Week 6
As the auditor of Komsu Air Limited (KAL) that manufactures
and installs large commercial air- conditioning 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 for KAL’s audit for the year ended 30 June
2017.