ACC 3400 Advanced Audit and Internal Review

│LECTURE 2│

COMPLETION OF THE AUDIT (II)

Suggested answers
a) Reasons to establish whether the company is a going concern:
• Financial statements are normally based on going concern concept - a fundamental principle of accounting.
• The concept implies that the business will continue into the indefinite future and published profits and asset values shown in financial statements will normally reflect this assumption.
• Alternative assumption is break-up values basis, potentially involving substantial losses to shareholders and creditors.
• Consequently both directors and auditors must consider whether business will continue without significantly curtailing the scale of operations at least until the next financial year end.
b) The following factors indicate that Dora Ltd may have going concern difficulties:
• Reported losses
• Share prices at a low level
• Board room resignations
• The need for a major reorganisation and plant closures
• Liquidity problems necessitating a new debenture issue, the re-scheduling of bank loan repayments and re-negotiation of overdraft facilities
• Adverse press reports to this effect
• A major court case against the company
c) Audit procedures during period after balance sheet date to test the applicability of going concern:
• Review sales and orders received after balance sheet date.
• Review budgets and management accounts for the whole following year and assess their reliability by comparing the budgeted performance in the period after balance sheet date with the actual performance.
• Review cash flow forecasts to see whether funds will be available to undertake reorganisation and make loan repayments, etc.
• Check legal obstacles of additional borrowing, including Articles of Association, debenture trust deeds, bank loan agreements, etc.
• Ascertain (by letter) state of proposed debenture issue with issuing house, merchants bankers, solicitors, etc.
• Ascertain (by letter) state of negotiations of bank loans and overdrafts with banks.
• Ascertain (by letter) state of court case with solicitors.
• Consider reasonableness of the proposed reorganisations and financing arrangements and assess likelihood of their success - engage management consultants or other experts where appropriate.
• Review minutes of directors’ meetings and obtain letter of representation from board concerning reorganisation, loan/overdraft position, and potential contingent liabilities (including the court case).
d) Approach for the court case:
• Court case represents a provision or contingent liability and it is need to consult HKAS37 “Provisions, contingent liabilities and contingent assets” for accounting treatments and disclosures in the financial statements.
• Review correspondence between Dora and Edmond and their legal advisers, particularly that relating to the claim for damages.
• With the client’s permission, approach the client’s legal advisers for asking their view on the likely outcome of the claim and the possibility of an out of court settlement.
• Seek independent legal advice if necessary.
• Ask the directors of Dora for their views on the matter, particularly their dealings with Edmond. Review board minutes concerning this matter.
• Need to determine the extent of potential liabilities including claims and legal costs (their degree of probability/remoteness) based on all the evidence obtained from the above procedures up to the time of the audit.
• Probable damages should be accrued as a provision with disclosures; possible but not probable damages should be disclosed as contingent liabilities (not recognised as a provision) and remote damages can be ignored.
• The estimate of the legal costs (including court costs) involved in defending the action against the company should be recognised as a provision. The actual costs to the date of the audit should be known, and an estimate should be made of subsequent costs.
• Consider any insurance cover. If the reimbursement is virtually certain, it should be recognised as a separate asset in the statement of financial position and may be offset against the claims provided in the statement of comprehensive income; otherwise, the expected reimbursement should be disclosed only but not recognised as an asset.
• If the auditor considers that the company’s provisions or disclosures are materially misstated then he should say so in his audit report.
at 31 December 2009.
You should then match the opening balances of the ledgers at 1 January 2010 against the audited closing balances.
If you ascertain that the opening balances contained material misstatement, you should advise ABC Limited to make the adjustments accordingly.
If, after performing audit procedures including those set out above, you are unable to obtain sufficient appropriate audit evidence concerning opening balances, your audit report should contain a qualified opinion (except for limitation) or a disclaimer.
Week 2
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