In: Finance
Q1. You are an audit manager of Morline & Co, a Public Accounting firm. The audit engagement partner, Joe Tan, has called you into his office to discuss a new audit client. You have been assigned to take charge of the audit for the financial year end, 31 December 2019 of Crown Hotel Group Bhd. (Crown Group) a listed company. The Group operates a chain of luxury hotels across Malaysia. As part of the expansion strategy, Crown Group has recently acquired a new hotel in Melbourne. You are very excited about auditing this luxury group of hotels, and are hoping that you may get to stay in one of the hotels during the audit.
Recently you had a meeting with Joe Tan, Datuk Paul Wong, the managing director of Crown Group, and Lisa Goh, the finance director of Crown Group. From detailed discussions with them, you note the following information:
Background information:
Crown Group owns four hotels in Malaysia namely Dolce, Corus,
Korma, Morib, one hotel, Belux in Singapore and a newly acquired
hotel in Melbourne namely Aston, which was acquired in September
2019. Each hotel operates through a separate legal entity, and
Crown Group owns 100% of each entity. The Group prepares
consolidated financial statements on an annual basis. The Head
Office is located in Petaling Jaya, Malaysia.
In 2019, the Crown Group had total revenues of RM 90 million (2018: RM 80 million), and operating profits of RM 8,500,000 (2018: RM 11,000,000).
Lisa Goh explained that all the hotels have been performing well over the last year, with the exception of Hotel Belux. See notes below
Information Technology (IT)
Lisa Goh highlighted that the Crown Group relies heavily on the use of information technology (IT) and noted that approximately 96% of bookings are made online via its website. The Group invested significantly in IT over the last six months, which resulted in an extensive upgrade of its website and the development of a user-friendly app. Datuk Paul Wong said, “We have spent a significant amount of money developing our IT systems and ensuring they are secure, as the rapid increase in cybercrime in Malaysia is frightening.” This development cost was capitalised in Financial Year 2019.
Finance team
Each hotel has a finance team, including a financial controller. At the end of every month, a reporting pack is prepared by the financial controller, including a copy of the management accounts, key completed reconciliations and detailed commentary on how the hotel has met the key performance indicators for that particular month. Each reporting pack is submitted to the head office, and the group financial controller reviews them and performs additional reconciliations. The group financial controller also prepares the year-end consolidated financial statements. Lisa Goh has, however, informed you that the group financial controller resigned in November 2019 because he could not cope with the pressure of the job. She has not been able to find a suitable replacement as to date. Lisa has asked if your firm would be able to help with the finalisation of the consolidated financial statements for the year ended 31 December 2019, as her team is currently struggling to find the time needed.
New acquisition
The hotel in Melbourne, Aston was acquired in September 2019 for RM 8,500,000, and will be included in the consolidated financial statements at 31 December 2019. The purchase of the hotel was financed by a bank loan. Datuk Paul Wong explained this was a significant investment for the Crown Group and that a further RM 2 million has since been spent on capital expenditure to ensure it meets the exceptionally high standards of the Group. Datuk Paul Wong has invited the entire audit team to travel to Melbourne for the opening of the hotel in June 2020 as his guests. He has also assured the team will be treated very well while there.
Valuation of the hotel properties
The group policy is to value Land and Buildings at fair value. The calculation of fair value and the allocation of fair value to Land and Buildings requires significant judgement. Datuk Paul Wong confirmed professional valuation experts were appointed to value Land and Buildings at 31 December 2019. Land and Buildings at that date were valued at RM 110 million, representing a revaluation increase of RM 12 million.
Loans and Borrowings
During the financial year to 31 December 2019, the Group borrowed
RM 10,500,000 in order to finance the purchase of the Aston, and to
complete the renovation work required. The loan is repayable over
10 years and the Group must adhere to strict loan covenants. The
bank requires the Group to provide management accounts on a
quarterly basis, if a loan covenant is breached, the loan may be
due for repayment immediately. Lisa Goh has informed you that the
group is also struggling to ensure management accounts for the
quarter ended 31 December 2019 will be submitted within the
allocated timeframe. The amount of interest paid was extremely
significant
Bonus
During the year, a new bonus scheme was introduced for both
managers and directors for all the hotel within the group in order
to increase revenue. The bonus is directly linked to revenue.
Advance payment
Advance deposits of 50% are collected for those booking for
conferences and wedding packages.
Hotel Belux
The hotel Belux is one of the biggest in the Group, and contributes
25% of total revenue is located in Singapore. Although revenue has
increased in 2019, profit has fallen significantly due to a number
of “special offers” in both accommodation rates and the restaurant.
Datuk Paul Wong believes the main causes for this fall are reduced
gross margins (due to the successful uptake of the various special
offer promotions during the year) and increasing costs (mainly
driven by payroll). The number of special offers were approved by
management in a bid to counter the tough economic environment
within which the hotel operates and thereby increase revenue.
Required:
(i) Identify and explain to the audit partner SEVEN (7) key audit
risks in respect of Crown Group.
(ii) Describe the matters Morline & Co should consider in the
context of ISA 620 in order to evaluate the adequacy of the
expert’s work in relation to engaging the services of a property
expert to value Land and Buildings.
(iii) Evaluate the ethical issues(s) if any in respect of the Crown
Group audit engagement and recommend appropriate safeguard(s).
ANSWER TO POINT (1)
AUDIT RISKS: Audit risk is the risk that an auditor will not detect fraud or errors while conducting audit.To Reduce audit risk proper audit procedure planning should be done.
There are three types of audit risk-
1. Control Risk: If Crown group Control System is weak and unable to detect Material Misstatement.
2. Detection Risk: That audit procedures are not able to detect Material Misstatement.
3. Inherent Risk: It is the risk that client financial statement susceptible to material Misstatement.
In the given case crown group has invested heavily in Information Technology which is new and may consist some loopholes.Auditors should possess good knowledge of Information Technology to detect any material Misstatement.
Another Risk is that Hotels are spread over different countries and auditors need to rely on work of experts.Currency exchange and other Law related issues of different countries is another risk.
Auditors are offered good hospitality at hotels this is another risk. No unreasonable favours should be taken by Audit Team.
The Request to help Crown Group to Consolidation should not be taken as there is conflict of ineterest.
ANSWER TO POINT 2
Following should be considered in the context of ISA 620 in order to evaluate the adequacy of experts work ( Property Expert)
ANSWER TO POINT 3
In Given case there are several ethical issues
As we know Group Financial controller has resigned and Crown group has asked auditors to help in consolidation of financial statement.
There is conflict of interest as auditor and preparer of Financial statement should not be the same. So auditor should not accept this offer to assist in consolidation of financial statement.
Another issue is that Crown group is offering audit team Good Hospitality in Melbourne Hotel. Any Such offers should not be accepted.