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- 10 Marks
Question
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)
Answer
i) Factors indicating that Kitchenhub Ltd may not be a going concern entity:
- Major customer ceased trading: Kitchenhub Ltd’s major customer owing GH¢0.6 million has ceased trading, likely resulting in significant loss of revenue.
- Loss of sales director: The departure of the sales director, with no replacement, may impact sales generation.
- Negative cash flows: The company is experiencing net cash outflows, forecasted to continue, worsening liquidity.
- Suppliers unpaid and threatening legal action: The inability to pay suppliers, coupled with threats of legal action, increases financial pressure.
- Loan default: Defaulting on a GH¢4.8 million loan and the demand to repay within six months significantly strains finances.
- No dividend payment: The directors’ decision to withhold dividends indicates severe cash constraints.
- 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:
- Planning stage: Analytical procedures are used as risk assessment tools to understand the entity and assess the risk of material misstatement.
- Final audit stage: Analytical procedures can be used as substantive procedures to obtain sufficient appropriate audit evidence.
- 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.
- Tags: Analytical procedures, Audit Planning, Financial difficulties, Going Concern
- Level: Level 2
- Uploader: Dotse