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)