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  • 10 Marks

AA – July 2023 – L2 – Q4a – Completion Procedures and Reporting, Planning and Approach for Audit and Assurance Engagements

Explanation of going concern indicators for Kitchenhub Ltd and the stages when analytical procedures can be used.

a) You are an Audit Assistant of Abinchi & Associate and your firm is planning the audit of a client. You have been provided with draft financial statements extracts and the following information is about your client, Kitchenhub Ltd, who is a kitchen equipment manufacturer. The company’s year-end is 30 April 2022.

Kitchenhub Ltd has recently been experiencing trading difficulties, as its major customer who owes GH¢0.6 million to Kitchenhub Ltd has ceased trading, and it is unlikely any of this will be received. However, the balance is included in the financial statements extracts below. The sales director has recently left Kitchenhub Ltd and is yet to be replaced.

The monthly cash flow has shown a net cash outflow for the last two months of the financial year and is forecast as negative for the forthcoming financial year. As a result of this, the company is unable to settle suppliers whose payments are due, and some are threatening legal action to recover the sums owing.

Due to its financial difficulties, Kitchenhub Ltd defaulted on a loan repayment, and as a result of this breach in the loan contract, the bank has asked that the loan of GH¢4.8 million be repaid in full within six months. In view of this, the directors have decided not to pay dividends for the period.

Below is the Financial Statement extract for Kitchenhub Ltd for the year ended 30 April:

Draft 2022 (GH¢) Actual 2021 (GH¢)
Current assets
Inventory 3.4 1.6
Receivables 1.4 2.2
Cash – 1.2
Current liabilities
Trade payables 1.9 0.9
Overdraft 0.8 –
Loans 4.8 0.2

Required:
i) Explain SEVEN (7) factors that indicate that Kitchenhub Ltd may not be operating as a going concern entity. (7 marks)
ii) Identify THREE (3) stages of an audit when analytical procedures can be used by Abinchi & Associate. (3 marks)

i) Factors indicating that Kitchenhub Ltd may not be a going concern entity:

  1. Major customer ceased trading: Kitchenhub Ltd’s major customer owing GH¢0.6 million has ceased trading, likely resulting in significant loss of revenue.
  2. Loss of sales director: The departure of the sales director, with no replacement, may impact sales generation.
  3. Negative cash flows: The company is experiencing net cash outflows, forecasted to continue, worsening liquidity.
  4. Suppliers unpaid and threatening legal action: The inability to pay suppliers, coupled with threats of legal action, increases financial pressure.
  5. Loan default: Defaulting on a GH¢4.8 million loan and the demand to repay within six months significantly strains finances.
  6. No dividend payment: The directors’ decision to withhold dividends indicates severe cash constraints.
  7. Declining current ratio: The company’s current ratio has declined significantly from 4.55 (2021) to 0.64 (2022), highlighting liquidity problems.

ii) Stages of an audit where analytical procedures can be used:

  1. Planning stage: Analytical procedures are used as risk assessment tools to understand the entity and assess the risk of material misstatement.
  2. Final audit stage: Analytical procedures can be used as substantive procedures to obtain sufficient appropriate audit evidence.
  3. Final review stage: Analytical procedures assist in forming an overall conclusion as to whether the financial statements are consistent with the auditor’s understanding of the entity.
  • 10 Marks

AA – Aug 2022 – L2 – Q4a – Completion Procedures and Reporting

Defines going concern and discusses the auditor's responsibilities and procedures in relation to going concern.

Pinto Ltd (Pinto) provides analytical services to a wide range of clients. Typical assignments range from testing food for illegal additives to providing forensic analysis on items used to commit crimes to assist law enforcement officers.

The annual audit is nearly complete. As Audit Senior, you have reported to the Engagement Partner that Pinto is having some financial difficulties. Income has fallen due to the adverse effect of two high-profile court cases, where Pinto’s services to assist the prosecution were found to be in error. Not only did this provide adverse publicity for Pinto, but a number of clients did not renew their contracts. A senior employee then left Pinto, stating lack of investment in new analysis machines thus increasing the risk of incorrect information being provided by the company.

A cash flow forecast prepared internally showed Pinto requiring significant additional cash within the next 12 months to maintain even the current level of services and operations. Pinto’s auditors have been asked to provide a negative assurance report on this forecast.

Required:
i) Define going concern and discuss the auditor’s responsibilities in respect of going concern.
(4 marks)

ii) State FIVE (5) audit procedures that may be carried out to determine whether or not Pinto is a going concern.
(6 marks)

i) Definition of Going Concern:
Going concern refers to the assumption that an entity will continue its operations for the foreseeable future without the intention or necessity of liquidation or ceasing trade. It is a fundamental accounting concept used in the preparation of financial statements as per IAS 1 – Presentation of Financial Statements.
(2 marks)

Auditor’s Responsibilities in Respect of Going Concern (ISA 570):
The auditor has three key responsibilities regarding going concern:

  • Evaluate Management’s Use of the Going Concern Assumption:
    The auditor should evaluate whether management’s use of the going concern assumption in the preparation of financial statements is appropriate.
  • Perform Appropriate Audit Procedures:
    The auditor must carry out procedures to assess whether the organization can continue as a going concern.
  • Report on the Going Concern Assumption:
    If the auditor believes that management’s use of the going concern assumption is inappropriate or that there are material uncertainties, the auditor must modify their audit report accordingly.
    (2 marks)

ii) Audit Procedures to Assess Going Concern:

  1. Review the Cash Flow Forecast:
    Obtain and review Pinto’s cash flow forecast for the next 12 months, analyzing assumptions and discussing with management to assess liquidity issues.
  2. Inquire of Management:
    Discuss with management their plans to obtain additional financing or take other measures to address the cash shortfall and evaluate the feasibility of these actions.
  3. Review Interim Financial Statements:
    Obtain and review interim financial statements to evaluate post-year-end performance and whether sales or income levels align with the forecast.
  4. Examine Legal Claims:
    Obtain a solicitor’s letter and review the details of legal claims against Pinto, assessing their potential financial impact.
  5. Review Post-Year-End Orders and Contracts:
    Review Pinto’s order book and contracts with clients to determine whether future revenue streams are sufficient to support continued operations.
  6. Assess Capital Investment and Equipment Needs:
    Consider whether lack of investment in new machines or equipment may further weaken Pinto’s financial position and ability to generate revenue.

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