Question

Cupid's Kiss Limited (“CK”) was founded in early 1980s focusing on the manufacturing and trading of baby food and snacks in Hong Kong. After years of development, CK is now one of the well-known baby food producers in Asia. You are the audit manager-in-charge of the audit of CK’s financial statements for the year ended 30 September 2020. The audit is substantially completed. After reviewing the audit documentation, you and your audit partner are satisfied with the audit. There are no significant issues or difficulties encountered in the audit. It has been agreed with CK that the auditor’s report for the year ended 30 September 2020 will be authorised and approved in mid-November 2020. Just a week before the planned approval date of the auditor’s report, you read a news headline: “A popular product of Cupid's Kiss is proven to contain toxic ingredients with a high risk of causing health problems as the raw materials were contaminated. Cupid’s Kiss announced an immediate product recall.”

Required:
(a) Determine and explain whether Cupid’s Kiss toxic ingredients problem is an adjusting event or a non-adjusting event. Discuss its implications to its financial statements for the year ended 30 September 2020.

(b) Suggest relevant audit procedures in response to Cupid’s Kiss toxic ingredients problem.

(c) Determine and explain the auditor’s obligation to follow up on the toxic ingredients problem if the news is only known by the auditor after the issuance of the auditor’s report and the financial statements.

Answer 1

a) They key difference between adjusting and non adjusting events is that adjusting events are indicative of conditions existing as on date of financial statements whereas in case of non adjusting events, no such prior conditions existed as on the date of financial statements and the event came to be known after the date of financial statements.

In the given case, there were no such conditions that existed as on the balance sheet date that CK Ltd's products were going to be recalled due to the presence of certain toxic ingredients. Only in scenarios that indicate that the going concern assumption is not approrpriate, shall such non adjusting events be adjusted for in the financial statements. Recalling of a single product due to a hazard, does not in itself make inappropriate the company's ability to continue as a going concern. Hence such an event shall be a non-adjusting event and shall not be adjusted for in the financial statements.

It's implication on the financial statements shall be such that, since the event is one where non disclosure of such event shall have an effect on the ability of users of financial statements to make decisions, it shall be appropriately disclosed by the management of the entity in its financial statements.

b) Some basic audit procedures that should definitely be carried out by the auditor are as follows -

1 - Review existing procedures (if any) laid down by the management to identify these events.

2 - Study minutes of the meetings of the Members, Board of the directors and other important executive committees (if any) held after the balance sheet date and enquire about the matters which may be relevant in this regard.

3 - Discuss with key officials on matters such as company’s policy on marketing of new products, price structure, major sales order booked or cancellation of sales orders and loss of major customers, if any, new borrowings, capital commitments, fresh guarantees, outcome of pending law suits and any change in accounting policies etc.

4 - Inquire about management's communication with its legal counsel as to whether any action is taken is proposed to be taken against the scenario that has occurred.

d) If there is an event that has come to the knowledge of the auditor after the issuance of the audit report as well as the financial statements, the auditor shall -

1) Discuss the matter with management and, where appropriate, those charged with governance

2) Determine whether the financial statements need amendment; and, if so,

3) Inquire how management intends to address the matter in the financial statements.

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