Section A – BOTH questions are compulsory and MUST be attempted
You are a manager in the audit department of Craggy & Co, a firm of Chartered Certified Accountants, and you have just been assigned to the audit of Ted Co, a new audit client of your firm, with a financial year ended 31 May 2015. Ted Co, a newly listed company, is a computer games designer and developer, and has grown rapidly in the last few years. The audit engagement partner, Jack Hackett, has sent you the following email:
Notes from meeting with Len Brennan
Ted Co was formed ten years ago by Dougal Doyle, a graduate in multimedia computing. The company designs, develops and publishes computer games including many highly successful games which have won industry awards. In the last two years the company invested $100m in creating games designed to appeal to a broad, global audience and sales are now made in over 60 countries. The software used in the computer games is developed in this country, but the manufacture of the physical product takes place overseas.
Computer games are largely sold through retail outlets, but approximately 25% of Ted Co’s revenue is generated through sales made on the company’s website. In some countries Ted Co’s products are distributed under licences which give the licence holder the exclusive right to sell the products in that country. The cost of each licence to the distributor depends on the estimated sales in the country to which it relates, and licences last for an average of five years. The income which Ted Co receives from the sale of a licence is deferred over the period of the licence. At 31 May 2015 the total amount of deferred income recognised in Ted Co’s statement of financial position is $18 million.
As part of a five-year strategic plan, Ted Co obtained a stock market listing in December 2014. The listing and related share issue raised a significant amount of finance, and many shares are held by institutional investors. Dougal Doyle retains a 20% equity shareholding, and a further 10% of the company’s shares are held by his family members.
Despite being listed, the company does not have an internal audit department, and there is only one non-executive director on the board. These problems, which Ted Co’s management is hoping to resolve in the next few months, are explained in the company’s annual report, as required by the applicable corporate governance code.
Recently, a small treasury management function was established to manage the company’s foreign currency transactions, which include forward exchange currency contracts. The treasury management function also deals with short-term investments. In January 2015, cash of $8 million was invested in a portfolio of equity shares held in listed companies, which is to be held in the short term as a speculative investment. The shares are recognised as a financial asset at cost of $8 million in the draft statement of financial position. The fair value of the shares at 31 May 2015 is $6 million.
As a listed company, Ted Co is required to disclose its earnings per share figure. Dougal Doyle would like this to be based on an adjusted earnings figure which does not include depreciation or amortisation expenses.
The previous auditors of Ted Co, a small firm called Crilly & Co, resigned in September 2014. The audit opinion on the financial statements for the year ended 31 May 2014 was unmodified.
Extract of draft financial statements and results of preliminary analytical review
Statement of profit or loss (extract)
Required:
Respond to the email from the audit partner. (31 marks)
Note: The split of the mark allocation is shown in the partner’s email.
Professional marks will be awarded for the presentation, clarity of explanations and logical flow of the briefing notes. (4 marks)