Section A – BOTH questions are compulsory and MUST be attempted
(a) You are a manager in Maple & Co, responsible for the audit of Oak Co, a listed company. Oak Co manufactures electrical appliances such as televisions and radios, which are then sold to retail outlets. You are aware that during the last year, Oak Co lost several customer contracts to overseas competitors. However, a new division has been created to sell its products directly to individual customers via a new website, which was launched on 1 November 2011.
You are about to commence planning the audit for the year ending 31 December 2011, and you have received an email from Holly Elm, the audit engagement partner.
Financial information provided by Rowan Birch:
Statement of comprehensive income (extract from management accounts)
Statement of financial position
Notes:
1. Oak Co established an equity-settled share-based payment plan for its executives on 1 January 2011. 250 executives and senior managers have received 100 share options each, which vest on 31 December 2013 if the executive remains in employment at that date, and if Oak Co’s share price increases by 10% per annum. No expense has been recognised this year as Oak Co’s share price has fallen by 5% in the last six months, and so it is felt that the condition relating to the share price will not be met this year end.
2. On 1 July 2011, Oak Co entered into a lease which has been accounted for as a finance lease and capitalised at $5 million. The leased property is used as the head office for Oak Co’s new website development and sales division. The lease term is for five years and the fair value of the property at the inception of the lease was $20 million.
3. On 30 June 2011 Oak Co’s properties were revalued by an independent expert.
4. A significant amount has been invested in the new website, which is seen as a major strategic development for the company. The website has generated minimal sales since its launch last month, and advertising campaigns are currently being conducted to promote the site.
5. The long-term borrowings are due to be repaid in two equal instalments on 30 September 2012 and 2013. Oak Co is in the process of renegotiating the loan, to extend the repayment dates, and to increase the amount of the loan.
6. The provision relates to product warranties offered by the company.
7. The overdraft limit agreed with Oak Co’s bank is $1·5 million.
Required:
Respond to the email from the audit partner. (31 marks)
Note: the split of the mark allocation is shown within the partner’s email.
Professional marks will be awarded for the presentation and clarity of your answer. (2 marks)
(b) Maple & Co is suffering from declining revenue, and as a result of this, another audit manager has been asked to consider how to improve the firm’s profitability. In a conversation with you this morning he mentioned the following:
‘We really need to make our audits more efficient. I think we should fix materiality at the planning stage at the maximum possible materiality level for all audits, as this would reduce the work we need to do.
I also think we can cut the firm’s overheads by reducing our spending on training. We spend a lot on expensive training courses for junior members of the audit team, and on Continuing Professional Development for our qualified members of staff.
We could also guarantee our clients that all audits will be completed quicker than last year. Reducing the time spent on each assignment will improve the firm’s efficiency and enable us to take on more audit clients.’
Required:
Comment on the practice management and quality control issues raised by the audit manager’s suggestions to improve the audit firm’s profitability. (6 marks)