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- 25 Marks
Question
Damongo Ltd (Damongo) is a computer hardware specialist and has been trading for over ten years. Damongo is the only hardware specialist listed on the Ghana Stock Exchange within five years after incorporation.
The company is funded partly through overdrafts and loans and also by several large shareholders. The year-end is 31 December 2017. Damongo has experienced significant growth in previous years. However, in the current year, a new competitor, HardWare Specialist Co (HardWare), has entered the market and through competitive pricing has gained considerable market share from Damongo. One of Damongo’s large customers has stopped trading with them and has moved its business to HardWare. In addition, a number of Damongo’s specialist developers have left the company and joined HardWare. Damongo has found it difficult to replace these employees due to the level of their skills and knowledge. Damongo has just received notification that its main supplier who provides the company with specialist electrical equipment has ceased trading.
Damongo is looking to develop new products to differentiate itself from the rest of its competitors. It has approached its shareholders to finance this development, however, they declined to invest further in Damongo. Damongo’s loan is long term and it has met all repayments on time. The overdraft has increased significantly over the year and the directors have informed you that the overdraft facility is due for renewal next month, and they are confident it will be renewed.
The directors have produced a cash flow forecast which shows a significantly worsening position in the coming 12 months. They are confident that the new products being developed is viable. Damongo has trading history of significant growth and they believe it is unnecessary to make any disclosures in the financial statements regarding going concern.
At the year end, Damongo received notification from one of its customers that the hardware installed for the customers’ online ordering system has not been operating correctly. As a result, the customer has lost significant revenue and has informed Damongo that they intend to take legal action against them for loss of earnings. Damongo has investigated the problem post year end and discovered that other work-in-progress is similarly affected and inventory should be written down. The Finance Director believes that as this misstatement was identified after the year end, it can be amended in the 2017 financial statements.
Required:
a) Describe THREE (3) procedures the auditors of Damongo Ltd should undertake in relation to the uncorrected inventory misstatement identified above.
(6 marks)
b) Explain FIVE (5) going concern potential indicators of Damongo Ltd.
(10 marks)
c) Identify SIX (6) going concern audit procedures which you should perform for Damongo Ltd.
(6 marks)
d) The auditors have been informed that Damongo’s bankers will not take a decision on the overdraft facility until after the audit report is completed. The directors have now agreed to include some going concern disclosures. Describe the impact on the audit report of Damongo Ltd if the auditor believes the company is a going concern but that this is subject to a material uncertainty.
(3 marks)
Answer
a) Procedures in relation to the uncorrected inventory misstatement:
- Assess the Extent of the Misstatement: Test a large sample of inventory items to assess the full extent of the misstatement and its potential impact on the financial statements.
- Discussion with Management: Engage with Damongo Ltd’s management to understand why the inventory misstatement occurred and whether the company intends to correct it.
- Compare to Materiality: Compare the misstatement to the materiality threshold. If the misstatement is material, request that adjustments be made to the financial statements to correct the inventory values.
b) Going concern potential indicators of Damongo Ltd:
- Increased Competition: A new competitor, HardWare Specialist Co, has gained significant market share, impacting Damongo’s future revenue.
- Loss of Key Customers: A significant customer has stopped trading with Damongo, further reducing revenue streams.
- Departure of Key Employees: Key specialist developers have left the company, which may hinder the company’s ability to develop new products and maintain competitiveness.
- Supplier Ceased Trading: Damongo’s main supplier has ceased trading, potentially affecting the company’s ability to continue operations or forcing it to find more costly alternatives.
- Worsening Cash Flow: The company’s cash flow forecast indicates a worsening position over the next 12 months, raising concerns about liquidity and solvency.
c) Going concern audit procedures for Damongo Ltd:
- Review Cash Flow Forecasts: Evaluate the assumptions used in the company’s cash flow forecasts and test them for reasonableness.
- Perform Sensitivity Analysis: Assess how changes in key assumptions impact the cash flow forecast and the company’s ability to meet its obligations.
- Post-Year-End Sales Review: Examine sales data and orders received after the year-end to assess whether there is evidence of recovery or deterioration in performance.
- Bank Confirmation: Obtain confirmation from the bank regarding the overdraft renewal and any associated conditions.
- Discussions with Management: Discuss with management their plans to mitigate any liquidity concerns and seek new funding.
- Legal Correspondence: Review correspondence with legal advisors about the likelihood and impact of potential legal claims from customers.
d) Impact on audit report if material uncertainty exists but the company is a going concern:
- If the going concern assumption is appropriate but there is a material uncertainty, the audit report should include an emphasis of matter paragraph.
- The paragraph should state that the opinion is not modified but highlight the existence of a material uncertainty, cross-referencing the relevant disclosures in the financial statements.
- If the disclosures made by management are inadequate, the audit opinion will need to be qualified or adverse depending on the materiality and pervasiveness of the issue.
- Topic: Audit and Assurance Risk Environment
- Series: MAY 2019
- Uploader: Dotse