In: Accounting
General Machinery Company Limited, a subsidiary company of Las Vegas Group Corporation (USA) Limited, is primarily a distributor of a range of machinery and equipment and also engages in other business activities. It has assets of approximately $4m, including current assets of nearly $2m. The draft Statement of Financial Performance of the company has just been completed by the company accountant and presented to the auditors, Disneyland Audit Company Ltd., to enable them to complete their audit. You, as the partner in charge of the audit, is surprised to find out that the company has made a profit this year, because your audit work during and after the end of the financial year had led you to expect a significant loss. The draft Statement of Financial Performance and some of the notes are shown below.
General Machinery Company Limited
Statement of Financial Performance
For the year ended 30 June 1997
1997 $ |
1996 $ |
|
Revenue |
30020000 |
30450000 |
Operating profit |
165000 |
1240000 |
Income tax expense |
10000 |
605000 |
155000 |
635000 |
|
Extraordinary items |
230000 |
|
155000 |
865000 |
|
Retained profit b/f |
55000 |
440000 |
710000 |
1305000 |
|
Dividend |
500000 |
750000 |
Retained profit c/f |
210000 |
555000 |
Notes to the accounts:
Inventory – the company values spare parts held for its machinery customers at average cost. Costs of spare parts representing more than 3 years’ expected consumption are written off.
Including an abnormal credit $150000, not subject to income tax, resulting from the revaluation of a block of land written off against profits several years ago when a quarrying operation was discontinued; it is now proposed to develop the site as a tavern and service station to serve the growing population of the area.
During your ensuing investigations, you ascertained the following:
You are required to complete the following:
A). Discuss the reasonableness of the directors’ proposed treatment of the 3 items above. Justify any changes or additional disclosure you would require in order to be able to give an unqualified audit opinion on the financial statements. Assume for the purpose of this part that you are able to satisfy yourself that the company’s continuation in business is not threatened.
B). Assume now that you have found that the company is fully utilizing its $300000 bank overdraft facility, which is secured over its assets, and your audit investigations have given you serious cause for concern as to the ability of the company to continue in business. Reconsider the treatment of the disclosures that you outlined for A above, and determine the type of audit report to be issued.
C) The audit has now been completed. A number of difficulties were experienced during the audit, including significant disagreements over the valuation of investment property holdings. You as the audit partner have suggested that the property value was overstated by $10m, a figure which was twice the level of materiality set for the audit. As a result of discussions with the audit committee, the CEO agreed to revise the valuations downward by $8m. All other issues were resolved to the satisfaction of you, resulting in an overall misstatement of the accounts of $2m. The audit partner is now considering the effect of the misstatement on the audit report.
Discuss the effect of the misstatement on the audit report.
D) Discuss the auditor’s responsibility for information accompanying a financial report.