CORPORATE REPORTING

Suggested Answers
Nov-Dec 2021

Answer to Question # 01
Response as follows:

From Tania Mahmud

To Finance Director
Date TODAY
Subject Draft financial statements

Please find attached a draft statement of financial position and statement of profit or loss and other comprehensive income
(Attachment 1). I have also attached an explanation of my adjustments and a determination of their impact and proposed alternative
accounting treatments (Attachment 2).

Regards
Tania

Attachment 1
Draft statement of profit or loss and other comprehensive income for the year ended 30 June 2021

BDT m
Revenue (4,398.4 + 81.6 - 8) 4,472.0
Cost of sales (2,579.2 + 144) 2,723.2
Gross profit 1,748.8
Distribution costs 482.4
Administrative expenses (645.6 - 172 + 64) 537.6
Finance costs (38.4 + 16 - 10.4 + 1.6+ 10.4 ) 56.0
Finance income (8.0)
Profit before tax 680.8
Income tax expense (136.5 + 26.9) (163.4)
Profit for the year 517.4
Cash flow hedge 10.4
Reclassification of cash flow hedge (10.4)
Total comprehensive income for the year 517.4

ASSETS BDT m
Non-current assets
Property, plant and equipment (645.6 - 144+ 960 - 182.4) 1,279.2
Current assets 3,036.8
Finance lease receivable (172-8) 164.0
Gross amounts due from customers 81.6
Trade receivables (1,396 – 80 + 10.4) 1,326.4
Cash and cash equivalents 1,464.8
-
Non-current assets classified as held for sale 16.0
Total assets 4,332.0
-
EQUITY AND LIABILITIES -
Equity -
Share capital 800.0
Share premium 672.0
Retained earnings b/f 816 Profit for year 517.4 1,333.4
Non-current liabilities -
Long-term borrowings 640.0
Deferred tax liability (264 + 26.9) 290.9
Current liabilities -
Trade and other payables (439.2 + 136.5) 575.7
Contract liability 8.0
Financial liabilities 12.0
Total equity and liabilities 4,332.0
Attachment 2

Freehold land and buildings

(1) Additions

Renovation of Purbachal property - allocation of costs

The basis on which the renovation costs have been allocated between repairs and maintenance and capital appears somewhat
arbitrary and has not been supported by adequate analysis.

IAS 16 requires that only direct expenditure on property improvements should be capitalized and that maintenance costs should
be written off to profit or loss. The 80:20 split was based on budgeted costs but has been used to allocate actual spend to date.

It is possible that the expenditure to date may include a higher or lower proportion of maintenance than that expected for the
project as a whole. As repairs should be expensed as the work is performed, this could affect the result for the period. Hence it is
important to review a breakdown of the costs actually incurred for the period.

For costs which are capital in nature, we need to evaluate whether any could more appropriately be recorded as plant and machinery
rather than included within building costs. The asset lives and depreciation rates would then differ if the asset is not treated as a
single composite property asset. I need much more information on the nature of the project to do this.

No disposals have been recorded in the year for any previous renovation or construction work on the Ferris Street building which
has been replaced by the work done in the year. In a major project of this type it is likely that there will be elements of the original
cost or of previous renovation projects which should be written off. I need to ascertain the nature of building and previous work
on it in order to determine what element of the carrying amount, if any, should be written off. For example, there may be partition
walls which have been demolished and replaced.

I need to review the budget and the basis of the 80:20 split proposed by the project manager. The project manager may not
understand the requirements of accounting standards and in particular of IAS 16 and may have been motivated by capital budget
constraints or other funding/approval limits than by an analysis of the true nature of the costs to be incurred.

The allocation of costs on a project which includes both types of cost is open to manipulation and can be judgmental and be
challenged by our auditors.

Adjustments required?

I cannot at present quantify whether any adjustment is required without further analysis being performed on the additions accounts
in the general ledger.

Construction of a sports stadium at Cumilla

The cost of BDT 144 million has been incorrectly treated as an addition to PPE and I have therefore corrected this as follows:

Abashan as the contractor should account for the construction of the sports stadium in accordance with IFRS 15, Revenue from
Contracts with Customers. This appears to be a contract specifically negotiated for the construction of an asset for which a fixed
contract price has been agreed.

It is a contract in which the performance obligation is satisfied over time because it meets the following IFRS 1 5 criteria:
• "The entity's performance creates or enhances an asset (eg, work in progress) that the customer controls as the asset is
created or enhanced."

(The contract specifies that control is transferred to the local authority as the stadium is constructed.)

• "The entity's performance does not create an asset with an alternative use to the entity and the entity has an enforceable
right to payment for performance completed to date."

Abashan can have no alternative use for the sports stadium.

For a performance obligation satisfied over time, IFRS 15 states that revenue should be recognized by measuring progress towards
complete satisfaction of that performance obligation. Appropriate methods of measuring progress include output methods and
input methods. An appropriate output method allowed by IFRS 15 is 'surveys of performance completed to date', often referred to
in the construction industry as 'work certified'. An appropriate input method allowed by IFRS 15 is costs incurred.

Contract costs were predicted to be BDT 128 million. However, the estimated total costs to complete the project have now
increased to BDT 180 million. The project is still expected to make a profit of BDT 92 million.
This is a fixed price contract and therefore there is reasonable reliability in respect of the measurement of contract revenue but
there is less certainty regarding the costs to be incurred. However, the surveyor has determined that these can now be reliably
measured.

Under the input method, i.e., using the costs incurred as a method of measuring progress towards satisfaction of the performance
obligation, the obligation is ((144 m/ 180 m) x 100 =) 80% satisfied. Therefore, 217.6 million representing 80% of the contract
revenue would be recognized.

Using the output method, i.e., work certified, the contract is 70% complete ((190.4 / 272) x 100). Revenue of 190.4 million would
therefore be recognized.

In the statement of financial position gross amounts due from customers should be presented as contract costs incurred plus
recognized profits less invoices raised to customers. Trade receivables should include the amounts invoiced less amounts received
from the local authority.

A comparison of the two methods (assuming costs are recognized on an incurred basis) is as follows:

Statement of profit or loss

Costs incurred Work certified

basis basis
BDT m BDT m
Revenue 217.6 190.4
Cost of sales -144 -144
Profit 73.6 46.4

Costs incurred Work certified

basis basis
BDT m BDT m
Statement of financial position
Gross amounts from customers 144 144
Costs incurred 73.6 46.4
Recognized profit 217.6 190.4
Progress billings -136 -136
81.6 54.4
Receivables 0 0

Implication for the financial statements

Using the work certified to date method results in a lower profit, although this method is also less subjective since it does not rely
on estimations of future costs to calculate the percentage complete. To maximise the amount of profit recognised the directors
could select the costs incurred method. Ultimately the profit recognised overall on the contract is the same over time, but the
allocation to
accounting periods is affected by the choice of presentation.

As BDT 136 million of revenue has already been recognised, the following adjustment to the financial statements is required if
the maximum amount of profit is to be recognised:

DEBIT Gross amounts from customers BDT 81.6 m

CREDIT Revenue BDT 81.6 m

Also I have reversed the additions to property, plant and equipment as follows:

DEBIT Cost of sales BDT 144 m

CREDIT PPE BDT 144 m

The assumption has been made that this has been classified as an asset under construction and no depreciation has been charged.
(2) Disposals

Uttara House

The lease does appear to be a finance lease given the transfer to the lessee at the end of the contract; this appears to be the case for
both the buildings and the land.

As the lease to the third party is a finance lease it is correct to treat the property sale as a disposal. However, the finance manager
has failed to account correctly for the disposal and the new finance lease following the guidance for lessor accounting as set out
in IFRS 16, Leases. As title to both land and buildings transfer to the lessee at the end of the lease period, the lease should be
accounted for as a single lease comprising both land and building elements. Assuming that the new lease is at fair market rates,
Abashan should realize a gain on the asset disposal and show a new lease receivable equal to the net investment in the lease. This
will be equal to the minimum lease payments discounted at the rate implicit in the lease.

Correcting journal entries

DEBIT Non-current assets - net investment in lease 172 m

CREDIT Gain/loss on non-current asset disposal 172 m

DEBIT Gain/loss on non-current asset disposal 46.4 m

CREDIT Administrative expenses 46.4 m

Thus giving rise to a gain on disposal of 172 million less carrying amount at date of disposal of 46.4 million 125.6 million.

As this is material it will require disclosure.

To record correctly the receipt of annual rental payment on 1 January 2021:

DEBIT Finance costs 16 m

CREDIT Non-current assets - net investment in lease 16 m

DEBIT Non-current assets - net investment in lease 8m

CREDIT Interest income 8m

Therefore, the net investment in the finance lease receivable will be 164 million (172 m – 16 m + 8 m). To confirm that these are
the correct entries, I need to see evidence that 172 million is the fair value of the property at its disposal date.

Condominium

As the properties were not sold at the year end, it is incorrect to derecognize the assets and recognize a gain in profit or loss. IFRS
5 requires that a non-current asset should be classified as 'held for sale' when the company does not intend to utilize the asset as
part of its ongoing business but intends to sell it. The Condominium office0, having been closed, potentially fall in this category.
To be held in this category, the likelihood of a sale taking place should be highly probable. As the sale is to be completed within
12 months of the year end, then this categorization would appear to be appropriate. Therefore, the following adjustment has been
made:

DEBIT Assets held for sale 80 m

CREDIT Trade receivables 80 m

DEBIT Admin expenses (Gain on disposal) 64 m

CREDIT Assets held for sale 64 m

Discontinued operations

Separate disclosure in the statement of profit or loss as 'discontinued operations' may also be required. The question of whether
the closures are a withdrawal from the market is a question of judgment as the business is now operated entirely online. There is
insufficient information in the summarized trial balance to determine this issue but it will be required before the auditors can
commence their work next week.

Depreciation
The depreciation charge suggests a cost of 2,360 million based upon the accounting policy of the company (47.2 m x 50 years).
This is significantly greater than the cost in the financial statements and is an issue which should be investigated.

3. Foreign currency receivables and forward contract

BDT m
Receivable originally recorded (Kz 483.84 m/5.6) 86.4
Receivable at year end (Kz 483.84 m/5.0) 96.8
Exchange gain 10.4

BDT m BDT m
DEBIT Trade receivables 10.4
CREDIT Profit or loss (other income) 10.4

Forward contract:
This is a cash flow hedge:

DEBIT Equity - (Other comprehensive income) 10.4

DEBIT Finance cost 1.6
CREDIT Financial liability 12

As the change in cash flow affects profit or loss in the current period, a reclassification adjustment is required:

DEBIT Profit or loss 10.4

CREDIT Equity - (Other comprehensive income) 10.4

Foreign currency and financial instruments gains and losses are taxed on the same basis as IFRS profits. As the finance cost and
the exchange gain are both in profit or loss, there are no further current or deferred tax implications.

The scenario states that "the arrangement satisfies the necessary criteria in IFRS 9, Financial Instruments to be accounted for as a
hedge". This is an objective-based test that focuses on the economic relationship between the hedged item and the hedging
instrument, and the effect of credit risk on that economic relationship. This transaction could be treated as either a fair value or
cash flow hedge. However, as a receivable is created there is no need for hedge accounting as the exchange difference on the
receivable and the future are both recognized through profit or loss.

Therefore, an alternative accounting treatment would be not to apply hedge accounting.

4) Property management services contract

Following IFRS 15, revenue should be recognised when, or as, a performance obligation is satisfied. The performance obligation
in the property management services contract with the local authority is the provision of those services (a contract in which the
performance obligation is satisfied over time). As at 1 June when the deposit is received, those services have not been provided
and so the performance has not been satisfied.

Therefore, it was incorrect to recognise the 8 million as revenue. Instead, it is a contract liability, defined by IFRS 15 as "an entity's
obligation to transfer goods or services to a customer for which the entity has received consideration (or the amount is due) from
the customer".

The following journal is required to correct the error:

DEBIT Revenue 8m
CREDIT Contract liability 8 m

5. Taxation

The following journal is required to adjust for current and deferred tax as noted in the assumptions:

DEBIT Income tax expense 136.5 m

CREDIT Current tax obligation 136.5 m
Being current tax adjustment - revised profit (680.8 -112) X 24%

DEBIT Income tax expense (112 m X 24%) 26.9 m

CREDIT Deferred tax obligation 26.9 m

Being adjustment for increase in temporary differences.

Deferred tax summary

BDT m
Deferred tax liability brought forward 264
Increase in taxable temporary differences ( 112 m X 24%) 26.9
Deferred tax liability at 30 June 290.9

Answer to Question # 02

Requirement (i):
Share based payment:
Year Share Options Cumulative Expense for the
Expense year
2021 1200 options x 300 employees x 75% x 75 x 1/3 6,750,000 6,750,000
2022 1200 options x 300 employees x 75% x 75 x 2/3 13,500,000 6,750,000
2023 1200 options x 300 employees x 75% x 75 x 3/3 20,250,000 6,750,000

Journal Entries:
2021 Employee benefit expense Dr 6,750,000
Equity Cr 6,750,000
2022 Employee benefit expense Dr 6,750,000
Equity Cr 6,750,000
2023 Employee benefit expense Dr 6,750,000
Equity Cr 6,750,000

Legal Actions by Mr. Sattar:

IAS 37 states that a provision should be recognised in the accounts if:
 an entity has a present obligation (legal or constructive) because of a past event.
 a transfer of economic benefits will probably be required to settle the obligation; and
 a reliable estimate can be made of the amount of the obligation.

Under IAS 37 contingent liabilities should not be recognised. However, they should be disclosed unless the prospect of settlement
is remote. The entity should disclose:
 the nature of the liability.
 an estimate of its financial effect.
 the uncertainties relating to any possible payments; and
 the likelihood of any reimbursement.
Revenue Recognition:
Revenue should be recognized by the present value amount of the instalment. Present value of the instalments are (20,000 x
11..26)= 225,200. Journal entry for revenue recognition would be:

Journal Entries:
2021 Trade Receivable Dr 225,200
Revenue Cr 225,200

Impairment loss to be recognized:

Particulars Cost at INR Exng. rate Cost at BDT
Carrying amount at reporting date 1,700,000 1.15 1,955,000
Historical cost 2,000,000 1.3 2,600,000
Impairment loss recognised in profit or loss (645,000)

Journal Entries:
2021 Impairment Loss Dr 645,000
Property, plant and equipment Cr 645,000
Requirement (ii):
Consolidation working:
1. MCL acquires shares of PCL at per when retained earnings was zero. That means entire retained earnings of PCL were earned
under MCL control. So the There will be no adjustment except for the unrealized profit.

2. Cheque against Trade receivable from PCL has been received for BDT 750,000 after year end. This was in transit and hence
considered for bank reconciliation. PCL paid the due amount in full. Hence, nothing is pending to adjust with PCL liabilities.
Hence entire 750,00 will be transferred to cash by adjusting trade receivables.

3. PCL sold Inventories worth of BDT 2,500,000 to MCL which has been completely sold off. Hence, Only Revenue and COGS
has been reduced in consolidated adjustment.

4. PCL sold some cycles worth of BDT 850,000 to MCL which remains unsold at MCL warehouse. As per general procedures
PCL charges 20% as margin on cost. Hence. This amount includes 20% unrealized profit for PCL which is equivalent to BDT
170,000. That means inventory of MCL has to be reduced by 170,000 and revenue of PCL needs to be reduced by 170,000.
Consolidated Statement of Financial Statements
Accounting
Particulars MCL PCL Consol Adj Consolidated
Adj
BDT BDT BDT BDT BDT
Assets
Non-current assets
Property, plant and equipment 10,106,845 4,794,848 (645,000) - 14,256,693
Right of use assets 3,559,222 49,780 - - 3,609,002
Investment in subsidiaries 3,808,510 - - (3,808,510) -
17,474,577 4,844,628 (645,000) (3,808,510) 17,865,695
Current assets
Inventories 7,148,934 2,324,957 - (170,000) 9,303,891
Advances, deposits and prepayments 631,394 697,479 - - 1,328,873
Trade receivables 1,121,242 2,873,314 225,200 (750,000) 3,469,756
Cash and cash equivalents 2,003,657 241,130 - 750,000 2,994,787
10,905,227 6,136,880 225,200 (170,000) 17,097,307

Total assets 28,379,804 10,981,508 (419,800) (3,978,510) 34,963,002

Shareholders' equity & liabilities

Shareholders' equity
Share capital 7,803,627 4,480,600 - (4,480,685) 7,803,542
Retained earnings (11,969,166) 316,576 (7,169,800) (191,986) (19,014,376)
Equity under shared based payment - - 6,750,000 - 6,750,000
Minority Interest - - 694,161 694,161
(4,165,539) 4,797,176 (419,800) (3,978,510) (3,766,673)
Liabilities
Long term liabilities
Post-retirement benefit obligation 452,758 142,993 - - 595,751
Non-current portion of lease liability 2,900,306 3,305 - - 2,903,611
3,353,064 146,298 - - 3,499,362
Current liabilities
Current portion of lease liability 720,239 23,100 - - 743,339
Secured short term bank borrowings 3,119,226 243,850 - - 3,363,076
Trade payable and other payables 4,949,227 3,214,827 - - 8,164,054
Inter-company payables 20,403,587 2,556,257 - - 22,959,844
29,192,279 6,038,034 - - 35,230,313

Total liabilities 32,545,343 6,184,332 - - 38,729,675

Total shareholders' equity & liabilities 28,379,804 10,981,508 (419,800) (3,978,510) 34,963,002
 Consolidated Statement of Profit or Loss
Accounting
Particulars MCL PCL Consol Adj Consolidated
Adj
BDT BDT BDT BDT BDT
Revenue

Export sales 15,597,041 18,254,372 225,200 (2,670,000) 31,406,613

Less: Cost of goods sold (15,939,888) (5,823,416) - (2,500,000) (24,263,304)
Gross profit (342,847) 12,430,956 225,200 (5,170,000) 7,143,309
General and administrative expenses (7,346,370) (1,471,165) 6,105,000 - (2,712,535)
Other income 13,379 99,087 - - 112,466
Loss before interest and tax (7,675,838) 11,058,878 6,330,200 (5,170,000) 4,543,240
Finance expenses (356,805) (47,209) - - (404,014)
Income tax expenses (349,835) (205,013) - - (554,848)
Loss after tax (8,382,478) 10,806,656 6,330,200 (5,170,000) 3,584,379
Other comprehensive income - - - - -
Total comprehensive loss for the year (8,382,478) 10,806,656 6,330,200 (5,170,000) 3,584,379

Answer to Question # 03

Requirement (a):

Analysis of the financial Position:

Key ratios:
2021 2020 % Change
Short term solvency ratio
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠
Current Ratio 1.32 1.18 12%
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠 − 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑖𝑒𝑠
Quick ratio 0.92 0.53 76%
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠

𝑁𝑒𝑡 𝐷𝑒𝑏𝑡
Gearing Ratio 12.70 28.31 -55%
𝐸𝑞𝑢𝑖𝑡𝑦
Performance ratio
Return on capital 𝑁𝑒𝑡 𝑃𝑟𝑜𝑓𝑖𝑡
26% 10% 162%
employed 𝑇𝑜𝑡𝑎𝑙 𝐸𝑞𝑢𝑖𝑡𝑦

𝑁𝑒𝑡 𝑃𝑟𝑜𝑓𝑖𝑡
Return on assets 2% 0.3% 460%
𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡
Efficiency Ratio
𝑅𝑒𝑣𝑒𝑛𝑢𝑒
Asset turnover 2.35 1.86 27%
𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡
𝑅𝑒𝑣𝑒𝑛𝑢𝑒
Net asset turnover 32.1 54.1 -41%
𝑇𝑜𝑡𝑎𝑙 𝐸𝑞𝑢𝑖𝑡𝑦

Commentary from ratio analysis:

Solvency of the entity:
Analysis of financial position of SAL indicates that Company has moderately strong financial position. Despite an increase from
previous year ratio of 1.18, its current ratio 1.32 for FY21 is still much lower than current ratio of 2 which is considered to be
standard. That means SAL has ability to meet its current obligation with current asset, but it will almost consume entire current
assets. Thus, it has very low level of working capital which might cause liquidation problem to the company.
Analysis further shows that quick ratio has increase significantly (76%) from previous year. However, it is still lower than industry
standard. As the quick ratio is lower than 1, it will face liquidation crisis in case it suddenly needs to pay off current liabilities.
Analysis on SAL financial statements shows that company debt has decrease significantly which lead to decrease in debt-to-equity
ratio. Debt to equity ratio has decrease to 12.70 from previous 28.31. During the year, SAL has paid off its intercompany loans
and shareholder loans. It is surprising that company is paying off almost interest free source of finance instead of paying off
interest bearing debts. Also, company needs investment in working capital. So, repaying of related party loans is not usual and
raises suspicion.

Performance ratios of the entity:

From the analysis of the performance ratios, it can be noticed that SAL is consistently generating positive returns for the
shareholders utilizing its assets. In 2021 return on ROCE was 26% which has seen massive growth of 162% from previous 10%.
Return on total asset is also increased to 2% from previous 0.3%. However, these returns are most coming from other income
which has been generated from disposal of fully depreciated assets. Therefore, despite SAL has high amount of return, it might
not be consistent.

Efficiency ratios of the entity:

Efficiency ratio aims to show how efficient an entity is in case of generating revenue utilizing its assets. Efficiency ratios shows
that SAL was efficient enough compared to previous year in generating sufficient revenue utilizing its assets or equity. However,
the ratio is very much poor. Furthermore, there has been disposal of assets. Which might lead to high efficiency ratio. Company’s
net asset turnover has drastically fallen to 32% from previous 54%. This clearly indicates that SAL management need to focus on
increase its efficiency in utilizing its assets and equity.

Analysis of Statement of profit or loss:

2021 2020 Change Change %

Revenue 4,416,822,949 5,475,654,506 (1,058,831,557) -19.3%
Cost of sales (4,248,914,370) (5,231,785,349) 982,870,978 -18.8%
Gross profit 167,908,579 243,869,158 (75,960,579) -31.1%
GP % 3.8% 4.5%
Net profit 36,260,306 10,191,436 26,068,870 256%
Net profit % 0.8% 0.2%

Commentary:
Analysis shows that SAL’s current year revenue (4,416,822,949) has decreased significantly by 19.3% compared to previous year
revenue of 5,475,654,506. This is due to COVID pandemic where business has been affected significantly. Following the trend of
revenue decrease, Cost of sales has also decrease. It has decreased by 18.8% which is in line with revenue decrease rate.
Company’s GP margin has decreased to 3.8% from previous year GP margin of 4.5%. Also, total gross profit has decreased by
31% which is very significant. This has been caused by loss of business during Covid pandemic and rise of raw material cost due
to the same reason.

Despite sharp decline in revenue and gross profit, company’s net profit has increased by whopping 256%. Net profit percentage
has increased to 0.8% from 0.2% of previous year. Most of this growth is coming from other income of the company which has
been generated from disposal of non-current assets. Furthermore, due to covid pandemic, there has been reduction of some fixed
costs which lead to decrease in administration cost. This also contributed to growth of net profit. However, having massive growth
during the year, overall net profit margin for the company is very poor. SAL needs to focus on increasing net profit margin by
either increasing sales price, reducing cost of production or administration.

Requirement (b):
Briefing Notes for Team Members

Prepared by: Engagement Manager, Smart Apparels Limited Audit

Subject: Result of the financial statement of SAL and addressing identified audit risks
We have received the financial statements of Smart Apparels Limited for the year ended 30 June 2021 and performed analysis on
those statements and available related non-financial information. Based on our analysis we have identified following risk areas:
Inappropriate revenue recognition:
SAL has shown a significant decrease in sale (19.3%) from previous year. Although it is explained by management that decrease
is due to Covid Pandemic. However, we need to check whether there is any other reason for revenue decrease. As this is a
significant component of the financial statements and primary source of profitability of the company, we have to check the reason
this sharp decrease. Furthermore, we must consider probable risks material misstatements in revenue.

Procedures to be followed:
➢ Understand revenue arrangements.
➢ Review the sales process and identify the risk of misstatements.
➢ Identify the controls available in the sales process and check for their operation and design effectiveness.
➢ Perform monthly, customer wise or product wise sales analysis.
➢ Check for reasons for revenue decrease.
➢ Obtain explanation from management for reason for sharp decrease.
➢ Perform substantive analysis on the suspected areas.

Cost of revenue:
Cost of sales also experienced sharp decreased from previous year. Following the revenue decrease Cost of sales has also decreased
by 18.8%. We need to confirm whether the cost of sales decrease is supported by the revenue decrease.
Procedures to be followed:
➢ Identify the cost components and how they are determined.
➢ Review the prime costs and allocation of factory overheads.
➢ Review the component of factory overheads and confirm for accuracy.
➢ Review the costing methods
➢ Identify the controls available in the costing process.

Collectability of Trade Receivables:

We have seen company is paying off its related party liabilities. However, its balance of related party receivables remains
unchanged. That clearly indicates that SAL has not taken appropriate action to collect the receivable. There is a risk that these
receivables might be non-existent or have become uncollectable.

Procedures to be followed:
➢ Discuss with management and understand the reason for not collecting the receivables.
➢ Send confirmations to the related parties to confirm the exitance of these receivables.
➢ Check whether foreign currency denominated receivables have been valued properly at the year end.

Risk that going concern assumption is inappropriate:

Analysis of financial statements shows that SAL has very low level of liquidity, it has been paying off its related party debts, it is
making continuous loses, it has observing sharp decline in revenue and gross profit. Furthermore, its net profit margin and return
on asset is very low. Asset turnover is also very poor. This clearly indicates that SAL his going though financial hardship and has
a threat to going concern.

Procedures to be followed:
➢ Obtain management assessment of company’s going concern.
➢ Check whether management assessment is appropriate.
➢ Obtain financial forecast for next 4 to 5 years.
➢ If company is not going concern, we must suggest management to prepare financial statements under liquidation basis.
➢ We also confirm whether adequate disclosure has been made in the financial statements.
➢ Conclude on the financial statements and prepare audit opinion.

Answer to question no 4 (a):

i) Audit Risk:
• Risk of improper revenue recognition:
DBL replaces expired products of retailers for free of cost. So, a portion of revenue should be kept as provision for
expired goods that will be replaced. If management do not recognize that provision, revenue will be misstated.

• Fraud by sale representative while replacing expired products:

Sales representatives collect sales order and also replaces the expired product. Therefore, sales representative might
show higher amount of expired product to get fresh product and then sell the extra products to the retailers for his
own interest.

• Misappropriation of fund by sales representative.

Sales representatives receives cash for the sold items. They might misappropriate the cash amount.

• Yearend inventory might include expired or obsolete products

As the shelf life is very short. Hence there is possibility that some of the inventory at the year end might become
expired. Also, there might be case that some product is not produced following food safety code. Hence, value of
these inventories might be zero and year end inventory value might be overstated.

ii) Appropriate audit procedures:

• Obtain understanding of revenue recognition process.

• Confirm that appropriate provision is kept for product replacement.
• Understand the product replacement process.
• Identify controls overs request from retailers for replacement and issue of replacement product.
• Identify and test controls over order collection and cash realization.
• Check valuation of the inventories at the year end.
• Perform stock count at the year end and identify expired product.

Answer to question no 4 (b):

Requirement (i):
Intra-group balances should agree because, in the preparation of consolidated accounts, it is necessary to cancel them out. If they
do not cancel out, then the group accounts will be displaying an item which has no value outside of the group and profits may be
correspondingly under- or overstated. The audit procedures required to check that intra-group balances agree would be as follows.
(1) Obtain and review a copy of the parent company's instructions to all group members relating to the procedures for reconciliation
and agreement of year-end intra-group balances. Particular attention should be paid to the treatment of 'in transit' items to
ensure that there is a proper cut-off.
(2) Obtain a schedule of intra-group balances from all group companies and check the details therein to the summary prepared by
the parent company. The details on these schedules should also be independently confirmed in writing by the other auditors
involved.
(3) Nil balances should also be confirmed by both the group companies concerned and their respective auditors.
(4) The details on the schedules in (2) above should also be agreed to the details in the financial statements of the individual group
companies which are submitted to the parent company for consolidation purposes.

Requirement (ii):
Where one company in a group supplies goods to another company at cost plus a percentage, and such goods remain in inventory
at the year end, then the group inventory will contain an element of unrealised profit. In the preparation of the group accounts,
best accounting practice requires that an allowance should be made for this unrealised profit.
In order to verify that intra-group profit in inventory has been correctly accounted for in the group accounts, the audit procedures
required would be as follows.
(1) Confirm the group's procedures for identification of such inventory and their notification to the parent company who will be
responsible for making the required provision.
(2) Obtain and review schedules of intra-group inventory from group companies and confirm that the same categories of inventory
have been included as in previous years.
(3) Select a sample of invoices for goods purchased from group companies and check to see that these have been included in
year-end intra-group inventory as necessary and obtain confirmation from component auditors that they have satisfactorily
completed a similar exercise.
(4) Check the calculation of the allowance for unrealised profit and confirm that this has been arrived at on a consistent basis
with that used in earlier years, after making the allowance for any known changes in the profit margins operated by various
group companies.
(5) Check the schedules of intra-group inventory against the various inventory sheets and consider whether the level of intra-
group inventory appears to be reasonable in comparison with previous years, ensuring that satisfactory explanations are
obtained for any material differences.

Answer to question no 5:
i) Muntasir is at present a member of the assurance team and a member of her immediate family owns a direct financial
interest in the audit client. This is unacceptable.
In order to mitigate the risk to independence that this poses on the audit, KRC needs to apply one of two safeguards:
 Ensure that the connected person divests the shares
 Remove Muntasir from the engagement team
Muntasir should be appraised that these are the options and removed from the team while a decision is taken whether to
divest the shares. Muntasir’s wife appears to want to keep the shares, in which case Muntasir should be removed from
the team immediately.
The firm should appraise the audit committee of Hallmark of what has happened and the actions it has taken. The partners
should consider whether it is necessary to bring in an independent partner to review audit work. However, given that
Muntasir’s involvement is subject to the review of the existing engagement partner, and she was not connected with the
shares while she was carrying out the work, a second partner review is likely to be unnecessary in this case.
ii) The audit firm has an indirect interest in the parent company of a company it has been invited to tender for by virtue of
its pension scheme having invested in ESL.
This is no barrier to the audit firm tendering for the audit of ESL. Should the audit firm win the tender and become the
auditors of ESL, it should consider whether it is necessary to apply safeguards to mitigate against the risk to independence
on the audit as a result of the indirect financial interest.
The factors that the partners will need to consider are the materiality of the interest to either party and the degree of
control that the firm actually has over the financial interest.
In this case, the audit firm has no control over the financial interest. An independent pension scheme trustee is in control
of the financial interest. In addition, the interest is unlikely to be substantial and is therefore immaterial to both parties.
It is likely that this risk is already sufficiently minimal as to not require safeguards. However, if the audit firm felt that it
was necessary to apply safeguards, it could consider the following:
 Notifying the audit committee of the interest
 Requiring Trustee to dispose of the shares in ESL.