Question

Skyblue Pty Ltd is a large private company that manufactures special reinforced concrete and other products used in the construction of airport runways and heavy use motor vehicle freeways. During the course of the audit for the year ended 30 June 2020, the government announced that it intends to scrap its proposed third runway project. You know that Skyblue Pty Ltd’s projections include a major share of the work expected to flow from this project.

The company has been experiencing some cash flow difficulties, although this is not unusual in the industry. Management has recently fully extended their overdraft facility in order to pay day-to-day expenses such as wages and salaries. The audit partner is concerned that the company may be facing going concern problems, but the managing director maintains that future capital expenditure can be cut back to alleviate the going concern issue. In addition, surplus assets can be sold to the growing Asian market and long-term debt can be rescheduled if necessary.

Required:

(a) Give examples of three other possible mitigating factors that have not yet been mentioned.

(b) What evidence should you obtain with respect to management’s representation about the various mitigating factors presented in question 6 and identified in part (a) above? (

(c) The engagement partner has decided to qualify the financial report on the basis of uncertainty as to going concern. However, the managing director argues that, as the company is privately held and all the shareholders are involved in the business, going concern problems should not be viewed as seriously as if the company was publicly listed and, therefore, an unqualified report should be signed. How would you respond to the managing director’s comments?

(d) What would be the impact on the audit of a comfort letter from a related company promising to provide financial support in the event that Skyblue Pty Ltd was unable to meet its debts?

Answer 1

(a) Other mitigating factors could be expectation of trade receivables to be cleared from a large party, a large confirmed order book within the medium term with multiple parties, and a possible ongoing sale of capital assets covering the cash crunch

(b) For the options presented by Skyblue the auditor would need to see documentation on the overdraft facility to see the extent to which they are leveraged. They would also need to see financial statements on the valuation of assets and the management report on what is critical for business and what can be leveraged. A statement from the bank on rescheduling long term debt would also be needed to verify that claim. The order book of the company will also be needed.

(c) Regardless of whether or not the company is privately held it is the job of the auditor to ensure that risks to the business are highlighted and dealt with as per financial prudence . So the MDs comments around that need to be countered transparently and firmly.

(d) While a comfort letter from a related company would provide some leeway to the auditors on the concerns regarding it being a going concern, it cannot be treated as a guarantee because the entity is "related"in a way and is beyond the purview of the current audit so there is no way to verify the claim of the letter. The audit should be conservative and take it in form rather than substance.