even if they had
missed the key points in the FR analysis.

2.2 Identification or errors and omissions

Most candidates were able to identify the incorrect translation of the subsidiary’s SOPL and
correctly stated that the average rate should have been used. Identification of the failure to
translate the goodwill at closing rate was also commonplace. However, a significant number
multiplied rather than divided by the exchange rate leading to answers which looked odd and
should have been questioned
Cancellation of intra-group balances and the FV adjustment on the brand was identified by the
stronger candidates. Only the very strongest appreciated the DT implications arising on the FV
adjustment.
Candidates demonstrated weak understanding of how fair value adjustments affect both goodwill
and the consolidated statement of financial position. Many stated that the brand should not have
been included on the SOFP as already included in goodwill (missing the point that it was deducted
in arriving at the goodwill figure and not “included in it”. Similar statements were made about
deferred tax.
Weaker candidates struggled with this requirement largely because they tried to recreate the
consolidation rather than identify errors and omissions.
2.3 Candidates attempts at the extracts were often weak but there were plenty of easy marks to
pick up and credit was given for own figures. Candidates were able to score well on the
recalculation of goodwill. It was then surprising to see candidates fail to transfer their own figure
for goodwill to the consolidated SOFP.

Page 20 of 29
@ICAEW
 Corporate Reporting – Advanced Level November 2022

Question 3

FF Ltd, a footwear manufacturer produces a range of well-known footwear made from leather for the
upper part and PVC, a synthetic material, for the soles. Until recently FF manufactured all its products
at a factory in the UK. From October 2021, responding to high demand for its products, FF outsourced
some production to Gan Co, a supplier in Vietnam. In the year ended 30 September 2022, Gan
produced 40% of FF’s footwear. Gan manufactures products to the same FF design as the UK.
Because it has access to a cheap supply of recycled plastic, Gan uses recycled plastic for the soles of
the footwear it produces instead of PVC. There have been negative media stories about carbon
emissions in the supply chains of the plastic recycling industry and FF is concerned about the impact
on its brand reputation.

The candidate is an audit senior asked to explain the financial reporting treatment and the key audit
risks of two issues concerning: the company’s pension plans and; a provision for environmental
restoration. The candidate is also presented with some draft disclosures and is asked to explain the
auditor’s responsibilities, any inadequacies in the disclosures and the implications for the audit.

Ethics

The candidate is required to identify the ethical issues arising from the request made by the client for
an additional assurance report relating to the environmental disclosures. The finance director, Marlon
Lane, an ICAEW Chartered Accountant is under pressure from the CEO to present the disclosures in
a favourable light. In turn the auditor is being put under fee pressure by the finance director.
In addition to setting out ethical implications for the finance director and EH the audit firm, the
candidate is also asked to identify actions for EH.

Total
Marks
1. In respect of the financial reporting issues
identified by the audit senior (Exhibit 1):
(a) For Issue 1, set out and explain the
appropriate financial reporting treatment in
the financial statements for the year ended
30 September 2022. Include the current and
deferred taxation treatment.
(b) For Issue 2, set out and explain the
appropriate financial reporting treatment in
the financial statements for the years ending
30 September 2022 and 2023. Ignore
taxation
14 • Assimilate and demonstrate
understanding of a large amount of
complex information.
• Evaluate, using judgement and
scepticism, the appropriate financial
reporting treatments for the pension
plans including current and deferred
tax treatment
• Recommend appropriate accounting
adjustments
• Assimilate and demonstrate
understanding of a large amount of
complex information.
• Evaluate, using judgement and
scepticism, the appropriate financial
reporting treatment for the provision
• Recommend appropriate accounting
adjustments identifying the cashflows
for restoration of the land deriving
from a past event (acquisition of the
waste disposal unit).
• Apply technical knowledge of
discounting to quantify the provision

(c) For each of Issues 1 and 2, explain • Apply technical knowledge of financial
the key audit risks for the audit of FF’s reporting to determine the key risks
financial statements for the year ended 30 • Apply professional scepticism to
September 2022. justify the key risks

Page 21 of 29
@ICAEW
 Corporate Reporting – Advanced Level November 2022

2. Identify and explain: 8 • Use the data & information given

a) EH’s responsibility as the auditor in
respect of social and environmental
disclosures in the FF’s published
strategic report for the year ended
30 September 2022.
b) Any inadequacies with the draft
disclosures relating to the product
and supply chain (Exhibit 2).
c) The implications of these draft
disclosures (Exhibit 2) for the audit
of the financial statements for the
year ended 30 September 2022.
analyse the data and information to
support requirement
• Use technical & professional
knowledge to analyse the data
• Relate various parts of the question to
identify critical factors
• Explain the nature of the EH’s
responsibility and implications for the
audit
• Apply knowledge from different
technical areas: analysing problems
that combine technical skills in a
single disciplinary environment
• Financial statement analysis: perform
calculations; explaining or stating the
issues
• Conduct critiques: critically reviewing
situations & problems

3. Identify and explain the ethical
issues for Marlon Lane and EH, and
set out the actions EH should take,
arising from Marlon’s request for EH
to prepare the additional assurance
report requested (Exhibit 3).
8 • Identify the threats in the scenario to
the ethical principles of professional
behaviour and objectivity arising from
Marlon’s email.
• Identify the self-interest threats and
threats to objectivity
• Explain the actions for EH
• Explain the scenario from different
perspectives.
• Demonstrate understanding of the
importance of contributing to the
profession & appreciating the ethos &
culture of the accountancy profession
30

3.1 For Issue 1, set out and explain the appropriate financial reporting treatment in the financial
statements for the year ended 30 September 2022. Include the current and deferred taxation
treatment

Issue 1 Pension plans

The ‘2017 plan’ is a defined benefit plan. For financial reporting purposes, the plan’s obligations and
assets are reflected on the statement of financial position and the changes are reported in profit or
loss in respect of service costs and interest – actuarial gains and losses are reflected in reserves
through OCI. The adjustments have both current and deferred tax implications

The ‘new scheme’ is a defined contribution scheme – the financial reporting of this scheme involves
only the recording of the contributions paid in the statement of profit or loss and a current tax
adjustment.

The FD has posted the total contributions to suspense account – these need transferring to profit or
loss in respect of the £80,000 for the defined contribution scheme and to plan assets in respect of the
£400,000 contribution to the defined benefit scheme

Adjustments need to be made to reflect the changes in actuarial assumptions prepared by the
actuary in respect of the defined benefit scheme.

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@ICAEW
 Corporate Reporting – Advanced Level November 2022

Fair value of Present Net defined

plan assets value of benefit
obligation pension
liability

£000 £000 £000

At 1 October 2021 48,914 (50,344) (1,430)

Interest 2.75% 1,345 (1,384) (39)

Contributions paid 400 400

Current service cost (290) (290)

Past service cost (260) (260)

Less: Benefits paid to

retired members (2,870) 2,870

47,789 (49,408) (1,619)

Remeasurement 1,430 (1,402)

28
gain/(loss)

At 30 September 2021 49,219 (50,810) (1,591)

Journals

£000
Credit OCI 28
Debit PorL 39 + 290 + 260 589
Credit Pension obligation 561
Being journal to record changes in the pension obligation

Debit pension obligation 400

Debit profit pr loss - defined contribution scheme 80
Credit suspense 480
Being journal to correct misposting of payment to pension company

(Journals not required, explanations accepted)

Current and deferred tax treatment

A temporary timing difference arises between the carrying amount of the net defined benefit
obligation and its tax base. The tax base is usually nil. It is often difficult to determine the amount of
current and deferred tax that relates to items in the profit or loss or in OCI. As approximation, current
and deferred tax are allocated below on an approximate basis.

Net Deferred
pension Current tax
liability tax (P/L) OCI asset
£000 £000 £000 £000

At 1 October 2021
(1,430) 286

Contributions paid
400 80 80

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@ICAEW
 Corporate Reporting – Advanced Level November 2022

Profit or loss debits

(Service costs + interest cost ) (589) (117.8) (117.8)

Gain on remeasurement
28 5.6 5.6

Profit or loss/ OCI movement

(37.8) 5.6 (32.2)

At 30 September 2022
(1,591) 318
Journal

£000
Debit OCI 5.6
Credit PorL – current tax charge 37.8
Debit Deferred tax asset 32.2
Being journal to record deferred tax adjustments

Key audit risks

A key audit risk is in relation to the valuation of the pension plan liabilities. This is an area involving
significant judgement and estimation, requiring management, after taking advice from their actuarial
advisers, to make a number of assumptions concerning the discount rate, inflation and mortality
estimates.

The assumptions used within the calculation are complex and changes to the assumptions could lead
to material adjustments to the financial statements. In particular changes in the rate used to discount
the liability can have material effect on the obligation.

A key audit risk arises also from the valuation of the plan assets which will require assessment of the
appropriateness of fair value measurements.

A further audit risks arises from identifying whether EH has the appropriate expertise within the firm.
EH should consider appointing an auditor’s expert

Issue 2 Waste disposal facility

A provision should be established if there is a present obligation arising from a past event, there is a
probable outflow which can be reliably measured. The board commitment creates a constructive
obligation that the project will be carried out.

Therefore, the provision established for the financial year 30 September 2022 is measured in respect
of the restoration of the grassland only – ie for 2/3rds of the annual cashflows. The element relating to
the disposal of treated waste is not provided. The provision is calculated as follows:

£000 DCF at 4% £000

30-Sep-23 2,000 0.962 1,924
30-Sep-24 2,000 0.925 1,850
30-Sep-25 1,000 0.889 889
4,663

This is recognised as a credit to liabilities and as a debit to assets because it is part of the cost of
bringing the asset to its present location and condition.

Year ended 30 September 2023

The provision at 30 September 2023 will be :

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@ICAEW
 Corporate Reporting – Advanced Level November 2022

£000 DCF at 4% £000

30-Sep-23 2,000 0.962 1,924
30-Sep-24 1,000 0.925 925
2,849

The charge to the profit or loss for the year ended 30 September 2023 will comprise of:

1. A finance cost - this should be recognised as the liability is now one year closer to being settled.
The finance cost increases the liability.

£000
Provision at 1 October 2022 4,663

Expenditure on 30 September 2023 (2,000)

Finance costs – balancing figure 186

Provision at 30 September 2023 2,849

2. Depreciation – the asset should be depreciated over its useful life – the asset that is created is
an enhancement of the factory building. A possible measurement of this would be over the life
of the property.

Key audit risks

A key audit risk exists around the use of discounting – the rate used should reflect the current market
assessments of the time value of money and the risks specific to the liability i.e., it would be a risk
adjusted rate. We would need to confirm the calculation of the discount rate or confirm that the cash
flows are risk adjusted.

A key audit risk arises over the uncertainty of the success of the project. The outcomes are uncertain
and therefore the asset carrying amount should be reviewed for impairment.

3.2 Identify and explain:

(a) EH’s responsibility as the auditor in respect of social and environmental disclosures in the
published strategic report for the year ended 30 September 2022.

Auditor responsibilities for information published in the financial statements

CA 2006 requires the inclusion of information relating to the environment, employees and social and
community and human rights issues including details of the company policies and their effectiveness
in the strategic report.

EH has a duty to ensure that information published in the strategic report does not conflict with other
information in the audited financial statements.

Social and environmental matters have a material impact on the financial statements. When these
matters are significant to an entity, there may be a risk of material misstatement (including
inadequate disclosure) in the financial statements

ISA (UK) 720 makes it clear that no opinion is expressed but that an auditor is required to read the
other information and do the following:

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 Corporate Reporting – Advanced Level November 2022

• Consider where there is material inconsistency with other information in the financial
statements
• Consider where there is material inconsistency with other information and the auditor’s
knowledge obtained during the audit
• Respond appropriately is a material inconsistency is identified; and
• Report in accordance with ISA (UK) 720.

ISA 720 requires auditors to include an ‘Other information’ section in the audit report which must
include:

• A statement that management is responsible for other information

• Identification of the other information,
• A statement that the auditor’s opinion does not cover the other information and no opinion is
expressed
• A description of the auditor’s responsibilities regarding reading and considering the other
information’ and a statement to say that there is nothing to report or where there is material
uncorrected misstatement a statement to describe this

b) Any inadequacies with the draft disclosures relating to the product and supply chain (Exhibit 2).

The disclosures for 2022 include both FF and Gan. It is therefore not possible to make meaningful
like-for like comparisons with the previous year and FF should show its results separately.

Product and supply chain

Energy from renewable sources – although the disclosure notes the positive effect of including Gan –
The disclosure does not make it clear how the company will achieve the ambitious target of 100% by
2030. The figure of 10% for 2021 relates to FF’s UK factory only. In 2022, 60% of production was in
the UK and 40% in Vietnam. The figure of 36% in the disclosure note assumes that 75% of Gan’s
energy is from renewable sources

% production x renewable energy % %

UK 60% x 10% 6
Gan 40% x 75% 30
36

Materials from sustainable sources

Although the KPI for use of sustainable sources has improved because of the inclusion of Gan, the
scenario notes that the negative media stories about the supply chain for the plastic recycling industry
could lead to reputational and financial implications for FF. Additional provisions or asset impairments
may be required. The disclosures do not address these issues.

% production x sustainable sources % %

UK 60% x 40% 24
Gan 40% x 100% 40
64

The disclosure figure of 64% assumes that 100% of the materials used by Gan are from sustainable
sources. This is contradicted by the disclosures relating to grams of waste per item – see below.

FF’s definition of the meaning of ‘sustainable sources’ should be defined – in the introduction to the
scenario the definition presented is subjective and challengeable – FF “claims that its business is

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 Corporate Reporting – Advanced Level November 2022

sustainable as its footwear is long lasting and durable and the leather it uses is a by-product of the
agricultural industry.”

How is this bench marked against other footwear manufacturers?

• Waste per item (in grams) and % of product returns

Using recycled material and lower quality leather has contributed to an increase in waste and returns
– this could lead to provisions and allowances being required for returns and inventory in the financial
statements. The disclosures here are moving in the wrong direction to the aims stated by FF.

Qualitative nature of disclosure

The disclosures contain terms such as ‘sustainable sources’ and renewable sources’ which are not
defined and are judgmental.

c) The implications for the audit of the financial statements for the year ended 30 September 2022 of
these draft disclosures (Exhibit 2) .

EH will need to consider the implications of social and environmental disclosures on the audit of the
financial statements particularly when planning the audit, carrying out audit procedures and at the
audit review stage.

FF will need to consider the above disclosures as part of understanding the nature of the business
and the inherent risk assessment.

Substantive procedures

FF should consider the effects of social or environmental issues on the financial statements when
designing audit procedures and substantive procedures will be required particularly for the following:

Provisions (for returns – and inventory impairment)

Contingent liabilities (for example, in relation potential breaches of laws and regulations)
Asset values (issues may impact on impairment of inventory or intangibles)
Going concern issues (considered below under audit reviews)

Audit review

Gan is a key supplier to FF – and should be included in the audit review.

EH should consider the implications of the loss of this supplier on FF’s ability to continue as a going
concern. Loss of reputation – may lead to fall in future revenue and impact on going concern.

4. Ethics

Ethical issues for Marlon

Marlon is in a role in which he appears to lack suitable experience. There is a self-interest threat as he
may be concerned about his future with the company. He appears unable to challenge Gerry, the CEO
and demonstrates a lack of professional behaviour by asking the auditors to be on his side.
Gerry may present an intimidation threat to Marlon.

Ethical issues for EH

EH is being asked to produce an assurance report on the social and environmental disclosures – this
should be separate from the audit – EH cannot ‘recycle’ procedures from statutory audit work

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because it is a much wider report. However, EH cannot ignore the information it discovers on the
audit.

EH needs to ensure that it is appointed by the board not just the FD – and to agree scope, terms and
fee. This is to remove the risk of potential ethical conflict arising from a lack of transparency.

EH is facing a conflict of interest between audit procedures and the assurance report. Also a self-
interest threat may arise depending on the size of the assurance work and fee.
Marlon has expressed the desire that the report is prepared cheaply –This creates a quality threat for
EH.

Actions for EH

The matter should be referred to EH’s ethics partner to ensure that the firm is not in breach of code if
the assurance engagement is undertaken. Separate teams will be required and EH should consider
whether the firm has the appropriate expertise to undertake the work.

Examiners’ comments

Many candidates performed well on this question, gaining full or close to full marks

3.1
Pension

A surprising number failed to provide an answer for the DC scheme at all or omitted to say
anything about tax, missing out on easy marks.
The most common errors were:

o Failing to correct entries to suspense account

o Posting past service costs incorrectly in the DB movement (either in wrong direction or
including in asset movement as well)
o Calculating deferred tax on part of the movement rather than on the end balance and then
comparing to the opening balance
o Failing to allocate the deferred tax between OCI and P&L account

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Provision

Answers to this element of the question varied with disappointing answers from many but some
good answers which scored well.
The most common reasons for lost marks were:

o Failing to make any statement about whether a provision was required and why
o Failing to distinguish between the restoration costs and waste costs
o Stating that the debit entry would be to P&L account rather than PPE
o Failing to consider the next accounting year as required

Some candidates wrongly interpreted the question as being about impairment which made no
sense in the context of costs being incurred.

Candidates also wasted time on tax implications which were explicitly excluded from this element.

Risks

Pension risks were often very poor. Candidates often adopted a scatter-gun approach listing lots
of vague risks rather than focussing on the key judgements and complexities.

Provision risks were generally better, focussing correctly on the judgement surrounding the
cashflows and the discount rate.

Disclosures

Most candidates scored well on this element of the question, gaining most marks from their
critique of the disclosures. It was encouraging to see candidates linking information from the
question with the disclosures made.

The element on the role of the auditor was answered less well with worrying levels of
misunderstanding demonstrated. Many appeared to think that the auditor needed to audit the
accuracy of the disclosure and/or audit FF’s supplier, Gan.

Generic answers on the implications of the disclosures gained fewer marks than those which used
specific information from the question to explain why there might be a need for provisions or
impairments or a going concern risk.

Some candidates wasted time talking about the assurance report which had been explicitly
excluded from this element of the question.

Ethics

Many candidates scored well on this section of the question.

Those who scored less well often wasted time on the ethical considerations for others such as
Gerry or actions for Marlon, neither of which were asked for.

Repeating the same point in multiple ways scored no extra marks.

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