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You are a manager in Hunt & Co, a firm which offers a range of services to audit and non-audit clients. You have been asked to consider a potential engagement to review and provide a report on the prospective financial information of Waters Co, a company which has been an audit client of Hunt & Co for six years. The audit of the financial statements for the year ended 30 April 2014 has just commenced.
Waters Co operates a chain of cinemas across the country. Currently its cinemas are out of date and use projectors which cannot show films made using new technology, which are becoming more popular. Management is planning to invest in all of its cinemas in order to attract more customers. The company has sufficient cash to fund half of the necessary capital expenditure, but has approached its bank with a loan application of $8 million for the remainder of the funds required. Most of the cash will be used to invest in equipment and fittings, such as new projectors and larger screens, enabling new technology films to be shown in all cinemas. The remaining cash will be used for refurbishment of the cinemas.
The draft forecast statements of profit or loss for the years ending 30 April 2015 and 2016 are shown below, along with the key assumptions which have been used in their preparation. The unaudited statement of profit or loss for the year ended 30 April 2014 is also shown below. The forecast has been prepared for use by the bank in making its lending decision, and will be accompanied by other prospective financial information including a forecast statement of cash flows.
Forecast statement of profit or loss
Note 1: The forecast increase in revenue is based on the following assumptions:
(i) All cinemas will be fitted with new projectors and larger screens to show new technology films by September 2014.
(ii) Ticket prices will increase from $7·50 to $10 from 1 September 2014.
Note 2: Operating expenses include mainly staff costs, depreciation of property and equipment, and repairs and maintenance to the cinemas.
Required:
(a) (i) Explain the matters to be considered by Hunt & Co before accepting the engagement to review and report on Waters Co’s prospective financial information. (6 marks)
(ii) Assuming the engagement is accepted, describe the examination procedures to be used in respect of the forecast statement of profit or loss. (8 marks)
(b) The audit strategy relevant to the audit of Waters Co concludes that the company has a relatively high risk associated with money laundering, largely due to the cash-based nature of its activities. The majority of customers purchase their cinema tickets and refreshments in cash, and the company transfers its cash to overseas bank accounts on a regular basis.
Required:
(i) Explain the stages used in laundering money, commenting on why Waters Co has been identified as high risk. (5 marks)
(ii) Recommend FOUR elements of an anti-money laundering programme which audit firms such as Hunt & Co should have in place. (6 marks)

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Section A – BOTH questions are compulsory and MUST be attempted
You are a manager in Dando & Co, a firm of Chartered Certified Accountants responsible for the audit of the Adams Group. Your firm was appointed as auditor in January 2014, and the audit engagement partner, Joss Dylan, has sent you the following email:
Attachment: Background and structure of the Adams Group
The Group operates in the textile industry, buying cotton, silk and other raw materials to manufacture a range of goods including clothing, linen and soft furnishings. Goods are sold under the Adams brand name, which was acquired by Adams Co many years ago and is held at its original cost in the Group statement of financial position. The Group structure and information about each of the components of the Group is shown below:
Ross Co, Lynott Co and Beard Co are all wholly owned, acquired subsidiaries which manufacture different textiles. Adams Co also owns 25% of Stewart Co, a company which is classified as an associate in the Group statement of financial position at a value of $12 million at 31 May 2014. The shares in Stewart Co were acquired in January 2014 for consideration of $11·5 million. Other than this recent investment in Stewart Co, the Group structure has remained unchanged for many years.
Information relevant to each of the subsidiaries
Ross Co manufactures luxury silk clothing, with almost all of its output sold through approximately 200 department stores. Ross Co’s draft statement of financial position recognises assets of $21·5 million at 31 May 2014. Any silk clothing which has not been sold within 12 months is transferred to Lynott Co, where the silk material is recycled in its manufacturing process.
Lynott Co is located overseas, where it can benefit from low cost labour in its factories. It produces low price fashion clothing for the mass market. A new inventory system was introduced in December 2013 in order to introduce stronger controls over the movement of inventory between factories and stores. Lynott Co is audited by Clapton & Co, and its audit reports in all previous years have been unmodified. Clapton & Co is a small accounting and audit firm, but is a member of an international network of firms. Lynott Co’s draft statement of financial position recognises assets of $24 million at 31 May 2014.
Beard Co manufactures soft furnishings. The company is cash-rich, and surplus cash is invested in a large portfolio of investment properties, which generate rental income. The Group’s accounting policy is to measure investment properties at fair value. Beard Co’s draft statement of financial position recognises assets of $28 million at 31 May 2014, of which investment properties represent $10 million.
Other information
As part of management’s strategy to increase market share, a bonus scheme has been put in place across the Group under which senior managers will receive a bonus based on an increase in revenue.
Adams Co imposes an annual management charge of $800,000 on each of its subsidiaries, with the charge for each financial year payable in the subsequent August.
Extracts from draft Group consolidated financial statements
Draft consolidated statement of profit or loss and other comprehensive income
Draft consolidated statement of financial position
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, logical flow and clarity of explanation of the briefing notes. (4 marks)

Section B – TWO questions ONLY to be attempted
(a) You are an audit manager in Rose & Co, responsible for the audit of Cooper Co. You are reviewing the audit working papers relating to the financial year ended 31 January 2014. Cooper Co is a manufacturer of chemicals used in the agricultural industry. The draft financial statements recognise profit for the year to 31 January 2014 of $15 million (2013 – $20 million) and total assets of $240 million (2013 – $230 million).
The audit senior, Max Turner, has brought several matters to your attention:
(i) Cooper Co’s factories are recognised within property, plant and equipment at a carrying value of $60 million. Half of the factories produce a chemical which is used in farm animal feed. Recently the government has introduced a regulation stipulating that the chemical is phased out over the next three years. Sales of the chemical are still buoyant, however, and are projected to account for 45% of Cooper Co’s revenue for the year ending 31 January 2015. Cooper Co has started to research a replacement chemical which is allowed under the new regulation, and has spent $1 million on a feasibility study into the development of this chemical. (8 marks)
(ii) In October 2013, Cooper Co’s finance director, Hannah Osbourne, purchased a car from the company. The carrying value of the car at the date of its disposal to Hannah was $50,000, and its market value was $75,000. Cooper Co raised an invoice for $50,000 in respect of the disposal, which is still outstanding for payment. (7 marks)
Required:
Comment on the matters to be considered and explain the audit evidence you should expect to find during your review of the audit working papers in respect of each of the issues described above.
Note: The split of the mark allocation is shown against each of the issues above.
(b) Max noticed that a section of the audit file had not been completed on the previous year’s audit. The incomplete section relates to expenditure incurred in the year to 31 January 2013, which appears not to have been audited at all in the prior year. The expenditure of $1·2 million was incurred in the development of an internally generated brand name. The amount was capitalised as an intangible asset at 31 January 2013, and that amount is still recognised at 31 January 2014.
Required:
Explain the implications of this matter for the completion of the audit, and any other professional issues raised, recommending any actions to be taken by the auditor. (5 marks)

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