5、You are a manager at Thyme & Co, a firm of Chartered Certified Accountants. You are currently involved in the completion stage of two engagements relating to different clients. Both engagements have raised issues that require your attention.
(a) Rocket Co is a listed client operating in the engineering industry. The company manufactures machinery for use in the aircraft, defence and marine sectors. The audit for the year ended 30 April 2017 is almost complete. The revenue and profit before tax figures recognised in the draft financial statements are $1,437 million and $139 million, respectively (2016 – $1,489 million and $175 million respectively).
Audit procedures identified two sales transactions in the final quarter of the year that related to two different customers but where the goods were delivered to the same location. Further investigations revealed that the goods were delivered to a third party, who agreed to store them until the customers were ready to receive delivery. The goods have yet to be delivered to the customers because they are both building new facilities and neither is sufficiently progressed to receive the new machinery. The contract terms explicitly state that Rocket Co is obliged to deliver the goods to the customers for final inspection and acceptance and the client has not agreed to any consequent amendments to these terms. The sales invoices were raised and the revenue recognised upon despatch of the goods to the storage facility. During discussions with the audit team, the finance director stated that the company had fulfilled its contractual obligations to provide the goods by a specified date. The revenue attributable to the two transactions totalled $17 million.
Required:
(i) Comment upon the matter described above and explain the further actions necessary before the auditor’s report can be signed. (7 marks)
(ii) Discuss the implications for the auditor’s report if no adjustments are made to the financial statements. (5 marks)
(b) You are reviewing the draft assurance report in relation to the examination of a forecast for Tulip Co. The forecast is included in a proposal due to be sent to Tulip Co’s lenders as part of an effort to secure a new loan. Audit procedures concluded that there is no reason to believe that the forecast is unrealistic or that it has not been properly prepared. You are currently reviewing the draft assurance report, which is provided below:
(a) Rocket Co
(i) Matters
Materiality
The revenue of $17 million recognised in relation to the highlighted transactions represents 1·2% of revenue and 12·2% of profit before tax. The sales are, therefore, material to the financial statements.
Bill and hold arrangement
IFRS 15 Revenue from Contracts with Customers specifies that an entity shall recognise revenue only when it has satisfied its performance obligations by transferring the goods (or services) to its customer.
Rocket Co believes that they have satisfied their performance obligations by having the goods available for the customers by the specified date. The situation, however, represents a ‘bill and hold’ arrangement, whereby Rocket Co has billed the customer but has yet to physically transfer the goods to them.
Transfer of control
IFRS 15 specifies that in these circumstances it should be determined when the customer obtains control of the goods. The contracts specify that the goods have to be delivered for inspection and ‘acceptance;’ implying that the customer will not accept control until they have satisfactorily completed their inspections. Rocket Co has, therefore, not fulfilled their performance obligations and should not recognise the revenue in relation to these two contracts.
Revenue recognition
Given Rocket Co’s listed status, management may be under pressure to report better results. Revenue has fallen by 3·5% based on the draft financial statements. If the $17 million relating to the bill and hold arrangement is excluded from the 2017 financial statements, then the reduction in revenue is greater, at 4·6%.
Further actions
Thyme & Co should request that the client adjusts their financial statements to reverse the revenue recognised in relation to the goods being stored at the third party facility.
If they refuse to adjust the financial statements, Thyme & Co should communicate the misstatement to those charged with governance. They should repeat the request to adjust the financial statements and inform them of the modifications that will be made to the auditor’s report if the adjustments are not made.
If the client still refuses to amend the financial statements, Thyme & Co should request a written representation from the client confirming their intention to proceed without amending the financial statements and that they are aware of the potential repercussions.
(ii) Auditor’s report
Material but not pervasive misstatement
If management refuses to reverse the $17 million of revenue recognised in relation to these transactions the auditor will conclude that the financial statements are materially misstated.
The matter is material to the statement of profit or loss but it is unlikely to be considered pervasive; the required adjustment would not lead to a reported profit being restated as a loss and the only captions of the financial statements affected will be revenue and receivables.
Qualified opinion
In these circumstances the auditor would issue a qualified audit opinion stating that ‘except for’ these matters the financial statements are fairly presented.
The auditor should also include a ‘Basis for Qualified Opinion’ paragraph below the opinion paragraph. This should describe and quantify the financial effects of the misstatement.
(b) Assurance report on examination of forecast
Addressee
The report is currently addressed to the shareholders of Tulip Co which is not appropriate. The intended users for the report are more likely to be the board of directors, who wishes to use it in conjunction with a loan application, and the report should be addressed as such.
Type of forecast
The report fails to specify what forecast the assurance relates to. Companies can forecast various elements of financial performance, position and cash flow. It is vital to identify specifically which forecast, and which elements of the forecast, are covered by the assurance report.
Period covered
The assurance report fails to specify the period covered by the forecast. This is important because it is plausible that only part of the forecast is covered by the assurance report, particularly if it is a long range forecast.
Specific document and page reference
The assurance report simply refers to the forecast ‘contained in the loan proposal’. This is not specific enough. This increases the risk that the same forecast can be reissued with the assurance report in other loan proposals. The assurance report should state the title of the document the forecast is included in and the page numbers upon which assurance is being provided.
Relevant standards
The report simply refers to ‘relevant standards;’ it should state which standards have been followed during the engagement. Given the nature of the assignment the report should state that it has been conducted in accordance with International Standard on Assurance Engagements 3400 The Examination of Prospective Financial Information.
Responsibility for preparation
The content of the report in relation to setting out the respective responsibilities of the practitioner and the responsible party are not in line with the relevant standards. Rather than stating that the practitioner is not responsible for the preparation of the forecast, ISAE 3400 specifies that the assurance report should state that management is responsible for the information provided and the assumptions upon which it is based.
Detail regarding the relevant assumptions
The assurance report should make it clear what assumptions the forecast is based upon and what assumptions the assurance report relates to. To this end the report should refer to the note in the forecast where the underlying assumptions are presented
Negative statement of assurance needed
The assurance provided in the draft assurance report is worded positively; ISAE 3400 requires that for an examination of prospective financial information a statement of negative assurance is provided.
For an unmodified report, such as that presented in the draft, the wording used should state that ‘based upon our examination of the evidence supporting the assumptions, nothing has come to our attention which causes us to believe…………’
IFRS
The report should refer to ‘International Financial Reporting Standards’ rather than ‘IFRS.’
Inappropriate caveat
The caveat at the end of the report should be reworded as it somewhat undermines the credibility of the forecast and the assurance provided by stating that the forecast is unlikely to be accurate.
A more appropriate statement would refer to the uncertainty in relation to the nature of a forecast and that the actual results may vary from those anticipated.
Reference to the purpose and distribution of the report
It is common practice for a report on prospective financial information to include a reference to the purpose of the information and on its distribution. Thyme & Co should consider including this reference as a means of limiting the distribution of the report to the intended parties.