Question

As the auditor of Komsu Air Limited (KAL) that manufactures and installs large commercial airconditioning systems. KAL typically has two or three large contracts (ranging from $6 million to $10 million each) in progress at any one time. The contracts usually take up to six months to complete, although unexpected on-site difficulties can result in lengthy delays in completion (of up to 12 months). KAL finances its operations with a mixture of equity, long-term debt (secured by fixed assets) and short-term bank loans.

It is now May 2017 and your planning of the audit of KAL for the year ended 30 June 2017 is nearing completion. You have met with the management of KAL and, from those discussions and a review of the preliminary information provided by KAL, you have identified several issues that may have implications for the company’s ability to continue as a going concern. The relevant issues are as follows:

 Competition in the industry is becoming more intense, with some customers now installing their own systems.

 KAL’s bank has requested cash flow forecasts for the coming year to support the short-term loans. It has indicated that it may need to withdraw funding or restructure debt if the forecasts are not adequate. The review of work-in-progress indicates that all the contracts in progress at year end are due for completion within six months of the balance date. There are no new contracts in place for the coming year, although management has indicated that there are orders currently being negotiated. The nature of the business is such that sales will fluctuate considerably from year to year depending on the timing of one or two large contracts.

 Assets consist chiefly of plant and equipment, some of which is specialised to the industry. Debtors are significant, but recoverability is not considered an issue as the ongoing projects are with reputable customers and management is not aware of any problems. Creditor balances are at normal levels, and the company is in a positive working capital position.

 Included in provisions is a large provision for warranty for one of KAL’s jobs completed at a hotel two years ago. It appears that the air-conditioning system is still not working and the hotel is now requesting a substantial refund of the contract price.

Required:

Explain whether you believe the area of going concern should be assessed as high risk and mitigating factors for KAL’s audit for the year ended 30 June 2017. (10 marks, maximum 300 words)

Answer 1

Q. What is the GOING COCERN CONCEPT ?

• As per this concept it is assumed that the business will continue to exist for a long period in the future.
• The transactions are recorded in the books of the business on the assumption that it is a continuing enterprise.
• Due to this concept we record fixed assets at their original cost and depreciation is charged on these assets without reference to thier market value.
• Without this concept, the classification of current and fixed assets and short and long term liabilities cannot be made and such classification would be difficult to justify.

After discussions with the management of KAL nad reviewing the preliminary information provided, there are several issues that have been recognized that may have implications for companys ability to continue as a going concern.

• Reasons for KAL'S appropriateness of going concern and some factors that might mitigate such risk:-

  

# Appropriateness of Going concern concept

• Net cash outflow from operating activites
• Default on compliance of loan terms which might lead to withdrawl of funding
• Substantial refund of the contract price by the hotel
• Realization of assets, Dose forecast deals with asset realization, including whether these realizations are practicable and realistic in amount
• Losing competitive edge and customers installing their own systems

# Mitigating Factors

• Controlling unnecessary operating expense. Negotiating a better payment cycle with clients.
• Providing cash flow forecasts after assessing future revenues from potential clients.
• Negotiating terms with hotel's management and providing them with an alternative without affecting the liquidity of business.
• Leasing assets rather than purchasing them outright.
• Introduction of new economically efficient systems and prompt completion of contracts. Efficient customer service.

THANK YOU !!

AND HAVE A NICE DAY!!