Question Tag: IAS 37

Search 500 + past questions and counting.
Professional Bodies Filter
Program Filters
Subject Filters
More
Tags Filter
More
Check Box – Levels
Series Filter
More
Topics Filter
More
  • 5 Marks

AAA – Nov 2023 – L3 – Q5c – Reporting

Comment on a draft audit report regarding a warranty provision disclosure.

c) On 1 July 2022, Obidi Ltd introduced a ten-year warranty on all sales of its cooking equipment. Total sales of the cooking equipment for the year ended 31 March 2023 amounted to GH¢2.5 million. The draft Auditor’s Report for the year ended 31 March 2023 showed revenue of GH¢5.6 million.

The notes to the financial statements disclosed that since the introduction of the warranty, Obidi Ltd’s cooking equipment has been guaranteed to be free from defects under normal household use. As a result, no provision was recognised, as the amount of the obligation cannot be measured with sufficient reliability.

The draft report on the Financial Statements of Obidi Ltd for the year ended 31 March 2023 was unmodified.

Required: As the Managing Partner, comment on the draft report before you. (5 marks)

The sales of cooking equipment represent GH¢2.5 million of revenue for the year, which is 44.6% of total revenue and therefore material to the accounts.

The conditions for recognising a provision in the financial statements in accordance with IAS 37 Provisions, Contingent Liabilities and Contingent Assets are that there is a present obligation as a result of a past event, it is probable that a transfer of economic benefits will be required to settle the obligation, and a reliable estimate can be made of the amount of the obligation.

Obidi Ltd’s management should recognise a provision in the financial statements for the year ended 31 March 2023 if the conditions are met. However, the disclosure in the accounts is as a contingent liability – but it is very unlikely that the company cannot make a reliable estimate of the obligation.

If a provision is not made for the warranty, then the auditor’s opinion would be qualified on the basis of a material misstatement (‘except for’) in respect of non-compliance with the requirements of IAS 37.

(5 marks)

  • 20 Marks

AAA – Nov 2016 – L3 – Q3 – Planning | Audit Evidence

Identify and explain audit risks, procedures, and evidence related to Kpandu Sika Ltd. for the year ended 31 December 2015.

You are a manager in Amable & Co, a firm of Chartered Accountants, responsible for the audit of Kpandu Sika Limited for the year ended 31 December 2015. Kpandu Sika Limited is a company listed on the Ghana Stock Exchange (GSE) which has been a client of your firm in the past three years. The company manufactures consumer electronic appliances which are then sold to major retail organizations. You are aware that during the last year, Kpandu Sika Limited lost several customer contracts due to cheap imports. However, a new division has been created to sell its products directly to individual customers in Ghana and worldwide via a new website, which was launched on 1 December 2015.

Financial information provided by the Finance Manager is shown below:

STATEMENT OF PROFIT OR LOSS

 

STATEMENT OF FINANCIAL POSITION AS AT

 

EQUITY AND LIABILITIES

NOTES:
i) Kpandu Sika Limited established an equity-settled share-based payment plan for its executives on 1 January 2015. 250 executives and senior managers have received 100 share options each, which vest on 31 December 2015 if the executive remains in employment at that date and if Kpandu Sika Limited’s share price increases by 10% per annum. No expense has been recognized this year as Kpandu Sika Limited’s share price has fallen by 5% in the last six months, and so it is felt that the condition relating to the share price will not be met this year-end.
ii) On 1 July 2015, Kpandu Sika Limited entered into a lease which has been accounted for as a finance lease and capitalized at GH¢19 million. The leased property is used as the head office for Kpandu Sika Limited’s new website development and sales division. The lease term is for five years and the fair value of the property at the inception of the lease was GH¢76 million.
iii) On 30 June 2015 Kpandu Sika Limited’s properties were revalued by an independent expert.
iv) A significant amount has been invested in the new website, which is seen as a major strategic development for the company. The website has generated minimal sales since its launch last month, and advertising campaigns are currently being conducted to promote the site.
v) The long-term borrowings are due to be repaid in two equal installments on 30 September 2016 and 2017. Kpandu Sika Limited is in the process of renegotiating the loan, to extend the repayment dates, and to increase the amount of the loan.
vi) The provision relates to product warranties offered by the company.
vii) The overdraft limit agreed with Kpandu Sika Limited’s bank is GH¢5.7 million.

Required:
a) Using the information provided by the Finance Manager, identify and explain the principal audit risks to be considered in planning the final audit.
(10 marks)

b) State the principal audit procedures which should be performed in respect of the provision for the product warranties offered by the company.
(6 marks)

c) State the principal audit evidence which you would expect to find in respect of the classification of the new lease in terms of IAS 17 Leases (Do not consider the application of the new leasing standard IFRS 16 Leases).
(4 marks)

a)

Principal Audit Risks:

  1. Profitability: Declining profitability with revenue falling by 12.3% and operating profit falling by 27.8% increases going concern risk.
  2. Management Bias: Risks of management overstating assets or understating liabilities due to renegotiating long-term finance.
  3. Operating Expenses: Possible understatement of expenses, especially due to new business division setup costs.
  4. Share-Based Payment Plan: Misstatement risk as no expense was recognized despite IFRS 2 requirements.
  5. Finance Costs: Static finance costs despite increased overdraft suggests possible understatement.
  6. Liquidity: Deteriorating liquidity position with increased reliance on overdraft indicates a going concern risk.
  7. Revaluation: Risk of overstatement due to material revaluation, potential depreciation issues, and deferred tax liability.
  8. Current Assets: Potential overstatement of inventory and receivables, increased holding, and collection periods.
  9. Long-Term Borrowings: Incorrect classification could lead to material misstatement; possible liquidity and going concern risk if loans are not renegotiated.
  10. Intangible Assets: Capitalization of website development costs may not meet IAS 38 criteria, leading to possible overstatement.

b)

Principal Audit Procedures:

  • Review and test management’s process in developing the provision for warranties.
  • Obtain independent estimates and compare them with management’s provision.
  • Review subsequent events that may affect the provision.

c)

Principal Audit Evidence for Lease Classification:

  • Verify the lease agreement terms, especially the lease term and payments.
  • Compare capitalized amount with the fair value of the asset.
  • Ensure correct classification as finance or operating lease per IAS 17 criteria.
  • 20 Marks

AAA – April 2022 – L3 – Q2 – Evaluation and review, Group audits, Current issues

Comment on matters raised and state audit evidence required for Lartey Company Ltd for the year ended 30 September 2020.

Lartey Company Ltd (LCL) is a Private Limited Liability Company that was incorporated several years ago under the Companies Act, 1963 (Act 179) now Companies Act, 2019 (Act 992). The company is currently listed on the Ghana Stock Exchange. LCL is one of the world’s leading leisure travel providers, operating under several brand names to sell packaged holidays. The company catered for more than 10 million customers in the last 12 months. Draft figures for the year ended 30 September 2020 show revenue of GH¢320 million, profit before tax of GH¢15 million, and total assets of GH¢410 million. LCL’s executives earn a bonus based on the profit before tax.

You are the senior manager responsible for the audit of LCL. The final audit is nearing completion, and the following points have been noted by the audit senior for your attention:

  1. Acquisition of Esinam Co. Ltd. On 15 November 2020, LCL acquired Esinam Co. Ltd, a company offering adventure holidays for independent travelers. Esinam Co. Ltd represents a significant acquisition, but this has not been recognised in the financial statements.
  2. Aseye Cruises One part of the company’s activities, operating under the Aseye Cruises brand, provides cruise holidays. Due to the economic recession owing to the Covid-19 pandemic, the revenue of the Aseye Cruises business segment has fallen by 25% this year, and profit before tax has fallen by 35%. Aseye Cruises contributed GH¢64 million to total revenue for the year ended 30 September 2020, and has identifiable assets of GH¢23.5 million, including several large cruise liners. The Aseye Cruises brand is not recognised as an intangible asset, as it was internally generated.
  3. Compensation Claim In July 2020, thousands of holiday-makers were left stranded abroad after the company operating the main airline chartered by LCL suffered Covid-19 restrictions. The holiday-makers were forced to wait an average of two weeks before they could be returned home using an alternative airline. They have formed a group which is claiming compensation for the time they were forced to spend abroad, with the total claim amounting to GH¢2 million. The reasons for the group claiming compensation include accommodation and subsistence costs, lost income, and distress caused by the situation. The claim has not been recognised or disclosed in the draft financial statements, as management argues that the full amount payable will be covered by LCL’s insurance cover.

Required: Comment on the matters raised and in your review of the working papers, state the audit evidence required to draw reasonable conclusions for the year ended 30 September 2020.

Acquisition of Esinam Co. Ltd.
Matters to consider:

  • According to IAS 10 Events After the Reporting Period, the acquisition of a subsidiary after the year-end is a non-adjusting event, as it is unrelated to a condition existing at the year-end. If non-adjusting events after the reporting date are material, non-disclosure could influence the economic decisions of users taken on the basis of the financial statements.
  • A note to the financial statements should disclose for each material category of non-adjusting event the nature of the event and an estimate of its financial effect, or a statement that such an estimate cannot be made.
  • As a note has not been provided, and Esinam Co. Ltd represents a significant acquisition, there is currently a breach of the disclosure requirements of IAS 10. If a note is not provided, the audit opinion should be qualified ‘except for’ due to material misstatement caused by a lack of disclosure required by accounting standards.

Audit Evidence Required:

  • A copy of the press release announcing the acquisition, including the date of the announcement.
  • A copy of any legal agreement pertaining to the acquisition, including the date that control passes to Lartey Company Ltd.
  • A review of any due diligence report received pertaining to the acquisition, detailing the value of assets purchased, and the consideration paid.
  • A review of the financial statements of Esinam Co. Ltd to determine that it represents a significant acquisition for the group, therefore warranting a disclosure note.
  • A review of any note provided by management to be included in the financial statements. (5 marks)

2. Aseye Cruises
Matters to consider:

  • The Aseye Cruises operation is clearly a significant part of LCL’s activities, contributing 20% to revenue (64/320 x 100%). This revenue stream is material to the financial statements. The identifiable assets of the business segment represent 5.7% of total assets (23.5/410 x 100%), so they are material to the statement of financial position.
  • The fact that the brand has performed poorly is an indicator of impairment according to IAS 36 Impairment of Assets. Although the brand itself is not recognised, the assets identifiable with the brand should be assessed for impairment by management, to determine their recoverable amount.
  • The assets represent a cash-generating unit, as the cash flows generated by the assets identifiable with Aseye Cruises are independent of cash flows generated by other assets of the company. Management should conduct an impairment test by calculating the value-in-use of the cash-generating unit, and also calculate the fair value less cost to sell, to determine the recoverable amount of the assets collectively. Any impairment loss should be expensed. Management may resist recognising an impairment loss due to its impact on their bonus payment.
  • The calculations involved in the impairment test contain subjective elements, such as determining the appropriate discount rate for discounting cash flows to present value, and assumptions over the projected cash flows of the brand. Management’s assumptions may need to be approached with scepticism due to the bonus based on profit.

Audit Evidence Required:

  • A review of management’s impairment test (if conducted), including:
    • Assessment that an appropriate discount rate has been used.
    • Agreement that the assumptions to determine future cash flows are reasonable and in line with business understanding.
    • Agreement that the correct carrying value of assets has been used for comparison of recoverable amount.
    • Agreement that all identifiable assets have been included in the cash-generating unit.
    • Recalculation of all figures.
  • Discussion with management over the expected future performance of Aseye Cruises, including any strategies to be put in place to combat the declining performance.
  • A review of post-year-end management accounts for the performance of Aseye Cruises after the reporting date.
  • A review of the level of bookings made in advance for cruises to be taken in the future. (7 marks)

3. Compensation Claim
Matters to consider:

  • The claim for compensation is material to profit as it represents 13.3% of profit before tax (2/15 x 100%). It is not material to the statement of financial position as it represents only 0.49% of total assets (2/410 x 100%).
  • Management may want to ignore the provision, as its recognition would reduce profit before tax by a material amount, therefore reducing their bonus payment. This issue is also inherently risky as it is based on reaching a judgement about the probability of the amount becoming payable.
  • However, the claim cannot be ignored. A proper assessment should be made as to whether the amount claimed should be treated as a provision or a contingent liability. According to IAS 37 Provisions, Contingent Liabilities and Contingent Assets, a provision should be recognised where there is a present obligation as a result of a past event, a probable outflow of economic benefit, and a reliable estimate can be made of the amount. In the event that there is a possible outflow of economic benefit, a note to the financial statements describing the nature and estimated potential financial effect of contingent liability should be provided.
  • The fact that the compensation, if paid, would be covered by insurance does not mean that the matter should be ignored. Any amount potentially recoverable from the insurers should be assessed as to whether it is virtually certain to be received, in which case a receivable should be recognised, or if the recoverability is less than virtually certain, a note to the financial statements describing the contingent asset should be provided. An assessment should be carried out on the recoverability of the amount claimed.
  • Further liabilities may also need to be recognised in respect of legal costs. This would further reduce the year-end profit figure.
  • In the event that the claim results in the recognition of a provision, and the insurance reimbursement results in the recognition of a receivable, the two items should be separately presented in the statement of financial position and not netted off.

Audit Evidence Required:

  • A copy of the claim made by the group of holiday-makers, detailing the GH¢2 million claimed and the basis of the claim.
  • A review of correspondence between the ‘claim group’ and the company.
  • Correspondence from LCL’s legal representatives, showing their opinion on the most likely outcome of the claim.
  • A copy of any press releases made by LCL concerning the stranded holiday-makers – this could help to establish whether a constructive obligation exists.
  • A review of press coverage and internet stories about the situation, to assess any comments made in public by company representatives regarding the claim.
  • A review of the standard terms and conditions that holiday-makers agree to on booking a holiday – this could help to establish any legal obligation, e.g., to cover the cost of accommodation before being returned home.
  • Details of any helpline or other means by which the stranded holiday-makers were given advice at the time of the incident (e.g., if the company advised them to book alternative accommodation, this may imply that the company is liable for the cost).
  • A review of invoices received pre- and post-year-end in respect of legal costs, to ensure they are adequately included in expenses and accrued for if necessary.
  • A copy of the business insurance contract detailing the level of cover, if any, provided for this situation, and any amount that will not be covered (an excess on the policy).
  • Correspondence between the insurance company and LCL establishing whether a claim on the insurance has been made.
  • A written management representation stating management’s opinion on the outcome of the court case and the likelihood of reimbursement from the insurance cover. (8 marks)

Take control of your business data with insight and in-depth understanding by taking this course. 

Services

Contact Info

  • +233203701923
    +233543919232
  • info@noohrabusiness.com

Get In Touch

Follow us on our social media and get daily updates.

Facebook-f Twitter Linkedin-in Envelope