Professional Documents
Culture Documents
The technical and skills marks available for each part of the requirement.
The information set out below was that used to mark the questions. Markers were encouraged to use discretion
and to award partial marks where a point was either not explained fully or made by implication.
Question 1
Scenario
The candidate is working as an assistant to a finance director and is required to correct the work of an
inexperienced junior. The candidate is required to explain and demonstrate understanding of the financial
reporting issues by preparing journal entries and a revised statement of changes in equity and a revised
EPS calculation.
The technical issues covered in this question are the disposal of a shareholding in a subsidiary company,
share options and the acquisition of an overseas subsidiary.
Requirements
a) Explain the correct financial
reporting treatment of the
items in Exhibit 1 and
prepare journal entries for
any adjustments you
propose;
Technical
marks
12
Skills
marks
6
Skills assessed
Available marks
Maximum marks
12
12
24
Page 1 of 28
To:
Carl.McCoy@Bauhaus.com
From: Maida.Cheema@Bauhaus.com
Subject: Year-end adjustments
1: Mission Mouldings Ltd (MM)
MM should have been treated as a subsidiary once Bauhaus achieved control, which was on 1 January 2009.
Goodwill arose on consolidation, and this would have been calculated as:
000
12,000
3,125
(3,400)
11,725
000
250
2,750
400
3,400
When Bauhaus sells the 40% of MMs shares on 1 March 2013, MM becomes an associate. As such MM
should be treated as a subsidiary for the first nine months of the financial year, and revenue and costs pro-rated
for that period. Therefore MM will only contribute directly 5.4 million (7.2 million x 9/12) to profit for the year.
Tutorial note: alternative assumptions regarding the fair value adjustment at disposal are acceptable.
A gain on disposal of the shares will arise on 1 March 2013. This is calculated as
000
20,000
14,000
6,975
(18,400)
(11,725)
10,850
000
3,125
2,500
1,350
6,975
For the period 1 March to 31 May 2013 the equity accounting method would be used, and Bauhaus should
show 630,000 (7.2m x 3/12 x 35%) in the statement of comprehensive income in respect of profits from
associated company.
The NCI would have 25% of the profit of MM in the statement of comprehensive income for the nine months that
the company is a subsidiary. This gives a figure of 1.35 million (7.2m x 9/12 x 25%).
Page 2 of 28
The entries which have gone through Bauhaus financial statements are:
000
7,200
(1,800)
5,400
9 months profit of MM
Less an adjustment for 25% to NCI x 9/12
000
5,400
(1,350)
4,050
1,350
Journal entries
Dr NCI
000
450
Dr Retained earnings
1,350
Cr Net assets
Being reversal of NCI adjustment made by the client replaced by
the correct NCI adjustment (net adjustment 0.45m)
Dr NCI at disposal
Cr Disposal of subsidiary
1,800
6,975
6,975
Cr Goodwill on consolidation
Dr Disposal of subsidiary
11,725
18,400
Dr Suspense account
Cr Profit on disposal
Dr Investment
000
11,725
18,400
20,000
34,000
14,000
630
630
2: Team Bauhaus
The share option scheme is equity settled, and has a four year vesting period. Because it is equity settled the
fair value of the options has to be used at the grant date when the scheme was set up, which is 1 June 2011.
Also the options are equity settled, there will therefore be implications for diluted EPS.
As all the cyclists were still with Team Bauhaus at 31 May 2012, there would have been a charge of 1.44
million (20,000 x 12 x 24 x ) in the income statement for that year, and the same amount credited to equity in
Page 3 of 28
the statement of financial position. This appears to have been correctly dealt with in the financial statements for
the previous year.
For equity settled schemes the fair value at the grant date is always used where possible to determine the total
cost of the scheme in the financial statements.
Because four members of Team Bauhaus departed they would not be entitled to any share options, and so the
total expense would be based on eight riders remaining in the scheme, as none are expected to leave according
to the team manager.
At 31 May 2013, the total credit to equity would be restated to 1.92 million (20,000 x 8 x 24 x 2/4). The
increase in the year of 480,000 would be charged to the income statement and credited to equity.
Journal required:
000
6,960
000
6,960
Dr Income statement
Cr Share option reserve
Being charge for the year
480
480
Cost of shares
NCI at acquisition
Less: Net assets at acquisition
Goodwill
$000
12,000
(8,000)
4,000
The goodwill will initially be measured using the exchange rate at the acquisition date to give a figure of 2.5
million ($4 million/1.6). This has to be restated at 31 May 2013 using the closing exchange rate to 2.758 million
($4 million/1.45). The increase in goodwill is part of the exchange movement arising in the year.
A goodwill impairment review is required at 31 May 2013.
In the group income statement the average rate should be used not the acquisition rate. Therefore NYW will
contribute 2 million to profit for the year ended 31 May 2013 ($3 million/1.5), this is not the figure calculated by
Andrea of 1.875 million ($3 million/1.6).
The closing rate is used to translate all of the assets and liabilities of NYW in the consolidated statement of
financial position. Andrea has currently only included the results for NY Wheels in the income statement and
has restated the cost by the increase in profit. Therefore a full consolidation of this subsidiary is required. An
exchange movement for the year will arise, this is taken to other comprehensive income. This will therefore also
appear in the statement of changes in equity.
The exchange gain is calculated as follows:
000
5,517
(5,000)
2,069
(2,000)
2,758
(2,500)
000
Gain
517
69
258
844
Page 4 of 28
000
9,375
2,758
7,586
969
At 31 May 2012
Equity
share
capital 1
shares
000
80,000
Share
premium
Retained
earnings
Share
option
reserve
Noncontrolling
interest
000
48,000
000
49,500
000
1,440
000
5,625
000
184,565
1,350
40,925
(6,975)
(6,975)
39,575
Disposal of
subsidiary
Share option
expense
480
At 31 May 2013
480
844
Ordinary dividends
paid
844
(4,000)
80,000
48,000
85,919
Total
(4,000)
1,920
215,839
29,800
(5,400)
4,050
10,850
630
(480)
125
39,575
Page 5 of 28
Equity shares
8 million
Basic EPS
Diluted EPS
Diluted EPS
IAS33 requires the basic EPS to be adjusted by the number of free shares held under options. However where
such options are treated under IFRS 2 and have not yet vested, the calculation needs to be adjusted in
accordance with the fair value of services yet to be rendered (per IAS33 para 47A and IAS33IE example 5A).
Thus
Number of options to vest
20,000 x 8
= 160,000
= 1,920,000
12
222
160,000
(154,435)
5,565
Alternative working
Amount to be received on exercise: 160,000 x 222
Number of shares issued at average market price (35,520,000/230)
Number of 'free' shares i.e. shares treated as issued for nil consideration
(160,000 - 154,435)
35,520,000
154,435
5,565
Page 6 of 28
Examiners comments
General comment on candidates performance
There were a wide range of answers from the excellent to the very poor and it was not uncommon for the
requirement to prepare a revised statement of changes in equity and the EPS calculation not to be attempted by
the weaker candidates. It was notable that candidates are far better at describing where financial reporting
treatments are incorrect, suggesting and calculating appropriate adjustments than actually setting out a journal
entry to adjust the financial statements. This is a key skill from earlier studies which many seem to have been
lost. Candidates often presented an incomplete journal or one which didnt balance.
Detailed comments
Mission Mouldings Ltd - disposal of shares in a subsidiary
In general this element was reasonably well completed by most candidates with the majority correctly
calculating the goodwill on acquisition, net assets at disposal, the sales proceeds and fair value of remaining
shares. However few were able to correctly determine the non-controlling interest at disposal or to provide
correcting journals that balanced.
Common errors included:
Omitting the share capital or including it as 500,000 not 250,000 in the calculation of goodwill
Not understanding the principle of what to include in the computation for NCI at the point of disposal.
(Common to see candidates missing this years profits, not taking 25% of the profits post acquisition).
Not noticing the instruction in the question to use the fair value method, or not understanding the
instruction.
Taking the market price of the share at the grant date instead of the FV of the option.
Not spotting the 4 year period so allocating over 3 years or 5 years (some thought that the remainder
should be allocated over 3 years as this was the time left instead of correcting last years figures).
Ignoring the previous year position and thus charging 960,000 (1,920,000 x 2/4) in the current year.
The majority recognised Andreas adjustment was incorrect and produced journals to correct it based on
their own figures.
New York Wheels acquisition of overseas subsidiary
Almost all candidates correctly identified that this was the acquisition of a subsidiary and were able to calculate
some of the elements of the exchange gain. Again, very few were able to provide correcting journals.
Calculations of goodwill were done well as was the translation. Many picked up that the profit for the year was
incorrect and should have been translated at the average rate. Common mistakes were:
Calculating exchange differences but not stating whether they were gains or losses.
Omitting the journal.
Page 7 of 28
Not bringing forward the correct share option balance even though students had corrected it in the
earlier part of the question
Not adjusting the profit figure adequately (although this could be because they had failed to complete
journals earlier and this would have made the task more straight-forward)
Not cancelling the NCI even though the subsidiary had been disposed of and the new subsidiary had no
NCI
Page 8 of 28
Requirements
Technical
marks
Skills
marks
4
Skills assessed
Page 9 of 28
Available marks
Maximum marks
13
12
25
Page 10 of 28
SGF
Branmoor
70%
30%
Kare
80%
55%
MedServ
ResHomes
Goodhealth
95%
HGH
100%
There are two companies which together own more than 75% of Kare. Neither owns more than 75% of
Kare which means that it is a consortium company. Both resident and non-resident companies are taken
into account when determining whether a consortium exists. The fact therefore that SGF owns 30% of
Kare and is not UK resident means that although it is unlikely to be able to partake in loss relief claims, it
nonetheless enables a consortium to be created and therefore the potential for loss relief to Branmoor to
exist.
As Branmoor is a consortium member it can make a consortium claim for its share of Kares losses.
Branmoor will pay Kare the equivalent amount of tax it has saved. Although this benefits cash flow for
Kare, it may not be effective in terms of tax rate.
The amount of consortium relief that can be surrendered to Branmoor is the lower of the Branmoors
available profits and Kares available losses ie the consortium members percentage holding in the
consortium company x consortium company taxable total losses eligible for consortium relief
The loss available to Branmoor will be reduced by any potential current year claims by Kare and any
potential group relief claims. This is regardless of whether such claims are actually made.
Page 11 of 28
Any actual group relief claims for other losses in the group are taken into account therefore any loss
surrendered by Goodhealth to ResHomes reduces any potential loss surrender by Kare Ltd to
ResHomes.
For group relief purposes, Kare, ResHomes, HGH and Goodhealth form a 75% group. The group
structure therefore enables losses both capital and trading to be relieved by these group members.
MedServ is not part of the group relief; and therefore its losses are not available for group relief. Its losses
can however be used either by means of a carry forward against future trading profits of the same trade
or by carry back to previous years profits should any be available.
Branmoor is an associated company but can only receive consortium relief. There are therefore 6
associated companies for tax rate purposes.
Calculate the maximum loss relief available to Kares subsidiaries and to the consortium shareholders.
For the purposes of calculating consortium relief, the loss in Kare will first be treated as if set against any
other profits of the same accounting period and then it will be treated as if group relieved to ResHomes
and HGH.
000
Loss
Overseas PE profits (See note below)
Property income
Loss available in Kare for group relief
(1,200.0)
136.0
326.2
(737.8)
Note: Double tax relief is available for the overseas tax on the profits of the permanent establishment.
However, as double tax relief for the overseas tax will not be available as the profits are eliminated in the
year ended 31 March 2013, the overseas tax of 24,000 (160,000 x 15%) can instead be treated as an
expense and deducted from the overseas profits as follows:
160,000 - 24,000 = 136,000
Before a claim for Consortium relief, consideration must be given to any potential group relief claims.
ResHomes is a member of the group relief group with Kare and has taxable profits of 415,800.
ResHomes also has a chargeable gain calculated as follows:
000
Sales proceeds
Less cost
Unindexed gain
Indexation allowance
248.0 194.2/194.2 = 0.277
0.266 x 400,000
Chargeable gain
745.6
(400.0)
345.6
(106.4)
239.2
000
415.8
239.2
655.0
Page 12 of 28
Goodhealth is also a member of the group relief group and has a trading loss of 210,000. There is also a
potential group relief claim between ResHomes and Goodhealth which is restricted because Goodhealth
only joined the group part way through the year.
ResHomes can claim the lower of Goodhealths trading loss and its own taxable total profits which relates
to the period they were members of the same group, ie 1 July 2012 31 March 2013. Goodhealths loss
of 9/12 x 210,000 = 157,500 is clearly the lower amount and may be surrendered as group relief. This
leaves a trading loss unrelieved in Goodhealth of 52,500.
Goodhealth also has a capital loss of 90,000. ResHomes can treat part of its chargeable gain
(239,200) arising on the sale of the residential home, as arising in Goodhealth. The amount that is to be
transferred should be sufficient to set off against the capital loss (90,000) and to utilise the amount of
loss in Goodhealth not surrendered as group relief to ResHomes (52,500). Therefore in total 142,500
of ResHomes chargeable gain is treated as being transferred to Goodhealth:
000
Goodhealth trading loss
Less group relief to ResHomes 9/12 x 210,000
Amount of loss not group relieved - see below
(210.0)
157.5
(52.5)
142.5
(90.0)
Chargeable gain
Less: Goodhealths trading loss after group relief to ResHomes
52.5
(52.5)
Taxable profits
Nil
Kare
Loss available for surrender as group relief
Group relief surrender to ResHomes
Group surrender to HGH
Consortium claim
Branmoor 70% x 334,800
Loss available for carry forward
415.8
96.7
512.5
(157.5)
(355.0)
Nil
000
(737.80)
355.00
48.00
(334.80)
234.36
(100.44)
There are six associated companies, so the upper and lower limits are divided by six (assuming Branmoor has
no other subsidiaries).
Page 13 of 28
Upper:
1,500,000/6
= 250,000
Lower:
300,000 / 6
= 50,000
Branmoor
Trading income
Less consortium relief
Taxable total profits
000
400.00
(234.36)
165.64
165,640 x 24%
Less marginal relief
39,753.60
(843.60)
(250,000 165,640)/100
Tax liability
Tax liability excluding Consortium relief
400,000 x 24%
38,910.00
57,090.00
96,000.00
57,090
85,200
9,600
151,890
Page 14 of 28
cash, such gains would be deferred until the shares in the new Ruritan subsidiary are sold. Therefore cash
consideration would trigger a chargeable gain and should be considered carefully.
However, crystallising a gain on incorporation of the PE may not be a negative point. If there are capital losses
in the group, this could be an opportunity to offset these losses against the gain on incorporation of the PE. This
issue needs further investigation and estimations of chargeable gains and losses across all subsidiaries are
required before Kare proceeds further with plans for incorporation.
The application of CFC rules may also need to be considered as a newly incorporated company does not fall
within the initial 12 months exempt period. There would be considerable compliance costs involved in this.
Change in business strategy Goodhealth
Restriction in the use of losses may apply where there is a change in ownership of a company if there is a major
change in the nature or conduct of the trade within three years before or after the change in ownership. (Also if
the trading activities become small or negligible before the change followed by a revival of the trade which is not
the case in this scenario.) Moving the trade on-line could be construed as a change in the nature of the trade. If
this is found to be the case, losses brought forward before the acquisition of Goodhealth by ResHomes could
not be relieved against future trading profits of Goodhealth. Therefore any changes of the business model need
to be considered carefully if brought forward losses are not to be lost
VAT and e-commerce
The location of the server will not relieve Goodhealth from the responsibility to charge VAT to its customers in
the UK. With respect to physical goods, tax applies in the country to which the goods are delivered.
VAT group
Companies under common control can apply for a group registration for VAT. A VAT group is treated as a single
entity which submits one VAT return. Not all companies eligible for group registration need be included in the
group registration. For example depending on the facts, it may not be appropriate to include ResHomes and
MedServ in the group registration as they are making exempt supplies. Including these companies may restrict
the ability to reclaim input VAT. Also it may be appropriate to exclude HGH as it makes some zero rated
supplies and is likely to be in a repayment position. Including HGH in the group registration may delay the
repayment of VAT and would have a negative cash flow effect.
The advice given by the predecessor suggests that he lacks understanding about certain key tax issues.
Therefore a sceptical approach should be taken and a review of computations submitted and prepared by the
predecessor should be undertaken.
Examiners comments
General comment on candidates performance
Many candidates did not consider the instructions given in the scenario which were a clearly defined and
ignored the task to explain how the losses could be used within the existing group structure. Instead some
candidates plunged head first into preparing calculations of the use of losses.
Candidates who did provide explanations recognised the consortium/group structure, the members of the group
relief group and that the losses available for consortium relief were after maximum current year and group relief
claims demonstrated good written communication skills. Often the theory explained wasnt executed in practice
and when the figures were produced they didnt always follow these principles.
A significant minority of candidates assumed that there were 5 associates not 6 and some assumed the number
of associates for calculating the tax for Branmoor was different than for the other companies.
The treatment of the DTR on the branch profits was often confused, rarely did a candidate suggest the expense
relief route but there were many deductions for DTR at the bottom of tax computations with no real explanation
as to why. Some candidates also incorrectly restricted CY loss relief to maintain DTR or simply ignored the
branch profits altogether.
The calculations of the capital gain and loss were generally done correctly and were often offset. It was
uncommon for the gain to be left in Goodhealth to use the losses not available for group relief.
Page 15 of 28
Probably the weakest answers were those that added all the losses together (often including MedServ) and
those that gave figures for group relief without clearly indicating which company the losses came from and to
which they were being surrendered. Sometimes it was only apparent what reliefs were being given by looking at
the payments for group relief section.
Payments for group relief were often taken as the losses not the tax on the losses and without consideration of
appropriate tax rates. Most candidates recognised HGH saved tax at the small profits rate.
Howlers seen too often include:
Page 16 of 28
Question 3 UniSel
Scenario
The candidate is an audit senior brought in to complete the audit of a new audit client UniSel Ltd which was
set up by three Universities to exploit commercially the intellectual property arising from research activities.
UniSel is too small to require an audit however under a clause in the shareholders agreement an audit has
been requested by one of the shareholders, ECU after concerns about the relatively high level of invoicing
to ECU in comparison with invoices raised to the other two shareholders.
The UniSel chief executive officer Marco Nyler has the casting vote on the UniSel board and is also on a
bonus scheme which will result in a bonus payable to him of 50,000 based on revenue exceeding 6
million. The bookkeeper is inexperienced and taken together with the dominance of Marco, the candidate
must evaluate the financial reporting and auditing issues in the scenario against the potential for Marco to
be adopting creative accounting techniques to achieve his bonus target.
An ethical issue arises when one of the finance director of one of UniSels shareholders, ECU, requests to
be updated on the UniSel audit. ECU is also an audit client of the firm.
Requirements
(i)
Technical
marks
8
Skills
marks
6
Skills assessed
(ii)
Page 17 of 28
(i)
20
28
Page 18 of 28
Bonus scheme depends only on revenue and not on profit and this may have incentivised Marco to enter into
non profitable contracts such as that with Smyth Laboratories.
Increased staff costs
Significant increase in staff costs has not been explained and needs to be understood, although it is not
unreasonable given increased levels of activity.
Tax
Appears to be no provision for tax at present although company has made a profit. Will need to consider
carefully current and deferred tax position and any tax losses brought forward from prior year or pre
incorporation expenditure.
Income from Smyth Laboratories
Smyth Laboratories is not a related party of UniSel although both companies share a common director in
Marco Nyler. However the daily rate of 300 does seem low, especially as it is below the rate charged to the
university shareholders. There is therefore a possibility that the arrangement with Smyth Laboratories may be
loss making and thus an onerous contract for which a provision may be necessary if UniSel has a commitment
to deliver more hours at this rate. Under IAS37, any excess unavoidable costs should be provided at the point
at which the contract becomes onerous.
In addition, the connection with Marco increases the likelihood that the arrangement may be more complex
than it appears with the lower rate being agreed due to some reciprocal arrangement.
The 350,000 from this arrangement was also key to exceeding the revenue target for Marcos bonus and the
lower rate may have been agreed simply to increase revenue. This may still be bona fide but will need careful
consideration.
Contract with Hickman Research
There are also consulting revenues with this client so will need to consider whether the 2 contractual
arrangements are really separable or part of a single contractual arrangement which should be considered
together.
IAS18 requires separate transactions to be considered together when they are linked in such a way as that the
commercial effect cannot be understood without reference to the series of transactions as a whole.
Even if the contracts are separate, we need to consider carefully the recognition point for the 1 million upfront
licence fee by consideration of the detailed terms of the licence. It may be acceptable to recognise up front
providing UniSel has no ongoing obligations and the amount is non-refundable.
However as the amount is equivalent to a royalty of 4% on 5 million per year for 5 years there is also the
possibility that it should be regarded as a prepaid royalty for subsequent years. It is also likely that there will be
some obligations on UniSel and therefore the up-front element should be deferred over the 5 year period.
The associated costs of the royalty to the university will still be payable on receipt of third party income but
recognition of cost should be spread in line with revenue.
We also need to consider whether there are any additional royalties due for that year.
US Company royalties 650,000
We need to look at the policy for recognition of on-going royalties. On-going royalties should be recognised at
the point they are earned and UniSel has the right to receive them. This is likely to be at the point when the
third party makes the sale unless there is a significant uncertainty either about the amount or the collectability.
IAS18 requires royalty income to be recognised on an accruals basis in accordance with the substance of the
relevant agreement.
The 300,000 for year end 31 December 2012 should have been partially recognised in the prior year. As this
is a first year audit it is important to look at opening position as well as the year end position especially when
the opening balance sheet was unaudited. Hence the beginning of year cut off is of equal importance because
Page 19 of 28
the inclusion of these sales has contributed to exceeding the target revenue for the year.
Accrual for remaining 5 months looks high compared to prior year and clearly involves judgment. It is crucial
that this is subjected to sceptical audit work as it has contributed significantly to meeting of revenue and profit
targets. Likely to be more recent information than was used to make the estimate and sales for 5 months to 31
May 2013 should now be known.
Level of receivables, accrued income and deferred income
Significant level of receivables raises questions about collectability and also the timing of revenue recognition
as we would not normally expect a long delay in payment.
Accrued revenue is high and includes more than the US Royalties discussed above, there is likely therefore to
be other judgmental items which will need careful consideration. We need to ensure also that the associated
costs such as the royalty payable to the Universities are also accrued, where necessary.
Conversely, deferred revenue is very low given that there could well be contracts with up front revenue and
ongoing obligations. Completeness of deferred revenue is likely to be a significant area of audit focus.
(ii)
Ensure that we have a good understanding of the companys revenue recognition policies for each
revenue stream and we have assessed those policies for acceptability. Documentation as it stands
does not set this out clearly.
Tutorial note - Consideration was given in the marking to candidates who highlighted the need to look at
the agency versus the principal question. Although it is clear from the question that the contract is with
UniSel and it would be difficult to argue for a net revenue presentation.
Look at agreements and other documentation supporting a sample of revenue contracts including
those which have an individually material effect on revenue. Determine from each contract what
revenues are payable and what deliverables UniSel has committed to deliver. Review should cover
licence, royalty, consultancy agreements and also consider whether multiple contracts with one
customer are linked. Key factors to consider include whether:
The agreement was signed within the period and there is clear evidence of a contractual
arrangement with UniSel under which it is valid to recognise revenue.
There are multiple elements
The price for each can be determined
All obligations have been delivered
There is clarity concerning the period over which obligations will be delivered
There are any other unusual factors which raise additional issues and questions
For each contract in the sample determine what revenues should be recognized in the year ended 31
May 2013 and compare this to the revenue UniSel has recognized. Determination should include
consideration of whether cut-off is correct at the beginning and end of the year and the completeness
of any deferred revenue.
For the consulting revenues and those charged to the university shareholders, obtain details of the
time spent by the staff working for a sample of clients and ensure that this can be reconciled to the
days of work which have been recognised in revenue and billed to the clients.
Consider the overall analytical review procedures which compare the total amount of billable time
incurred by the staff with the revenues earned from the time. By doing so assessing the
reasonableness of the total revenue recognised. Verify assumptions and data used by testing it and
ensuring that it can be corroborated by information from payroll and other departments not directly
linked to accounting.
Review consulting invoices and those issued to the shareholder universities in May 2013 and June
2013 and ensure that the revenue has been recognized for all the services provided before the year
end.
Page 20 of 28
(iii)
Test the completeness of the licence and the royalty revenue by selecting a sample of contracts from
the contract files and ensuring that only expected revenues are included. Pay particular attention to
any estimated royalty revenue, ensuring that it is based on reliable and recent information from the
customer and not from a projection received some time ago. Where possible verify that accrued
revenue has been received since the year end.
Consider the classification and disclosure of the revenue reported within the accounts and ensure that
the disclosures are complete and accurate.
Response to Marys request for information and other ethical matters
Confidentiality of client information is the key to any audit appointment and client information should not be
disclosed to those outside the audit team.
Whilst there is clearly information arising from the UniSel audit which will be of interest to Mary and ECU, (most
notably an assessment of whether the development committee is making fair decisions regarding the timing of
licensing arrangements) this information cannot simply be shared with Mary.
ECU is a shareholder but the auditors responsibility is to report to the shareholders as a body, information
cannot be imparted to just one shareholder.
ECU has a director on the Board of UniSel and it would be normal for the auditor to report to those charged
with governance, however once again this report should be to the whole board.
Even if there were evidence of fraud against ECU, communication would not be direct to ECU but to the police
or the relevant authorities.
Hence there is not really anything which can be reported to Mary at the meeting without breaching client
confidentiality. This potentially places Gerrards in a difficult position as it does have knowledge relevant to the
ECU audit.
Communication should be to UniSel Board or the shareholders as a whole although it is important to ensure
that the ECU member is present and has full access to the information to share with their management team.
Mary should be encouraged to ask questions through the UniSel Board member for ECU.
The position as auditor of both clients places Gerrards in a potential conflict of interest position.
Gerrards will need to put safeguards in place if it is to continue to act for both parties. This may include
notifying UniSel and ECU of the potential conflict; using separate engagement teams and preventing access to
information; issuing clear instructions to the teams about confidentiality and potentially requiring team
members to sign up to particular confidentiality undertakings; involving an independent review partner to
assess how the potential conflict has been dealt with from an audit perspective. It looks like the same manager
is involved on both teams at present which may not be acceptable.
Given Marcos character and highly influential role, we need to consider whether there are any indicators which
would mean that the firm might choose not to work for UniSel.
Examiners comments
The most common weakness to answers to this question was an inability to identify the pertinent ethical issues
arising from the audit of UniSel. Many candidates majored on the business ethical issues of Marco's dominance in
the business and his bonus (these are audit risks rather than ethical issues) rather than looking at the question from
the auditor's point of view. Although candidates were expressly asked for a response to Mary's request on an update
on the audit, it was common to find that candidates overlooked this.
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Some candidates did very well on the identification of audit risks and relevant audit testing of revenue. However, few
managed to say much of relevance on the financial reporting issues and weaker candidates tended to leave out this
aspect completely.
Detailed comments
Audit risks were generally identified well. The FR aspects were often more vague and difficult to interpret. Many said
that revenue would be recognised when the risks and rewards were transferred but the question required more
specific knowledge to be applied to different types of revenue e.g. revenue received in advance (to be spread),
revenue that should be recognised when accrued not invoiced and revenue that may be linked (1 or 2 contracts
very few identified this point). Candidates sometimes merged the risks and financial reporting aspects together. This
approach is acceptable however it was often not clear whether the candidate was identifying a risk or a financial
reporting issue. Sometimes the financial reporting issue identified consisted of a comment from the question which
was given no credit in marking e.g. staff costs have increased.
Audit procedures on revenue were generally fine and answered very well. It was pleasing to see that these were
often focussed and related to revenue as required by the scenario.
Performance on ethics
Candidates who adopted the correct approach to the ethics section did identify the confidentiality issue and potential
self-interest threat of representing both clients. There seemed to be some confusion between risks and ethics, so
many discussed Marcos personality.
Fortunately only a few weak candidates said that we could discuss the issues arising on the audit with Mary.
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Question 4
Scenario
The scenario in this question is a UK based machine tools manufacture with the as its functional currency.
The company expanded at the beginning of the current accounting period by opening a manufacturing
division in Thailand in order to serve customers based in East Asia. The candidate is working on the audit of
Stoghopper and a colleague has raised a number of audit issues with respect to the Thai operation as
follows:
Translation of multi-currency bank account balances where normal control procedures have not
operated to convert a yuan receipt from a Chinese customer into the Thai currency (the baht) prior to
the year end.
An interest free loan to a supplier has been made in the year.
There has been an impairment indicator with respect to a new production facility in Thailand following
a patent by a competitor of a more efficient production process.
Candidates are required for each of the above three issues: first to set out and explain the appropriate
financial reporting treatment; second to describe audit risks and related audit procedures
Requirements
Technical
marks
4
Skills
8
Skills assessed
Available marks
Maximum marks
1.
1.1
17
23
Sale transaction
The sale should be recorded at the exchange rate at date of transaction. A receivable would be recorded at the
same time. As the transaction has not been entered in the cash book the receivable will still be outstanding at
the year end and will therefore be overstated at the year end.
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Cash balances
The balance on the Number 1 account of 440m baht is a monetary asset and needs to be translated into
Stoghoppers functional currency of sterling at the year-end exchange rate on 30 June 2013 of
1 = 55 baht. (With most sales and costs in the UK it is clear that the Stoghopper functional currency is sterling).
Similarly the other bank account with a balance of 2 million yuan needs to be translated to sterling at the year
end. Ideally, this should be translated directly to sterling from yuan at the 1/yuan year end exchange rate.
However assuming currency markets are efficient then this can be translated first into baht and then sterling
using the information provided. Thus
2 million yuan x 5.1
10,200,000 baht
450.2m baht
8,185,455
Sterling equivalent
Number 1 account (450.2m baht/55)
This figure will be shown in the statement of financial position of Stoghopper at 30 June 2013.
Exchange gain
On receipt, the value of the yuan in sterling is 2 million yuan x 5/54.5
At 30 June 2013 value of yuan in sterling is 2 million yuan x 5.1/55
Exchange gain
= 183,486
= 185,455
1,969
Tutorial note: any movement on the /baht exchange rate from that previously reported would give rise to an
exchange difference on the cash balance as a monetary asset. However insufficient information is provided to
calculate this.
1.2
Audit risk
Bank account balances are not being properly
controlled giving rise to unauthorised exchange
rate differences
Audit procedures
Review treasury policy, instructions to banks to
transfer funds and treasury policies to find out
why the yuan balance was not transferred
immediately on receipt.
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2.
2.1
IAS39 para 43 requires a financial asset to be measured initially at fair value. A zero interest rate is not a fair
value, but the fair value can be determined by using a market yield to discount to a present value.
The initial fair value of the loan when issued on 1 July 2012 is therefore:
400m baht/ (1.06)
356m baht
7.12m
Treating the loan as held to maturity then, using the amortised cost method, the loan at the financial year end of
30 June 2013 is:
356m baht x 1.06
377.36m baht
This is a monetary asset and would be translated at the year-end rate of 55 baht = 1. In the financial
statements of Stoghopper it would therefore be translated as:
377.36m baht/55
6.86m
There are two elements to these transactions for financial reporting purposes: (i) interest income on the loan;
and (ii) exchange loss.
The interest income is recognised as the effective rate even though there is no cash received. As it accrues
over the year, it is translated at the average exchange rate. The interest cost in baht is therefore:
356m baht x 6%
21.36m baht
406,857
647,273
Reconciliation:
Interest income
Exchange loss
On interest
On loan
406,857
(18,494)
(647,273)
This reconciles with the opening balance divided by the opening exchange rate less the closing balance divided
by the closing exchange rate as above.(7.12m - 6.86m) = 0.26 million
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2.2
Audit procedures
Check procedures used to verify the
creditworthiness of the supplier when the loan
was originally extended.
Verify the terms of the loan and the security
available from Rangoon if the loan is not
repaid.
Enquire whether there is a charge over assets
as security for the loan.
Examine correspondence (legal
correspondence, board minutes, as well as
letters/emails/memos with Rangoon) for any
possibility of early repayment.
Consider audit visit to Thailand or instructing
local auditors.
3.
3.1
Cost
Depreciation
Carrying amount
Baht
600m
100m
500m
Expressed in baht the asset is not impaired as the recoverable amount is the value in use of 520m baht (which
is greater than the fair value less costs to sell)
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However for the purpose of testing for impairment the carrying amount should be measured at the normal
historic exchange rate, but the recoverable amount should be determined at the closing exchange rate.
Thus the carrying amount in s is 500m baht/ 50 =
10m
9,454,545
3.2
Audit procedures
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Examiners comments
General comment on candidates performance
Many candidates struggled with the calculations in this question and some incomplete answers were submitted
which suggested lack of knowledge in this technical area of the syllabus rather than poor time management.
However, the audit risks and procedures were performed particularly well and many candidates scored full
marks in this part of the question.
Detailed comments
Some candidates were challenged by all three financial reporting issues. In the first issue, the foreign currency
translation was done correctly by only a minority of candidates. In the second issue, although most got the point
about the need to discount the financial asset, few actually did so. Of those who discounted it, not all translated
it correctly. A few thought it was a financial liability. In the third issue many candidates concluded that no
impairment was necessary. Some thought that impairment was necessary but only because they got the basic
IAS 36 decision rule wrong. Relatively few correctly identified the need to translate recoverable amount at
closing rate.
The audit aspects were handled better on the whole than the financial reporting, although a common error was
to identify procedures only, and not risks and related procedures as required.
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