Question

b) You work in a reputable audit firm and you are currently reviewing the working papers of several audit assignments recently curried out by your audit firm. Each of the audit engagement is nearing completion, but certain matters have recently come to light which

Dr Cletus Agyenim Boateng, Dr Emmanuel T. Asare and Mr Augustine Addo

may affect your audit opinion on each of the assignments. In each case, the year-end of the company is 30 August 2019.

i. Mimie Company (Profit before tax Ghc 750,000)

On 6 September 2019 a letter was received informing the company that a customer, who owed the company Ghc 150,000 as at the year-end had been declared bankrupt on 30 August. At the time of the audit it was expected that unsecured creditors, such as Mimie, would receive nothing in respect of this dept. The directors refuse to change the financial statements to provide for the loss, on the grounds that the notification was received by the statement of financial position date.

Total debts shown in the statement of financial position amounted to Ghc 2,375,000. 3 marks

ii. Kokuvi Company (Profit before tax Ghc 2,500,000)

On 20 July 2019 a customer sued the company for personal damages arising from a defect in one of its products. Shortly before the year-end, the company made an out-of-court settlement with the customer of Ghc 50,000, although this agreement is not reflected in the financial statements. Further, the matter subsequently became known to the press and was extensively reported. The company’s legal advisers have now been informed that further claims have been received following the publicity, although they are unable to replace a figure on the potential liability arising. The company has referred to the claims in a note to the financial statements stating that no provision has been made because the claims are not expected to be material.

3 marks

iii. Baaba Na Company (profit before tax Ghc 1,250,000)

The audit work revealed that a trade investment stated in the statement of financial position at Ghc 2,500,000 has suffered a permanent fall in value of Ghc 1,500,000. The company has refused to put an impairment charge through for it on the grounds that other investments (not held for resale) have risen in value and are stated at amount considerably below their realisable values.

iv. Achah Martin (profit before tax Ghc 500,000)

This client is a furniture company, currently manufacturing for the local market using local materials and some of its own workforce. The labour cost has been included in the cost of a non-current asset in the statement of financial position at a value of Ghc 50,000. During the audit it was discovered that the direct labour cost records for the early parts of the year have been accidently destroyed.

3 marks

You are required to:

Discuss each of the cases outlined above, referring to materiality considerations and, where appropriate, relevant accounting principles and appropriate accounting standards, explaining the audit reporting implications in each case.

Answer 1

i)

The decision taken by the Directors of Mimie Company is wrong. In the given scenario, the expected loss arising from the bankruptcy of the customer has come out on the last date of audit period; ie, on 30th August, 2019. This indicates that the loss pertains to the current accounting period and the same need to be shown in the Financial statements prepared as on 30th August, 2019. But the directors decided not show the same as the notification was received on the financial position date. When we compare the materiality level, the amount of expected loss, ie, GHC 150,000 is almost 6% of the total debt outstanding for the company as the year end. This constitutes a fairly large sum of money and hence the company need to make necessary provisions for the amount GHC 150,000 as on 30-08-19 in their Financial statements.

ii)

In the given situation, the company had provided defective goods to the customer and when the customer has raised a complaint against the company, instead of moving legally for it, the company did an out-of- court settlement. Such an adjustment is always done by companies. But in the given case, as the same has received public coverage, the customer has again sued the company. But as it is mentioned, the expected amount payable is not certain at the given point of time. And also the company has mentioned in the notes to accounts that no provision has been made for such a claim as the amount is not material. As we could see, the same case was settled out of court for GHC 50,000. When we compare the amount with such a huge profit of GHC 2,500,000 made by the Kokuvi Company, this amount seems to be very minimal and hence can be considered as immaterial. Hence we can conclude that the decision taken by the management to not show the expected amount payable for the claim is acceptable.

iii)

Baaba Na Company has experienced a permanent diminution in the value of investments held by them by GHC 1,500,000. But the company is of the opinion not to show any fall in the value of investments as the other investments held by them has gained its value over the period of time. But, as the accounting standards on investments state, Long-term investments are usually carried at cost. However, when there is a decline, other than temporary, in the value of a long term investment, the carrying amount is reduced to recognise the decline. Where there is a decline, other than temporary, in the carrying amounts of long term investments, the resultant reduction in the carrying amount is charged to the profit and loss statement. The reduction in carrying amount is reversed when there is a rise in the value of the investment, or if the reasons for the reduction no longer exist. Also, Long-term investments are usually of individual importance to the investing enterprise. The carrying amount of long-term investments is therefore determined on an individual investment basis. Hence, we conclude that the company should recognise the loss on diminution in the value of Investment and show the closing balance of investment at GHC 1,000,000 (2,500,000-1,500,000).

iv)

As far as my understanding, the company has developed a non-current asset for themself and has shown it in their financials. For developing the same, they have incurred a sum to the extend of GHC 50,000 for labour cost. In the given case, the said accounting is acceptable as the total cost of the asset should include all variable and fixed costs. But as they have mentioned, the labor cost records of the early parts of the year has been destroyed and hence there are no evidences to support the expenses incurred. In this given scenario, as an auditor, we should perform few alternative audit procedures. One best way could be recalculating the labour cost of the item considering the normal time taken for its production, number of labor required and the cost per hour for each labor for the production of the asset. Also, the auditor can verify if the cost as per financials match with the normal production cost of the said asset when they produce it for external sale to its clients. Another procedure that could be followed is by comparing the cost of the same product manufactured by their competitors and ensuring that a equitable amount has been charged. The same cannot be ignored as the amount involved equalls 10% of the total profit earned by the company is of high materiality as the company would be claiming depreciation on year to year for a period of minimum 5 years or any higher period as found justifiable and thereby getting a tax benefit for all these years.