Tutorial 4: Completion of the audit
1. The impact of subsequent events (adjusting and non-adjusting) on the Financial
Statements and
2. The impact of corrected and uncorrected issues on the auditor’s opinion, wording of the
Independent Auditor’s Report.
Problem 1: subsequent events
You are about to issue the auditor's report for client Morandi &Co which is the listed
company that produces components for computers.
You draw the following information from financial statements:
Financial statement
31 Dec 2022
extracts
Revenue £112,000
Total assets £188,500
Profit before tax £60,000
The following matters have been brought to your attention:
1) On 3rd January work-in-progress is found to be overstated by £1,600.
2) On 4th March a company's application for £100,000 of a bank loan was rejected.
3) On 3rd April, it is found that no provisions were made for the major customer who is
struggling to pay £8,000.
The auditor’s report is signed on 1st March 2024 and the financial statements are issued
on 1 April 2024.
Materiality is set at the level of 5 - 10% profit before taxation.
Required:
For each of the events above explain whether the financial statements require
amendment in order to avoid a modified audit opinion.
When answering show your calculations and clearly specify:
- the indicator,
- whether it is material,
- whether the event is adjusting or non-adjusting, and
- the impact of the events on the financial statements.
Problem 2: auditor’s report
You are about to issue the auditor's report for audit company clients. The following matters
have been brought to your attention:
(i) Daisy Inc. has included land in the calculation of depreciation, which was previously not
depreciated. Total depreciation is £$2.3m, with £0.9m attributed to land. This results in an
overstatement of depreciation expense and remain uncorrected. Profit before interest and
tax is £8m.
(ii) Petal Co’s computerized inventory system experienced a malfunction for a period of
two months, resulting in corrupted records and backups. As a result, inventory data for
these two months cannot be accessed. Inventory costs for these two months amount to
£1.2m. Profit before interest and tax is £9.7m.
(iii) Mega Corp’s, main competitor has initiated a lawsuit of £7 million against them,
claiming a breach of copyright. This legal dispute is still in progress and is not expected to
be resolved in client’s favour. Profit before interest and tax is £12m.
(iv) Rose Inc. generated revenue of £5.8 million from selling goods via its website and a
store. However, £2.5 million of sales made through the website were recognized on a cash
basis instead of an accrual basis. Despite this discrepancy, management refuses to
correct the issue. The audited profit before tax of Rose Inc. is £1.4 million.
(v) Alpine Solutions reported a profit before interest and tax of £3.9 million for the previous
fiscal year, significantly reducing its retained earnings. A month after the year-end, the
company's application for a £1m bank loan was rejected. All information is properly
disclosed in the Notes to Financial Statements.
Required: Explain the impact on the audit opinion for each of these issues above.
Additional explanation:
Pervasiveness means that an issue is widespread or found everywhere. A pervasive misstatement
would be so serious that, to all intents and purposes the FS are useless. Similarly with a pervasive
lack of sufficient appropriate audit evidence.
Pervasive problems (leading to a disclaimer or an adverse opinion) are rare. It is much more
common to have qualified (except for) modified opinions where the shareholders can still make
some use of the FS.
An example of pervasive leading to a disclaimer of opinion could be the destruction after the year-
end but before the audit of all of the client’s supporting documentation. Sometimes a problem with
a very large single item can be pervasive. Eg profits = $10 million, total assets = $50 million, but
there is a complete lack of evidence about an inventory of $25 million.
Going concern qualifications are not always pervasive. If there was no real prospect of the
company continuing and the FS were drawn up on a going concern basis, then the misstatement
would be pervasive: the FS should have been produced on a break-up basis. If there was merely
some doubt about GC that has not been mentioned in the FS (and that could have been handled
by the inclusion of a note to that effect and an emphasis of matter drawing attention to that note),
then the misstatement would not be pervasive: it could be cured by the note.
