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- 10 Marks
Question
Logistics Ltd is a logistics and freight forwarding company based in the port city of Takoradi, and you are the Audit Manager in charge of the year-end audit. The draft financial statements show a profit before tax of GH¢2.6 million and total assets of GH¢18 million.
In your discussion with management, the following issues came up:
i) Management informed you that due to the ongoing coronavirus pandemic, shipping from China has slowed down considerably, and as a result, many employees have been laid off. A redundancy provision of GH¢220,000 is included in the draft financial statements. The audit review and calculations confirmed that the redundancy provision should be GH¢450,000. The Finance Director is, however, not willing to adjust the draft financial statements. (5 marks)
ii) An employee has filed a wrongful dismissal lawsuit against Logistics Ltd for GH¢1.2 million. This case is ongoing and will not be resolved before the Auditor’s report is signed. The matter is disclosed as a contingent liability. (5 marks)
Required:
Discuss each of the issues and describe their impact on the Auditor’s report, if any, should these issues remain unresolved in terms of ISA 705 (revised); Modification of the Auditor’s Opinion.
Answer
i) Redundancy Provision:
Under IAS 37 (Provisions, Contingent Liabilities, and Contingent Assets), if the economic outflow to discharge an obligation is probable, a provision must be recognized. Logistics Ltd has under-declared the provision for employee redundancy by GH¢230,000, which represents 8.5% of profit before tax (GH¢230,000/ GH¢2.6 million). This is material but not pervasive.
Impact on Auditor’s Report:
According to ISA 705 (Revised), the Auditor should inform those charged with governance about the Finance Director’s refusal to adjust the provision. If management does not amend the financial statements, the Auditor should issue a qualified opinion due to the material misstatement in the financial statements. The basis for the opinion should include the description and quantification of the financial effects of the under-declared provision. (5 marks)
ii) Contingent Liability:
The wrongful dismissal lawsuit for GH¢1.2 million represents 46% of profit before tax (GH¢1.2 million / GH¢2.6 million), making it a material issue. Under IAS 37, contingent liabilities must be disclosed if the economic outflow is possible. Logistics Ltd has disclosed this matter as a contingent liability.
Impact on Auditor’s Report:
If the matter remains unresolved, the Auditor should issue a qualified opinion based on materiality. The basis for the qualified opinion should explain the disclosure of the contingent liability and its potential impact. Since the outcome of the lawsuit is uncertain, it should be disclosed in the contingent liability note in the financial statements. (5 marks)
- Tags: Audit report, Contingent Liability, IAS 37, ISA 705, Redundancy Provision
- Level: Level 2
- Topic: Completion Procedures and Reporting
- Series: MAY 2021
- Uploader: Dotse