Matters to discuss at meeting

During the completion stage of the audit, the effect of uncorrected misstatements must be evaluated by the auditor, as required by ISA 450 Evaluation of Misstatements Identified during the Audit. This requires that the auditor obtains an understanding of management’s reasons for not making recommended adjustments to the financial statements and that they take this into account when evaluating whether the financial statements as a whole are free from material misstatement.

In order to maintain accurate accounting records, management should be encouraged to record all misstatements to ensure that the risk of material misstatements in future periods is reduced due to the cumulative effect of immaterial uncorrected misstatements.

ISA 450 also requires that the auditor communicates with those charged with governance about uncorrected misstatements and the effect that they, individually or in aggregate, may have on the opinion in the auditor’s report. Each of the matters included in the summary of uncorrected misstatements will be discussed below and the impact on the audit report considered individually and in aggregate.

(i) Impairment

When performing an impairment test, in accordance with IAS 36 Impairment of Assets, the carrying value of the asset (or cash generating unit) in question is compared to the recoverable amount of the asset. If the recoverable amount is lower than the carrying value an impairment loss should be recognised, reducing the asset down from its carrying value to the recoverable amount.

The recoverable amount is calculated as the higher of the fair value less costs to sell and value in use. In relation to the cash generating unit, Boston Co estimated that the greater of these two figures was the value in use at $3·5 million. This was compared to the carrying value of $3·6 million and the asset has been impaired by $100,000 accordingly.

The findings of audit procedures carried out suggest that an inappropriate estimate was used in the calculation of value in use. Boston Co applied the company’s annual growth rates when estimating the cash flows attributable to the cash generating unit. A more relevant estimate for the growth rates, specific to the cash generating unit, was available and should have been used.

This would have generated a value in use of $3·1 million which is still higher than fair value less cost to sell of $3 million, and should be used as the recoverable amount. As management already impaired the asset to $3·5 million, a further impairment of $400,000 is required to value it appropriately at $3·1 million.

At the meeting management should be asked why they used the company’s forecast growth rates, rather than the factory’s growth rates and whether any matters have arisen since the audit to suggest that the growth rates used by the audit team are now inappropriate.

The adjustment represents 6·25% of profit and 0·4% of total assets. While not material to the statement of financial position, it is material to profit. If management does not adjust for this or provide justifications as to why their valuation is more appropriate, then this will lead to a material misstatement of the financial statements.

(ii) Borrowing costs

Interest charges are borrowing costs. The borrowing costs relating to the construction of qualifying assets, such as property and plant, should be capitalised during the construction period, in accordance with IAS 23 Borrowing Costs.

As the manufacturing plant is not due for completion until November 2016, it is still a qualifying asset and the interest should have been capitalised. Boston Co has incorrectly expensed the interest as part of the finance charges for the year.

The correcting adjustment is therefore to reduce finance charges and to add the interest to the cost of the asset on the statement of financial position.

The charges of $75,000 represent 1·2% of profit and 0·07% of assets so are not material to either profit or the statement of financial position.

(iii) Cleveland Co

At the year end Boston Co would have recognised a net receivable of $95,000 as being due from their customer Cleveland Co. Although $30,000 has been received after the year end, the request to have the company liquidated indicates that any further payment is unlikely to be received. In accordance with IAS 10 Events After the Reporting Period, this is an adjusting event indicating that management’s assessment of the recoverability of the balance is inaccurate and that the remainder of the outstanding balance should be written off as an irrecoverable debt.

As Boston Co has previously provided for $5,000 management should provide for the remaining $65,000 in the financial statements for the year ended 31 December 2015. This will reduce trade receivables in the statement of financial position and profit before tax by $65,000.

At the meeting enquiries should be made as to whether any further correspondence has been received from either the management of Cleveland Co or the liquidators offering any form of reimbursement to Boston Co. If not, then the proposed adjustment should be encouraged.

The adjustment represents 1·0% of profit and 0·06% of total assets so is not material individually to either profit or the statement of financial position.

(iv) Investment in Nebraska

The investment in Nebraska has been designated as fair value through profit or loss. As such, the value at the year end must be adjusted to reflect the fair value of the investment and any gain or loss recognised in the statement of profit or loss.

The fair value of the investment at the year end is $643,500 (150,000 shares x $4·29). This represents an increase in the fair value of $43,500, which should be taken to the statement of profit or loss as a gain. The carrying value of the investment should also be increased by this amount.

$43,500 represents 0·7% of profit and 0·04% of total assets. It is therefore not material individually to either profit or the statement of financial position.

Impact on the audit opinion and auditor’s report

When considering their opinion, the auditor must conclude whether the financial statements as a whole are free from material misstatement. In order to do this, they must consider whether any remaining uncorrected misstatements are material, either on an individual basis or in aggregate.

The aggregate effect of the misstatements would be to overstate Boston Co’s profit by $346,500 ($465,000 – $118,500). Total assets on the statement of financial position would also be overstated by this amount.

This represents 5·4% of profit and 0·3% of total assets. The overstatement would therefore be material to the statement of profit or loss on an aggregate basis but not to the statement of financial position.

However, as the necessary adjustment regarding the impairment of the factory building is individually material, management should be informed that if the valuation calculated by the audit team is more appropriate then failure to incorporate this adjustment will result in the auditor concluding that the financial statements are materially misstated. Based upon this, a modification to the audit opinion in accordance with ISA 705 Modifications to the Opinion in the Independent Auditor’s Report will be required.

The type of modification depends on the significance of the material misstatement. In this case, the misstatement regarding the impairment is material to the financial statements, but is unlikely to be considered pervasive. This is supported by the fact that the adjustment is not material to the statement of financial position and it is therefore unlikely that the auditor will conclude that the financial statements as a whole are misleading.

Therefore a qualified opinion should be expressed, with the auditor stating in the opinion that the financial statements show a true and fair view ‘except for’ the effects of the matters described in the basis for qualified opinion paragraph.

A basis for qualified opinion paragraph should be placed immediately before the opinion paragraph. This should include a description of the matter giving rise to the qualification, including quantification of the financial effects of the misstatement.

The remaining uncorrected misstatements are, individually and in aggregate, immaterial to the financial statements and it will be at the discretion of management to amend and will have no impact on the audit report. Although as previously mentioned because of the impact on future periods, management should be encouraged to amend for all misstatements. If management intends to leave these as uncorrected misstatements, written confirmation of their immaterial nature should be obtained via a written representation.