EXERCISE 1
To determine whether or not the financial statements should be
adjusted in respect of each of the events described, IAS 10 Events
After the Reporting Period needs to be applied. If the event
provides evidence of conditions that existed at the reporting date
(an adjusting event), then an adjustment should be made. If the
event provides evidence of conditions that arose after the
reporting date (a non-adjusting event), no adjustment is required
but a disclosure may be necessary if the event is material and
non-disclosure would render the financial statements misleading.
The auditor will only require the directors to amend the financial
statements for adjusting events if the adjustment is material.
When assessing materiality in the exam, it is sufficient to
calculate materiality in relation to each measure individually,
using the lower end of the thresholds for prudence. If the item is
material to one or more of the measures then it requires
adjustment.
(1)Gold is Us was placed into administration after the year-end,
which provides evidence of the recoverability of the receivables
balance at the year-end. Therefore this is an adjusting event.
The total value of the balance is $211,000 which is 1% of
revenue, 2% of total assets and 20% of profit, and is
therefore material. The receivables balance should be written off
or an allowance for receivables created.
(2)The sales director left the company after the year-end and is
suing for constructive dismissal, which is an event that arose after
the reporting date. Therefore this is a non-adjusting event. The
total value of the claim is $280,000, which is 1.3% of revenue,
2.9% of assets and 26.7% of profit before tax and is therefore
material. This may also be considered material by nature. The
nature of the event and any estimates of the financial impact
should therefore be disclosed.
(3)A fire destroyed inventory after the year-end, which is
therefore a non-adjusting event (as the inventory was not
damaged at the year-end). The total value of inventory stored at
the premises is $1,054,000, which is 5% of revenue, 11% of total
assets and 101% of profit and is therefore material and the
nature of the event and any estimates of the financial impact
should be disclosed.
(4)After the year-end a letter was received offering to settle a
claim for unfair dismissal out-of-court. This is an event that
provides evidence of the valuation of the provision at the year-
end and is therefore an adjusting event. The current provision is
for $40,000 and the adjustment would therefore be $15,000. This
is not material being 0.07% of revenue, 0.15% of total assets
and 1.43% profit before tax. Therefore no adjustment is
necessary.
Exercise 2
(a)Analysis of events
Legal claim: The legal claim is an adjusting event because it
provides evidence of a condition existing at the end of the
reporting period. As at 31 March 20X2, the claimant had
purchased and used the product, and the damage to the
claimant's skin had already occurred.
The legal claim is material, because, if the claimant lived for,
say, another 40 years, the company would owe him/her $4
million. This is 100% of the current year draft profit before tax.
Therefore profit should be reduced and liabilities increased by
the expected value of the claim.
Proposed dividend: The proposed dividend is a non-
adjusting event because the condition arose after the end of
the reporting period. No liability for the dividend can exist until
the shareholders approve the dividend.
The proposed dividend is material because it constitutes 50%
($2m/ $4m x 100) of the company's profit before tax, as well
as being material by nature.
Therefore the dividend should not be recognised in the
financial statements for the year-ended 31 March 20X2.
However, the proposed dividend should be disclosed in a note
to the financial statements.
(b)Audit procedures
Legal claim:
Review legal correspondence in order to understand the
likely outcome of the legal claim.
Review customer correspondence/legal files in order to
identify other similar claims which could give rise to
additional liabilities.
Discuss with the production director the likely cause of the
burns (e.g. allergy in user or inadequate printed instructions
on product use) to determine the likelihood of any claim
being successful in court.
Review trade/consumer press to identify whether the claim
might damage Reallycool's reputation which could impact
future revenues or even create a going concern threat.
Propose adjustment of the financial statements to the
directors.
Proposed dividend:
Inspect board minutes in order to confirm the amount of the
proposed dividend.
Propose an adjustment to the financial statements to
remove the dividend from being recognised in the statement
of changes in equity but ensure that the dividend proposal is
disclosed within the notes.
(c)Impact on audit opinion
The auditor must modify the audit opinion if the directors
refuse to make the relevant adjustments in the financial
statements requested by the auditors.
Both the legal claim (which should have been recognised)
and the proposed dividend (which should have been
disclosed rather than recognised) are materially misstated.
The auditor must express a qualified ('except for') opinion if
they conclude that the misstatements are material, but not
pervasive, to the financial statements.
The auditor must express an adverse opinion if they
conclude that misstatements are both material and
pervasive to the financial statements.
Given the size of the amounts involved, an adverse opinion
may be appropriate in these circumstances.
Exercise 3
(a)Items to be included in a written representation letter
All books, records and relevant information have been made
available to the auditors.
Financial statements have been prepared in accordance with
an applicable financial reporting framework.
All transactions have been recorded and reflected in the
financial statements.
The effects of uncorrected misstatements are immaterial to
the financial statements.
Any instances of non-compliance with laws and regulations
have been disclosed to the auditor.
The directors believe the company can continue to trade as
a going concern.
The directors have no plans that will materially alter the
carrying value or classification of assets or liabilities in the
financial statements.
No plans to abandon any product lines that will result in any
excess or obsolete inventory.
All subsequent events have been disclosed to the auditor
and reflected appropriately in the financial statements.
No irregularities involving management or employees that
could have a material effect on the financial statements.
(b)Reasons why the auditor obtains written
representations
Formal confirmation by management of their responsibilities
To support other evidence relevant to the financial
statements if determined necessary by the auditor, e.g.
matters requiring management judgment.
Required by ISA 580 and other ISAs
EXERCISE 4