CR Questions 60+

Chp 15 Page 1
TUY1
Bonus Part
FR treatment
The provision is material to the financial statements ie 20.4m
How likely is the profits to exceed 100m
Bonus is for accrual for 6/12 for April X6 it was set up
Number of staff 500

Closure leave -70
430
Provision for redudancy not taken into account

Bases of Bonuse 20.4 Based on 500 EE's
Adjusting to 420 17.136
6 months 8.568
Therefore correct bonus provision 8.568
DR PL staff cost 8.568

CR Liability 8.568
Audit Procedures
Review payroll at YE for actual number of employees
Enquire as to why the provision not included in accounts
Recacluate the provision that management has performed
Enquire as to why no reducacny provision
Bad press for closure of entity
Insepc employment contract to verify underlying terms of bonus

£102 is the darft and confirm actual profit to cofnrim and if they actived
then no bonus will be payable
£100 no bonus and this could be manipulated as staff could do that
vertfiy the estiamted of leaver is fair of 70 and audit 3 Dec and this can be verify
how many EE are left and how good is the estimate and if not adjust
confirm with HR records how many EE left by 3 Dec
Pensions
FR treatment
a fixed sum if guaranteed at the date of retirment
Obligation Assets
Bf 36,400 22,700 -13,700
Interest 7% 2,548 1,589
Service cost 4,850
Contro paid 15,060 PL
Benefits paid - 3,300 - 3,300 DR asset/net obliation
40,498 36,049 -4,449 CR Cash
Remitt balance -3,138 -4,149 this does not hit the PL and should be DR
Closing acturuy 37,360 31,900 -5,460 the planned assets
At year endObligation 37,360

Assets 31,900
Net deficit -5,460 to the balance sheet
CR Obligation 3,138 gain

CR Assets 4,149 loss
DR OCI 7,287
In the PL
Service cost 4850
Interst net 959 2548 - 1589
Audit adjutment
Pension exense 15,060 to 5,809
DR net pension
CR PL
Deferred tax part of this not taken into account
Even though the pension right have not changed but contrubtion increases
this is obligation and reporting the 15.06 in the PL as other income
incorrect
Chp 15 Page 2
The correcting journal

DR Planned assets
Audit Procedures
Recaluate the pension working done by the client
Check the bank statement to see if benefits paid was 3,300
Review balance sheet to see net deficit of 5,460
Actuarial assumption could be wrong - review f they are qualified and expertise
consider if we can rely on their work have they done this for the client in prev years
Obtains WR from directors of Martine confirming assumptions are consistent
Check any emails and letters from Martine and actuary
Valutaion of plan assets and liability may be incorret in the FS

Obtains cerifciates confiming the assets and liab held at scheme
Review accruacy and validitty of vaultuion of actuarity
Agree the valution performed to the SFP figures in accoutns
Errors in calc
Misspoitning entries in accounts
Agree cash to bank statement
recalc the interest calc and compare to figures in PL
review the disclosures for IAS 19 EE benefits and incline with standard
Interest should based high quality of corporate bonds and is this

7% similar to the rate
Reconsiling to receviables ledger

Not clear what prod carried out say GDNI
need to determin if delviered and why invoices not posted
if these are not delivered then reco in invetoy and cut off so no double counting
Circularisation
Take balance from Circularisation - as risk of ovestaements
No justification to sample size TR balance 6m material at 180k
No control assurance for TR
If take 6m balance /180k then 33 samples
Method of selecting the sample was not show 10 largest are likely to be superstores
But sales is made up 1/3 small retailiers
thus insuff assurance over balances on small retails
It not appropriate to change sample over client comments ie the disput balance
this of ovesrtatment and investigate this
this replacement may bias the intreption of the results
Letters should be written by client not audit and incldue mg auth to info
reply should be to auditors office reduce risk of inception
negative concieration option only require reposen if disagree with balance
non resposd doe not disgitued betwenen unwilling and inablity to repode
Postive affirmation that balance is correct
Given the weak controls and no assurance then does not seems appproote
consider recofnrimg the 8 non repeoseive on postive baiss
The balance with H superstore apprear to recosile with cheq but CUT OFF of payable needs testing
the work on invoice oustadning is no adequate we need to see when goods delivered
rather than when invoice was sent and receive, if pre YE then in GRNI and confirmed balance stood 203
617
Sample of TR
selection of additonal smaple of smaller customers
review post YE cash from custoemrs to attest recoverability of balances
Extend this producre for 8 balance no reply
Unusual items
A)
check for other misspoiting
Chp 15 Page 3
B)
ESP,DEPS Page 4
DEPS
Redem loan
Ord share stock Rate Coupon
Jan-04 4,000,000 5,000,000 7% 350,000
Terms convert from loan stock to shares
Dec-07 40 £125 This is the worse chase as highest terms
Dec-08 40 £130
Dec-09 40 £135
5m/£125 x 40 1.6m shares issue Dec 07

SOFP Loan stock Jan 04 4.8m
Effective interest rate 8.50%
Tax 20%
Profit at Dec 04 1m
Bf Interest 8.5%Coupon Cf
4 4,800,000 408000 -350,000 4,858,000
EPS Covertiable DEPS

Earning 1,000,000 326,400 1,326,400
Weigh av of share 4,000,000 1,600,000 5,600,000
EPS £ 0.250 £ 0.204 £ 0.237
Earnings = 408,000 x (100-20%) = 326,4000

Weigh av = 5/125 x 40 = 1.6m
Profit
Sep-05 10,500,000
Oct 04 6m convertiable bond liabiltiy of 2.5m and 8% rate
bond converted 5 years with 50 for £100
tax 28%
2.5m /£100 x 50 1,250,000

Earning = 2.5m x 8% x 100-28% = 200,000
EPS Covertiable DEPS
Earning 10,500,000 144,000 10,644,000
Weigh av of share 6,000,000 1,250,000 7,250,000
EPS £ 1.750 £ 0.115 £ 1.468
Groups Page 5
75%
Net assets 250,000

FV of NCI 90,000.00
Acq YE
SC 100,000 100,000
Assets 440,000 RE 150,000 245,000
Share capital 100,000 FV adj 50,000
Retained earnings 245,000 PURP -6000
Liabilities 95,000 Net assets 300,000 339,000
440,000
PPE FV > CA 50,000

PURP 6,000 12,000 / 2
NCI
% of NA 25% x 339 84,750
Share of goodwill:
NCI at acquisition date at fair value 90,000
NCI share of net assets at acquisition date (25% × £300,000) -75,000
15,000
99,750
80% Acq of D
Consideration 600,000 Acq
Asssets 400,000 400,000
FV adj 120000
85% Acq of M
Consideration 800,000 Acq Year
Asssets 700,000 700,000
FV adj 120,000
Goodwill 205,000
Impairment -40000
NCI on propertion of net assets
CA of D assets compared to recoverable amount
Asssets 400,000
Good will
Consideration 600,000
400k x 80% 320000
Good will 280,000
Notional goodwill
280 x 20/80 70,000
750,000
carrying amount of goodwill of D of impariment los
Good will of D 280,000

Impairment (80% x 230,000) -184000
96,000
Carrying amount of NCI in M after impairmetn loss
CA of M Net assets 700,000

Goodwill 205,000
Notional goodwill
Groups Page 6
15/85 x 205k 36,176

941,176
Recover amount -660,000
Impairment loss 281,176
Allocaiton
Notional good will 241,176
Other assets 40,000
NCI
700 - 40 x 15% 99,000
Acq of B At Dec 17 the goodwill

Share % 30% Consideation 10,000,000
Consideration 4,000,000 NCI 2,000,000
30% Held 3,000,000
Net assets 15,000,000
CA 6,400,000 FV of NA -8,400,000
FV 7,200,000 Goodwill 6,600,000
800,000
Acq of B - More
Mar-17 50%
Consideation 10,000,000
Net assets
CA 7,800,000
FV 8,400,000
600,000
NCI 2000000
30% Held 300000
NCI used
Jan X1 Sept X1
Purchase of B 95% Disposal New % 5%
SC 100,000 Net assets 320,000
Goodwill arise 70,000 FV of 5% 200,000
RE 130,000 Consideration for Sale 340,000
300,000
Impairment 20,000
Land reval 25,000
NCI using proption method
Disposal from 95% to 5%
Considation 340,000
FV of interst retained 20,000
360,000
Net assets 320,000
Goodwill 70k-20k 50,000
NCI 5% x 320k -16000
-354,000
Gain on disposal 6,000
Acq 60% YE
Consideation 450
Groups Page 7
net assets 650 550

NCI 240
Goodwill 90
NCI prop basis
Impairment loss if recoverable amount was 510 and 570
CA of net assets 550 550

Goodwill 90 90
Notional goodwill
40/60 x 90k 60 60
700 700
Recover amount -510 -570
Impairment loss 190 130
Recognised goodwill 90 90
Notional food will 60 40
Other asset pro rata 40
190 130
Carrying value after impairment

Goodwill (90 - (150x60%) / (90 -(130 x 60%) 0 12
Other Assets 510 550
(550-40) 510 562
The 150 is goodwill and notional goodwill ie 60 + 90 = 150
Date of acq RE at acq Consid SC Prop of FV of NCI

July X7 20% 270 120 300
July X8 60% 450 480 300
Goodwill at June X9 NA = 450 + 300

Consideration 480
NCI - 20% x 750 150
FV of prev interest 160 Notional goodwill 20/60x480
FV of NA -750
40
Profit on decrognition of investment

Fair value at date of control obtained 160
Cost -120
40
Hedge Accounting Page 8
Nov X& Contract sell $

Sell Bulldozer 1 April X9
Forward contract
sells Bulldoser at date
How can she accounts for it?
The hedging relationship may be designated either a tair value hedge or a cash tlow hedge.
The contract to sell the bulldozer represents a firm commitment with Roadmans,
not merely a proposed transaction, and it is expressed in a currency other than Pula's functional
currency. A hedge of the foreign currency risk ot a firm commitment may be accounted for as a tair value hedge or as a cash tlow hedge.
Ex 1
Convertible debt 10,000,000
Premium 10%
Issue cost 288,000
Effecitve interest 10%
Redemption 7 years
Shares 1,000,000
RE 9,600,000
11% irred bonds 8,200,000
Tax 23%
Share price 12
PE ration 8
Reporting
An enhanced interest convertible has a dual nominal rate, with the higher rate payable in the latter part of the term.
The advantage to TP is that it delays the larger cash interest payments to match, presumably, the cash inflows it will have from its long-term projects (given that a seven-year horizon is
envisaged).
Compound instruments have both a liability and an equity element. In that case, IAS 32, Financial lInstruments: Presentation requires that the component parts be split, with each part
accounted for and presented separately according to its substance. A convertible bond is an example that has a debt element and the value that might be ascribed to the right to
purchase future equity. The right has value, otherwise it would not be packaged into a convertible bond and issued to investors.
IAS 32 requires both liability and equity elements to be disclosed, and suggests some measurement methods, although it should be realised that these are likely to be
approximations.
An example of one measurement method is that the issuer of a bond convertible into ordinary shares, for example, first determines the carrying amount of the liability component by
measuring the tair value of a similar liability that does not have an associated conversion element. The carrying amount of the equity option to convert into ordinary shares is then
determined by deducting the tair value of the financial liability from the fair value of the compound financial instrument as a whole.
The financial liability element hasa stepped or enhanced interest feature. As such, the payments required by the debt should be apportioned between a finance charge at a constant
rate on the outstanding obligation, and a reduction of the carrying amount. Ihe ettect of this accounting on a stepped interest loan is that an overall etective interest cost will be
charged in each accounting period; an accrual will be made in addition to the cash payments in earlier periods and will reverse in later periods.
The requirement is that the financing costs are allocated over the term of the loan at a constant average rate.
For the loan proposal in question, the following would appear in the financial statements over the term of the loan. (The efective interest rate is 10%.)
Cost of loan 10,000,000

Prem 1000000
Cost issue -280,000
10,720,000
Year Balance bfdw Fin cost 10% Cash paid Bfwd

1 10,720,000 1,072,000 -490,000 11,302,000
2 11,302,000 1,130,200 -490,000 11,942,200
3 11,942,200 1,194,220 -1,510,000 11,626,420
4 11,626,420 1,162,642 -1,510,000 11,279,062
5 11,279,062 1,127,906 -1,510,000 10,896,968
6 10,896,968 1,089,697 -1,510,000 10,476,665
7 10,476,665 1,047,667 -1,510,000 10,014,332
The effect given in the financial statements is that of smoothing the costs relating to the debt, with costs greater than interest actually paid in early years and lower in later years.
The above calculations assume that there is no value attributable to equity conversion rights. The split accounting treatment in IAS 32 should really use the interest rate on similar
bonds without conversion rights, rather than the 10% rate above, to determine the value of the liability. A constant rate would apply to all seven years.
Investment criteria
Assuming that the debt is held to redemption, then the cost of debt (yield to redemption) after tax is found by trial and error. As an initial guess, the cost of debt is likely to be between
15.1% and 4.9%, and less than the 10% calculated above because of the tax reliet on interest, say 8%.
By trial and error theretore:
10.712m= (1 - 0.23X0.49m x AF2@ka) + (1 -0.23X1.51m x AF3-7@ka)+ (10m/(1+kd))
Try 8%:
RHS (0.77 x 0.49m x 1.783) + (0.77 x 1.51m x (3.993/1.08-))+ 5.835m
= 0.673m +3.980m + 5.835m
= 10.488m
This is discounted too much, therefore decrease rate.
Try 7 7%:
RHS = (0.77 x 0.49m x 1.808) + (0.77 x 1.51m x (4.1/1.072)) +6.227m
= 0.682m +4.164m + 6.227m
= 11.073mm
The actual value of 10.712 million is approximately 40% between the two values and thus the after-tax cost of debt is approximately 7.6%, ie, substituting kd = 7.6% confirms that this
is the IRR or cost of debt after tax.
The impact on WACC, the cost of capital for the company, can then be determined.
The current (growth-adjusted) cost of equity of the company can be found by inverting the P/E ratio. Thus:
1/8 12.5%
The current pre-tax cost of debt is taken as the SOFP value at 11%. Theretore the current WACC is as follows.
Current MV of equity=£12.48 x 10m
=£124.8m
Current value of debt plus equity =f(124.8 + 8.2)m
£133m
WACC = [((12.5% x 124.8)/133) +((1 0.23) x 11% x 8.2/133)]
12.25%
Since the cost of debt of the convertibles is lower, WACC will fall to:
Revised WACC = (12.259%x 133 + 7.6% x 10.712) + (133 + 10.712)
11.90%
ASSurance issues
Given that the company had difficulty in raising a rights issue last year, there may be some doubt that the company can raise debt.
In any case, if the company wishes to finance projects that add to the company's risk profile, it should be prepared to accept more relaxed financing criteria than it currently adopts.
We need to assess the additional burden on profitability that the new debt issue will impose. As mentioned, during the course of our audit, it would be worthwhile seeing the
projections relating to the net cash inflows arising from the proposed developments.
It will be important to assess interest cover relating to the overall debt charges to ensure that the company is not overexposing itselt.
There will be a large redemption in seven years and we should make sure that the company establishes a sinking fund for this. This will be an additional drain on cash resources.
We will need to verify if there are any covenants on the existing debt. The company may well be in breach of these should it undertake to develop and finance it in the way proposed.
Once the property development begins we will have to take professional advice on year by year valuations of the assets.
We will need to review the status of the debt issue for redemptions. Any redemptions will alter subsequent interest calculations. This will depend on the details of redemption dates in
the debt contract and the likely value of the future share price of the company, which is unknowable at this time.
It will be important to determine the nature of the cash flows arising trom the new development since there is a substantial increase in interest costs relating to the new debt after the
second year. Presumably, the structuring of the debt agreement in this way matches the projected income tlows trom the future developments. We should review this to ensure that
the company has the appropriate cash capacity to deal with these levels of outtlows.
Thave assumed a tax rate of 23%, although this may change in the future and the conclusions of this report may alter accordingly. As part of our audit it may well be worthwhile
conducting some sensitivity analysis of the cash projects from the new developments to obtain some idea of the degree of risk to which the company is exposed.
Fair value
The assurance relating to fair value is dealt with in ISA (UK) 540 (Revised December 2018), Auditing Accounting Estimates and Related Disclosures, and the auditors will almost
certainly seek to conduct their audit in relation to this standard. In particular, they will obtain audit evidence that fair value measurements and disclosures are in accordance with the
entity's applicable tinancial reporting tramework, including lFRS 13. This will involve gaining an understanding of the entity's process for determining tair value measurements and
disclosures and of the relevant control activities.
In understanding the processes used to measure fair value, the auditor might look to obtain assurance on the following:
Relevant control activities over the process used to measure tair value
Ihe expertise and experience of those persons determining the tair value measurements
The precise role that information technology has in the process
The types ot accounts or transactions requiring tair value measurements or disclosures (tor example, whether the accounts arise trom the recording ot routine and recurring
transactions or whether they arise from non-routine or unusual transactions)
Ihe extent to which the entity's process relies on a service organisation to provide tair value measurements or the data that supports the measurement. When an entity uses a
service organisation, the auditor complies with the requirements of ISA(UK) 402, Audit Considerations Relating to an Entity Using a Service Organisation
The extent to which the entity uses the work of experts in determining tair value measurements and disclosures
The valuation techniques adopted (ie, Level 1,2 or 3)
The valuation approach adopted (income approach, market approach, cost approach)
The signiticant management assumptions used in determining tair value (particularly it Level 3 unobservable inputs are used)
The documentation supporting management's assumptions
The methods used to develop and apply management assumptions and to monitor changes in those assumptions
The integrity of change controls and security procedures tor valuation models and relevant information systems, including approval processes
The controls over the consistency, timeliness and reliability of the data used in valuation models
After obtaining an understanding of the processes, the auditor is likely to identify and assess the risks of material misstatement at the assertion level related to the fair value
measurements and disclosures in the financial statements in order to determine the nature, timing and extent of the further audit procedures.
Income tax Page 9
31 Dec X6
Stake 60%
Inventory value
CA 8,000
Fair value 12,000
tax is budapest 25%
Tax lisbon 20%
Inventory recognised at lower of NRV and cost
Income tax
(1) No deferred tax liability is recognised in respect of the goodwill.
True
The recognition of a deferred tax liability in relation to the
initial recognition of goodwill is specifically prohibited by 1AS 12.15(a).
(2) A deferred tax liability of f800 is recognised in respect of the inventory.

Under IAS 12.19 the excess of an asset's fair value over its tax base at the time of a business
combination results in a deterred tax liability. As it arises in Lisbon, the tax rate used is 20%
and the liability is £800 (E12,000- £8,000) x 20%).
Difference 4,000
tax rate 20%
800
(a) Development costs have been capitalised and will be amortised through profit or loss,
but were deducted in determining taxable profit in the period in which they were incurred.
Deferred tax liability
'Development costs' lead to deferred tax liability.
(b) Accumulated depreciation for a machine in the FS is

greater than the cumulative capital allowances up to the reporting date for tax purposes.
Deferred tax asset
No deferred tax implications
(c) A penalty payable is in the statement of financial position.

Penalties are not allowable for tax purposes.
'A penalty payable' has no deferred tax implications.
Property 1,500,000 Jan X6

Life 20 Years
Dec X7 revalu 2,160,000

Tax 20%
CA Tax baase TD
Property 2,160,000 1350000 810,000
tax base is the legal cost of the property

As CA is great than tax base Deffer tax liability
tax charge 162000

Revaluation 810,000
tax on revalu 162000
There was no liability last year the carry amount and tax base the same
the charge in the current year is for the amount of liabiltiy
Because the revaluation surplus is recognised as other comprehensive income and

accumulated in equity (IAS 12.62), the deferred tax charge is
recognised as tax on other comprehensive income and also accumulated in equity, under IAS 12.61.
Tax loss Dec X7 4,700,000

Allow loss carry back for 1 year then carry forward indefinatlyi
Profits for year
Dex X6 500,000
Dex X8 1,000,000
Dex X9 1,200,000
Dex X10 1,200,000
Tax charge
Loss 4,700,000
Loss carried back -500,000
Loss to be carried forward 4,200,000
Income tax Page 10
Limited loss 4 year 2,200,000

25% deferred tax asset 550,000
A deferred tax asset shall be recognised tor the carry forward of

unused tax losses to the extent that future taxable proits will be available tor offset (IAS 12.34). The loss incurred in the
The current year is a one-ot, and the company has a history of making profits
and expects to do so over the next two years. So it is likely that there will be tuture protits to oftset.
£500.000 of the loss will be relieved by carry back. leaving £4,200,000 for carry forward.
But the carry forward is limited to the likely future profits, so £2.2 million.
Fair value adjustment

Parent acq 80% Jul-05
Property FV 30m
Useful life 20 years
FS Year June 2015
Tax rate 16%
Carry amount at June 2015 15

Tax base
The fair value adjustment to the property reduces goodwill by £24 million (being 80% of the £30m FV adjustment).
As a result of the fair value uplift, the non-controlling interest must be adjusted up by f6 million (20% x £30m).
The journal to record the adjustments to property, goodwill and the NCI at the date of acquisition is:
DEBIT Property 30m
CREDIT Goodwill 24m
CREDIT NCI 6m
The fair value uplift is subsequently depreciated such that by the

reporting date its carrying value isEl5 million (10/20 yrs x £30m). I he journal to record the consolidation
adjustment for extra depreciation is:
DEBIT Group retained earnings (80% x £15m) £12m

DEBIT NCI (20%x 15,000) £3m
CREDIT Property- accumulated depreciation £15m
Deferred tax liability

At acquisition, property held within Dorian's accounts is uplifted by £30 million as a consolidation adjustment.
This results in a taxable temporary difference of £30 million, and
so a deferred tax liability of £4.8 million (16% x £30m) at acquisition.
DEBIT Goodwil £3.84m
DEBIT Non-controlling interest (20% x £4.8m) £0.96m
CREDIT Deferred tax liability £4.8m
By the reporting date, f15 million of this temporary difference

has reversed and therefore a further journal is required to reduce the
deferred tax liability by £2.4 million (16% x £15m)
DEBIT Deferred tax liability 2.4m

CREDIT Retained earnings (80% x £2.4m) 1.92m
CREDIT NCI (20% x £2.4m) £0.48m
Subsidaries rate
B sale of goods to parent 12m with 20% mark up and half remained at YE 30%
R tax loss 6.5m and carried forward agaisnt future profits 20%
PERP
Sale 12 120/120
Cost 10 100/120
Profit 2 20/120
Half remain 1
PERP
Deferred tax impact 0.3
The intra-group sale gives rise to an unrealised year-end profit of f12m x 20/120 x % =£1m.
Consolidated profit and inventory are adjusted for this amount.
This profit has, however, already been taxed in the accounts of Burley.
A deductible temporary difference therefore arises which will reverse when
the goods are sold outside the
group and the profit is realised. The resulting
deferred tax asset is f1m x 30% = £300,000.
This may be recognised to the extent that it is recoverable.
Tax loss bfwd

R loss set against futre
CV Nil
Income tax Page 11
tax base 6.5

base is greater than CV than asset
the tax charge 1.3
An unrelieved tax loss gives rise to a deferred tax asset; however,
only where there are expected to be sufficient future taxable profits to use the loss.
There is no indication of Rhydding's future profitability,
although the extent of the current year losses suggests that future profits may not be available. lf this is the case then no
deferred tax assets should be recognised.
If, however, the current year loss is due to one-off factor, or there are
other reasons why a return to profitability is expected, then the deferred tax asset may be recognised at
20% x £6.5m= f1.3 million
FV of
options at Exercise vesting
Directors Grant Date Options grant price date
EH 1-Jun-05 40,000 3 4 Jun-07
KB 1-Jun-06 120,000 2.5 5 Jun-09
Price of shares 31 May 2007 £8

Price of shares 31 May 2006 £8.50
Expense PL for options 60,000

cum expense for 2 years 31 May 07 220,000
tax rate 30%
Share options
The company will recognise an expense for the consumption of employee services given in
consideration for share options granted, but will not receive a tax deduction until the share
options are actually exercised. Therefore a temporary difference
arises and IAS 12, Income Taxes requires the recognition of deferred tax.
A deferred tax asset (a deductible temporary difference) results from the difference between
the tax base of the services received (a tax deduction in future periods) and the carrying
value of zero. IAS 12 requires the measurement of the deductible temporary
difference to be based on the intrinsic value of the options at the year-end. This is the difference between
the fair value of the share and the exercise price of the option.
If the amount of the estimated future tax deduction exceeds the amount
of the related cumulative remuneration expense, the tax deduction relates not only to the remuneration
expense but also to equity. If this is the case, the excess should be recognised directly in equity.
Year to 31 May 20X6

Deferred tax asset
EH
Fair value 40,000 x 8.5 x 1/2 170,000
Exp price of options 40,000 x 4 x 1/2 -80,000
Intrinsic value 90,000
tax at 30% 27000
Cum expenses 60,000 less than 90,000 therefore
CA 60,000 As the TD is more CA = Asset

Tax base 90,000
Deferred tax asset of 27,000 is recognised in SOFP 27,000 Deferred tax DR

Deferred tax - 30%*60000 18,000 PL Income CR
excess of £9,000 - 30% x 30,000 9,000 equity CR
Year to 31 May 20X7

Deferred tax asset
FV
EH 40,000 x 8 x 1/2 320,000
KB 120,000 x 8 x 1/3 320,000
FV 640,000
Exercise price of option

EH 40,000 x 4 -160,000
KB 120,000 x 5 x 1/3 -200,000
-360,000
Intrinsic value 280,000

tax at 30% 84,000
Less last year recognised bfwd - 27,000
57,000
Cum expense 220,000

this is less than IV 280,000
Deferred tax asset 84,000
Income tax Page 12
CA 220,000 As the TD is more CA = Asset

Tax base 280,000
CR Deferred tax income 57,000

CR Equity 60,000 x 30% - 9,000 9,000
DR PL 48,000
Ch 20 Q5 Page 13
60% 85% 30% 9/12 month in year aq

Anima Orient Carnforth Oxendale
Revenue 1,410,500 870,300 640,000 760,090
Cost of sales -850,000 -470,300 -219,500 -345,000
Gross profit 560,500 400,000 420,500 415,090
Operating expenses -103,200 -136,000 -95,120 -124,080
Profit before taxation 457,300 264,000 325,380 291,010
Income tax expense -137,100 -79,200 -97,540 -86,400
Profit for the year 320,200 184,800 227,840 204,610
Equity
SC 4,000,000 3,500,000 2,000,000 3,000,000
RE 1,560,000 580,000 605,000 340,000
5,560,000 4,080,000 2,605,000 3,340,000
25%
fv prop
Carnforth 3m 85%
ACQ YE
SC 2,000,000 2,000,000
RE 605,000
FV uplift 320,000 50 land 50 % PPE
Depn 1,000
Orient 60% NCI 1,520,000

SC 3,500,000 3,500,000
RE 195,000 580,000
3,695,000 4,080,000
385,000
Oxendale 30%
SC 3,000,000 3,000,000
RE 130,000 340,000
3,130,000 3,340,000
210,000
P to Sub Orient
Sale 149,500
Profit 19500
Half left 9750
P to As Oxendale 30%
Sale 207,000
Profit 27000
Third left 9000
30% of it 2700
Imparment to Oxendale 10,000
3-Dec
60% 85% Adjust
Anima Orient Carnforth
Revenue 1,410,500 870,300 160,000 -149,500 2,291,300
Cost of sales -850,000 -470,300 -54,875 149,500 -1,238,125
PURP (W4) -9,750
PURP (W4) -2,700
Gross profit 1,053,175
Operating expenses -103,200 -136,000 -23,780 -263,980
air value adj dpen -1,000
Profit before taxation
Income tax expense -137,100 -79,200 -24,385 -240,685
Profit for the year 320,200 184,800 55,960
Non-controlling interest
Ch 20 Q5 Page 14
Orient Ltd (40% × £184,800 (W2)) = £73,920

Carnforth Ltd (15% × £55,960 (W2)) = £8,394
Non-controlling interest = £73,920 + £8,394 = £82,314
Share of profits of associate

profot 204,610
30% share 61383
Imparment -10,000
51,383
Consolidated retained earning

Cfwd 1,560,000
PURP -9,750
PURP -2,700
Profit O 231000 60% × (580 – 195))
Profit C 47566 (85% × 55,960) (W2)
Profit of O ass 53,000 ((30% × (340 – 130)) – 10 (impairment)
1,879,116
Non-controlling interest – SFP Orient Ltd

FV of NCI 1,520,000
Post ac re 154,000 40% × (580 – 195))
1,674,000
Carnforth
NA as per Q 2,605,000
Fair value adjustment (increase) 320,000
ess extra depreciation on FV adj -1000
2,924,000
NCI at 15% 438600
2,112,600
Fin Instr Page 15
Bonds issue 10,000,000

Interest 7%
Reedem 2 years
Shares 12,500,000
Market rate 10%
CF Discount
Year 1 700000 0.909091 636363.636
Year 2 10,700,000 0.826446 8842975.21
Liability 9479338.84
-12,500,000
Equity -3020661.16
Bonds issue 5,000

Interest 8%
Par value £10 £50,000
Reedem 2 years
Shares 15,000
Market rate 10%
Incurred trans cost 1000
CF Discount
Year 1 £4,000 0.909091 3,636
Year 2 54,000 0.826446 44,628
Liability 48,264
- 50,000
Equity - 1,736
Issue cost
Ratio 48,260:1736 Net Liab
Liability 965.2 48,264 47,299
Equity 34.8 1,736 1,701
1000
IRR Calc 47,299 11.16%

-£4,000
-54,000
Bfwd Interest at IRR CF Cfwd

Year 1 47,299 5,279.00 -4000 48,578
Year 2 48,578 5,421.74 -4000 50,000
Bonds issue 15,000,000

Interest 6%
Par value £10 £150,000,000
Reedem 4 years
PV of cap + int 13,000,000
Fin Instr Page 16
Shares
Market rate
Incurred trans cost 400,000
Tax rate 25% tax is deduct for profit
Bond Issue cost Total

Liability 13,000,000 346666.667 12,653,333
Equity 2,000,000 53,333
15,000,000 400,000
Equity part 2m - (53,333 x 25% x 53,33) 1,960,000
TR 128.85
Pay 3 instalmetns 50
Market rate 8%
Expect credit loss -75.288
Prob of default 25%
In the FS
Interest on TR 10.308 Interest in PL
Loss allowance recog for 12m
75.288 x 25% -18.822
This must be unwould by 1 year
18.882 x 8% -1.50576
-20.32776
DR Fin cost
CR Losss allowance
Jan X8
Bond 100,000
5 years term
Interest 5% 5000
Exp credit loss 1000
Dec X8
FV of debt 96000
Exp credit loss 1500
JAN X9
Sell bond 96000
FS for X8 and X9
Jan X8
DR Debt Instr 100,000
CR Cash 100,000
DR Impariment allow PL 1,000
CR Other Comp Income 1,000
Fin Instr Page 17
Dec X8
DR Cash 5,000
CR Interest income 5,000
DR Impairment allow increase 500
CR Other com income 500
DR Other com income 4,000
CR Debt inst 4,000
FV adjustment 100 - 96
JAN X9
DR Cash 96,000
CR Debt inst 96,000
DR Loss of sale PL 2,500
CR Other comp income 2,500
Loss
FV 98,500 100 ,000- 1500
Sale price 96000
Loss -2,500
RR Page 18
PPE
Carrying amount 30
New eq 5
35
Cash generating unit

net selling price 33
Cash flow 3.2
Discount 10%
Perpuity 32
List at £33m
safety equip required even if no benefit
value all relate assets to an impairment test in this case
recoverable amount is 33 as price greater than asset value of 32
This is less then carry amount the asset write down 32m
£m
Investment property 3.1
legal costs 0.1
3.2
Useful life 20 Prop legal costs

Dec x6 3.45 167.5 est
july x6 fair value held for sale 3.5 160 est
Oct x 7 sale 3.7 165 incured
Fair value model

in Dec X6 0.25 incresae in value and reval res
the transaction cost should be incldued in intital measuremnt under FV
thus 3.45 - 3.2
Cost model - gain on sale

carry amounts is cost less depn to date
3.2 less 18 months dpen over 20 years
2.96m
it is then measured on low oc CA and fair value less cost

FV -3.5 less .16 = 3.34
Fair value less cost to sell
Carry amount = 2.96m
Profit on sale 3.7m less cost to sell 165k

less the 2.96m
profit = 575,000
Fair value method - gain on sale

Carry amount before sale was 3.5m
measure asset H4S at lower of CA at FV less cost to sell does
not apply to inv property at FV as at FV
cant deducts cost to sell off of FV 3.5m
profit on diposal 3.6 - 165k less 3.5m = 35,000
thus making a difference of 540,000
Definition of investment property and theretore within the scope ot IAS 40, Investment Property?
Abuilding owned by an entity and leased out under an operating lease
Land held for long-term capital appreciatio
Cost per item

Variable 200,000
Fixed 40,000
240,000
Inventory 85
Contract sale 225,000 sell 15 units at this rpice
RR Page 19
Normal selling price 260,000
Value of inventry
Contract NRV lower than cost
15 x 225,000 = 3.3.75m
General cost is lower than NRV 240k x 85-15 = 16.8m
20.175m
Intangiable asset as needs to have signifcant control over expected future economic beneift as a person
is therefore not an intangible asset
Office 5
Life 50
Depn = 0.1m per year
after 5 years reval 8m
5 years after that recoverable amount was 2.9m
After 5 a year reval reservce was 3.5m

other comp income 3m for revalue and 0.5m for the depn
New carry amount 40/45 x 8m = 7.1m

recover amount now 2.9m
which is 4.2m impairment
but has reval res of 3.5 so only impairment 0.7m
jan x7 jan x7
copy right remian perMV a Dec X7 NBV
D 900,000.00 6 700000 150,000.00 750,000.00
B 1,200,000.00 16 1150000 120,000.00 1,080,000.00
S 1,700,000.00 8 Unknown 212,500.00 1,487,500.00
D 1,400,000.00 indefite 2100000
Depn char 150,000.00

Depn char 120,000.00 10 year period not 16
Depn char 212,500.00
impiar D 50,000.00
D dpen 140,000.00 10 year period
672,500.00
3 year IFA
expnese 70,000 not probable so expense
cost to reg 9000
period 9
value £9,450
licences 15
total cost £141,750
revalue res = 141,750 - 9,00 £132,750
before reval at £4,50

3 years depn £47,250
3 years of cost 3000
transferred to RR £44,250
balance at RR £88,500 132,750 - 44,250
CA of licence £94,500 141750 - 47250

value 67500
Impairment £27,000
this £27,000 was to RR
balance at RR £61,500 88,500 - 27,000
TU2 Page 20
20YO 20X9 20YO Issue 1 Issue 1 revIssue 3 Revised

£m £m £m
Revenue 32.7 32.9 32.7 -2 30.7
Cost of sales -25.8 -27 -25.8 -25.8
Gross profit 6.9 5.9 6.9 4.9
Administrative expenses -4 -3.4 -4 -1.6 2 -3.6
Operating profit 2.9 2.5 2.9 1.3
Finance costs -1.1 -1 -1.1 -0.64 -1.74
Profit before tax 1.8 1.5 1.8 -0.44
Income tax -0.5 -0.4 -0.5 -0.5
Profit after tax 1.3 1.1 1.3 -0.94
ASSETS 20YO 20X9 20YO Issue 1 Issue 1 revIssue 3 Revised

Non-current assets
Property, plant and equipment 61.2 61.4 61.2 6.4 67.6
Current assets
Inventories 1.7 1.5 1.7 1.7
Trade and other receivables 6.2 5.9 6.2 6.2
Cash 0.2 0.2 0.2 0.2
Total assets 69.3 69 69.3 75.7
EQUITY AND LIABILITIES
Equity
Issued capital - £1 ordinary shares 20 20 20 20
Retained earnings 27.7 28.4 27.7 -2.24 2 -2 25.46
Total equity 47.7 48.4 47.7 45.46
Non-current liabilities
Long-term borrowings 16 16 16 5.17 21.17
Current liabilities
Trade and other payables 3.7 3.9 3.7 2 5.7
Short-term borrowings 1.4 0.3 1.4 1.47 2.87
Taxation 0.5 0.4 0.5 0.5
Total equity and liabilities 69.3 69 69.3 75.7
Issue 1
Lease he liability is held at amortised cost as follows:
5 years bf Interst 8% repay CF
Payments 2 8,000,000 640,000 -2,000,000 6,640,000
6,640,000 531,200 -2,000,000 5,171,200
PV of lease 8
Interest on Lease 8% CL 1,468,800
NC 5,171,200
The lease is recognised incorrecly
reverse woud
DR Lease 2
CR SPL 2
Depn 8/5 1.6
Finace cost 0.64
Carry amount at year 6.4
Current Liabilty 1.47

NCL 5.17
Current treatment an expense of £2m has been recognised.

Under IFRS16 a liability should be recognised at the PV of the lease payments with a matching Right of Use Asset.
• Initially, recognise an asset and a corresponding liability at the PV, being £8m.
• Subsequently depreciate the asset over the 5 years giving a SPL charge of (£8m/5) £1.6m and a carrying value at year end of £6.4m
• There would be a finance cost in the P/L of £640k, the closing liability is £6.64m split between NCL and CL as £5.17m and £1.47m respectively.
Issue 2
• Rellacks has made a guarantee for Monmost to cover their debt where there is failure to pay.
There is uncertainty regarding whether Rellacks would have to pay and this would need to be assessed
Per IAS 37 it appears this is a contingent liability (possible liability) which should be disclosed.
If assessed as probable it should be recognised as a provision.
As Monmost is a related party (controlling interest) under IAS24 this should be disclosed anyway.
Issue 3
Recognised all 3m
over 12 months
4 months this year
3/12*4 1m
remaining deferred 2m
Under IFRS15, revenue for services should be recognised on the basis of the stage of completion.
not all of the renveue should be recognised in the current year
as this happened in begin of sept then 4 months recgonised as revenue
so we will defer part of this income
Ratios Revised 20X9

GPM 16.0% 17.9%
TU2 Page 21
Operating profit margin 4.2% 7.6%

Current ratio 0.89 1.65
Interest cover -0.747126 -2.5
Gearing 52% 33%
Gearing! Long-term borrowings + Short-term borrowings Less adjustment 0of -.2.24 +2)
Total equity
Ratio/movement
Revenue has fallen from 32.9m to 30.7m (Using revised numbers)
Why
With the economic downturn it is unsurprising that revenue has fallen.
However, in light of recent complaints regarding poor maintenance this may
also have been a contributor to lower room occupancy in the current year.
Implication
If lack of maintenance continues
this might result in further
customer dissatisfaction and
impact adversely on revenue.
Ratio/movement
Food and drink revenue
has fallen by 7% to £6.8m people not wishing to spend as much
Why
Could be as a result of the recession
people not wishing to spend as much
on meals and opting for cheaper
establishments.
Implication
Information on the pricing of
foods and drinks in comparison
to prior year and other medium
sized fims to assess whether
pricing is affecting their
competitive performance.
Ratio/movement
Paul is retiring next month
Why
This is worying given that Paul has
been managing director for 30 years
and would have significant skills,
knowledge and expertise. Under
Paul's direction Rellacks has been
able to win Best Hotel award twice.
Implication
All of the other directors of the
company are also directors of
Monmost and have no
experience in the hotel
business.
Ratio/movement
Companies principal assets are PPE, No PPE movements in the current year.
Why
There have been no acquisitions/disposals of PPE items
The assets are worth significantly more than the book values which provides assets
some comfort over using these assets as security
Implication
Would need to obtain evidence regards the valuation of these assets
Ratio/movement
Paying dividend of 10p – current year dividend
(10p*20m) = 2m they have been paying this since 20x6
Why
Dividends of such amounts are not sustainable in light of the falling profits
Cash in the bank following this dividend is £0.2m. It appears this dividend is
stripping the business of cash.
Implication
If such dividend payments
continue to be made then it
could mean continued
reductions in maintenance
spend which may adversely
impact revenue and
reputation.
Ratio/movement
Short term borrowings have increased by £1.1m to £1.4m
Why
Possibly to fund the significant sum of dividend paid out (as above).
Implication
Might be suggesting that Rellacks may well struggle the interest on the loans)
to meet other expenses (liquidity issue – can they pay
Oversea Transaction Page 22
OS Sub
Goodwill $175,000
HR 1.321
CR 1.298
Av FY 1.302
AV Acq 1.292
Goodwill at FS
Year end 175/1.298
Using closing rate
OS Sub
Net asset $300
Profit year $150
HR 2
CR 3
Av FY 2.5
Year end recog in FS

Net assets
Last year rate 300/2 150
this year rate 300/3 100 -50
Profit
Average rate 150/2.5 60
this year rate 150/3 50 -10
Loss recognised in equity -60
Lease Liab, ROU, Leaseback Page 23
Lessee
Payments 50,000 at 8%
PV of payments not made
Cash flow Discousnt value PV Year end
Year 1 50,000 1.08 ^ -1 46,296 CR Lease Liabiltiy 199,636
Year 2 50,000 1.08 ^ -2 42,867
Year 3 50,000 1.08 ^ -3 39,692
Year 4 50,000 1.08 ^ -4 36,751
Year 5 50,000 1.08 ^ -5 34,029
199,636
In Arrears
Liability bf Interest 8% Repayment Liability Cfwd
Year 1 199,636 15,971 -50,000 165,606
Year 2 165,606 13,249 -50,000 128,855
Current Liab (balance fig) 36,751

NCL 128,855
Liabiitly at Year end 165,606
Assumed 13%
Cash flow Discousnt value PV Year end
Year 1 50,000 1.13 ^ -1 44,248 CR Lease Liabiltiy 148,724
Year 2 50,000 1.13 ^ -2 39,157
Year 3 50,000 1.13 ^ -3 34,653
Year 4 50,000 1.13 ^ -4 30,666
148,724
In Advance
Liability bf Payment Capital Interest 13% Cfwd
Year 1 148,724 - 148,724 19,334 168,058
Year 2 168,058 - 50,000 118,058 15,347 133,405
Current Liab (balance fig) 50,000

NCL 118,058
Liabiitly at Year end 168,058
Use PV Function £148,724

PV( Interest rate, no of years, repayments amount)
PV(.13,4,50000)
Sale and Leaseback

Proceeds of FV
FV Sale 20,000,000
CA 7,000,000
Contract ROU for 5 year
PV of Lease 5,700,000
5.7/20x7
ROU 1,995,000 i.e 28.5% x 7m
PV Lease / FV x CA
DR Cash 20,000,000
DR ROU 1,995,000
CR Lease Lability 5,700,000
CR Building 7,000,000
CR Profit of disposal BAL 9,295,000
Proceeds below FV
Sale 19,500,000
FV 20,000,000
CA 7,000,000
ROU 1,995,000 (5.2+.5)/20x7

PV Lease + prepayment ie diff in sale & FV / FV x CA
DR Cash 19,500,000
DR Prepayment 500,000 FV less Sale
DR ROU 1,995,000
CR Lease Lability 5,700,000 Lease payments + prepayment
Sale 14,000,000
FV 15,000,000
Difference 1,000,000
CA 17,000,000
PV of Lease 7,400,000 PV Lease + prepayment / FV x CA
ROU 9,520,000 1+7.4)/15 x 17
DR Cash 14,000,000
DR Prepayment 1,000,000 FV less Sale
DR ROU 9,520,000
CR Lease Lability 8,400,000 Lease payments + prepayment
CR Profit of disposal BAL - 880,000
Proceeds above FV
Sale 20,500,000
FV 20,000,000
Difference -500,000
CA 7,000,000
ROU 1,995,000 (6.2-.57.4)/120 x 7
DR Cash 20,500,000
DR ROU 1,995,000
CR Lease Lability 6,200,000 Just the LL
Sale 43,000,000
FV 40,000,000
Difference -3,000,000
CA 45,000,000
ROU 16,312,500 40-3/45 x 17
DR Cash 43,000,000
DR ROU 16,312,500
CR Lease Lability 17,500,000

CR Profit of disposal BAL - 3,187,500
Lessor Accounting
Lease years 3
Annual payment 20,000
Gaureantee RV 12,000
RV at end 15,000
Thus ungareanteed RV 3,000
Interest 10%
PV of 3 year 20,000 payment 49,737 PV(.1,20000,3

PV of gauranteed RV 9,016 12000 x 1.1^-3
PV of MLP 58,753
PV of ungauranteed RV 2,254 3000 x 1.1^-3
Net investment value 61,007
Lessor accounting for finance lease

Lease years 4
Annual payment 2,000
FV 5,710
PV of lease payment 5,710
RV at end 0
Interest 15%
End of year 1 accounting treatment

DR Lease Receivable 8,000
CR PPE 5,710
DR/CR PL 2,290
CR Intest income 857

DR Cash 857
Interest income
Opening 15% Cash Closing
1 5,710 857 - 2,000 4,567
2 4,567 685 - 2,000 3,251
3
4
Finance Lease assset 4,567
Non current asset 3,251
Current asset - balance 1,315
Operating Lease
Non financing lease has all risk and rewards still with lessor
Lease year 7
Payment at start 175,000
year payments 70,000 for 6 years
Total receiveable 595,000

Reconginsed per year 85,000 175 + 70x6 / 7
Years Cash SPL Income Deferred Release to PL

1 175,000 85,000 90,000.00
2 70,000 85,000 75,000.00 15,000.00
3 70,000 85,000 60,000.00 15,000.00
4 70,000 85,000 45,000.00 15,000.00

5 70,000 85,000 30,000.00 15,000.00
6 70,000 85,000 15,000.00 15,000.00
7 70,000 85,000 - 15,000.00
315,000.00 90,000.00
Mock 1 Page 27
(2) Fair value adjustments
Cavaradossi
Acq'n date Movement At year end
£m £m £m
PPE (450 – 250 – 50 – 120) 30 (5)* 25
* Extra depreciation = 30 × 1/6
Scarpia
Goodwill Retained SOFP & NCI

earnings
Acq'n date Movement At year end

£m £m £m
PPE (700 – 400 – 40 – 260) 0 0 0
(3) Futures contract
The double entry required is:
Dr Financial asset (future) £2m

Cr Other comprehensive income (with effective portion) £1.9m
Cr Profit or loss (with ineffective portion) £0.1m
(Here both credits can be posted to retained earnings as we are preparing a statement of financial position.)
(4) Sale and repurchase (Tosca)
In substance, this is not a true sale (see answer to part (b) for more detailed explanation). The adjustment required is:
Dr Property, plant and equipment £8m

Dr P/L/Retained earnings (to cancel profit on disposal) £2m
Cr Loan £10m
(5) Goodwill in Cavaradossi
(2 marks)
£m
Consideration transferred 380
Non-controlling interest (450 × 20%) 90
470
Net assets acquired -450
Goodwill (as per draft SOFP) 20
Impairment loss (W6) (10 × 80%) -8
12

£m
Goodwill in Scarpia
Consideration transferred
550
(6) Impairment loss on Cavaradossi
£m Non-controlling interest (700 × 25%)
175
Notional goodwill (20 × 100%/80%) 25
Net assets (480 + (W3) 2) 482
725
Fair value adjustments (W2) 25

Carrying amount Fair value of marks)
532 (2 net assets acquired
(700)

Recoverable amount (520 + (W3) 2) 522
Goodwill
Impairment loss (532 – 522) 25 10
(1 mark)
Allocate to:
1) Goodwill 10
2) Other assets pro rata 0
Group share of goodwill impairment (10 × 80%) 8 (2 marks)

£m
(7) Investment in associate (Scarpia)

Fair value at date control lost
340
1
Group share of post-acquisition profit
2
1
(20m × 3/12) × 40%

(8) Non-controlling interests (Cavaradossi) 342
£m (Mark for

Per question 101
Share of cash flow hedge adjustment (20% × 2 (W3)) 0.4 treating associate)

NCI 101.4 1
(9) Retained earnings

Tosca Scarpia Scarpia
40% 35% sold
£m £m £m
Per question/at disposal (310 – (3/12 × 20)) 696.5 310 305 1
Sale & repurchase (W4) -2 ½
Group profit on disposal of Scarpia (W10) 56.2 ½
Pre-acquisition (W1) -260 -260
Mock 1 Page 28
50 45 1
Share of Cavaradossi cash flow hedge adj
(80% × 2 (W3)) 1.6 ½
Share of Scarpia post acquisition
(50 × 40%) 20 ½
(45 × 35% sold) 15.8 ½
Impairment loss (W6) -8 ½
780.1

£m
£m

Fair value of consideration received

300
½
Fair value of 40% investment retained

340
½
Less: share of consolidated carrying value when control
lost:

Net assets ((750 – (20 × 3/12)) × 75%)
558.8

1
Goodwill (W5)
25.0

1

(583.8)

56.2

37 Page 29
Investment in O Ltd
80% holding 9,600.00

AM Directors 20%
1 June X4
AM Sale 4000
Profit 500 3/12 taken
31 May X4 NA 12000
NCI 2800
Proptionate
Acq of futher 20%
does not cross an accoutning boundary nor result a change in control
No gain or loss is recorded
Propsed Fair valuation exerise is not needed
DR NCI 2800
DR Equity (balance fig) 1200
CR Cash 4000
Issue of convertble bonds

1 June X4
Bonds 10000
100,000 £100 Bonds 5%
31 Mat X7 3 years
10 Shares converted
Smilar debt 8%
Year CF 5% DF 8% PV
1 500 0.9259259 462.96
2 500 0.8573388 428.67
3 10500 0.7938322 8,335.24
9,226.87
Liab 10,000.00
Equity 773.13
Convertiable bonse has equity and liability elemtn
liabiltiy of the gross proceeds is calc with PV of max CF at rate of interest to bonds without rights
the liabiltiy should be split into short and long term at YE
the 773.13 will be equity
PBT 3 month interest 184.54

3/12 x 8% x 9,227
Investment in Nt Ltd
1 June X4 Acq 45%
SC 3000
Believe to have sign influence thus assicoate
Call option on 20% 1500
Excerise option before June X9
Loss 31 Aug X4 -300
PPE 150
NCA 50
NA 200
Should be classed as Subsidary

Share of NA for GW
SC 3000
Share of 55% NA 110
Less NA -200
2910
Loss taken into account as Sub

3 months loss -75
NCI will also need to be take into accounts
IFRS 10 para 12 states that "An investor with the curent ability to direct the relevant activities has power, even it its rights have yet to be exercised".IFRS 10 para B47 also
requires an investor to consider potential voting rights in considering whether it has control and (para B22) whether they are substantive ie, whether the holder has the practical
ability to exercise the right.
Although Congloma does not have the majority of the voting rights in Neida and there are other powertul investors, two factors in accordance with IFRS 10 suggest that
Congloma may still have control and should therefore account for Neida as a subsidiary rather than as an associate.
It has the power to affect its returns from Neida through its control of Board decisions over research and development, arguably the most important decisions in a research
driven entty such as Neida.
It has the right to acquire further shares through its call option. The exercise of this option will give it a majority holding of 65%. In this case the rights to acquire further shares
appear to be substantive as Congloma's additional 20% holding will cost it f1.5 million compared to the £3.0 million it paid for its initial 45% shareholding. While this is a
higher amount per share it is not substantially higher and can reasonably be expected to be a competitive price tor a stake which takes it to a majority holding in the
company.
The FD's proposal to account for Neida as an associate is therefore incorrect.
Accounting for Neida as a subsidiary means that 100% of its results, assets and liabilities will be consolidated within the group financial statements and the 55% share not
owned by the group will be accounted for as a non-controlling interest
The acquisition will have a signiticant impact on the group statement of cash flows with the investment shown within investing activities.
Using the share of net assets method to determine goodwill on acquisition and the net asset information provided will give a goodwill figure of f3 million + (55% of f200,000)-
£200,000 - £2.91 million which will be included as an intangible asset in the group financial statements and will need to be subjected to a review for impairment.
However further consideration needs to be given to whether some/most of this value should be attributed to intangible assets which are not shown at present on Neida's
statement of financial position. In particular, there may well be value in the research and development project for Lastlo which appears to have reached the commercial
exploitation stage.
The Lastlo project should be valued as a separable intangible on acquisition (and subsequently within the consolidated financial statements) if it could be sold separately from
Neida and has a stand-alone value. Ireatment as a separable intangible will also affect group accounts in future years as intangibles other than goodwill are amortised through
the statement of consolidated profit or loss.
In addition to the Lastlo project there may be other separable intangibles in the form of intellectual property rights or contractual rights such as patents.
As Neida is accounted for as a subsidiary, its loss for the 3 months ending 31 August 20X4 will be included in group profit before taxation (although 55% of it will then be
37 Page 30
attributed to the non-controlling shareholders)- therefore adjustment required of f300,000 x 3/12-£75,000.
Consideration also needs to be given to whether the option to acquire a further 20% of Neida has a value which should be recorded within the financial statements.
Given Neida's loss for the year, an impairment review should also be considered.
Disposal of 75% Interest
30 June X4
Sale 6000
CA of NA 5600
CA of GW 1500
Profit recognised is .3m
Projected loss -3000
25% fair value 1000
As a significant interest in Tabtop is expected to be retained, Tabtop will be an associate following the part disposal. The loss of control triggers the need to re-measure goodwill
and the retained interest will therefore be valued not at net asset value but at fair value.
Therefore, the FD is corect in his recommendation of the accOunting treatment in this instance however the calculation of the gain on disposal is incorrect. There is in fact a
small loss, calculated as shown below:
Proceeds 6000
FV of 25% 1000
7000
Less
NA of T 5600
Goodwill 1500
7100
Loss on disposal -100
Associate rather than sub

Loss 2months -500
25% of that -125
This loss includes the downward revaluation to tair value of the remaining non-controlling interest, thus explaining why it is different to the calculation performed by Jazz.
Jazz is correct in her proposal that from now on the remaining interest in Tabtop will be equity accounted for. The full results of Tabtop will be included in the consolidated
statement of profit or loss up to 30 June 20X4. From that date onwards just the group's share of Tabtop's loss after tax will be included and this will also be deducted from the
carrying value of the investment in Tabtop in the consolidated statement of financial position.
Tabtop will be included as an associate rather than a subsidiary for the last two months of the year. This will mean that rather than a loss of £3m x 2/12 £500,000, only a loss of
25% of that amount (E125,000) will be included in the profit before taxation. Therefore, an adjustment of £375,000.
As Tabtop has been making losses it is possible that it will not succeed under its new owners and the remaining investment in the company will need to be reviewed for
impairment.
Impairment on investment in S Ltd

Holding 80%
value in use 9200
CA of NA 8000
CA of GW 4000
NCI (Prop method) 1060
An impairment adjustment will be required it the carrying amount is lower than the higher of the value in use and the fair value less selling costs. The value in use is £9.2 million
which is below the carrying amount and theretore an impairment charge should be recorded. The tollowing calculation assumes that it is correct to use the value in use. If the
fair value less costs to sell the remaining business were higher then that figure should be substituted in the calculations above givinga lower impairment charge.
The impairment in the overall value of Shinwork needs to be allocated between Congloma and the non-controlling interest. As the non-controlling interest is determined using
the proportion of net assets method, there needs to be a notional grossing up of goodWill in order to compare the carrying and recOverable amounts.
The parent company's goodwill of f4 million needs to be notionally adjusted to include the NCI notional goodwill of £1 million (20%/80% x £4m) giving a total goodwill figure
of £5 million.
CA of GW 4,000 80%
NCI GW 1,000 Balance fig
5,000 4000/80%
CA of NA 8,000
Goodwill 5,000
13,000
value in use - 9,200
Impairment 3,800
Impairment
80% 3,040
20% NCI - 760
Other financial reporting issues

Whether there are other costs which should be provided for? There are likely to be redundancy costs and other costs of closure/disposal which should be provided for at the
point at which a detailed plan and announcement have been made (IAS 37). It is not clear from the information given whether this is the case or will be by year end. However
both the amount of the required provision and the timing of its recognition need further consideration.
Effect on consolidated profit before tax for the year ending 31 August 20X4
Consol PBT 7,000.00
Investment in O Ltd 0.00
Issue of convertble bonds - 184.54
Goodwill no amorited but reduction in proft - 75.00
Disposal of 75% Interest -100
Loss of year -125 500k recognised 375 500 meant to be 125 so increase profit
Impairment on investment in S Ltd -3040
3,975.46
(2) Group audit procedures required on transactions identified

General points on scope of group audit work
The group auditor's ability to obtain sufficient evidence will be affected by significant changes in the group such as those for Congloma. Identification of significant componentss
may change as entities are added to the group or sold off or as the relative materiality of their operations changes. The group auditor should be involved in the assessment of
risk for all significant components which will require a full audit using component materiality; and audit of specitied balances related to significant risks.
If work done at significant components does not provide sufficient audit evidence then some non-significant components will be selected and additional procedures pertormed
at those rather than the analytical reviews pertormed in the past. Changes in the group may mean that such an approach becomes necessary.
In this case, work at the components is performed by other teams from A&M LLP but the group audit partner will still need to be involved in planning and directing the work of
those teams to ensure that sufficient assurance is given at group level.
37 Page 31
Oldone
As Oldone has been a subsidiary for some time, few additional audit procedures are likely to be required.
However, the sale by the Chief Executive of his shares does increase his incentive to overstate the results of the company in the period to 31 May 20X4. There is theretore an
enhanced risk of management override of controls and fraud. The subsidiary audit team should be made aware of this and asked to report to the group team on the results
of focussed audit procedures on journal entries and judgemental provisions.
The results as at 31 May 20X4 will determine the entry made to reserves and therefore some additional work may be required to look at whether an accurate cut off in
revenue and costs was achieved at that date. Any unusual trends in the last three months compared to the earlier part of the year should also be thoroughly investigated.
The sale and purchase agreement for the shares should be reviewed to identify key terms and ascertain any performance conditions or additional liabilities
The entries made to record the new investment and the elimination of the non-controlling interest balance should be reviewed to ensure that they are accurate.
Convertible bonds
The terms of the convertible loan agreement should be reviewed and agreed to the loan agreement document and ensure that the financial reporting treatment agrees to
ne terms.
In particular the sources for the comparable interest rate should be checked as it is this which drives the split of the compound instrument for accounting purposes. A higher
or lower rate could make a signiticant difference.
The bond's value is greater than planning materiality and is a complex transaction and requires scrutiny given the lack of experience of the client's staff.
Neida
Review purchase agreement and loan agreement to identity key terms and form an independent assessment as to whether Congloma has control over Neida and whether
there are other key terms which should be considered in forming that assessment or determining the amounts to be included in the financial statements.
Assess the date at which control passed and ensure that Neida's results and cash flows have been consolidated from that date. Given the immateriality of Neida's results to
the group, detailed audit work at the subsidiary level is unlikely to be required, although consideration should be given to the total level of costs incurred and whether any
material amounts should have been capitalised as R&D - this is unlikely in current year as total loss only expected to be £300,000 and this is likely to equate to the costs as no
significant revenue expected in start-up phase.
Ensure that the investment balance held in the holding company has been eliminated on consolidation and that the goodwill shown has been correctly calculated and
disclosed. Check that the investment is correctiy included in the group cash flow statement as an investing cash flow.
Obtain details of the fair values attributed to assets and liabilities at the date of acquisition. For each significant item (tangible assets and net current assets are unlikely to be
signiticant based on information provided), consider the basis for the fair value and assess the reliability of any valuations provided by external experts. Ihis is most likely to
be relevant for separable intangibles such as R&D.
Ensure that we have sutfticient understanding of Neida's operations and commitments to be able to assess whether the assets and liabilities at the acquisition date are
reasonable and complete as it is possible that liabilities may have been missed or that the identitication of separable intangible assets is incomplete. Consider the
monitoring controls which Congloma exercises over Neida and discuss plans for the company with the Congloma nominated Neida directors.
Review Neida's business plans and consider whether there is any indication that the goodwill and/or intangibles are impaired. There will inevitably be signiticant judgement
involved in the valuation of a research company and the assessment performed at the time of the acquisition and basis tor the offer of £3 million should be relevant in
making this assessment. While signiticant change would not normally be expected in just a few months it is possible thata research breakthrough or developments made by
a competitor could have a significant effect on the prospects of Lastlo and Neida and we need to make enquiries as to whether this is the case. A change in key personnel,
particularly those developing the project, would also be significant.
labtop
Review sale agreement and ensure in particular that all costs have been recognised and that consideration has been given to any liabilities or contingent liabilities arising
from guarantees or warranties given to the purchaser.
Consider the terms of the agreement with the new majority shareholder and assess whether Jazz is correct in saying that Congloma retains significant influence and should
therefore account for labtop as an associate.
Review the accuracy of the accounting entries made to reflect the disposal.
Consider the extent of procedures required at Tabtop to provide assurance on the results consolidated for 10 months (which may still mean it is a significant component) and
also whether additional audit procedures are required at the disposal date at labtop to verity the accuracy of the net asset balance used in the disposal calculation and the
split of results between the period when Tabtop was a wholly owned subsidiary and that when it is an associate. In considering the level of work required we should take into
account any due diligence procedures undertaken by the acquirer (although we are unlikely to be given access to these) and whether a closing date audit is planned on
which we may be able to rely.
Consider whether the inclusion of Tabtop as an associate changes our overall assessment of the work required on the associate balances- Tabtop was considered significant
when a subsidiary. It may be that in the future it is audited by a ditferent component auditor and that will give rise to the need to assess that auditor and determine the level
of assurance gained from their work.
Shinwork
The key judgement in the impairment calculation is the amount of the value in use. Obtain detailed projections supporting the value of f9.2 million and subject both cash
flows and discount rate to scrutiny comparing cash flows to past results, sales order levels etc, and reviewing/performing sensitivity analysis for the key assumptions made.
There may also be going concern indications and a going concen review should be considered.
The amounts to be included in the consolidated statement of financial position for Shinwork will be lower than in the prior year (as will its contribution to profit and revenue
as business is declining). Need to consider therefore whether Shinwork is still a significant subsidiary entity (although it seems likely that this is the case given the size of its
remaining value in use).
Also need to consider whether, given Shinwork's diminishing contribution and also the disposal of Tabtop, work will be required at some of the subsidiaries previously
considered insignificant in order to obtain sufficient coverage of key balances across the group.
38 Page 32
Draft financial information for the statement of financial position at 30 June

20X5 Adjustments 20X4 Adjustments
ASSETS £'000 £'000
Property, plant and equipment 113,660 -18260 95,400 120,400 the FV is 95,400 so reduce by 18,260
Development costs 10,380 10,380 10,380
Inventories 32300 32,300 23,200
Trade and other receivables 36,100 36,100 30,400
Non current asset held for sale 17,270 17,270 Asset held for sale after impariment
(Overdraft) / Cash -8,400 8400 0 5,600 Overdraft reclassifty to other liab
184,040 191,450 189,980

Share capital 37,000 37,000 37,000
Retained earnings 85,220 -990 84,230 68,520 Profit diff ie 16,700 - 15,710
Other components of equity -£42 -42 Adjustment due to hedge
Long-term borrowings 22,000 22,000 39,000
Trade and other payables 31,600 31,600 39,400
Financial liability £42 42 Hedge liablity
Cash overdraft £8,400 8,400 Overdraft
Current tax payable 4,420 4,420 6,060
Provision for redundancy costs 3,800 3,800
184,040 191,450 189,980
Draft financial information for the statement of profit or loss for the year ended 30 June
Revenue 436,000 -92,000 344,000 451,700 -119,300 332,400 Adjsutment for Dis Op
Cost of sales -306,180 72,084 -234,096 -318,500 77,400 -241,100 Adjsutment for Dis Op
Distribution costs and administrative expenses -107200 33,800 -73,400 -101400 34,700 -66,700
Finance costs -1,500 -1,500 -1,500 -1,500
Loss/Profit from discountied operations -12,274 -12,274 Loss after impairment and depn 3 months
Income tax expense -4,420 -2,600 -7,020 -6,060 1,400 -4,660
Profit for the year 16,700 15,710 24,240 18,440
Other comp income

Cash flow hedge -£42
15,668
Exhibit 3: Issues requiring adjustment in the financial statements- prepared by the finance director
Disposal of Lawn Mover Division - Discontinued operations

1 March board decision to sell dvision at fair value
Land and bulding FV 13,000

Plant 7,000
20,000
Selling cost 4% of FV -800
Lega rights of Name 800
Staff redundant and provision 3,800
20X5 20X4
£'000 £'000
Revenue 92,000 119,300
Cost of sales -72,084 -77,400
Distribution costs and administrative expenses (Note) -33,800 -34,700
-13,884 7,200
Income tax credit/(charge)
(Loss/profit after tax 2,600 -1,400
-11,284 5,800
Land Buildings Plant and equ Total

Lawn Mower Division: £'000 £'000 £'000
Cost at 30 June 20X4 and 30 June 20X5 5,600 6,000 12,000 23,600
Accumulated depreciation at 1 July 20X4 -960 -3,400 -4,360
Depreciation charge tor the year ended 30 June 20X5 -120 -860 -980
Deprication add back 3 months 30 215 245
Carrying amount at 30 June 20X5 5,600 4,950 7,955 18,505
Continuing activities:
(ie, the other three divisions)
Carrying amount at 30 June 20XX5 32,200 34,700 28,500 95,400
Total carrying amount at 30 June 20X5 37,800 39,650 36,455 113,905
Fair value
Cost to sell 4% 13,000 7,000 20,000
-520 -280 -800
12,480 6,720 19,200
Impairment CA adjust less FV 0 -1,235 17,270 18,505 - 1,235
The buildings are being depreciated over a 50-year life to a zero residual value.
The plant and equipment is being depreciated on a 10% reducing balance basis.
The company's policy is to recoanise all depreciation charaes in cost of sales
Loss from discounted operation

Substainal and serate part of busineess and only 1 of 4 division and profit center therefore seperated
In accordance with IFRS 5 para 31 it is therefore a component of the entity and
should be treated as a discontinued operation in accordance with
IFRS 5 para 32. It is therefore required that Heston makes appropriate presentation
and disclosure of the effect of the division in the year ended 30 June 20X5 in accordance
with IFRS 5 para 33 including comparatives for 20X4.
The costs identified are those that will no longer be incurred when the division is disposed of.
Draft loss from discounted operation accounts -11,284

Depn add back 3/12 x 980 245
Impairment -1,235
Loss from discounted operations -12,274
Property, plant and equipment 113,660

Balance figure -18260
Fair vlaue 95,400
Cash Flow Hedge

1 May X5
Purchase steel 6,000
Sept price £165
June X5 eq contract £158
Cost at start £990,000

38 Page 33
Cost at end £948,000

Loss of contract £42,000
DEBIT Other comprehensive income 42

CREDIT Financial liability 42
Analysis of financial statements-for inclusion in finance director's section of the commentary in the annual report.
Revenue
The headline figure in the draft financial statements showed a decrease in revenue of 3.5% overall for the company.
The adjusted financial statements strip out the Lawn Mower Division as a discontinued activity. The revenue from Lawn Mowers fell signiticantly by 22.9% in the year but this, in
part, was due to a major new entrant in the industry over which Heston had no control. The response has been to decide to sell off the Lawn Mower Division to prevent further
losses.
The adjusted statement of profit or loss shows revenue of £344 million from continuing activities (ie, from the three remaining divisions). This shows that revenue from these
three divisions actually increased compared to the previous year by 3.5%.
One of the underlying possible causes of this change could have been the reduction in all selling prices of the three divisions of 10%, which may, as intended, have increased
sales volumes. If we adjust for this price change to show changes in sales at constant prices then this shows:
20X4: £332.4m
20X5: £382.2m (£344m/0.9)
This shows that sales volumes (crudely measured) have increased by about 15%. More information is needed to explore the extent to which the price decrease was the primary
causal tactor for the volume increase (for example, sales mix between products will also affect the year on year analysis) but it is indicative that the policy has proved successful
in expanding sales volumes.
Profit
The headline figures in the original draft financial statements showa significant fall of 31.1% in profit for the year from £24.24 million to £16.7 million.
A key factor for analysts is the extrapolation of profits into the future by exploring trends. The adjusted statement of profit or loss strips out the losses from the Lawn Mower
Division and shows profit from continuing activities which will form the basis of profit in future.
The adjusted figures reveal that the three divisions collectively showed an increase in profit for the year on continuing activities of 52% from £18.44 million to £27.98 million.
This is a positive trend which can be emphasised to analysts, particularly if there is evidence that it will continue in future.
Gross margin
The unadjusted gross profit margin has not changed significantly from 29.4% to 29.7%. However, the gross margin from the discontinued operation has fallen from 35.1% to
1.6%.
The adjusted financial statements show that gross margin on continuing operations has increased from 27.5% to 31.9%. At first sight this may seem surprising as selling prices
have been reduced which would normally indicate a reduction in gross margin. However, the increased sales volume has taken advantage of the high level of fixed costs, and
therefore operating gearing, in order to enhance the gross margin and compensate for the selling price reduction.
Financial position and liquidity

The liquidity position of Heston has worsened significantly as measured by the decrease in cash of £14 million from a positive balance of f5.6 million to an overdraft of f8.4
million.
On the other hand, £17 million of the long-term loan has been repaid in the year.
A concerning aspect of liquidity which may raise questions from analysts is the apparent worsening of the working capital position. Both receivables and inventories have risen
significantly, whilst payables have decreased. All these have had a detrimental effect on cash and have been financed from cash generated from operations. The reasons for the
changes in working capital need to be ascertained by further investigation.
There has been no cash spent on PPE in the year. It is not clear whether this is because there were no viable opportunities to acquire new assets or because the cash was not
available given it is being consumed by increases in working captal.
A summary of the liquidity changes can be seen by drawing up a statement of cash tlows tor the year ended 30 June 20X5 from the draft financial statements provided.
Note: Candidates are not expected to prepare a statement of cash fiows, but may refer to individual figures or groups of figure (investing, tinancing, or operating cash tlows)
within their narrative. Ihe statement or Cash Tiows therefore provides a Tramework Tor such an approach.
£'000
Profit before taxation 21,120
Adjustments for:
Depreciation (120,400 -113,660) 6740
Provision 3,800
Increase in inventories -9,100
Increase in receivables -5,700
Decrease in payables -7,800
Cash generated from operations 9,060
Income taxes paid -6,060
Net cash from operating activities 3,000
Cash flows from financing activities

Repayment of long term borrowings -17,000
Net decrease in cash and cash equivalents -14,000
Cash and cash equivalents at 1 July 20x4 5,600
Cash and cash equivalents at 30 June 20X5 -8,400
Other matters for further investigation

An analysis of the fair value of assets. This would include the credentials of those who have completed the valuation. This should evaluate the potential for borrowing using
the assets as security in order to enhance liquidity.
Comparison of the ratios with those for other companies in the sector, to assess relative performance.
Additional segmental analysis for each of the three continuing divisions, to assess performance and development opportunities for each segment independently. IFRS8
segment disclosure may be appropriate.
39 Page 34
1 Oct X4
Acq of sub's
HXP Ltd 100%
Softex Ltd 100%
Exhibit 1: Larousse Group - draft consolidation schedule for the year ended 30 September 20X5 - prepared by Marie Ellis
Larousse plHXP Softex Adjs. Adjust Group Revised Draft
Statement of profit or loss £m £m £m £m £m
Revenue 56.5 12 16 -14 84.5 70.50
Cost of sales -33.3 -7.5 -12.5 14.88 -53.3 - 38.42
Administrative expenses -8.3 -1.5 -1.5 -1 0.8 -12.3 - 11.50
Selling and distribution costs -4.7 -0.7 -1.4 -6.8 - 6.80
Finance costs -1.6 - 0.26 -1.6 - 1.86
Profit betore tax 8.6 2.3 0.6 -1 10.5 11.92
Income tax expense -1.7 -0.5 -0.2 -2.4 - 2.40
Profit for the year 6.9 1.8 0.4 -1 8.1 7.50
Statement of financial position

Non-current assets
PPE 38 10.8 16 64.8 64.80
Intangible assets 2 2.00
Goodwill - HXP 5.6 3.18 5.6 6.78
Goodwill-Softex - 2.00 0
Investment in HXP 12 -12 0 -
Investment in Softex 22 -22 0 -
Current assets -
Inventories 9.2 1.9 1.7 -0.88 12.8 11.92
Trade receivables 10.8 2 2.1 -2.6 14.9 12.30
Cash and cash equivalents 0.6 2 2.6 2.60
Total assets 92 15.3 21.8 -28.4 100.7 100.40
Share capital 10 4 5 -4 15 10.00

-5 -5
Share options 1 -0.8 1 0.20
Retained earnings at 1 October 35.8 7.4 14 -7.4 49.8 35.80
Equity -
-14 -14
Profit for the year 6.9 1.8 0.4 -1 8.1 8.10
Non-current liabilities 28.4 0 0 2 3.18 30.4 33.58
Def con -
Current liabilities -
Trade and other payables 8.2 1.6 2.2 -2.6 12 9.40
Current tax payable 1.7 0.5 0.2 2.4 2.40
Short-term borrowings 1 0 0 1 1.00
92 15.3 21.8 -28.4 -0.216974 100.7 100.483
Acquistion of HXP
Cash 12
FV of NA 11.4
Deferred con 6 30 Sept X7 - 3 years
Discount rate 5%
Goodwill in accoutns 2.6
Recalc goodwill
Cash 12.00
Def con 5.18
FV of NA - 11.40
5.78
Def con calc 1.05 ^-3 x 6 5.18

Unwind 1 year 5.44
To PL - 0.26
Marie's treatment of the deferred consideration is incorrect. IFRS 3, Business Combinations requires that consideration should be measured at fair value at the date
of acquisition. Fair value of the contingent consideration is the discounted present value of the consideration payable on 30 September 20X7:
Total consideration at 1 October 20x4 (£12m +£5.2m) £17.2 million. After deducting share capital and retained earnings at date of acquisition, goodwill is
calculated as f5.8 million (£17.2m - £11.4m). The goodwill figure is high, relative to total consideration. It is possible that at least part of it comprises unrecognised
separable intangible assets, and more information is required on this point.
Goodwill arising in a business combination should be tested annually for impairment. More information is required on whether or not this test has been done, and
on the results of the impairment testing if it has been carried out.
Adjusting journal entries
DEBIT Goodwill (5.8m- £2.6m)
CREDIT Deferred consideration (E5.2m- £2m)
HXP reports a profit before tax in the year ended 30 September 20X5 and therefore the contingent condition is met for the first of the three years. The discount is
unwound, and debited to finance costs.
Fair value of deferred consideration at 30 September 20X5: fóm x 1/(1.05 - f5.4m. The journal entry required to recognise the unwinding of the discount isas
follows:
DEBIT Finance cost (f5.4m - £5.2m) 0.2
CREDIT Deterred consideration 0.2
Acquistion of Soft
Cash 22
FV of NA -19
Internal R&D 2
Recalc goodwill
Cash 22.00
Internal RD - 2.00
FV of NA - 19.00
1.00
Acquisition of Softex The research asset can be recognised at acquisition as it is a separable identifiable asset
and the subject of a transaction at fair value. Goodwill is therefore reduced by £2 million;
the correcting journal entry is as follows
DEBIT Intagable assets 2
CREDIT Goodwill 2
39 Page 35
Intergroup balance HXP Softex

% of revenue from sales to Larousse plcC 50% 50%
% of revenue from sales outside the group 50% 50%
GPM on intra-group sales 40% 20%
% of intra-group purchases for YE remaining in L plc's inventories 20% 25%
Intra-group TR from LarousSse plc at 30 September 20X5 1.2 1.4
Revenue as per accounts 12 16

50% lated to L 6 8 14
Sales outside 6 8 14
DEBIT Revenue 14
CREDIT Cost of sales 14
PURP 6 x 20% x 40% margin 0.48

8 x 25% x 20% margin 0.4
Total PURP 0.88
DEBIT COS 0.88
CREDIT Inventroy 0.88
Intra group balance elimate

DEBIT TP 1.2 +1.4 2.6
CREDIT TR 2.6
Share options
Shares 1
Options 1000
EE'S 50
Vesting 4 years
EE left 4
Expected leaving 2
FV at start 20
FV at end 21.74
Calc done
1,000 * (50-4) x £21.74 = £1m (to nearest £100,000)
This expense is included in administrative expenses and is credited to equity.
Calc should have done over 4 years

1,000 * (50) x £20 1000000
1,000 * (50-4-6) x £20 = 800000 200000
The incentive scheme started by Larousse involves the exchange of services for equity instruments in the entity. Therefore, this scheme falls within the scope of IFRS
2, Share-based Payment, as an equity-settled share-based payment transaction. Marie is correct in recognising this transaction in the financial statements, but the
calculation is incorrect. Where payments are received in the form of share options in exchange for services rendered, IFRS 2 requires that the fair value of the
transaction is recognised in profit or loss, spread over the vesting period. Ihe indirect method of measurement is appropriate here: ie, measurement of the tair value
of the equity instruments granted at the grant date. The grant date in this case is 1 October 20X4, and the fair value to be used in the transaction is at that date ie,
£20 per share.
An adjustment is also required in respect of the non-market based vesting condition that share options will vest on 30 September 20X8 only to those employees still
in employment with Larousse at that date. At 30 September 20X5, four of the 50 employees have actually left, and a further six are expected to leave. Theretore, the
calculation of the expense to be recognised is based on 40 (50-4-6) employees. The expense must be spread over the four-year vesting period, and the
calculation is as followS:
(1,000 x 40 x f20.00)/4-£200,000
The adjusting journal entry is as follows:

DEBIT Equity: share options (£1m - £200,000) 0.8
CREDIT Administrative expenses 0.8
Gross profitability
The pertormance of the group as a whole appears satistactory, in that it is profitable: gross profit percentage, based on the draft consolidated statement of protit or loSs,
is ([30.3/70.5] x 100) 43.0%. Comparative figures, calculated using the same accounting conventions, would help to indicate whether or not this is a good pertormance.
Similarly, budget figures would also help in assessing the extent to which performance falls short of, or outstrips, expectations.
Drilling down into the figures produces more refined information. Gross profitablility across the group can be analysed in more detail as follows:
Company/nature of sales
Gross profit %
Larousse/all external ((23.2/56.5] * 100) 41.10%
HXP/internal to group 40%
HXP/external to group (W1) ((2.1/6.0] x 100) 35%
Softex/internal to group 20%
Softex/external to group (w2) |((1.9/8.0] x 100) 23.80%
Response to the board on social responsibility reporting

External auditors' responsibilities in respect of social responsibility reporting
Even though the proposed reporting is voluntary, there are implications for Larousse's external auditors. The auditors will be obliged to consider the potential impact of
the new policies and targets upon the financial statements. Ihey will primarily be concerned to ensure that any disclosures relating to social responsibility are not
inconsistent with information seen by the auditor in the course of the audit. In accordance with ISA (UK) 720 (Revised November 2019), The Auditor's Responsibilities
Relating to Other Information the auditor's report will need to include an Other Intormation section. This will either include a statement that the auditor has nothing to
report or, if there is an uncorrected material misstatement of the other information, a statement that describes the issue (ISA (UK) 720.22(e).
The additional reporting by Larousse will therefore involve additional audit work. All four targets can be expected to involve additional expenditure, and there may be
implications such as constructive obligations giving rise to the need for provisions. The auditors will also be interested in the extent to which HXP and Softex are obliged,
by local law and regulation, to take responsibility for clean air and water. Such obligations could give rise to the recognition of additional provisions. The auditors will be
obliged to consider the existence of such tactors in undertaking their assessment of inherent risk. In extreme cases, non-compliance with relevant laws and regulations or
any of the new pertormance targets might affect a company's going concern status and the auditors would need to consider this as part of their own assessment of
Larousse's going concern status
Proposal for additional assurance report

The proposal that the auditors should be asked to produce an additional assurance report goes beyond the normal external audit appointment. The auditors could be
invited to provide assurance in respect of the proposed social responsibility reporting, and this would form a new engagement for services, separate from the statutory
audit. This is a perfectly feasible suggestion, although the audit firm would need to consider carefully its own competence to provide such services, and it may decidee
that it does not wish to tender for such work. In such a case, it would be necessary to appoint another external veritier.
Because there is no statutory or other regulatory requirement to produce a social responsibility report, the terms of any assurance engagement can be determined by
Larousse in discussion with the appointee. However, it is likely to involve the use of the assurance standard AA1000 Accountability Principles issued in 2018 by
AccountAbility, a non-protit network that works with business and governments to promote sustainable development. The key part of this social responsibility reporting is
therefore content which outlines how we report our sustainability credentials. AA1000 provides guidance on what this includes: in summary though, this kind of reporting
39 Page 36
is expected to consider four main principles:

Inclusivity - consideration of all stakeholders who affect, and are atfected by, our work
Materiality- consideration of any relevant or significant factors, not just financial
Responsiveness consideration of the actions taken by us in response to stakeholders' issues
Impact- consideration of the impact that we have on the economy, the environment, society, stakeholders and even ourselves as an organisation
The additional assurance report might include the following:
The objectives of the engagement and any limitations on its scope (to manage users' expectations)
Intended users of the report
The responsibilities of both ourselves and the external verifier for this reporting
Description of the scope of the report, including any limitations
Description of the disclosures covered and the methodology used in veritying them, including criteria used for evaluation
Statement on level of assurance
Findings and conclusions concerning the reliability of performance in line with the four AA1000 principles (specified above)
Observations and recommendations
Notes on competencies and independence of the external verifier
The name of the external veritier of the report, the date and place signed
Where there is objective, third-party, evidence about progress towards Larousse's targets as set out in Exhibit 3, their verification will be relatively straightforward. For
example, in the case of target1, there should be regular monitoring reports about water quality, produced by appropriately-qualified scientific observers. Provided that
this can be assessed as high-quality, third-party evidence, it should provide a good level of assurance for the verifier. Similarly, it should be possible to assess, from empl
oyment records, the extent to which the employment of child labour under target 3 is being successfully phased out. Where there are distinct, quantifiable targets and
records, veriftication is likely to be straighttorward.
However, where targets are more qualitative in nature, it may be more difficult for the verifier to draw conclusions. In this respect, targets 2 and 4 are more vague (what is
an 'effective" health and safety programme?) and it may be that the targets will require redrafting to be more specitic and quantifiable. It would be important to gain a
precise understanding of the nature of the proposed social responsibility reporting, as these would be the starting point for any additional assurance report.
Ethical implications and actions arising from incident set out in Exhibit 4
Alex's note of the overheard conversation is potentially highly significant. However, it contains no actual evidence and the allegations are apparently informed by dislike
of Dennis Speed. This may be no more than malicious gossip, without any foundation in fact. The preliminary calculation of goodwill on the acquisition of HXP (see earlier
calculation) producesa relatively high figure, but it may include as yet unrecognised intangible assets. HXP is profitable, and there is no clear evidence that Larousse has
overpaid for ts investment in HXP.
Even it Alex considers that the allegation is malicious gossip, he is not entitled to ignore this information. His first task should be to investigate the allegations, as
discreetly as possible. If the allegation that Dennis was involved in adjusting the price paid for the acquisition of HXP is correct, then the issue is not just one of unethical
behaviour, it may also have a criminal dimension, as fraudulent manipulation of documents may have taken place. The transaction could even be defined as money
laundering. If this is the case, then Alex must take care that his enquiries do not 'tip off Dennis.
Once Alex is sure that he has all the relevant facts in the case, he may decide to escalate the matter. He would be well-advised to contact the ICAEW for help in
determining whether or not the matter should be taken forward, what kind of evidence is required, and what action would be most appropriate.
Both Alex and Dennis are CAEW Chartered Accountants and are bound by the ICAEW Code of Ethics. They must act with integrity in all circumstances and must display
professional behaviour. If the allegations are correct, then Dennis has been involved in fraudulent manipulation for personal gain. This involvement, if more widely known,
Is Iikely to bring the profession into disrepute.
It will be helpful to Alex if Larousse has established internal procedures for dealing with the allegations. Larousse is unlisted and may not have appointed non-executive
directors. However, if there are non-executives, it may be appropriate for Alex to approach the chair of the audit committee. However, before getting to this point, he
must be certain of his facts, and must be very careful about how he presents the allegations.
At all stages, Alex must keep a detailed record of his investigations, deliberations and conclusions as this may be required as evidence in the event of criminal and/or
professional disciplinary action.
Aside from the ethical and legal issues that are potentially involved in this case, there are also accounting implications in respect of the disclosure of related party
transactions. A related party is a person or entity that is related to the entity preparing its financial statements, in this case Larousse. A person, or a close member of that
person's tamily is related to the reporting entity it they are a member of the key management personnel of the reporting entity. Dennis as tinance director is, clearly, a
member of Larousse's key management personnel and his wife is a close member of his family. Therefore, Lola Gonzalez is a related party to Larousse. HXP is a related
party to Larousse, as its subsidiary.
According to IAS 24, Related Party Disclosures, a related party transaction is a transfer of resources, services or obligations between related parties. The transaction
involving the sale of Lola's shares to Larousse is therefore very clearly a related party transaction that will require disclosure in the group financial statements.
40 Page 37
Exhibit: Draft trial balance at 31 August 20X5 prepared by John Birch
Debit Credit
£'000
Operating costs 11,353
Inventories and work-in-progress at 1 September 20X4 4,355
Sales 15,680
Selling costs 1,162
Administrative expenses 2,340
Other income: property letting 70
Current tax charge 350
Ordinary share capital 60
Trade receivables 3,281
Trade payables 3,965
Current tax payable 350
Cash 82
Retained earnings at 1 September 20X4 5051
Revaluation surplus at 1 September 20x4 971
Property at 53 Prospect Street 3,335
Computer and office equipment at cost 242
Computer and office equipment- depreciation at 31 August 20X5 110
Deferred tax at 1 September 20X4 243
26,500 26,500
Cost of sales
Inventory erorr 31 Aug X4 bfwd 3742
Reinstate statement of comp income
Inventory for 1 Sept X5 4355
Difference 613
Inveotry at closing WIP 4437
IAS 8, Accounting Policies, Changes in Accounting Estimates and Errors requires

that material prior period errors should be corrected retrospectively. The error in calculation of
opening work-in-progress meant that work-in-progress was overestimated by £613,000,
which is 16.3% of the correct balance, almost 4% of sales revenue and which is likely to
be material in relation to profit. Assuming that the error is material, it will be
necessary to restate the comparatives in the financial statements. Profit for the year ended 31 August
20X4 was overstated by f613,000, as was work-in-progress, and these comparative
figures must be altered. In respect of the financial statements for the year ended 31 August
20X5, the correction of the error is to be reflected in the statement of changes in equity.
DR RE 613
CR Work in prog 613
Cost of sales adjust

Corrected opening WIP 3742
Add operating exp -11,353
Less Closing WIP -4437
-12048
Accounting for foreign currency

Invoice amont in $ $ 220.00 31 Dec X4
Invoice amont in $ $ 180.00 30 June X5
Refinanciing able to pay $ 250.00 31 Aug X5
FX RATE £1 = $1.06 31 Dec X4 £ 207.55

FX RATE £1 = $1.16 30 June X5 £ 155.17
FX RATE £1 = $1.12 31 Aug X5
YE rate £ 357.14
Amount recoverable £ 223.21
Difference £ 133.93
50% allowance needed
Invoices recoveded 208 +155 £ 363.00

Amount recoverable £ 223.00
£ 140.00
The first invoice, dated 31 December 20X4, tor N$220,000 was settled in full out oft the receipt of N$250,000 on 31 August 20X5.
Amount recorded 155

Settlement rate 30,000 / 1.12$ -27
Retranslation of closing monetary assets
$180 - 30 = 150 / 1.12 -134
Gain on trans -6
DR PL net loss on transtion 6

CR TR 6
Direcotrs allowance on 50% of debt

£134 x 50% 67
DR PL Operating exp 67
CR TR 67
Property revaluation
1 Sept X2
Land 300
Building 1700
2000
1% depn on Building
NBV at 31 Aug 20X4 1666
Depn 34
Reval at Aug X4
Land 600
Building 2580
3180
Moved to another 1 Jan X5
Lease for 9 months
Let out old property

5 year lease
Property at valuation at 31 August 20X4 3,180

Installation of air conditioning system (March 20X5) 100
Professional fees in respect of leasing 53 Prospect Street 25
40 Page 38
Costs of relocation to 15 Selwyn Road 30

3,335
Valautions Land Building
1 Jan X5 620 2600 3220
31 Aug X5 650 2850 3500
Investment property
As the letting of the property is to an unrelated third party, and the property is no longer occupied by Telo, it is likely to be classified under IAS 40 as investment property. IAS 40
permits two alternative accounting treatments: the cost model as under IAS 16, Property, Plant and Equipment, or the tair value model. Under the latter model, any change in
the value of the property is recognised in protit or loss.
The property at 53 Prospect Street was subject to a change of use during the year. For the four-month period from 1 September 20X4 to 1 January 20X5, it was recognised ass
property, plant and equipment under the IAS 16 revaluation model. For the eight-month period from 1 January 20X5 to the year end on 31 August 20XS it was recognised as
investment property under the IAS 40 tair value model.
Where there is a change in use, lAS 40 reauires that the property is revalued at the date of change and any difference recognised as a revaluation gain or loss under AS 16.
Cal of revl gain or loss

Depn charge held ISA 16 no depn charged for 4 months 1 Jan X5 therefore ajdustment
Building 2580
Years 98
4/12 of this 0.333333
8.77551 2580/88 * 4/12
Rounded 9
Carry amount 3180-9 3171
1 Jan X5 620 2600 3220
Reval gain 49
DR Op cost depn 9
DR PPE 40
CR Rev gain 49
Recog of investment property

AS 40 permits the inclusion of certain costs in an investment property. John has recognised protessional tees in respect of leasing 53 Prospect Street and this is acceptable. The
subsequent capitalisation of the cost in March 20X5 ot installing the air conditioning system is also likely to be acceptable. However, the inclusion of relocation costs of £30,0000
to the 15 Selwyn Road property is not permissible, and this item must be recognised as an expense in profit or loss:
DR Operating costs 30
CR Property 30
CA at 1 Jan X5 and Aug X5

PPE REVAL 3,220
Pro fess 25
3,245
Add Air con 100
3,345
Revaluation of investment property

Investment property held under the IAS 40 tair value model is not subject to depreciation. Any change in the value of the property, as noted earlier, is recognised in profit or
loss.
The surveyor's valuation at 31 August 20X5 of £3,500,000 (E650,000 for land and f2,850,000 for buildings) exceeds the carrying amount above of £3,345,000 by £155,000. This
amount is recognised as a gain in profit or loss:
31 Aug X5 650 2850 3500
Carry amount 3,345
155
DEBIT Profit or loss 155

CREDIT Investment property 155
Deferred tax balance

Deferred tax at 1 September 20X4 243
Tax rate 20% 0
The deferred tax balance at 1 September 20X4 arose in respect of the 53 Prospect Street property. Because a revaluation under lAS 16 does not attect taxable profits, a deferred
tax adjustment is required, calculated as the difference between the tax base of the asset and the carrying amoOunt.
The deferred tax treatment of an investment property depends upon the valuation model that is adopted. Where investment praperty is held under the cost model, the
accounting treatment is the same as tor IAs 16, where revaluation gains are recognised through other comprehensive income, thus not affecting profit or lOSs. However, where
investment property IS held under the tair value model, gains are recognised through profit or loss and the amount of the gain is taxable, or in the case of a loss, allowable for
tax.
Therefore, the revaluation gain arising under lAS 16 of £49,000 is subject to deferred tax, whereas the gain arising in the last eight months of £155,000 under IAS 40 is not
subject to deferred tax as it is taxed as part of profits for the year.
Because deferred tax on IAS 16 revaluation gains is recognised through other comprehensive income, the amount of the revaluation surplus reported at 31 August 20X4 was
reduced by the amout of the deferred tax balance. The 'gross' revaluation surplus was therefore: £971,000 + f243,000 - £1,214,000. This amount has been increased by
£49,000 in the year ended 31 August 20X5 to a total of £1,263,000.
Deferred tax on this amount £1,263,000 x 20% -£253,000 (to nearest f"'000), an increase of (£253,000- f243,000) £10,000.
Therefore an adjustment is required as follows:
Revalution gain 49
Gain 8 months 155 No subject to Def tax
Reval surpluse bfwd 971

Def tax bfwd 243 243
Revalution gain 49
1263
20% def tax 252.6

Less bfwd -243
10
DEBIT Other comprehensive income 10

CREDIT Deferred tax 10
SOFP Adj Adj Total

Investment prop 3,500 3,500
PPE 132 132
TR 3,281 -6 -67 3,208
Cash 82 82
Inventory 4,355 82 4,437
11,350 11,359
SC 30 30
RE 5051 -613 1,283 5,721
Reval 971 49 -10 1,010
40 Page 39
Tax payable 350 350

TP 3,965 3,965
Def tax 243 10 253
10580 11,329
SOCI
Sales 15,680 15,680
COS -11,353 695 -9 -30 -67 -6 -10,770
Selling costs -1,162 -1,162
Administrative expenses -2,340 -2,340
O income: Prop Let 70 70
Gain on reval 155 155
Current tax charge -350 -350
1,283
Re suprls 49 49
Def tax -10 -10
1,322
41 Page 40
Exhibit 2: Newpenny's updated purchasing internal control procedures prepared by Newpenny purchasing manager in July 20X5
Background
Newpenny's purchases can be categorised as follows:
(1) Materials (including components) used in the manutacture of vacuum cleaners
(2) Services such as utilities and agency statf
Purchase orders
Receipt of materials
Receipt and posting of invoice
Month end accruals process
Cash payments
You should then consider the audit assetions relevant to payables and accruals balances, setting out the following for each assertion:
An explanation of the assertion as it relates to trade payables and accruals
The key control activities you have identified from the information provided
Your initial assessment as to whether the controls you have identified individually or in combination with other controls are capable of ensuring that the audit assertion is met
An explanation of any potential internal control deficiencies identifying:
any gaps you have identified in the control activities;
matters on which you require additional information, and
areas where you are concerned that the controls may not be designed effectively to meet the relevant assertion.
ANSWERS
Financial reporing advice
JE agreement
The new agreement with JE introduces the possibility of a retrospective change in the price paid for motors from 1 August 20X5 to 31 December 20X5. This is unlikely to be
determined before August 20X6 as it depends on the quantity of motors purchased for the year to 31 July 20X6.
In considering whethera provision for any additional payment is required, Newpenny will need to have regard to the requirements of AS 37 which requires a provision where:
there is a present obligation as a result of a past event- that is the case here so long as the order threshold of 100,000 units has not already been exceeded by the year-end
as the contractual arrangement was made before the year end
a reliable estimate can be made - that is likely to be the case here as Newpenny should have a budget showing predicted purchases and will know both the number of
motors purchased pre year end and the additional cost of £1 per motor if total purchases less than 100,000; and
it is probable that there will be an outtlow of resources. This will depend both on the number of motors purchased to date and those which Newpenny expects to purchase in
the 7 months following the year end.
actual purchases to date and projected purchases for the next 7 months show that the target of 100,000 motors will be exceeded then no provision is required, although this
should be kept under review in the period after the reporting date until such time as the financial statements are issued.
If the actual and projected purchases total less than 100,000 then a provision equivalent to f£1 for every motor purchased between 1 August 20X5 and 31 December 20X5
should be made. lo the extent that the motors have been used in vacuum cleaners that have been sold, this will increase the cost of goods sold.
The number of motors purchased is in Newpenny's control and it would be possible to achieve the cheaper price by stockpiling motors. However, it would then be necessary to
consider whether any provision would be required against potentially excess inventory and there would also be considerations regarding the level of purchases Newpenny
could commit to in future years.
To the extent that motors are held in inventory at the year end this may affect the value at which inventory is carried. However, this will need careful consideration as the
standard cost established at the start of the year is likely to be based on the then agreed price of £20 per motor and may or may not have been changed when the agreed price
changed.
Newpenny will need to look carefully at what standard cost has been used and what variances have been included in inventory to ensure that the inventory of motors is carried
at the actual expected cost of £20 per motor assuming an additional payment is required.
The liability being considered here is not a contingent one as the future event (that is orders of motors) which will determine the price per motor is within Newpenny's control.
n order to recognise at year end any refund for motors purchased, Newpenny would need to have already exceeded the target quantity of 110,000 motors. As the future
purchases of motors are within its control it can also recognise an asset it it is virtually certain that it will meet the threshold. if this is the case, then the inventory carrying value
vill again require consideration as outiined above.
Warranty
The issue with the Model2000 cleaners appears to be a specific one and is unlikely to be covered adequately by the general warranty provision which is based on the history of
past claims. Newpenny has an obligation to repair or replace fauity products which are under warranty and there is therefore a present obligation in respect of a past sale. A
specific provision should theretore be made
If the issue is regarded as a warranty issue then the maximum population of cleaners which can be returned will be those still in warranty at the year-end (and not already
replaced). It seems likely that not all of these will develop the fault so the provision should be based on the total number of Model2000 cleaners which Newpenny expects to be
returned under warranty and the cost of repairing or replacing them (based on an engineer's assessment of the work required and the cost of the relevant parts/product).
However, as one customer has alleged that the fault has caused a fire, there is also the potential for legal daims for consequential losses and the potential for these needs to be
taken into consideration when determining the total amount to be provided.
Newpenny should take legal advice as to whether it should recall all potentially faulty product as further issues like this could be costly both financially and reputational and
there may also be a safety issue which Newpenny has an obligation to resolve. This might well increase the replacement cleaners/parts which Newpenny has to provide but
reduces the potential for damaging and expensive legal cases.
The basis for the provision can therefore only be determined when Newpenny has legal advice as to the steps it should take and the likelihood of significant claims against it if it
does not take those steps. The details of the product returned to date and the findings of the engineers will be important in determining the appropriate course of action.
Memorandum to assist in planning audit - initial assessment of controls in place

General observations
In order to place reliance on the operating effectiveness of controls we will need to be confident that the controls were in place throughout the period. That may not be the case
as the procedures documentation was prepared by the purchasing manager who only joined Newpenny in May 20X5. He may have changed the procedures on his
appointment
While the purchasing manager will clearly have some insight into procedures and controls in this area he may not be the best person to provide an overview of all relevant
procedures and cotrols. We also need to consider where additional relevant controls may be present but not visible to the purchasing manager.
In addition, we need to understand the extent to which controls have changed or been strengthened following the audit findings in the prior year.
Existence/rights and obligations-should the liability be recognised in the accounts at all?
The liabilities which are recorded have occurred and pertain to products or services which Newpenny has purchased.
Existence/rights and obligations - should the liability be recognised in the accounts at all?
The llabillties which are recorded have occurred and pertain to products or services which Newpenny has purchased.
Control activities identified:

The liability for goods received is triggered by the goods received clerk posting details of the physical receipt of goods which match to goods ordered by Newpenny. There is
segregation here between that clerk, the purchase clerk who inputs the orders and the finance clerk who inputs invoices.
Invoices are either matched to purchase orders or goods received entries or are sent for authorisation by the relevant department prior to posting. They are only posted to the
purchase ledger once that approval has been obtained.
Orders for materials are authorised by a manager in accordance with the authorisation limits set by the finance department so transactions should only be initiated for materials
which are required by the business.
Purchase orders for services are also prepared and authorised by the relevant departments.
There is segregation between the preparation of purchase orders, the receiving of goods and the processing of invoices.
Month end accruals for open purchase orders are reviewed by the financial controller who also tests a random sample of items to back up to ensure that they are valid.
Initial assessment of the design of the controls:
The activities identified are designed reasonably effectively for ensuring that the liabilities recorded for materials used in manufacturing reflect the goods which have been
delivered. However, in the prior year there were old items on the GRNI accruals listing which did not represent valid accruals. We need to determine whether similar items are
there this year and also whether a control process Such as a review of the listing has been introduced.
The control activities have more significant design weaknesses for other purchases either of goods or services as, if there is no purchase order, it appears that the invoice may
be posted without any further check as to whether the goods or services have actually been received. It is therefore possible that a lability may be recognised without a valid
underlying transaction pertaining to Newpenny.
Completeness and allocation - are there any more liabilities which should be recognised?
Liabilities have been recorded for all goods and services delivered betore the year end and not yet paid. The cut-off procedures at the period end accurately differentiate
between goods and services which were delivered betore the year end and those which were delivered after year end.

The recognition of a GRNI accrual is initiated by the matching of goods received on the system.
There is segregation of duties between those posting the receipt of goods and those who have authorised and posted the orders.
Posting details of the physical receipt of goods generates a 'received' sticker. The store manager checks for the presence of this sticker betore moving the goods into the stores
area thus ensuring that all goods received have been booked into the system and an accrual has theretore been recorded.
At the month end the purchase clerk reviews all open purchase orders to determine whether the goods and services were received before the period end and an accrual
should therefore be made.
Supplier statement reconciliations are performed if a supplier provides a monthly statement.
41 Page 41

The control activities appear to be designed to give reasonable assurance that the liabilities recorded in respect of manutacturing goods received are complete and recognised
on a timely basis thus ensuringa correct cut-off. Ihey could be further enhanced it action is taken promptly when goods are discovered without a 'received sticker or there is a
back-up of unprocessed deliveries.
In addition, further information is needed about what happens when goods are received for which there is no purchase order and how these are followed up.
The control activities to ensure the completeness of other liabilities are less convincing as they appear to rely on a review of open purchase orders and it is clear from the
procedures that purchase orders are not raised for all purchases.We need to understand the proportion of purchases for which no order exists so we can assess whether this is
IKely to be a material part of the overall population.
Supplier statements are reconciled which is an excellent control for completeness and accuracy but this is only the case if the supplier routinely sends a statement and may only
cover a small proportion of the total population.
Where a purchase order has not been raised, the posting of invoices is delayed until the invoice has been authorised. This means that there is a risk of cut off errors and missed
accruals. Controls could be improved it the invoices were logged as they were received so that they could be accrued for as necessary at a period end and also to ensure that
none go missing or are unduly delayed by this authorisation process.
Further evidence that the control activities here may not be designed effectively is provided by the audit adjustment for missed accruals in respect of agency staff in the prior
year. We need to enquire whether additional controls have been introduced as a result. These could sit within the HR function and therefore not be visible to the purchasing
manager.
A further complication is introduced by the presence of new purchase contracts such as that with JE - these mean that the complete recording of accruals/invoices based on the
agreed price' may not in itself be adequate to ensure the overall completeness of payables and associated accruals. We need to enquire into the processes to ensure that all
Such contracts are identified, tuly understood and their impact accounted for appropriately. I his area is not addressed at all at present
We should also enquire as to whether any arrangements exist whereby goods not physically delivered to the warehouse nevertheless give rise to an obligation to pay for an
asset which belongs to Newpenny.
It is also important for completeness that cash payments made and processed to the ledger are paid to the correct supplier and have not been fraudulently diverted to another
account. Would expect controls over the purchase ledger Masterile data to address this risk. None are identified in the information provided.
Accuracy and valuation - is the liability recorded at the correct amount?

Payables and associated accruals are recorded accurately at the actual amount which will be payable.

The purchase ledger is reconciled to the nominal ledger at each month end.
The bank account is reconciled to the bank statement at each month end
Accruals for goods received are made automatically based on the standard costs within the system.
Month end accruals made by the finance clerk are reviewed by the financial controller who requests back up on a sample basis.
Supplier statement reconciliations are performed when a supplier provides a statement.
Payment runs are authorised by the financial controller and one of the other BACS signatories which means that the
or posting of purchases before the amounts are paid. This also serves as a review of items posted to the payables balance and the reasonableness of the amounts involved.
a final review by those not involved in the authorisation

The controls identified provide some assurance but further details are required to assess whether they are designed effectively.
Reconciliation activities are as expected but financial controller both authorises payments and is responsible for the reconciliation. Need to see further detail about who reviews
the reconciliation and how any reconciling items are dealt with before assessing the effectiveness of that control.
The accruals for materials received are based on standard costs which is not unreasonable providing that such costs are kept up to date and there are not large variances. Need
to understand more about the control processes in place here.
The review process for accruals seems good and supplier statement reconciliations will also help to ensure accuracy- however, as discussed previously there are reservations
Over how much of the population these cover.
Classification and presentation - is the liability properly disclosed and presented?

Payables and associated accruals are classified correctly in the nominal ledger and financial statements.
Controls identified
The purchase ledger is reconciled to the general ledger at each month end.

Controls identified to date are clearly inadequate. They cover only one small part of the population and no reconciliation of the GRNI accrual or other accruals balances is
identified.
However, this is not likely to be a complex area and may be best covered by substantive procedures on the financial statements as a whole.
Dashboard data:
Number of manufacturing managers 30
Only one of the 30 managers has been identified as an outlier.
This provides some assurance about the processes and controls for a large majority of
manutacturing managers.
Average value per individual order £2,343

The average value per individual order is less than half (47%) the maximum of £5,000. This indicates
that the limit is well within manager's normal operating limits and does not constrain most
managers making orders without the need for authorisation.
There is the risk of split orders however to avoid the need for authorisation. For example, managers
may split an f8,000 order into two orders for f4,000.
Average value of monthly total orders per 45,864

The average monthly value of orders is less than half (46%) the maximum of £100,000. This indicates
that the limit is well within manager's normal operating limits and does not constrain most
managers making orders without the need for authorisation.
There is the risk of managers early ordering to avoid the need for authorisation. For example: if July
is a peak month then they could order more at the end of June than is needed, so there is enough
inventory to avoid f100,000 being exceeded in July orders. Patterns of orders late in the month
precedinga peak month could be investigated.
Frequency of managers exceeding £90,000 in any one month 16

There are no instances of managers exceeding £100,000 in a month (which would have required
authorisation) but a number of instances where managers came close to this limit.
Frequency of managers exceeding £100,000 in any one month (requiring approval from senior zero
Investigate where managers have been near limit and investigate benaviour around limit, eg.
41 Page 42
delaying orders at the end of the month and making early orders at the end of the previous month.
Understand role of managers. Some managers may be responsible for higher value/volume orders.
Understand why a flat limit for all managers has been applied it this is the case.
manager)
Outlier-John Fuller
Average value per individual order £3,246
The average order is 39% higher than the average order for all managers and 65% of the maximum
Tor a single order.
This places John Fuller as a high risk item in ordering more than other managers.
This may mean a build-up of inventory arising from excessive orders or ineficient usage.
An alternative explanation is that John may work in a high cost area. He may therefore need a higher
limit than other managers.
Average value of monthly total orders £64,379

The average monthly total of orders is 40% higher than the average monthly order total for al
managers and 64% of the maximum for a single month. Investigate the price and volume causes of
the high average value.
% of individual orders exceeding £4,000 35%

A high proportion of John's orders were near the £5,000 limit yet the next most frequent incidence
is 0-£1,000. This may be regarded as an unusual pattern.
Benford's Law (First digit law) is that numerical data sets frequently show that the leading digit is
likely to be the most common. (le, in this case there should be more small orders than large orders.)
This is true in other sections of John's distribution but not of the highest grouping of f4,001-
£5,000.00
This may be a risk of excessive ordering or possibly fraud.
% of individual orders in last three days of the month 27%

A significant proportion of orders occurred in a short period of time at month ends. If this does not
reflect the pattern of usage then it may be a behavioural response by John to circumvent monthly
maxima for ordering without authorisation (see above).
Investigate the reasons why this pattern of ordering should have occurred and whether there is any
commercial rationale.
Compare with other managers whose order patterns have not been extracted by DAACA analytics
as outlierS.
Frequency of John exceeding £90,000 in any one month 7

There were only 16 occurrences of orders exceeding £90,000 by 30 managers and John made 7
(almost half) of these.
Despite this, on no occasion did his monthly order total exceed f100,000, thereby requiring
authorisation. There may be a risk he is avoiding authorisation and any scrutiny.
Number of orders matched with GRN 13,546

The norm is that orders should be matched with GRNs. This total figure should be reconciled with
the total number of orders and GRNs issued in the period.
Number of unmatched orders 1,175

This could be a timing difference between the order being made and the goods arriving.
Analyse by each individual supplier and assess whether the time delay is normal for each supplier's
delivery terms.
Predict number of outstanding unmatched orders based on totals of orders made and usual time
delay for each supplier.
Number of unmatched orders over 2 months old 22

Two months seems excessive for a delayed delivery. This is a small number so all 22 could be
investigated in case they reveal a control weakness (eg, undelivered orders not been followed up;
inability of supplier to deliver).
Number of unmatched GRNs 17

The goods received department staf are instructed that if there is no matching purchase order on
the system, materials should not be accepted.
If this instruction had been fully applied, then this number should be zero. This suggests a control
weakness in that goods may have been received and delivery accepted for goods not ordered.
There may be a further risk that an invoice has been received and paid which would be a more
serious control weakness.
Investigate all 17 items and establish the causes.
42 Page 43
E PLC Listed on AIM

Materiality 2.4m 5% of PBT
Mistatment reported 120k
Exhibit 1: Earthstor- Draft statement of financial position at 30 June 20X6 - prepared by Earthstor finance department
ASSETS £'000 Adjustments

Non-current assets
Intangible assets - website development costs 31,300 -9824 21,476
Financial asset - investment in IraynerCo 8,000 -2000 6,000
Property, plant and equipment 56,309 -4762 51,547
Investment property 4074 4,074
Loan to T Co 3150 3,150
Current assets 0
Inventories 144,380 144,380
Trade and other receivables 22,420 -4000 18,420
Cash and cash equivalents 71,139 71,139
Total assets 333,548 320,186

Equity
Ordinary share capital (E1 shares) 10,000 10,000
Retained earnings 163,362 -850 -688 -9824 152,000
Translation reserve (TraynerCo) -1,500 -2000 -3,500
171,862
Non-current liabilities 12,175 12,175
Current liabilities 149,511 149,511
Total equity and liabilities 333,548 320,186
Interest free foreign loan

TranerCO OS Supplier
1 July X4
Loan issue 20m$
Repayable June X7
Effective interest rate 6%
Agree to sell 10% share 45m$ On Oct X5
July X5 1:$5
Average rate June X6 1:$5.5
June X6 1:$6
Interest fee foreign loan FV $ £ rate £ at YE Interest 6%Rate Av £
Balance at X4 20 1.06^-2 17.79993 3.559986 4 -0.440014 Rate 5 1.067996 5.5 0.194181
Balance at X5 17.79993 1.06^1 18.86792 3.144654 3.333333 -0.188679 rate 6
0.415332 Diff £ rate PY to CY
The loan to Iraynerco represents a financial asset for Earthstor. IFRS 9 requires a financial asset to be measured initially at tair value. A zero interest rate loan Issued at par would
not result in an arm's length transaction and IFRS 9 requires the tair value in such a case to be determined as the present value of the cash receipts under the effective interest
rate method. The discount rate should be that on similar loans. The loan will meet the business model test and the contractual cash tlows test (payments of principal, being the
initial fair value and interest, being interest accrued using the effective interest rate method), and should be subsequently measured at amortised cost.
FV at start 17.79993
FV £ 3.559986
The difference of f0.44 million between the f4 million recognised by the company in trade and other receivables and £3.56 milion is recognised as an expense in profit or loSs.
Each year the unwinding will be treated as finance income. It would be appropriate to use the amortised cost method as the loan is a non-derivative financial asset; there is a
determinable repayment date and the intention appears to hold the investment to maturity. The loan at the financial year end of 30 June 20X6 is:
MYR17.8m x 1.06 - MYR18.87m
This is a monetary asset and would be translated at the year-end rate of f1 - MYR6. In the financial statements of Earthstor it would therefore be translated as:
MYR18.87m/6 £3.15m
There are two elements to this transaction for financial reporting purposes:
Interest income on the loan

TIhe interest income is recognised at the effective rate, even though there is no cash interest received. As the interest accrues over the year, It is translated at the averagge
exchange rate.
The interest cost in MYR is therefore: MYR17.8m x 6% = MYR1.07m
Translated using the average rate into f this is: MYR1.07m/5.5 = £0.20m
Exchange rate loss

The exchange loss on the interest is: MYR1.07m/5.5 -MYR1.07m/6 - £0.02m
The exchange loss on the loan is: MYR17.8m/5- MYR17.8m/6- £0.59m
Interest income 200

Exchange loss: -20
On interest -590
-410
This reconciles with the opening balance divided by the opening exchange rate less the closing balance divided by the closing exchange rate as above
(£3.56m - £3.15m) =£0.41 million.
The loan is currently recognised at MYR20m/5= £4 million and should be recognised at £3.15 million.
DEBIT Financial asset (debt instrument) 3,150

CREDIT Trade receivables 4,000
DEBIT Exchange differences- retained earnings (0.02 +0.59) 610
CREDIT Interest income retained earnings 200
DEBIT Interest cost - (£4m - £3.56m) 440
Investment in 10%
Fin asset £9.5m 1:$5 Legal fee £0.50
June X6 1:$6
Loss regcons £1.50
July X6 Sold more 10% $36m 6
TraynerCo-equity investment
The investment in TraynerCo is an equity investment held for the long term and not intended for immediate sale. An irrevocable election has been made to recognise the
movement in fair value in other comprehensive income, and this includes foreign currency exchange gains and losses (except in the case of an impairment).
IFRS 9 para 5.1.1 states that (unless the financial asset is measured at fair value through profit or loss) the transaction costs are added to the value of the asset, not written off to
profit or loss. Therefore, Earthstor's treatment of the legal costs is correct.
IFRS 13 defines tair value as the price that would be received to sell an asset or paid to transter a liability in an orderly transaction between market participants at the
measurement date". Fair value is a market-based measurement, not an entity-specific measurement. It focuses on assets and liabilities and on exit (selling) prices. It also takes
into account market conditions at the measurement date. In other words, it looks at the amount for which the holder of an asset could sell it and the amount which the holder of
a liability would have to pay to transfer it. IFRS 13 states that valuation techniques must be those which are appropriate and for which sufficient data are available. Entities should
maximise the use of relevant observable inputs and minimise the use of unobservable inputs.
With regards to the investment in TraynerCo, there is no observable quoted price for the shares. There is evidence that the price has fallen because Henry Min has sold a further
10% of the shares for MYR36 million and therefore the fair value recognised at 1 October 20X5 has changed at 30 June 20X6.
The question is whether the subsequent sale of a further 10% of the shares in TraynerCo by Henry Min represents a fall in the fair value of the shares at the year-end due to: (1)
market conditions or (2) because the company is performing poorly or (3) because the initial valuation was incorrect either deliberately or unintentionally as suggested by the
comments made by the finance director.
As the fall is due to market conditions, then the loss including the exchange difference is taken to other comprehensive income.
42 Page 44
The following adjustments are required:

Recognition and subsequent recognition £'000
Initial recognition of shares is MYR45m/5 including transaction costs 9,500
At year end MYR36m/6 6,000 FV 10%
Loss to be recognised in OCI 3,500 45m$ On Oct X5 4.5
$36m Sell 10% more
As the loss is recognised in other comprehensive income an adjustment is required as follows:
DEBIT Equity investment: TraynerCo 1,500
CREDIT Translation reserve 1,500
CREDIT Equity investment: TraynerCo 3,500
DEBIT OCi/OCE 3,500
Being reversal of translation of investment in equity instrument and movement in fair value
IFRS 7 requires disclosure of risks relating to financial instruments which include credit, currency, interest rate, liquidity, loans payable and market risk. For each type of risk,
disclosure is requiredof the expoSures to each risk and how they arise, the entity's policies and processes for manaqing risk and any changes from previous period.
Oversea Investment Building

Aug X6 admin function relocated to Signore for tax reasons
One floor occuptied
Low price for supplier
Buldiing in PPE 56,309 recognised as this
Exchange rate 1:$2.7
Building OS $10m
1 Feb X6 1:$2.1
Similar property June X7 $11m
The property should be recognised as an investment property. The company has adopted the fair value method to account for investment properties and therefore the property
should be revalued at the year end to its tair value. Movement on the change in tair value of investment properties is recognised in profit or losS.
The Singapore investment property should be recognised at cost on 1 February 20X6 and the change in fair value measured as followS:
At 1 February 20X6 SGS10,000,000/2.1 4,762

At 30 June 20X6 SG$11,000,000/2.7 4,074
Change in fair value 688
The property should be separately recognised as investment property.

DEBIT Operating costs (retained eanings) 688
CREDIT PPE 4,762
DEBIT Investment property 4,074
Website development costs

Costs
Planning costs 3,000
Professional fees for photograph 1,300
Fee paid to Tanay (Note) 5,000
Internal software development c 22,000
31,300 Remoove
De recog -3,000 Planning costs
-1,300 Professional fees for photography and other graphic design
-5,000 Fee paid to Tanay (Note)
22,000
Note: f5 million was paid to Tanay, an internationally-famous singer, who is the 'name behind the Earthstor brand'.
The costs of acquiring and developing software that is not integral to the related hardware should be capitalised separately as an intangible asset. This does not include internal
website development and maintenance costs which are expensed as incurred unless representing a technological advance leading to future economic benefit.
Capitalised software costs include external direct costs of material and services and the payroll and payroll related costs for employees who are directly associated with the
project.
Capitalised software development costs provided they meet the criteria under SIC 32 and IAS 38 - the fact that the costs integrate the website with other process systems of the
business and are not merely providing content and advertising would suggest that they do - should be stated at historic cost less accumulated amortisation. Amortisation is
calculated on a straight-line basis over the assets' expected economic lives. Amortisation is included within administrative expenses in the statement of profit or loss.
Therefore, Earthstor has probably incorrectly capitalised the planning costs, and also possibly the fees paid to Tanay and the photography and graphic design costs (further
information is required on the nature of these expenses). These costs should be expensed during the year. An amortisation charge of f22m/7 years x 2/12 - £524,000 is
required to be charged from 1 May 20X6. This is below the materiality level on its own but taken together with the incorrect capitalisation of costs, this should be adjusted:
DEBIT Operating expenses (f3,000,000 + £1,300,000 + £5,000,000 + £524,000) 9,824

CREDIT Intangible assets 9,824
43 Page 45
Exhibit 1: Financial information provided by the EyeOP finance assistant

£m
Revenue (Note 2) 178.9
Cost of sales (Note 2) -92.6
Gross profit 86.3
Administrative expenses (Note 1) -36.3
Non-recurring item- development costs (Note -14
Profit from operations 36
Finance costs -12.2
Profit before tax 23.8
Income tax -4.8
Profit for the year 19
Other comprehensive income for the year

Total comprehensive income for the year 19
Depreciation of £4.1 million and lease rentals of £5.5 million are included in cost of sales.
The leases are for less than 12 months, and EyeOP has taken advantage of the IFRS 16
recognition exemptions for short-term leases.
HiDef PLC AIM company

EyeOP Share acq % Cons FV
Dec X4 50,000 1,000,000 0.05 700,000 6,200,000
Nov X5 2,500,000
Aug X6 650,000 70% 85,000,000 63,000,000
Goodwill calcuation
FV of con paid to acq control 85,000,000
NCI valued prop method 18,900,000 30% X 63M
FV held prev at acq date 6,200,000
110,100,000
FV of NA -63,000,000
Goodwill 47,100,000
Net asset method to value NCI
Pension Schemes
Plan A
ER Contribtion of 6.4
Contract obligation
Based on average for 3 year salary
Assets Obligation
Opening balance 22.00 - 60.00 -38
Interest 1.10 - 3.00
Contro 6.40
Redudancy - 4.20
Service cost - 5.90
Benefits paid - 2.10 2.10
Sub total 27.40 - 71.00
Gain/loss re measure recog OCI 5.20 - 3.50
At year end 32.6 -74.5
Scheme A is a defined benefit plan because EyeOP has provideda guarantee over and above its obligations to make contributions. Therefore, the contribution of £6.4 million in
respect of Scheme A should be credited from the statement of profit or loss and debited to the net benefit obligation. The service cost of £5.9 million and tinance cost of £1.9
million (see calculation below) should be charged to the profit or loss.
Plan B
ER contro 2.8
Not eligle for A
Right of scheme assets
Fixed salary 7% ER and 3% EE
Scheme B appears to be a detined contribution plan therefore the accounting treatment adopted by the finance assistant is correct. This is a defined contribution plan because
there is no obligation on the part of EyeOP other than to pay its contribution of 7% to the pension fund.
Recommended adjustments:
DEBIT Finance costs (£3 million- £1.1 million - £1.9 million) 1.9
CREDIT Net benefit obligation 1.9
DEBIT Operating expenses (£5.9 million+ £4.2 million) 10.1
CREDIT Net benefit obligation
DEBIT Net benefit obligation 6.4
CREDIT Operating expenses 6.4
CREDIT OCI 1.7
DEBIT Net benefit obligation 1.7
IAS 19 requires that the interest should be calculated on the net benefit obligation. This means that the amount recognised in the profit or loss is the net of interest charge on
the obligation and the interest income on the assets. Therefore, the actual return on the plan assets is not relevant here.
EyeOP has taken on an additional liability in respect of the senior employees made redundant - this cost is a curtailment cost which is charged to the statement of profit or loss.
IFA Capilsation & Revenue recognisition

1 Oct X4 Per month Total
Devlopement cost 4 60 Expense
1 Jan X6 Breakthrough - Com viable
Complete 30 April X6 3.5 14 Intagible asset
Orders 600
Price 6,000
Total sales 3,600,000
Non refund payment 25% 900,000
Delivered 31 Dec X6 50 Pay 75% Jan X7

Life of product 4
Total Sales for 4 years 3,500
Delivered 31 Dec X7 875
Variable cost 22,000
Total VC 77,000,000
Journals client made
DEBIT Cash 9
DEBIT Receivables 27
CREDIT Revenue 36
DEBIT Cost of sales 13.2
CREDIT Inventories 13.2
43 Page 46
This item does not representa non-recurring item and it is incorrect to expense all the development costs as it is posible that some of the costs should be capitalised.
In the period to 1 January 20X6 not all the criteria in IAS 38 appear to have been satisfied as the technical breakthrough in relation to the project happened on 1 January 20X6,
and so the costs of £4 million a month should be expensed in the statement of profit or loss. 1Therefore, the treatment was correct for the financial statements for the year ended
31 December 20X5 as the probable future economic benefits were uncertain betore that date.
Once the technical breakthrough was made on 1 January 20X6, the development costs should have been capitalised until the project was completed on 30 April 20X6. An
intangible asset of f14 million (4 x £3.5m) should therefore have been created.
The following adjustment is therefore required:
DEBIT Intangible asset 14

CREDIT Profit or loss 14
Once production of the Medsee commenced in May 20X6, the development costs should be amortised. This can be done on a unit of production basis (per IAS 38 para 98).
I recommend that £14 million is amortised over the number of Medsee cameras produced in the year ended 31 December 20X6. This gives an amortisation charge of £200,000
(E14 million x 50/3,500).
DEBIT Operating expenses 0.2

CREDIT Intangible asset 0.2
EyeOP intends to recognise revenue in respect of the 600 cameras which customers will order by 31 December 2OX6 because the orders are non-cancellable. However,
following FRS 15, Revenue from Contracts with Customers, revenue should only be recognised when the pertormance obligations in the contract have been satistied. There is
only one performance obligation: supply of the cameras. This performance obligation is satisfied when control of the cameras has been transferred to the buyer. This normally is
upon delivery, and so revenue in respect of only 50 cameras should be included in the statement of profit or loss 50 x £60,000 - £3 million. The cash received in relation to
orders not yet fulfilled should be treated as a contract liability.
The adjusting journal is therefore:
DEBIT Revenue 33
CREDIT Receivables 24.75
CREDIT Contract liability 8.25
The accrual for cost of sales should therefore be removed in relation to the original journal for revenue.
DEBIT Inventories 12.1

CREDIT Cost of sales (550 x £22,000) 12.1
Exhibit 2: Hidef consolidated forecast statement of profit or loss and other comprehensive income for the year ending 30 November 20X6 (excluding the impact of the
proposed purchase of 650,000 EyeOP shares)
£m 20X6
Revenue 383
Cost of sales -264.2
Gross profit 118.8
Administrative expenses -102
Profit from operations 16.8
Finance costs -5.5
Income tax -2.3
Other comprehensive income for the year

Total comprehensive income for the year 9
Other information
Depreciation of £28.1 million and lease rentals of £35.5 million are included in cost of sales. The leases are for less than 12 months, and HiDef has taken advantage of the IFRS
16 recognition exemptions for short- term leases.
HiDef's consolidated revenue and costs are expected to remain constant for the foreseeable future. Revenue for the year ended 30 November 20X5 was £400 million.
Key group performance targets for HiDef

Revenue growth Increase of 7% each year
Gross proit percentage Greater than 35%
EBITDAR /Interest Greater than 12
EBITDAR = Earnings before interest, tax, depreciation, amortisation and rentals.

Adju
Revenue (Note 2) 178.9 -33 145.9
Cost of sales (Note 2) -92.6 12.1 -80.5
Gross profit 86.3
Administrative expenses (Note 1) -36.3 (10.1)+6.4-0.2 -40.2
Non-recurring item- development costs (Note -14 14 0
Profit from operations 0
Finance costs -12.2 -1.9 -14.1
Income tax -4.8 -4.8
Profit for the year 19 6.3
OCI gain 1.7 1.7
Consolidation adjustments
Disposal of previously held shareholding in EyeOP
When control is achieved:
any previously held equity shareholding should be treated as if it had been disposed of and then reacquired at fair value at the acquisition date; and
any gain or loss on re-measurement to fair value should be recognised in other comprehensive income in the period because the original investment was at FVTOCI.
other comprehensive income may not be reclassified from other comprehensive income to profit or loss, and any gain arising on derecognition is also recorded in other
comprehensive income.
Therefore, the following journal is required in HiDef's statement of comprehensive income to dispose of the shareholding in EyeOP before consolidation:
As the shares in EyeOP were previously classified as being at fair value through other comprehensive income, any gains in respect of it which were previously recognised in
DEBIT Investment in EyeOP: f6.2m - 2.5m 3.7

CREDIT Other comprehensive income and other components of equity 3.7
To recognise the gain on the deemed disposal of the existing holding prior to control being obtained.
IFRS 10 states that where a subsidiary prepares accounts to a different reporting date from the parent, that subsidiary may prepare additional statements to the reporting date of
the rest of the group, or if this is not possible, the subsidiary's financial statements may be used for consolidation provided that the gap is three months or less and that
adjustments are made for the effects of significant transactions.
20X6 EyeOP Adjusted Adjusted sub
Revenue 383 145.9 48.63333 431.6333

Cost of sales -264.2 -80.5 x4/12 -26.83333 -291.0333
Gross profit 118.8 x4/12 140.6
Administrative expenses -102 -40.2 x4/12 -13.4 -115.4

43 Page 47
Profit from operations 16.8 0 x4/12 0 25.2

Finance costs -5.5 -14.1 x4/12 -4.7 -10.2
Profit before tax 11.3 x4/12 15

Income tax -2.3 -4.8 x4/12 -1.6 -3.9
Profit for the year 9 x4/12 11.1
Other comprehensive income for the year 3.7 6.3 x4/12 0.566667 4.3
Iotal comprehensive income for the year -2.3 1.7 15.4
Profit attributable to:
Owners of HiDef 10.5
Non-controlling interest (2.1 x 30%) 0.6
Consolidated statement of other comprehensive income 11.1

Profit for the year 4.3
Other comprehensive income 15.4
Total comprehensive income tor the year
Total comprehensive income attributable to: 14.6
Owners of HiDef 0.8
Non-controlling interest (2.7x 30%) 15.4
Part (4)
(1) Revenue increase by 7%
Consolidating the adjusted revenue of EyeOP results in the revenue target being met in the year ending 30 November 20X6.
£400 million x 107% - £428 million compared to projected revenue including EyeOP for 4 months, of £431.6 million.
Next year the target will also be met as predicted revenue wll be £578.4 million (see below) which represents a 34% increase on the revenue for 20X6. However, in subsequent
years without further initiatives or acquisitions, revenue will remain constant and therefore the growth will need to be ether organic or from other acquisitions.
(2) Gross profit percentage of 35%

This target is currently not predicted to be achieved either with (32.6%) or without (31%) the acquisition of the 650,000 EyeOP shares. EyeOP achieves a gross protit percentage
of 45% compared to HiDet 31%. The acquisition will not have a signiticant impact in achieving this target in the current financial year because only 4 months of EyeOP's results
will be consolidated with HiDefs. In addition, the impact of the Medsee contract on the consolidated gross protit for the current tinancial year is relatively small because only the
sale of 50 cameras should be recognised in revenue.
The margin predicted on the Medsee contract in 20X7 and subsequently is 63%:
Revenue (3,500/4 875 cameras x £60,000) 52.5

Cost of sales (875 x f22,000) 19.25
Gross profit 33.25
EyeOP s gross margin in 20X6 excluding the revenue from the 50 new imaging cameras contract is as follows:
Revenue 145.9 -3 142.9

Cost of sales 80.5 -1.1 79.4
Gross profit 65.4
44.40% 44.80%
The directors should be sceptical about EyeOP's assertions regarding the margin achievable on the Medsee contract as currently it is significantly greater than the margin
achieved on its other contracts. There may also be additional fixed costs.
In 20X7, 1009% of EyeOP's results for the entire year will be included in the consolidated statement of profit or loss which willincrease the overall gross profit percentage. Given
the assumption that other revenues and costs will remain constant, the contract for the sale of imaging cameras therefore represents further additional revenue for the group.
EyeOP's gross profit for the year ended 31 December 20X7 would include an additional f33.25 million from the Medsee contract which would be consolidated together with its
results for the entire year (assuming these remain constant) in the group tinancial statements tor the year ending 30 November 20X/ (see working below).
EyeOP Revenue COS

20X6 excluding Medsee 142.9 79.4
Add: new contract additional revenue 875 cameras 52.5 19.3
Projected for year ending 31.12.20X7 195.4 98.7
Add HiDef 383 264.2
Group revenue 578.4 362.9
Group cost of sales -362.9
Gross profit 215.5
GP 37.30%
The group gross profit percentage for the year ending 30 November 20X7 is likely to be 37% which would mean that the target of 35% would be met next year.
44 Page 48
Materially 2m
Misstatment over 40k to audit committee
Fixtures,
Assets fittings
Freehold under and
land and constructi equipmen
buildings on t
Cost or valuation
At 1 September 20X5 129.5 2.8 29.5 161.8
Additions 0 21.8 4.1 25.9
Assets coming into use 13.5 -13.5 0
Disposals -1.5 -1.5
At 31 May 20X6 143 11.1 32.1 186.2
Depreciation
At 1 September 20X5 6.1 0 15.4 21.5
Charge for the period 2.4 0 2.8 5.2
Disposals -0.9 -0.9
At 31 May 20X6 8.5 0 17.3 25.8
Carrying amount
At 1 September 20X5 123.4 2.8 14.1 140.3
At 31 May 20X6 134.5 11.1 14.8 160.4
3 month forecast
Cost or valuation
At 31 May 20X6 134.5 11.1 14.8 160.4
Additions 0 8 0.5 8.5
Depreciation charge for the period -0.8 0 -1 -1.8
Revaluation gain 40 40
At 31 August 20X6 173.7 19.1 14.3 207.1
Interim adit memoradum on PPE

Professional valuation 31 Aug X3
Increase in value 25%
Contruction of new scholl completed May X6
Total cost 13.5
Building sell & sale of land

Carry amount 3
Sale 5
Training center cost 4

Completed 31 Aug X7
15 years will pay 300k for rental
Staff cost 100k per year
Draft financial reporting advice

The proposed arrangenment with Beddezy involves both the sale of a piece of land and ongoing arrangements in respect of two buildings which wll be built orn it.
To determine how both the initial land sale and the ongoing arrangements should be accounted for, it is necessary to consider whether the arrangements in respect of the
buildings constitute lease arrangements. This is addressed by IFRS 16, Leases
Key factors to consider are as follows.
Is there an identitiable asset?
Does the customer have the right to obtain substantially all the economic benetits from use of the asset throughout the period of use?
Who has the right to direct how and for what purpose the asset is used?
Does the customer have the right to operate the asset throughout the period of use without the supplier having the right to change those operating instructions?
In the case of the hotel, the IFRS 16 criteria are not met as TT will not have the ability to operate the hotel and there is more than a remote possibility that more than an
insignificant amount of its capacity will be taken by parties other than TT. Indeed, TT has no commitment to take any rooms. TT does not have the right to obtain substantially all
the economic benefits from use of the asset, the right to direct how and for what purpose the asset is used, or the right to operate the asset without Beddezy being able to
change the operating instructions.
In the case of the management training centre, the lFRS 16 criteria are met as the centre will be operated by TT and its manager will supervise those controlling access to the
building. t will also have exclusive use of the centre. Ihe arrangement does theretore include a lease tor the management centre and this should be accounted for under IFRS
IFRS 16
Having established that the arrangement contains a lease, it is necessary to return to the sale of the land and consider how that should be accounted for. Half of the land which
has been sold will be used tor the hotel and TT has no right to re-acquire that land and no lease over it during the term of that arrangement. That element of the sale should
therefore be accounted tor as a disposal, resulting in the disposal of an asset with a carrying amount of £1.5 million (assuming the entire plot is priced at the same price per
acre) and the recognition of a profit of E1 million in the period in which the arrangement is signed. Further information is needed to assess whether the price for the land is a fair
market price given that the sale is part of a much more complex arrangement.
This entry will give rise to an increase in net assets as the profit is recognised.
The sale and leaseback of the land provided for the management training centre and for the centre itself must be accounted for in accordance with IFRS 16.
The present value of the future lease payments cannot be calculated without first determining what element of the payments relates to the cleaning, maintenance, security and
reception services to be provided as this would need to be excluded from the calculation. The cost of the building to Beddezy will be f4 million. Excluding the element (of
£100,000 per annum) which relates to staft costs and services, the future lease payments (undiscounted) will be £3 million (15 x £200,000).
However, this covers the lease of the land as well as the building. Apportioning between them in the ratio of the cost to Beddezy would mean that (E3 million x 4.0/6.5) =
£1.85 million would relate to the building before discounting.
15 year
300k 4500000
Half of the land in use 1/2 use
Carry amount 3 1.5
Sale 5 2.5
2 1
Cost of training building 4,000,000
15 year
44 Page 49
Staff cost 100,000

15 x 200k 3000000
ratio of cost 3m x 4/6.5
1.85m building
Financial reporting adjustments

The element of the lease payments which relates to the services to be provided should be taken to profit or loss as a charge in the period in which those services are provided.
The land sale for the management training centre will be treated as a sale and leaseback under IFRS 16, with a gain recognised on the rights transferred and a right-of-use asset
in respect of the rights retained, calculated as:
Carrying amount x (PVFLP + FV)
As regards the training centre, this is effectively a new lease as the building did not exist at the time of the sale. A right-of-use asset would be set up consisting of the discounted
present value of the future lease payments relating to the building.
45 Page 50
Balance at 1 NovembeMateriallty
Additions Parent 5,000,000
Depreciati 100% sub 250,000
Balance at 31 Oct X6
20X6 20X6 20X5 20X5
Forecast Forecast
Balance at 1 November Ph244 Other PPE Ph244 Other PPE
Additions 5.8 10 0.3 8.9
Depreciation 1.8 2.2 6 1.5
Balance at 31 October -0.5 -0.7 -0.5 -0.4
7.1 11.5 5.8 10
Intangible asset: research and development (R&D)

Balance at 1 November 7.2 8.2 0 7.9
Additions 0 1.6 7.2 2.3
Amortisation -1.2 -1.8 0 -2
Balance at 31 Octobe 6 8 7.2 8.2
Forecast
Building 6.2
Sale 8
Adaption cost for sale 1.5
Net casf outflow

Oct X7 1.4
Oct X8 1
Oct X9 0.5
20X6 20X5
Revenue 24.8 31.4
Cost of sales -15.2 -18.8
Gross profit 9.6 12.6
Operating expenses -7.2 -8.8
Operating profit 2.4 3.8
Finance costs -1.8 -1.4
Profit before tax 0.6 2.4
Income tax -0.6
Profit for the year 0.6 1.8
ASSETS 20X6 20X5

Non-current assets
Property. plant and equipment 18.6 15.8
Intangible asset: R&D 14 15.4
32.6 31.2
Current assets
Inventories 12 7.8
Trade receivables 4.6 5.8
Cash and cash equivalents 3.6
Total assets 16.6 17.2
49.2 48.4
Ordinary share capital 4 4
Retained earnings 17 16.4
21 20.4
Long-term liabilities: borrowings 20.6 22.4
Deferred tax 0.6 0.6
21.2 23
Current liabilities
Trade payables 3.8 4.4
Tax payable 3.2 0.6
Overdraft 7 5
49.2 48.4
Cash flows from operating activities

Profit before tax 0.6 2.4
Adjustments for:
Depreciation 1.2 0.9
Amortisation 3 2
Finance costs 1.8 1.4
45 Page 51
6.6 6.7
Change in inventories -4.2 0.4
Change in trade receivables 1.2 -0.7
Change in trade payables -0.6 0.9
Cash generated from operations 3 7.3
Interest paid -1.8 -1.4
Tax paid -0.6 -0.7
0.6 5.2
Net cash from operating activities
Cash flows from investing activities -4 -7.5
Purchase of property, plant and equipment -1.6 -9.5
Investment in development assets -5.6 -17
Net cash used in investing activities
Loan (repaymentyfinancing -1.8 13
Net change in cash and cash equivalents -6.8 1.2
Opening cash and cash equivalents 3.6 2.4
Closing cash and cash equivalents -3.2 3.6
Acq of Z
Consideration 18 Aug X3
Goodwill 3.75
Loans to Z 10
Development of Ph244
capilisated of dev cost 6
Offer 2.4
legal fee if accept 0.2
Loan 11
Balance to L PLC 9.6
Repayment June X6 1
Repayment Dec X6 1
Interest ratio needed 1.2
Gearing 130%
Inventory 12
Ph44 2.6 Ceased X6
Sale value 1.4
Gross margin 40%
Inventory right off 1.2

PERP 1.04
Impairment of Ph244 PPE and intangible development asset

Specially-constructed production building
Recoverable amount is the higher of fair value less costs to sell and value in use. In the case of the specially-
constructed production building, the asset can apparently be sold only if it is adapted tor more general use. Fair
value less costs to sell therefore appears to be £6.5 million (t8m - £1.5m). Ihe value in use of the asset is uncertain
as it is dependent upon funding being made available for future R&D projects.
The carrying amount of this building is £6.2 million. This is less than the estimated recoverable amount of £6.5
million and so no impairment loSs appears to arise in respect of this building9
The renegotiation of the bank loan and the apparent unavailability of future funding from the Lomax Group
suggests that the asset may not have a value in use.
More information is required on this point, and such information may not become available until the conclusion of
renegotiations over funding. However, at the moment, as the recoverable amount is higher than the carrying
amount, the value in use calculation would not be required.
R&D: Intangible development asset

The balance on the Ph244 development asset at 31 October 20X6 of £ó million and the balance of PPE £0.9
million (E.1m-t6.2m) can be examined together for recoverability, especially as an ofter exists that covers both
elements. If recoverable amount is lower than £6.9 milion, an impairment loss should be recognised.
The fair value less costs to sell of the Ph244 assets is estimated at £2.4m- £O.2m - £2.2 million, based on the offer
from the non-UK competitor.
The value in use of the Ph244 assets can be estimated by discounting projected net cash inflows from the project,
as follows:
Net casf outflow Discount 8%

45 Page 52
Oct X7 1.40 0.93 1.30

Oct X8 1.00 0.86 0.86
Oct X9 0.50 0.79 0.40
2.55
Applying the IAS 36, Impairment of Assets criteria, recoverable amount appears to be around £2.6 million, as
value in use is higher than tair value less costs to sell.
If this value is realistic, the impairment loss that should be recognised is £6.9 million (carrying amount)- £2.6
million (recoverable amount) = E4.3 million
However, there is a great deal of uncertainty surrounding the above calculation of impairment loss. Questions
arise as tollows:
re the projected net cash flows dependent upon the availability of the Ph244 production building? If so, the
value in use depends upon Zego continuing to own the production building.
Is the discount rate of 8% pa supplied by Zego's Finance Director in September 20X6 realistic? The discount
rate used should be a pre-tax rate that reflects current market assessments of the time value of money and the
risks specific to the asset for which future cash flow estimates have not been adjusted. We would require more
intormation to be satustied that 8% pa is appropriate.
The fair value less costs to sell figure of £2.2 million comprises one offer from a non-UK competitor and a rough
estimate of costs to sell. Niether may be representive of outcome. More informtion would be required
about the new market
Inventories
Inventories fall outside the scope of IAS 36, Impairment of Assets. Inventories should be measured at the lower of
cost and net realisable value, according to IAS 2, Inventories.
£3.6 million of the inventories balance relates to Ph244 products. Cost = 60% x sales value, so this inventories
balance represents (f3.6m x 100/60) £6 million in potential sales and (fóm -£3.6m) £2.4 million in potential gross
profit.
The total forecast future sales of Ph244 can be estimated from the sum of forecast net cash inflows as follows:
(£1.4m + £1.0m + £0.5m) - £2.9m. Forecast cost of sales - (£2.9m x 60%) = £1.7m.
Theretore, if the forecast ot future net cash inflows proves to be reliable, the maximum amount of inventories that
can be sold at cost tl./ million.
The impairment loss on inventories that should be recognised now is therefore estimated at (£3.6 - £1.7)=£1.9
millid Ol.
Clearly, a great deal more work would be needed to confirm that the estimates of tfuture cash infiows are realistic.
Taxation
The draft financial statements include no estimates in respect of tax, possibly because Julia Brookes is not
technically qualified to pertorm tax calculations. Adjustments are likely to be necessary. Ihe impairment losses
estimated so tar total t6.2 million (E4.3 million in respect of Ph244 assets and E1.9 million in respect of Ph244
inventories), and there may be adjustments to the tax charge or deferred tax balance in respect of these losses.
However, insufficient information is currently available to estimate the tax impact.
Lego Ltd: Analytical review

November 20X6
I have estimated impairment losses totalling £6.2 million. These estimates are likely to require revision, and there
will probably be further accounting adjustments required, especially in respect of taxation.
However, assuming additional losses of £6.2 million, the profit figures in proft or loss are all affected.
Gross profit (assuming impairment losses are recognised in cost of sales) falls to (£9.6m - £6.2m) £3.4 million.
Operating profit becomes a loss of (E2.4m - f6.2m) £3.8 million.
Profit before tax and profit for the year become losses of (£0.óm - £6.2m) £5.6 million.
On the statement of financial position:
Non-current assets fall from £32.6 million to (E32.6m - £4.šm) £28.3 million.
Inventories fall to (£12.0- £1.9m) £10.1 million.
Retained earnings are reduced to (E17.0m- f6.2m) £10.8 million.
Key accounting ratios for Zego are those specified by the bank covenants ie, interest cover and gearing.
Interest cover
Interest cover per the draft financial statements: (2.4/1.8) = 1.33
Interest cover for 20X5: (3.8/1.4) = 2.71
Interest cover per the draft financial statements is therefore just within the parameter set by the bank of 1.2
Clearly, once impairment losses are considered, the interest cover covenantis breached as there is an operating
loss of £3.8 million.
Searing = net debt/equity
Gearing per the draft financial statements: (20.6+3.2y21.0 - 1.13 x 100 113%
Gearing for 20X5: (22.4-3.6/20.4 0.92 x 100 92%
Gearing at the 20X6-year end, per the draft financial statements, like interest cover, is within the parameter set by
the bankof 1.3.
Once impairment losses are considered, equity falls to (E10.8m + £4.0m) £14.8m and the gearing calculation is as
follows:
(20.6+3.2/14.8-1.61 x 100- 161% and the bank covenant is breached.
he calculation of additional ratios is in the Appendix.
45 Page 53
Pertormance
There has been a signiíficant drop in revenue between 20X5 and 20X6 (over 21%). An explanation for this is the
disappointing performance of the Ph244 products. However, this factor may be masking an overall downturn in
sales performance. Zego was able, in the 20X5 financial year, to generate £31.4 million in sales without the Ph244
product, and it has not matched this performance in 20X6.
It may be that some of the other Zego products are nearing the end of their lifecycle and that they will have to be
replaced by new products. It would be helpful to see a budget for the 20Ox6 financial year to see how tar actual
sales of other products have deviated from budget.
Given the change in sales mix, some variation in gross profit margin is to be expected. It has, in fact, fallen. Cost of
sales may already include the recognition of losses relating to the Ph244 productor other write downs. After
recognising impairment losses, gross profit margin is much reduced.
Operating expenses have been reduced by £1.6 million (over 18%) between the two accounting years. This is
Surprising as such expenses would normally be expected to be fixed in nature rather than variable. A possi ble
explanation for the reduction is a cost-saving programme. Zego is short of cash, having moved from a
cash position at the end of 20X5 to a sizeable overdraft at the end of the 20X6 financial year. Cost-saving measures
would be recommended in the circumstances, and may have been successful. However, it is also possible that eg,
accruals may have been understated, deliberately or accidentally, and cut-off in respect of operating expenses
may require additional audit work.
mfortab
Finance costs have risen over the year, as might be expected because of the additional overdraft borrowings.
Taking year-end figures, the approximate interest rate on borrowings has increased only slightly, which may be
due to a more expensive rate on short-term overdraft finance. More information will be required on the terms
attached to borrowings.
Profit for the year before tax is much reduced from the previous year, before considering the effect of impairment
losses. Return on capital employed is low at 5.4% even before considering impairment losses.
Cash flow
Even though Zego has obviously had a very difficult year, there is nevertheless a small cash inflow from operating
activities, an indicator which couid bode wel Tor the Tuture.Proit Delore taxadusted 1or depreciation,
amortisation and finance costs is very little changed in 20X6 compared to 20X5. Cash interest cover has fallen
substantially.
Investing activities have declined in 20X6 compared to 20X5, possibly because Zego has lacked the finance for
investment in new projects (only £5.6 million of investment compared to £17.0 million in the previous year).
This is a concern if, as surmised above, some of the company's products are nearing the end of their lifecycle. This
industrial sector appears to require large investments in R&D and any falling off could have a significant effect on
the company's ability to generate future cash flows.
However, the ratio of capital expenditure to depreciation and amortisation, although much reduced from the
previous year, shows a positive figure, and the company is continuing to invest at a slightly faster rate than
depreciation and amortisation.
Zego benefitted from E13.0 million in financing intlows in the 20X5 financial year, much of which appears to have
been invested in the Ph244 development. By contrast, in 20X6, the only financing cash flow has been a repayment
of £1.8 million. The meeting notes (Exhibit 5) show that £1 million was repaid to the bank on 1 June 20X6, but no
mention is made of an additional £0.8 million repayment. This may have been a repayment made to Lomax, but
further investigation would be required.
Efficiency
Inventory turnover in the Zego business appears to be very slow indeed. This may be a feature of the industry, but
better control would improve working capital usage. The ratio has worsened significantly in the 20X6 financial year
because of the effects of failing to sel Ph244 products.
Trade receivables days have remained constant between 20X6 and 20OX5. Without knowing the terms of Zego's
trade it is not possible to say if 67-68 days represents a good performance.
Liquidity
he ratio of current assets to current liabilities is high in both years under review. However, once inventories are
removed from the equation Zego looks somewhat exposed at the 20X6 year end in this respect, as current
liabilities exceed trade receivables balances.
Memorandum- Audit risks for Zego

Prepared by: Andy Parker
November 20X6
Breaching gearing ratio and financing
There is a significant element of financial risk related to the continuing financing of the company. Zego is already
highly geared, even before the effects of impairment losses are considered. Once impairment losses are
45 Page 54
recognised the business has breached its loan covenants. The fact that the bank has called a meeting to take
place next week suggests that the bank is aware of the company's current dificulties. The worst-case scenario is
that the bank will exert its fixed and floating charge over the assets of the business. Although the value of assets
has fallen significantly because of impairment losses, it is likely that there will be sufficient assets to recover the
entire value of its outstanding loan with the bank. Also, a payment of £1 million to the bank is due on 1
December 20X6 (Exhibit 5) and the company has no cash to pay it.
However, this would mean that the company would face liquidation unless group support (eg, a commitment by
Lomax Group to repay the bank borrowings) could be obtained. The notes of the meeting with Grahame Boyle,
Group Finance Director, suggest that Lomax's main board directors are reluctant to provide further support to
Zego, in which case the level of financial risk is heightened.
The bank may be prepared to renegotiate its lending to Zego, and the liquidation of the company could be
averted. A significant factor that is likely to be considered by the bank is that the business is fundamentally
profitable; it has produced positive operating cash flows in 20X6. However, there are indications that some of the
Lego products could be reaching the end of their lite cycle, and further investment would be required to fund
new R&D to develop a pipeline of new products.
The financial risk is augmented because of timing. Zego is material in group terms, and the Lomax Group has
made a commitment to a preliminary announcement of results on 5 January 20X7. Negotiations with the bank
may not have been concluded by that date, which adds to the overall financial risk.
From an audit viewpoint, compliance with ISA 570 (UK) (Revised September 2019), Going Concern, would be
required, and this is likely to be a significant element of the audit work. Auditors are required to evaluate
management's assessrment of the business's ability to continue as a going concern, including the possible
existence of any material uncertainties regarding going concern. This would involve examining the process
involved in the assessment, the assumptions upon which the assessment is based and management's plans for
future action.
The extent of the financial risk facing Zego is currently uncertain and developments during the period of the
audit must be monitored closely.
Operating performance
During 20X3 and 20X4 Zego's management made a significant investment in a new product. The investment has
now largely tailed, resuting in major impairment losses. Ihe failure may call into question the R&D capability of
he company, making it less likely that further finance will be committed to future related projects.
There is some evidence arising from the preliminary analytical procedures on the draft financial statements that
investment in other projects may have tailed off, anda suggestion that other products are nearing the end of
their life cycles. More information is needed on Zego's product range to confirm or refute these possibilities.
The Ph244 product was superseded by a better product from a competitor. If the competitor maintains its
technological superiority, Lego's longer-term prospects could be prejudiced.
Lomax's group directors appear to be sceptical about the capabilities of Zego's management team. This may be
no more than a reaction to the failure of Ph244, but the lack of confidence is likely to feed into future decisions
by group of the level of support they are prepared to provide Lego.
Absence of a finance director and inexperienced financial controller

Compliance risk is, currently, less of a concern than financial and operating risks for Zego. However, the absence
of a Tinance director is a signiticarnt concern and a suitabDy qualitied replacement has not been appointed.
There is currently no qualified Chartered Accountant, as far as we know, working in Zego. The part-qualiftied
Tinancial controller nas prepared draft financial statements, but has not recognised any adjustments in respect of
impairment or taxation, which may cast doutbt upon her technical abilities. she may not be surficienty technicaly
competent to recognise compliance needs and the company could therefore find itselt in breach of regulations.
Ihe audit team needs to be vigilant to ensure that compliance risk is recognised by Lego's management, and
that sutficient steps are taken to ensure compliance with relevant regulation.
Implications for financial statements

Zego
If renegotiation fails for additional finance and the Lomax Group is unable/unwilling to provide support, Zego
may no longer be a going concern and its financial statements would probably have to be prepared under the
break-up basis of accounting. Additional disclosures would be required under IAS 1, Presentation of Financial
Statements
f doubt continues over the business's ability to continue as a going concen, ue dt
disclose clearly that there is a material uncertainty f the adie dncldi statements must
macdo the audit oninion is unmodified but a Material Uncertainty Related to Going Concern section is added. If
made, tne auait opinion is unmoea Dut a Materia ocertainy Kelated to Gongconcem section is added. n
adequate disclosures are not made, the auditors must express a qualitied or adverse audit opinion.
een
Lomax plc
The main implication for the financial statements of Lomax plc, the parent company, is the measurement of the
assets of investment in Zego Ltd and the long-term receivable. Either or both may be impaired, and additional
audit work WIll be required in respect of measurement and recoverability.
Group
The main implication for the group financial statements (given that intra-group balances cancel out) is in respect
45 Page 55
of the measurement of goodwill on acquisition of Zego, which may be impaired.

46 Page 56
YE 30 Sept X6
Oct X5
Acq 80% Krone $
Investment in ZCC OS $ 350.00
Prop method
Goodwill
Share capital 50
Pre acq profit 240.5
Fair value of land 76
FV of NA $ 366.50
Consideration $ 350.00
NCI - NA x 20% $ 73.30
$ 423.30
FV of NA $ -366.50
Goodwill $ 56.80
At HR 5.4 £ 10.52
at CR 4.2 £ 13.52
Exchange rate gain $ -3.01
CA of goodwill $ 13.52
FX reserves
gain on FX goodwill $ -3.01
FX gain on Net inve in forgin $ -1.70 Intercompany loan
Gain on retranslation of sub $ -16.63
$ -21.33
NCI share of gain $ 3.33
Consol ex reservese $ -18.01
Gain on retranslation of sub

Opening NA $ 366.50
At HR 5.4 £ 67.87
at CR 4.2 £ 87.26
Exchange rate gain $ -19.39
Retained loss for year -92.9

At AR 4.8 -£ 19.35
at CR 4.2 -£ 22.12
Exchange rate loss $ 2.76
Overall gain $ -16.63

NCI share of gain 20% $ -3.33
Pension & Average Before Consol Consol Consol Consol Consol Consol
TrinkUp ZCC OS Sub DF T Interest rate ZCC PL consol adj Adj 1 Adj 2 Adj 3 Adj 4 Adj 5 Adj 6
£m £m
Revenue 189.2 494.6 494.6 4.8 103.04 292.24 -61.3 230.94
Cost of sales -124 -354.2 -354.2 4.8 - 73.79 - 197.79 -4.2 61.3 - 140.69
Gross profit 65.2 140.4 140.4 4.8 29.25 94.45 90.25
Other operating income 15.7 0 4.8 - 15.70 -15.7 -
Operating expenses -35 -188.8 -56.6 -4.2 -249.6 4.8 - 52.00 - 87.00 15.7 1.7 - 69.60
Profit/(loss) before tax 45.9 -48.4 -48.4 4.8 - 22.75 23.15 20.65
Tax -9 5 11.4 16.4 4.8 3.42 - 5.58 0.8 - 4.78
Profit/(loss) for the year 36.9 -48.4 -48.4 4.8 - 19.33 17.57 15.87
Other comprehensive loss 0 -56.6 56.6 0 4.8 - - -
Total comprehensive income/(loss) for the y 36.9 -105 -105 - 19.33 17.57 15.87
Profit attrube to
Parent 19.7
NCI -4.6
f£3.4m x 20%- £0.7m) (£19.4m x 20%- £3.9m + share of PURP - deferred tax adjustment -
Other comprehensive income 21.3
lotal comprehensive income for the year 37.17
Total comprehensive income attributable to:
Owners of parent company 19.7 + 18.0 37.7
Non-controlling interest -1.3
(E4.6m share of loss - £3.3m share of gains)
Draft statements of financial position at 30 September 20X6

Non-current assets TrinkUp ZCC OS Sub
Property. plant and equipment 127.3 244.5
Financial asset- investment in ZCC 64.8
Amount owed by ZCC 36.4 1.7 -38.1
Deferred tax 0.8 5 11.3
Net current assets 30.8 101 -4.2
259.3 345.5
Equity
Share capital 150 50
Retained earnings at 1 October 20X5 52.8 240.5
Profit/(loss) for the year 36.9 -48.4
Pension reserve 0 -56.6
239.7 185.5
Deferred tax 19.6 0
Long-term loan owed to Trinkup 0 160 -38.1
259.3 345.5
Inventory PURP
T purchase ZCC cofee 296 Krone 30 Sept X6
Inventory held £18
Mark up 30%
Profit 4.15
Deferred tax 20% 0.83
Price paid 296.00

£ value at 4.8 61.67
An adjustment is required for the profit on coffee in Irinkup's inventory. Ihis is because in the consolidated income statement this profit is not realised and therefore should not be reflected in
the combined results of the two entities. Once the inventories are sold to a third party this adjustment will no longer be required.
This is an adjustment to the consolidated financial statements and not the individual company accounts (although it is required to calculate the NCl).
The unrealised profit is calculated as follows:
£18m x 30%/130%- £4.2 million
The temporary difference resuts in a deferred tax asset as in the group accounts there is a tax charge (or in ZCC's case the tax losses may be understated) for a non-existent asset which needs
to be removed.
Although no adjustment is required to the individual financial statements, a deferred tax asset would be included in the consolidated financial statements as follows:
DEBIT Cost of sales 4.2

CREDIT Inventory 4.2
DEBIT Deferred tax asset 0.80
CREDIT Tax charge 0.80
46 Page 57
This is a consolidation adjustment and will impact the consolidated reserves (Cost of sales) and inventory.
Intragroup trading must be eliminated on consolidation. Iherefore, the revenue and costs of sales must be adjusted for the intragroup sales and purcha
Revenue K294m @ average rate £1 - K4.8
DEBIT Revenue 61.30

CREDIT Cost of sales 61.30
OCI - Management charge from Sub

T OOI is mangement charge 75.3 Krone 30 Sept X6
In OOI and in ZCC operating expenses
Rate £ at 4.8 15.6875
Also, the intragroup management charge must be eliminated:
DEBIT Operating income 15.7

CREDIT Operating expenses 15.7
As the transactions are settied transactions, there are no adjustments required tor exchange difterences.
These are consolidation adjustments and will cancel each other out on the consolidated statement of profit or loss. They will not impact on the individual financial statements.
Deferred tax on tax loss

ZCC trade loss 100
Tax rate 20%
Potentially an adjustment is required for deferred tax in respect of the tax losses of ZCC. Ihe future profits may allow ZCC to recognise a deferred tax asset. However, there is a risk that not all
the losses Will be recoveradle e, to the extent that the tax loss arises trom an intragroup chargge.
ZCC trade loss 100
Less Mang charge - 75.30
24.70
deferred tax 20% 4.94

CREDIT Tax charge 5.00
Defined controbution pension scheme

Contribution 56.6 Krone
recognised as OCI and reseveres
tax relief in year paid and paid 15 Oct X6
LCCs tinancial statements must be adjusted to comply with IFRS before consolidation.
The contribution to the pension should be shown in expenses in the statement of profit or loss because this is a payment to a defined contribution scheme. Under IAS 19 this is shown under
expenses and not as a reserve movement
A deferred tax adjustment arises on this because the tax base is zero. A tax deduction will be available in the future of K56.6m x 20% =K11.3 million.
These are adjustments to ZCC before consolidation.

CREDIT Tax charge - profit and loss deferred tax on pension cost 11.3
DEBIT Profit or loss transferred of pension cost to expense 56.6
CREDIT OCI 56.6
Intercompany loan
Loan 160 Krone 1 April X6
Interest 5.25%
Interest for both companies

6 months charge 4.2
Rate £ 4.2 1
Assumed that inerest has been correctly treat for tax purposes
Loan to Sub
Ihe loan to ZCC is a monetary item and as it is denominated in the functional currency of the subsidiary the exchange diterence is recognised in the parent company's proft or loss.
Therefore, an adjustment is required in Trinkup's own financial statements to record the exchange gain as followsS
Loan 160
at april X6 4.4 36.36364
Year end 4.2 4.2 38.09524
-1.731602
DEBIT Amount owed by 2CC £1.7m

CREDIT Profit and loss £1.7m
On consolidation, however, the loan is treated as a net investment in a foreign operation and the exchange difference is removed from profit or loss and it will be recognised as other
comprehensive income and recorded in equity in the consolidated statement of financial position.
On consolidation, the exchange gain should be transferred to OCl and shown as part of total exchange differences on consolidation.
his is because the loan is similar to an equity investment in ZCC as the loan is not required to be settled in the near future. Iheretore, accounting for the exchange diference in equity ensures
that the monetary item is effectively treated in the same way as an equity investment.
The intra aroup loan cancels on consolidation.
DEBIT Long term liabilities £38.10

CREDIT Amount owed by ZCC £38.10
FV and CA of land
PPE include land 156 Krone 1 Oct X5
FV 232 Krone 1 Oct X5
Adjustments to the fair values of assets and liabilities of a toreign operation under lFRS 3 are recognised in its functional currency; the adjusted carrying amounts are then translated at the
closing rate.
The land should be revalued for consolidation purposes by K76 million and this will form part of the goodwill calculation.
£1/K exchange rates were as follows:

1October 20X5 £1- K5.4
1 April 20X6 £1-K4.4
30 September 20X6 £1 K4.2
Average for the year to 30 September 20X6 £1 K4.8
47 Page 58
Name Position SH % SC held

Jan Furby CEO 50% 50,000
Finance
Max Evans director 25% 25,000
Carol Furby Marketing

(wife of Jan) director 25% 25,000
£m
Revenue 25.00
PBT 3.20
Planning materiality 150,000
Performance 100,000
Uncorrected accrual 50,000

eorro in calc of sale comission payable
Supplier statement
Balance per Balance per

purchase Included in supplier
Supplier Note ledger accruals Difference statement
Barnes 1 231,650 21,560 57,230 310,440
Farnell 2 148,000 - 160,000 308,000

On Barnes, there appears to be a clear error. Although immaterial on its own, it adds to the unrecorded misstatement of £50,000 already identified and is above £5,00 (the level at which
adjustments should be accumulated for further consideration). Hence, I propose an adjustment to record the missed liabilty:
DEBIT Cost of goods sold £57,230

CREDIT Accruals £57,230
Auditing issues and additional auditing procedures

Kevin has completed the remaining audit procedures but his work has identified some errors. We will therefore need to look again at whether there could be further material errors in the
untested balance and may need to extend our testing.
On Farnell, Kevin has already taken the right action by raising an audit adjustment (although we may want to consider if cost of goods sold is the right classification for engineering services).
The related party nature of this transaction is considered below along with other procedures to ensure that it related to pre-year end transactions at a fair price.
In addition, we should undertake further audit procedures to determine whether there are other examples of goods delivered direct to customers as was the case with the Barnes accrual and
therefore not captured by the normal accruals process. Ihis should be discussed with the operations manager.
Overall, the understated accruals identified by our work now amount to £267,230 (£160,000 + £57,230 + £50,000) which is a material amount and we should ask Max to make this adjustment.
We should also enquire further about the reasons for the errors and consider any possible motivation for under-stating costs. One such motivation might be the share option scheme target of
£2.6 million for profit before taxation (depending on the precise definition in the share option agreement) although at present this is still met when this adjustment, and the addition to the
reorganisation provision proposed by Max are made - see below.
With enhanced fraud risk, it is likely that we will need to do more work in this area. However, this is not straightforward as it is Max who is himself proposing the additional provision (albeit for
an amount which ensures that the target is still met beftore any other adjustments are made).
Restructuring cost provision

CA of trucks 100,000
Anticapited cost 75,000
175,000
Restructuring cost provision
Whether the provision should be made as suggested by Max depends on the outcome of additional audit procedures.

The auditing issue here is that the financial statements may be misstated if Max makes the £1/5,000 provision as proposed.
Kevin has performed some detailed work on the provision proposed by Max. His work on the accuracy of the redundancy costs and the carying value of the trucks is sufficient. However, his
work does not address adequately the following points:
Is it appropriate for the provision to be made as at 30 September 20x6? 1AS 3/ states that for a constructive obligation to exist for restructuring costs there must be a detailed plan and an
announcement made to those wno will be afrected by the restructuring (in this case the lorry drivers). Kevin has not ascertained whether this is the case.
Whether it is correct to assume that there will be no proceeds at all from the sale of the trucks. This appears to be what is being assumed and it seems an unlikely outcome
Whether the trucks should be reclassified as assets held for sale and how any anticipated reduction in their value should be treated within the financial statements.
Are there any other legal or other costs which should also be provided for within the provision?
Further procedures and information required is as follows:

Enquire end, then as the to when provision the decision should be was reversed to outsource
the delivery function and seek evidence such as board minutes to corroborate this. Iif the decision was not made until after the year
fthe decision was made before 30 September 20X6, seek further evidence that detailed plans had been made at that date identiying the number of employees affected and setting out
costs and timetables. Much of that clearly exists now but the question is whether it did at the year end.
Request evidence that an announcement had been made to the employees affected by 30 September 20X6 and corroborate this through discussion with HR personnel and, if deemed
appropriate, those affected (such as the manager of the delivery function).
Enquire what plans there are for the trucks and whether they were held for sale at 30 September 20X6 or were still in use at that date. To be reclassified as 'held for sale' assets and valued at
the anticipated net proceeds, they would need to be both held for sale and actively marketed.
Ascertain why Max has assumed no sales proceeds on disposal of the trucks given that they have a carrying value and therefore would appear to have remaining useful life (unless the
depreciation rate is inappropriate).
Seek external evidence of the prices for similar second-hand trucks and determine whether an audit adjustment is required to reduce the amount of the provision made.
Consider further how any 'impairment' to the carrying value of the trucks should be reflected within the financial statements - it would seem more appropriate to show this as
impairment/additional depreciation thus reducing the carrying value of the asset rather than including it within provisions.
Enquiry as to whether there will be legal or other costs incurred which should also be included within the provision.
One additional point for consideration is the need to reconsider our materiality figure given the reduction in profit from this adjustment and the creditor adjustments identified above and the
share option scheme considered further below.
Valuation of freehold
valuation now 1.2
Orginal 1
Increase 0.2
Assuming the £200,000 uplift is correct and that the previous revaluation uplit has been recorded correctly, the adjustment to be made in the financial statements will be:
DEBIT Carrying value of freehold property £200,000
CREDIT Revaluation reserve £200,000

Carey identified only the signed final valuation report as outstanding. This has still not been received but Max has indicated that he will bring it with him tomorrow.
Max also indicates that the new report will show a higher valuation than the one on which we performed our audit procedures. Such a last-minute change is unexpected and requires further
investigation.
In addition, Max's email implies that the valuation may have been infiluenced by a discussion between Jan and the valuer, who clearly know each other socially.
In the light of this knowledge and the last-minute change, we will need to perform additional audit procedures on the revised valuation and should reconsider whether we involve our own
expert for an independent view on the assumptions and methodology used now that the independence of the company's valuer has been called into question.
Specific procedures to be pertormed are as follows:
Obtain a copy of the updated valuation report.
Discuss with the valuer the reviewed assumptions/methodology used and the reasons for the last-minute change in his assessment of the value.
* Conclude as to whether the revised valuation is on an appropriate basis and within a reasonable range.
* Consider whether management might have any motivation for increasing the asset value such as future borrowing requirements secured on the asset or the net asset value in any potential
sale of shares/the business.
Assess the valuation used in the light of our assessment of other estimates within the financial statements and our overall consideration of bias.
Share option scheme

1 Dec X2 5 Ee
500 £1 opts
47 Page 59
Ex price £5
Vesting Nov X6
Provised that 2.6m profit
FV of shares
At start value 112500
Over 4 years 28125
10 months Sept X3 23437.5
2 months Sept X7 4687.5
Finacial reporting adjustment

Max's response about the share option scheme raises a new issue as entries should have been made to record the cost of the share option scheme over the vesting period.
Considering the adjustments identified above, the company's profit before taxation (before any charge for the share option scheme) is:
£3.2 million-£175,000 (maximum) for the reorganisation provision £267,230 for missed accruals - £2,757,770 - which is above the target profit of £2.6 million. Thus, a share option expense
should have been recorded as follows:
500 options x fair value of £45-£112,500, which should have been recognised equally over the four years to 30 November 20X6 falling into financial years as follows:
30 September 20X3 (10 months) 23,438

30 September 20X4 28,125
107,813
30 September 20X7 (2 months) 4,688
Prior period errors have clearly occurred here and IAS 8 requires these to be corrected retrospectively where material, thus presenting the financial statements as if the error had never
occurred. In this case the error in each year and cumulatively to 30 September 20X5 is not material (E79,688) and therefore the error should be corrected in the financial year ended
30 September 20X6, resulting in an additional charge to profit or loss of £107,813. The correcting journal entry is as follows:
DEBIT Share option cost- operating expenses £107,813

CREDIT Equity £107,813

The fact that Max has not told HJM about the share option scheme previously raises some questions about his openness with the auditor (especially as he might have been expected to know
how to account for it) but it may also be, as he suggests, an honest mistake and he has been open about it in response to Carey's question. It also seems surprising that the scheme was not
identified from a review of the minutes of Board and shareholder meetings so steps should be taken to ensure that it was approved appropriately. We should also consider carefully whether
any changes should be made to the audit approach to ensure that other similar items are not missed, albeit that this one was not material to any of the years signed oft.
Max's apparent failure to understand how to account for the share option scheme does also raise questions about his competence and we should consider carefully whether there are other
matters he may have got wrong.
Our audit procedures to corroborate this charge are as follows:
Obtaina copy of the rules for the share option scheme and ensure that all relevant factors have been considered in the calculation of the accounting entries.
Evaluate the basis on which the fair value of £45 was calculated, the expertise of Max who calculated it and the need for expert input in assessing it
Ensure that appropriate disclosures are made in the financial statements. Required disclosures include:
a description of the scheme;
the number of options outstanding at the beginning and end of the year (2,500), along with the exercise price (E5);
details of how the fair value was determined;
for key management (such as Max and possibly others), the share options should be disclosed as related party transactions; and
the total expense in the period.
When the shares are issued f2,500 should be credited to share capital and f10,000 to share premium as the exercise price is higher than the nominal value of a share
Completeness of related party disclosures

There are several related parties and transactions which may require disclosure in the financial statements. Hurther audit procedures need to be undertaken to identity these before
recommendations can be made.

There is still outstanding audit work in this area as the matter raised by Carey has not been addressed by Kevin or in the response from Max.
Kevin's work has however identified one potential related party with whom there have been transactions during the year, Farnell.
IAS 24 sets out details of what constitutes a related party and what needs to be disclosed.
Farnell is owned by Jan and his brother but it is not clear from Kevin's work whether Jan, Carol and/or their close family members control or have significant infiuence over the company. This is
information that should be sought from Jan or from independent sources. If they do control it then Farnell ill be a related party (as Jan and Carol are key members of management of
Key4Link) and the nature of the relationship, along with details of transactions and balances must be disclosed. Audit procedures will need to be performed to agree the balances disclosed to
accounting records and to review those records tor evidence of any further transactions with karnell.
Also, we need to apply additional scepticism in respect of the Farnell liability and to perform further testing to ensure that the liability does indeed relate to pre-year end services and that the
amount charged represents a tair price.
In addtion audit work Is required to condlude as to wnetner there are also otner related party transacions to disclose. Ihe Drocedures to be perfomed Will indlude
enquiry as to the procedures Key4Link have in place to identiy director/shareholder interests-this will include the register of interests maintained by the board;
review of publicly available records to ascertain whether the directors/shareholders have interests in other companies which might be controlling interests. Might also be helpful to identity
any companies in which they hold directorships although this will not of itself necessarily make the other company a related party;
review of minutes for any disclosed conflicts of interest;
enquiry of the directors as to the other interests they have and
scrutiny of the company's ledgers and minutes to identity transactions with any parties identified as related parties from the procedures performed.
The share option scheme is also a related party transaction-the accounting and disclosure of this are considered above
48 Page 60
20X4 June 20X3 Dec X3

Revenue 30,300 20,700 51,700
Customised mobile devices 18,010 10,800 25,900
Software services 48,310 31,500 77,600
Other mobile devices 15,700 6,100 20,500
Mobile device repairs 2,100 5,200 7,800
Total revenue 66,110 42,800 105,900
Gross profit 39,541 21,625 54,025

Distribution costs -3,823 -3,122 -8,547
Administrative expenses -6,563 -6,054 -13,755
Operating profit 29,155 12,449 31,723
Finance costs -1,280 -1,550 -4,125
Profit before tax 27,875 10,899 27,598
Taxation -2,000 -2,180 -5,520
Profit for the period 25,875 8,719 22,078
Number of devices 20X4 Dec X3

Customised mobile devices 650,000 636,000
Other mobile devices 392,000 205,000
GPM 30% 25%
Seasonal sales 40% moble in first 6 months

group revenue increase 66.11m up 54.5%
New products Denwa+

Deposits recevied 2,000 June X4
Final payment 13,000 Aug X4
Receive service 2 year + free guarentee
Replace old device Konext
Guarantee of replacement of old device
Hows it been treated

Customised mobile devices 10,000
Software services 5,000
In COS and GPM 60%
Said they recongised revenue in June X6 doesn’t matter when delivered
Revenue recognition
Konext has recognised £15 million revenue in respect of the Denwa+ device. However, following IFRS 15, Revenue from Contracts with Customers, revenue should only be
recognised when the performance obligations in the contract have been satisfied. There are two performance obligations: supply of the mobile devices and provision of the
software services. In the case of the mobile devices this is a performance obligation satisfied at a point in time. It is satisfied when control of the devices has been transferred to
the buyers, that is upon delivery. This takes place on 1 August 20X4, so no revenue for this will be recognised in the financial statements for the six months to 30 June 20X4.
In the case of the software services, this is a performance obligation satisfied over time. This is because the customer simultaneously receives and consumes the benefits
provided by Konext's performance as it performs. Time elapsed (an input method) is an appropriate way to measure progress towards satisfaction of the performance
obligation, and theretore the software services should be recognised separately over the two-year period.
Therefore, none of the £15 million ill be recognised in the interim financial statements and only some of it will be recognised in the year ending 31 December 20X4.
The cash received in relation to orders not yet fulfilled should be treated as a contract liability.
The deposits should be recognised in cash and included as a contract liability. Although they are non-refundable it does not create an obligation to complete the contract.
IAS 34 requires the same recognition and measurement principles to apply in the preparation of the interim financial statements as at the year end. Therefore, although
ultimately the sales wil be recognised in the year to 31 December 2OX4, no revenue should be recognised in the six months to 30 June 20X4 in respect of the Denwa+ devices
as delivery will take place in August 20X4.
Guarantee of replacement device

This is a multi-element sale and it needs to be determined whether there is a market price for the guarantee element - which would require separate recognition.
As no revenue is recognised at 30 June 20X4 the adjustment for guarantees, if any, would be made at the year end.
At 30 June 20X4, I wold need to determine where the original entries had been booked and to reverse them - therefore I recommend the following adjustments:
Revenue sales of devices 10,000

Revenue- software services 5000
Contract liability 2000
Receivables 13000
Accrued costs 6000
Cost of sales 6000
Being removal of revenue and related cost of sales
This will leave the deposits as a balance of E2 million as a payable on the statement of financial position at 30 June 20x4.
Refone Ltd
Jan X2 purchase
Cash generating unit
Property, plant and equipment 7,550
Brand name 4,175
Goodwill 1,975
Inventory 225
Receivables 1,950
15,875
Payables and other liabilities -3,425
Net assets 12,450
Offer 8,000
Pre tax cashflow 1,200 5 years to June X9
Pre tax annual discount rate 5%
Year Discount Cashflow
1 0.952381 1,200 1,142.86
2 0.907029 1,200 1,088.44
3 0.863838 1,200 1,036.61
4 0.822702 1,200 987.24
5 0.783526 1,200 940.23
5,195.37
NA 12,450.00
FV to sell 8,000.00
Impairment 4,450.00
Impairment of Refone
Refone is a cash generating unit. The net assets of the Refone business should be carried at no more than the recoverable amount which is defined as the higher of the fair value
less costs to sell and the value in use.
Indicators of impairment
The launch of the new product with a guaranteed replacement of the device rather than repair, is one factor which could indicate impairment. The amount of third party
business is not known but if a significant part of its business comes from Konext customers then a decline in the number of devices needing repairs will be an indicator of
48 Page 61
impairment
However, the trend of results would indicate too that there is impairment of the Refone CGU.
The Refone business has generated f2.1 million in revenue in the first six months. The results from the previous year suggest that the business is in decline. The business
generated £5.2 million in the six months to 30 June 20x3 and only £2.6 million in the second half of the year.
Calculation of the impairment charge
The recoverable amount is the higher of the value in use and the fair value less costs to sell. A recent offer to buy Refone suggests that the fair value is £8 million.
The value in use should be calculated using management-approved forecasts. Jacky estimates f1.2 million as a reasonable forecast of the cashflows from the division for five
year S.
Basing the value in use on the pre-tax cash tlow of £1.2 million over tive years then the PV of a five-year annuity is:
£1.2m x 4.329 £5.2 million.
The fair value less costs to sell is f8 million (which is greater than the value in use and therefore represents the recoverable amount).
This would suggest an impairment loss of f12.450 million- £8 million - f4.45 million. However, there are several risks arising from this calculation:
The discount rate - no information is given as to how this has been calculated and therefore management should be asked to justify this rate.
The cash flows would appear to be optimistic considering the division's declining performance.
The recoverable amount is based on one offer and there is no indication of when this offer was received and how firm the ofter was.
IAS 36.76 states that the carrying amount of the CGU should not include the carrying amount of liabilities unless the recoverable amount cannot be determined without
considering the liabilities - the net assets have been used in this calculation as it is assumed that the business would be sold with the liabilities.
If the liabilities were not going to be assumed by the buyer, then the comparison to determine the recoverable amount would have taken into consideration the gross assets
only.
The impairment is recognised first against goodwill and then the remaining amounts allocated to the other non-monetary assets - this precludes it from being allocated against
inventory because inventory valuation is dealt with under IAS 2.
CA Impaired
Property, plant and equipment 7,550 1,594
Brand name 4,175 881
Goodwill 1,975 1,975
13,700 4,450
£4.45 million £1.975 million £2.475 million to allocate
£2.475x £7,550/£7,550 + £4,175 (£11,725) - £1,594,000 to PPE
£2.475 x £4,175/£11,725 £881,000 to Brand name
Timing of the impairment

There is uncertainty about when this impairment should be recognised. AS 34 states that the same recognition and measurement principles should be used in the interim
financial statements as in the annual financial statements. Therefore, if the conditions for impairment were met at 30 June 20X4 the impairment should be recognised.
Further enquiries should be made of the directors to determine the future of this business after the launch of the new mobile device. Particularly regarding the recent offer for
the net assets.
The adjustment required is:
DEBIT Profit or loss 4,450

CREDIT Property, plant and equipment 1,594
CREDIT Brand name 881
CREDIT Goodwill 1,975
Under investigation as info secuirty

No provision?
Deferred advertising costs

March X4 eng with adv company
Invoice total 1,000
recong in PL and TP
Agree to issue 100,000 £1 shares to settle amouunt
Issue 1 Sept X4
But accounted as prepayment
Ine cost of the advertising services should be recognised when the service has been delivered.
There does not appear to be any grounds for deferring the costs. IAS 34 states that a guiding principle is that an entity should use the same recognition and measurement
principles in its interim statements as it does in its annual financial statements.
As the costs would not be regarded as an asset at the year-end it would not be appropriate to recognise the deferral of the costs as a prepayment since they have already been
incurred before 30 June 20X4.
Share issue to Nika

The issue of shares to Nika falls within the scope oft IFRS 2, Share-based Payment. t is an equrty settled share-based payment because essentially Konext has receiveda service
in exchange for an issue of shares. This type of transaction with a third party is normally measured at the fair value of the services received. The value of the shares at the
settlement date will theretore be irrelevant. Ihe cost should be shown in profit or loss when the service has been delivered -therefore the cost has been incorrectly prepaid.
The adjustment required is:

CREDIT Prepayments 1,000
To remove the prepayment and charge the cost to profit or loss
A further issue is the £1m credit balance being shown as a payable to Nika. Because it is going to be settled by an issue of shares, we should no longer show a liability but
instead recognise shares to be Issued as part of equity. Ihe adjustment required is:
48 Page 62
DEBIT Payable 1,000

CREDIT Equity 1,000
To remove the liability to Nika and to recognise the shares to be issued
Defined benefits scheme

June X4
Defined benefit scheme 900
Defined contribution scheme 3600
4500 Interest
Assets Obligation
Interest 6m 3.25% 29.25 117
Service cost -2800
12.2 14.5
The treatment with respect to the defined contribution payment is correct.

IAS 19, Employee Benefits encourages the use of a professionally qualified actuary in the measurement of the plan's defined benefit obligations. For interim reporting
purposes, IAS 34 states that reliable estimates may be obtained by extrapolation of the latest actuarial valuations.
The treatment of the contribution paid in respect of the defined benefit payment is incorrect and estimates should be made by extrapolation as follows:
Fair value of assets 12,200

Present value of obligations -14,500
Net benefit obligation at 31 December 20X3 -2,300
Interest cost 3.25% x 2,300,000 -75
Service cost f2,800,000 x 6/12 -1,400
Contributions paid into the scheme 900
Estimated net benefit obligation at 30 June 20X4 -2,875
Therefore, the following adjustment is required:
£'000 £'000
DEBIT Profit or loss- administrative expenses service cost 1,400
CREDIT Profit or loss - administrative expenses contribution paid 900
DEBIT Finance costs 75
CREDIT Net pension benefit obligation 575
49 Page 63
Adjust 1 Adjust 2 Adj 3 Adj 4 ex Adj 5

Fenner to 30 Elac: consolidated Aq 25% PERP provision rate agent cost
June 20X7 excluding Fenner) to
31 May 20X7
Revenue 382.4 1,855.40 1,855.40
Cost of sales -272 - 1,482.90 5.50 - 0.80 - 1,478.20
Gross profit 110.4 372.50 377.20
Operating expensees -91.2 - 270.80 - 0.60 - 271.40
Investment incomne 3.60 - 1.00 2.60
Finance costs -77.7 - 9.40 - 3.88 - 1.50 - 14.78
Profit/(loss) before tax -58.5 95.90 93.63
Income tax 12 - 19.10 - 19.10
Profit/(loss) for the year -46.5 76.80 74.53
Non-current assets
Tangible assets 1180 1,799.70 1,799.70
Investments 0 456.00 - 50.00 406.00
Investment in ass 395.13 395.13
Suspense account 0 350.00 - 350.00 -
Current assets -
Inventories 43.2 243.80 - 1.50 242.30
Trade receivables 88.8 238.90 - 0.60 238.30
Cash 16.40 16.40
Total assets 1312 3,104.80 3,097.83
Equity
Ordinary share capital (£1 shares 10 150.00 150.00
Reserves 208.4 2,255.40 2,253.13
Long-term liabilities 1003.2 388.30 388.30
Current liabilities -
Trade payables and accruals 65.6 305.60 305.60
Provisions and borrowings 24.8 5.50 - 5.50 0.80 0.80
Total equity and liabilities 1312 3,104.80 3,097.83
Elac Investmenet in Fenner

20X4 5% Consideration 50
1 Feb X7 20% Consideration 350 one of principle shareholders
25% held equally 3 other investors appointed direct
Dividends 25%
1 Oct X6 20p 2 0.5
30 April X7 40p 4 1
Until 1 February 20X7, the investment in Fenner was recognised in the consolidated financial
statements of Elac at cost in non-current asset investments. Any dividends received trom Fenner
were credited to investment income. On 1 October 20X6 Elac received a dividend from Fenner of
20p per share: £100,000 (20p x £10m x 5%). This was correctly re cognised in investment income.
However, a change of status of the investment took place on 1 February 20X7 with the purchase of
an additional 20% of Fenner's ordinary share capital. Elac's holding of 25% appears to confer
significant intluence over the operations of Fenner and therefore Fenner is an associate of Elac from
1 February 20X7. Normally, a holding of over 20% of the ordinary share capital of another entity
suggests significant intluence, and this is turther reinforced by the power to appoint a director. It is
clear that no one party exerts control over Fenner and this tactor also makes it more likely that Elac
can exert significant influence.
As Fenner is an associate, Elac must recognise the investment using the equity method of
accounting. This means that in the consolidated statement of financial position, the investment in
Fenner is shown at cost plus the group's share of post-acquisition retained profits or less the
group's share of post-acquisition losses (less any dividend received). In the statement of profit or
loss Elac takes credit for its share of the associate's profit after tax, or deducts its share of the
associate's loss after tax.
Fenner was an associate for four months of the financial year (1 February to 31 May 20X7). Elac
recognises its share of the loss for that period: f46.5m x 4/12 =£15.Sm x 25% = £3.9 million in
consolidated profit or loss.
Elac's share of the dividend of 40p per share paid by Fenner on 30 April 20X7 is: £10m x 25% x
40p -£1 million. This reduces the carrying amount of the investment in the associate.
Therefore, the carrying amount of the investment in Fenner in Elac's consolidated statement of
financial position at 31 May 20X7 is calculated as follows:
4 month as assicoate
Loss 46.5
month 4/12 15.5 of loss
25% holding 3.875
Dividends
30 April X7 40p 1
20X4 5% Consideration 50
1 Feb X7 20% Consideration 350
49 Page 64
Loss -3.875
Less dividends recevied -1
395.125
DR Investment in associate 350

CR Suspense account 350
DR Investment in associate 50
CR Investments 50
DR Profit or loss 3.9
CR Investment in associate 3.9
DR Investment income 1
CR Investment in associate 1
Trading with Fenner

P sells to Sub
Sale 145.2
Mark up 20% 121
Profit 24.2
Inventory held 35
Trade payment with F 37.6
Equity accounting requires elimination of any unrealised protit in inventory, to the extent of the
group's share. where the associate sells to the parent, as in this case, the unrealised profit is in
group inventories, from which it must be eliminated. The group share of unrealised profit at 31 May
20X7 is calculated as follows:
Inventory held 35.00 AT YE

Mark up 20% 29.17
Profit 5.83
25% share 1.46
DR Share of PL assicaote 1.5

CR Inventory 1.5
Otherland contract $
1 Jan X7 1 year control with Elac

Price $ 5,000.00
GPM 30%
Pay commission 5%
if below 16,000 3%
Monthly sales 1,600.00

total sales 8000
Commision is 5% as sales assume stay at the level
Spot rate at 1 January 20X7 1 = O$2.2 2.2

Spot rate at 31 May 20x7 1 = O$2.4 2.4
Forward rate (at 1 June 20X7) for 31 December 20X7
£1 = O$2.8 2.8
Average rate period 1 = O$2.1 2.1
COS
Provision for exchange rate loss 31 May to 31 Dec
SALES $ 56.00 5000 X 7 X 1600
Jan X7 $ 25.50
Forward $ 20.00
Provision for onerous contract

IAS 37, Provisions, Contingent Liabilities and Contingent Assets, requires that a provision should be
made for onerous contracts at the time a contract becomes onerous. This is the point at which
future benefits undera contract are expected to be less than the unavoidable costs under it. The
contract with Otherland is described by the finance director as "expected to make a much larger
margin than UK sales".
The consolidated profit or loss statement includes the results of Elac itself plus its other
subsidiaries, theretore Elac's normal gross profit margin on UK sales cannot be calculated. However,
the group gross protit margin is 20%. If this is indicative of Elacčs own gross profit margin, the
margin on the Otherland contract is likely to be higher than this. Assuming a gross margin of 30%
on the Otherland contract, gross margin for the remaining seven months of the year could be
calculated at 30% * (7 months x 1,600 x OS5,000) = O$16.8 million.
Sales $ 56.00
30% GPM $ 16.80
The Otherland dollar is clearly weakening over the 20X7 calendar year, with a loss in value of over
20% expected. However, the anticipated exchange losses are very likely to be outweighed by the
profits to be earned under the contract. Therefore, it is unlikely that the contract with the Otherland
customers is onerous, although more precise information about profitability would be required to
contirm this.
Reverse provision
DR Provision 5.5
CR Cos of Sale 5.5
49 Page 65
Trade recieivables
TR with otherland $ 10.10
£ 4.80 Average rate
TR with otherland $ 10.10
$ 4.21 Closing rate
Difference adjusted for $ 0.59
Therefore, an exchange loss has arisen of (f4.8m - f4.2) £0.6 million.
trade receivables denominated in foreign currencies are monetary items. As required by IAS 21,
The Effects of Changes in Foreign Exchange Rates monetary items in foreign currency outstanding
at the reporting date should be translated at the closing rate.
DR Ex change rate PL 0.6

CR TR 0.6
Gains and losses arising from the retranslation of monetary items are recognised in profit or loss tor
the year. Such gains and losses could be reported under various headings in the statement of profit
or loss. The adjustment in this case will be recognised in operating expenses.
Agency cost and accrual

Price $ 5,000.00
GPM 30%
Pay commission 5%
if below 16,000 3%
Monthly sales 1,600.00

total units 8000
at 5,000 40000000
Commision is 5% as sales assume stay at the level
Commission 2000000
YE rate 2.4 833333.333333333
DR COS 0.8
CR Provison 0.8
It is incorrect to classify the agent's commission as a contingent liability. At the reporting date, 31
May 20X/, an obligation exists to pay the agent commission tor sales over the five-month period
from 1 January 20X7. t is a present obligation arising from past transactions (the sales) and it can
be measured with a reasonable degree of certainty.
The finance director has stated that average monthly sales for the first five months of 20X7 are
1,600 windows. If this level of sales continues to be achieved for the rest of 20X7, total sales for the
year will be 19,200 windows, which comfortably exceeds the 16,000 windows at which the agent is
paid 5% commission. Because commission depends upon total sales for the year it is not possible
at 31 May 20X7 to calculate the commission figure with complete accuracy because a tall in sales
for the rest of the year could result in total sales falling below 16,000 units.
Investment income
Dividends from Fenner
1 Oct X6 0.1
30 April X7 0.1
50 Page 66
Entity Materialty
Subsidiary in countries - Arca & Elysia £850,000 UK audit team
A$ and E$
Recruit1 plc - the parent company Materiality will be determined UK audit team
separately for each.
UK subsidiaries
R1-Arca This entity is not required to issue Hind audit team in Arca to
Results are expected to be audited financial statements and so perform audit procedures
material to the Recruit1 Work will be pertormed using
group. component materiality of £300,000
(A$600,000 as at 31 December20X6).
Other non-UK subsidiaries UK audit team to perform
(including R1-Elysia) review procedures for
Results are not expected to £500,000 unexpected fluctuations
be material to the Recruit1 or material balances
group.
Response as follows:
(1) Review of Arcan reporting memorandum
The exchange rate has changed from when materiality was set in A$. If £300,000 is still the correct
component performance materiality, that would now be equivalent to AS540,000 meaning that the
other receivables and prepayments should have been tested. However, changes in exchange rates
across the group and differences in results from those anticipated when materiality was set may
have changed the overall materiality of component materiality tor Arca. Group team should
theretore look at this before asking Arcan team to do more work on other receivables and
prepayments.
Revenue
Weaknesses in audit procedures
The work performed on revenue seems very limited and is unlikely to be adequate - specitic
weaknesses are
agreement to an invoice and the receivables ledger does not prove that the service to which the
invoice relates was delivered pre-year end and that it is appropriate to recognise the revenue. It
also gives no assurance as to the completeness ot revenue; and
payment from the customer may give some more assurance that the service has been delivered
but, in a business such as recruitment, there may well be stage payments and invoices or an
element invoiced in advance.
Financial reporting and auditing issues

Hence payment may be in advance of appropriate revenue recognition. Ihe need ftor such testing is
emphasiSed by the error identified in relation to prior year revenue which should have been
deterred. t seems unlikely that there should not be a similar deferral in the current year but there is
no signiticant balance within creditors.
Further audit procedures and information required

As revenue is likely to be a key risk area (as required by auditing standards), the Group audit team
will need more detail on R1-Arca's ditterent revenue streams:
Enquire of management about the key revenue streams, determine the critical invoicing dates
and appropriate point at which revenue is recognised for each revenue stream.
Determine whether the recognition point is both appropriate and in line with the group policy.
For each stream confirm by reference to customer contracts and invoices recorded that thee
revenue recoanised is in line with the policy and that revenue is both accurate and complete.
Payroll
The work pertormed on payroll appears to be limited to agreement to schedules prepared bya
third-party service company. Ihere is no indication that the Arcan team has considered whether it is
appropriate to place reliance on this entity and its expertise and such an assessment should have
tormed part of the audit work. In addition, it is unlikely that a payroll service company will operate
without reliance on data supplied by R1-Arca and this should be tested.

The financial reporting issue here is that there may be an over or understatement ot liabilities at the
year end in respect of payroll balances. Also without an appreciation of the controls around the
payroll tunction and their service company, there is a possibility of traud and inappropriate
50 Page 67
payment tfor services not pertormed.
Further audit procedures and intormation required:

Perform substantive analytical review procedures to assess whether the balance could be
materially mis-stated.
Enquire of the Arcan audit team to determine whether they have assessed the expertise of the
service company and assessed internal controls.
Taxation
There is insutticient work done on taxation. No assessment has been made of whether their tax
acvisers are suitably competent.

The taxation charge comprises current tax only and there is no mention of a deferred tax balance
even though it is clear that there are some temporary ditterences from the explanation of work
done on the current tax charge. Where such ditferences exist, a deterred tax asset or liability will
exist and should be recognised (unless in the case of an asset it is not considered recoverable).

More information is required as to what temporary differences exist and whether any deferred tax
has been or should be recognised. It is possible that any balance will be totally immaterial tor group
purposes but that cannot be assessed without further intormation.
Reserves
The audit procedures comprise no more than identitying why the reserve balance is ditferent and
are completely inadequate.

The commentary on the brought forward reserves figure appears to identify a material item which
relates to the prior year and was erroneously recorded within group revenue in the year ended 30
April 20X6. A$2,250,000 equates to £1,250,000 at the year-end exchange rate which is above
group materiality.
Amaterial error should be treated as a prior period adjustment and the comparatives restated.
However, as the amount is only just above materiality, it should be considered along with any other
smaller and similar adjustments noted in other group entities which might offset (or indeed add to)
it. In addition, it is important to determine whether there are related direct costs which should also
be deterred thus reducing the efect on reported profit
However the error is treated, it should not be shown in the way it has been, simply as a reserves
movement. If a prior period restatement is required, then it should be shown as a reduction in the
prior year revenue. If not, then the reduction in revenue will be retlected in the current year profit or
loss account. There is also likely to be an adjustment to the tax charge (unless this has already been
taken into account).

The discovery of the error raises some potential issues with the accuracy of the prior year financial
statements in other areas and potentially with the competence of the finance team and the way in
which they keep the parent company intormed. The group team should therefore consider whether
t attects the determination of component materiality or the level of work required in Arca.
Non-current assets
The overall balance is above component materiality and we would therefore have expected some
work on existence, ownership and potential impairment

There is no audit evidence to confirm the existence, ownership and valuation of a material balance
in the financial statements. The potential is that the balance is therefore not fairly stated.

The team in Arca should be asked to pertorm these procedures as the scope set for them was to
test all balances over £300,000 and not all movements.
Trade receivables
A significant amount of the sample has not been followed up for further enquiry.
50 Page 68

The receivables balance and revenue cut off are key audit areas and there is a potential for
misstatement of both balances.

The Arcan team should be asked to perform additional procedures to update their work on post
year end cash receipts and to pertorm alternative procedures to contirm the accuracy and validity
of the receivables balance it payment has not been received.
Procedures need to be pertormed to address the completeness ot any receivable provisions by
reference to ageing, balances not paid within normal credit terms etc. Ihese do not appear to have
been pertormed at present.
Cash and short-term investments

Although agreements to confirmations are key procedures, this is a very signiticant balance and no
detail is given of what is included.

The key issue here is presentation -there could be investments which need to be disclosed
separately within the financial statements or for which the valuation needs further consideration. It is
also possible that some items should not be treated as cash and cash equivalents within the cash
flow statement.

The Arcan audit team should obtain a breakdown of the balance and determine the appropriate
presentation of the balances.
Trade payables and accruals

The balance appears not to be material and therefore the Arcan team have not performed any
procedures.

However, it seems likely from the error discovered in prior year revenue that the balance is
understated, at least as tar as deferred revenue is concerned. Even excluding this consideration, the
total balance of A$503,000 (excluding tax) seems very low compared to statt and other costs and is
potentially understated.
In addition, the tax payable balance will need to be classified separately within the group financial
statements and the group audit team will need to ensure that this has happened.

Audit procedures should be performed to check completeness by looking at post year end cash
payments and invoices and ensuring that the costs have been accrued in the correct period.
Other points
The memo does not set out any details of the team in Arca, their qualifications, their independence
etc. These confirmations will be required by the group audit team.
There may also be other general procedures that the Arcan team should perform such as review of
minutes, consideration of local laws and regulations etc. To the extent that these are required, the
results should be reported.
There is not clear identification in the memo of the audit risks identified and the focused
procedures pertormed in response to them. Would expect head oftice and Arcan teams to have
input into the identification of the risks.
Overall need to be satisfied that the UK team has had sufficient involvement in the planning,
evecutian and rasults of the wark in Arca as reauired hu auditina standards
Property Loan
E$'000 E$'000
Initial purchase transaction on 30
September 20X6 6,000 6,000
Conversion and start-up costs incurred
(funded from cash)
External contractor costs 4,200 0
Allocated salary costs of R1-Elysia
employees 850 0
Marketing costs 900 0
50 Page 69
Security, insurance and other running

costs incurred while the building was
empty 750
Interest for 7 months to 30 April 20X7 210
Fair value gain on property due to increase

inprices in the 7 months to 30 April 20X7 500
Carrying amounts in the consolidation

reporting pack at 30 April 20X7 13,200 6,210
Sept X6 £1:$4
April X7 £1:$3.6
Interest 6%
Additional work
Covert in £ at 4.6 2388.462
Split loan NCL 1667

CL 58
(2) R1-Elysia's property transaction, review the further information provided

Bank loan
As there is no discount or premium on redemption, it is correct to recognise the loan at
ES6,000,000 and accrue interest at 6%. The bank loan will be measured at amortised cost and the
interest accrued over the term of the loan. The interest 'charge of E$210,000 appears correct being
7/12 of ES6 million at 6%. However, the total balance owing on the loan of E$6.210 million at 30
April 20X7 should be split between current and non-current elements and converted at the year
end exchange rate of E$3.6: £1.00 resulting in the tollowing balances within the group accounts:
Non-current liabilities f1,667,000
Current liabilities f58,000
Audit procedures:
loan agreement should be requested and reviewed to ensure that all relevant
terms have been summarised and considered in determining the financial reporting treatment
Classification of property
The property has been treated as an investment property in Elysia but is unlikely to quality as such
under the provisions of IAS 40. This is because R1-Elysia uses the building tor its own training
courses and provides services to the lessees of the property in the form ot administrative support
and catering. Such services are unlikely to be insignificant to the rental arrangement.
As a result, the building should be included within PPE in the Recruit1 consolidated financial
statements and stated not at fair value but at depreciated cost in line with Recruit1's accounting
policies. The revaluation gain of E$500,000 should therefore be reversed.
Audit procedures:
further information should be requested on the extent to which R1-Elysia intends
to use the property to ensure that this cannot be regarded as insignificant and examine further the
total rental package and terms tor external tenants to ensure that the services provided by R1-Elysia
could not be regarded as incidental.
Accounting for interest cost

At present, none of the interest cost has been included within the capitalised cost of the building.
However, assuming six months is considered 'a substantial period of time' (which seems reasonable
given the substantial conversion costs incurred) then capitalisation would be required under IAS 23
as the purchase cost has been funded' for that period betore the asset can be brought into use. As
a result, interest of ES180,000 should be capitalised. No further borrowings were needed to fund
the building costs of conversion so there is no additional interest cost to consider.
Audit procedures:
Confirm interest rate to loan agreement and dates to schedule of works or board
meeting minutes.
Measurement of property cost

Costs capitalised should be only the directly attributable costs of bringing the asset into working
condition for its intended use (IAS 16). As a result, it is incorrect for R1-Elysia to have capitalised the
following:
50 Page 70
.E$900,000 relating to marketing costs

ES750,000 relating to security, insurance and other running costs
The E$850,000 capitalised for allocated salary costs should only be capitalised if directly
attributable to the project and not it the members of staff would have been employed in any event.
Depreciation
No depreciation has been charged but the property was brought into use one month betore the
year end. There should therefore be a charge for one month's depreciation although this is not
material at E$10.38 million/25 years x 1/12 = E$34,600 (£9,600).
Assuming it was not correct to capitalise the allocated salary costs, the revised carrying value of the
property is:
$
Cost 6
External contractor costs 4.2
Capitalised interest 0.18
Less depreciation -0.035
10.345
Year end rate 3.6 £ 2.87
EST0.345 million Is translated at the year-end rate of Es3.6: £1 = £2.8/4 million as this is translation
arising on the consolidation of a subsidiary which maintains its books in a currency other than the
group functional currency.
Audit procedures
As the amounts capitalised are material to the group results, the group team will
require supporting documentation for a sample of the costs incurred and will also want to see land
registry or equivalent documentation to establish ownership. In addition, physical verification work
may be required either by the team or a representative in Elysia.
Deferred tax
There are temporary differences arising because of the treatment of interest and capital
expenditure which will give rise to deferred tax balances.
In respect of the building, the tax base is stated as E$12.7 million less the 50% capital allowance
E$6.35 million.
The tax base of the accrued interest is nil as it will all be tax deductible in the future.
The carrying value of the property in the financial statements (including the capitalised interest)
is E$10.38 million less depreciation of E$35,000 = E$10.345 million.
The carrying value of the accrued interest is a liability of ES210,000.
Any deferred tax on the revaluation is irrelevant in the group accounts as the revaluation is not
recognised in the group accounts.
A deferred tax liability arises in respect of a timing difference between the tax written down value of
the building (ES6.350 million) and its carrying amount. A deferred tax asset arises on the accrued
interest cost as tax relief is only available when the interest is paid on 30 September 20X7.
Audit procedures
: As the Elysian tax regime is unlikely to be familiar to the group team, expert
advice should be sought to ensure that the information provided regarding the tax treatment of the
property investment and income is correct. The team should question whether the additional costs
capitalised tor the contractor, salary and marketing really quality tor capital expenses. The tax
computation should also be requested so that the treatment within the current tax charge can be
confirmed.
There may also be other deferred tax implications from other items within the financial statements
but these are unlikely to be material.
Temporary
CA Tax base difference DT at 35%
Property (excluding capitalised interest) 10.165 6.35 3.815 1.335
Accrued interest 0.21 0 0.21 -0.074
1.261
Other points
The fact that the group finance director seemed unaware of such a large transaction in a wholly
owned subsidiary suggests that there may be a weakness in governance and internal controls and a
the risk that other significant transactions may have been missed at group level as there are several
50 Page 71
subsidiaries where detailed audit procedures have not been carried out. While the desk top review
will have identified significant balances, for example, it may not have identified business
relationships, investments, and contingent liabilities. The team should ascertain the extent to which
senior management was aware of the investment and then consider additional procedures such as
review of subsidiary board minutes, discussion with local tinancial controllers to ensure that no
other significant transactions have been missed.
51 Page 72
Acq listed co MegaB PLC
Audit Fee 60,000

Materiality 800,000
PBT 16,000,000
Change in ownership of EF
Pension
Revisied reval 1.05
Reorg and bonus cost

redund 12
cost 1.25
50 to leave by sign off 0.635
9months en Year endinYear ended

30 Septembe31 Decemb31 December 20X6
Actual Updated foActual
£m £m £m
Revenue 175 274.3 214
Gross profit 51 76.2 64.2
Operating profit 18.9 34 21.4
Profit after tax 14.7 26 16.1
Net assets 53.1 74.9 38.4
Inter compnay sales 15
Brand
valued 20
(a) Valuation of EF brand at £20 million
The brand is an intangible asset and the relevant accounting guidance is set out in
TAS 38. For it to be recognised within the separate financial statements ot EF, it would
need to be identifiable, that is capable of being sold separately from the business or
arising from contractual or other legal rights. It is debatable whether this is the case and
clear that EF has not historically recognised the asset as an intangible within its financial
statements.
In addition, to recognise an intangible, EF would need to be able to measure its cost

reliably. It could subsequently choose to adopt a revaluation model for intangibles but
only it the requirements for initial recognition were met and an active market can be
demonstrated. The cost to Megab has been determined as part of the overall
acquisition cost but this is not the cost to EF and the CFO's email makes it clear that he is
unsure what costs were incurred. Indeed, it seems likely that the value of the brand has
built up over time through reputation rather than because of direct expenditure.
Unless it can clearly be demonstrated that there has been an error and the brand could
and should have been recognised in the past, it would not be correct to do so now just
because a valuation has been obtained. Additional information is required. Clear
evidence ot an error seems unlikely as the costs will have been considered at the time.
Hence the brand should not be reflected in the separate financial statements of EF as it
does not meet the requirements for recognition within those financial statements. No
entry should be made. The brand will be recognised on consolidation only as part of the
acquisition accounting entries.
Goodwill 11.2
internal generated
51 Page 73
Goodwill of £1.2 million

This is goodwill generated internally by EF and it is clear from IAS 38 that internally
generated goodwill should not be reflected within an entity's financial statements.
No entry should be made. The goodwll will be recognised on consolidation only as pat
of the acquisition accounting entries in the consolidated financial statements.
Investment property
head office value 3
land 0.7
3.7
3 floors rented out to tenants

10 year lease
rent 40,000
EF uses other 2 floors
TR allowance Allowance
31 Aug X7 1.35
31 Dec X6 0.8
Revaluation of PPE
PPE, including the head office building, has historically been recognised within the EF
financial statements at depreciated cost- and the company can choose to change its
accounting policy and move to a revaluation model, providing the fair value of the asset
can be measured reliably (which does appear to be the case). It does however have to
apply this model consistently tO a class of assets. In this case, Megaß has specitied that
the revaluation model is to be used both for investment properties and all other land
and buildings.
The only asset with an uplift if the revaluation model is used will be the Head Office
Building. In the tair value exercise conducted by MegaB this has been treated as an
investment property and we therefore need to consider whether this is the correct
classification. Ihe relevant accounting guidance is set out in lAS 40.
For the whole property to qualify as an investment property, only an insignificant potion
should be owner-occupied. Ihat is clearly not the case for the head otfice property as EF
still occupies two tloors out of three. However, it is still possible that the portion which is
rented out could be regarded as an investment property if t were capable of being sold
separately or leased separately under a finance lease. Further information is needed to
determine whether this is the case.
If the rented-out floor is regarded as an investment property, then the carrying value will
need to be apportioned between the tWo portions and the valuation of the rented floor
determined separately from the value of the remaining owner-occupied portion. it is
clear from the information that historically the whole property was owner-occupied and
therefore we need to follow the guidance on 'change in use' within lAS 40. The change
in use date could be 1 September 20X/ when the rental agreement commenced. A
valuation should be obtained at that date and the uplift over carrying value (tor the
rented tloor) recognised under IAS 16 as a credit to revaluation reserve (within other
comprehensive income). The valuation of the investment property element is then re
measured at fair value at each period end with subsequent gains and losses going to the
profit or loss account.
The remaining two tloors of the property which are still owner occupied will also need to
be valued as the tair value model is to be adopted. Any uplitt will be taken to reserves
through other comprehensive income and to revaluation surplus and will need to be
apportioned between land and buildings so that depreciation can be based on the tair
value.
(d) Trade receivable allowance

IFRS 9, Financial Instruments uses an expected credit loss model for impairment of
financial assets in which credit losses are recognised in three stages:
Stage 1: Initial recognition (and subsequently if no significant deterioration in credit

51 Page 74
risk): 12 months' expected credit losses recognised and interest calculated on the gross
carrying amount
Stage 2: Credit risk increases significantly (rebuttable presumption if> 30 days past
due): lifetime expected credit losses recognised with interest calculated on the gross
carrying amount.
Stage 3: Objective evidence of impairment exists at the reporting date: lifetime

expected credit losses recognised with interest calculated on the net carrying amount
net of allowance for credit losses after date evicdence exists.
A simplitied approach is required for trade receivables, contract assets and lease
receivables. For trade receivables or contract assets that do not have an IFRS 15
financing element, the loss allowance is measured at the lifetime expected credit losses,
from initial recognition. Since the receivables in question do not have a significant
financing component, it is therefore not permissible to change to the three-stage
process
Changes to overall audit plan and areas of audit focus because of information received
Audit timing
The timing ot the audit will need to change as final audit work was planned tor March and
Lewis-Morson require sign ot by the middle of February. Whether E can be ready by this
date is debatable as its October results will not be ready until early December implying that it
takes it more than a month for it to close its books. A ditticult year end is likely to take even
longer, leaving little if any time for audit.
This issue needs to be discussed with the client as soon as possible to determine when it is
possible for audit work to start, what work can be done before the year end and rolled
forward and what can be left until atter the group reporting date on the basis that it will not
be material given the higher level ot component materiality. Leaving work until later may
however not work as more statt are due to leave at the end of February and it may be difticult
to get answers to enquiries about 20X7 after that date.
A realistic timetable needs to be agreed with the client and Lewis-Morson, especially as the
new issues and approach mean that the audit is likely to take more time than in the past.
Controls reliance
In the past, the audit approach has relied on testing the operating ettectiveness of controls
over revenue and trade receivables. Ihe controls were operating ettectively until June 20X/.
Since that date there have been signiticant redundancies among finance and other statt and
day to day accounting has moved to a shared service centre. It is theretore highly likely that
both the controls and those responsible for carrying them out have changed. We know that
the CFO is now responsible for both reviewing the financial statements and posting journal
entries for the more complex and judgemental items which may be indicative of a lack of
review and segregation of duties.
In addition, there is a new and very signiticant revenue stream relating to sales to overseas
distributors which will not have been covered by the controls work done to date.
More information is needed on when processes changed, what the new processes are and
what assurance, if any, can be given by Lewis-Morson on the controls operating at the shared
service centre. Additional audit work will be required to assess the design and
implementation of controls in the post-acquisition period and to determine whether
operating effectiveness should be tested and relied on. It seems likely that in at least some
areas, design and implementation testing will identity weaknesses in control (due to statf or
other changes) and that additional substantive work will be required either on the whole
balance or, for income statement balances, for transactions processed under the new and
potentially weaker control environment. Where the old controls are relied on for 10 months
of the year, we will still need to update the interim testing to cover the two months from
1 November 20X7.
Urgent work on the control environment is needed to re-assess the audit approach and
determine what additional substantive procedures are required. This should include
discussion with Lewis-Morson.
51 Page 75
Materiality
The forecast result for the year has changed significantly because of the additional revenue
following the acquisition. Planning materiality of f800,000 was based ona profit after tax of
£16 million whereas the expected profit is now f26 million which might imply a rise in
materiality to £1.3 million on the same basis.
However, there are other factors to consider:
Lewis-Morson have asked us to use component materiality of £3 million both for reporting to
them and for the statutory audit. We cannot simply accept this but need to form our own view
on what materiality should be.
That view should be based, not only on the financial results, but on factors such as the
ownership structure (which has clearly changed) and the focus of the users of the accounts.
Given that EF is now a wholly owned subsidiary of MegaB rather than a standalone entity
reliant on external financing, it might be appropriate to increase materiality.
We also need to consider the key Tocus Tor users or the financial statements. For
management, the key tocus will clearly be operating profit as they each earn a significant
bonus based on achieving the forecast profit of £34 million. If actual results are close to this
level, then a small change could make the difference between achieVing and not achieving
protit. Ihat will need to be considered in determination of the materiality level we use.
The EF board have said that they intended to retain the same level of fees. This puts MKM
under pressure to cut audit time and costs to retain margin and we need to make sure that
this is not unduly intluencing the work proposed or the materiality level adopted.
Management incentive to mis-state the results

There is clearly an enhanced risk of management override of controls following the
acquisition. Ihe remaining management will want to please the new owners and to dellver
the anticipated results as there is clearly significant emphasis on this in judging their
pertormance and potentially their future with the company/group.
In addition, they have signiticant personal bonuses contingent on achieving the torecast
operating protit.
We theretore need to think caretully about areas where they could manipulate results and to
tocus our audit on all areas of judgement. This will include areas already identitied as key
areas of audit interest but also some of the new areas identitied below. Attention will need to
be paid to balances where analytical review procedures reveal changes in the post
acquisition period and we should ensure that we look at this as soon as possible to identity
any additional risk areas.
The forecast gross profit looks challenging compared to prior year as there is an overall
increase of £12 million. However, the torecast operating protit assumes that there will be
small decine in operating costs from f42.8 million to f42.2 million. There would be
additional depreciation on the property, the additional irrecoverable debt expense and
reorganisation costs, none of which appear to have been considered. Further details on the
forecast figures are required to assess what level of risk there is to achieve the torecast and
therefore the degree of pressure there will be on management.
Last year of audit/group reporting

The last year in which an audit firm audits an entity increases the audit risk as the work will be
subject to the scrutiny of a new auditor. Ihis is perhaps mitigated here as the new auditor is
most likely to be auditing the entity only as part of a much larger entity.
However, the MegaB group is a new stakeholder and may raise additional questions and
issues and reporting to the group auditor brings additional responsibility and therefore
inherent risk.
Changes/additions to areas of audit focus

Revenue recognition risk is increased by the new overseas sales channels. These are
intercompany sales and so will eliminate in the Megaß consolidation. They are therefore of
limited interest for group reporting. However, in the stand-alone financial statements of EF
they represent a new and material revenue stream and the contractual terms will need to
be understood fully.
51 Page 76
The new sales also appear to be EF's first overseas transactions so there is a risk that
foreign currency transactions have not been accounted for correctly.
Selling to other group companies at a lower margin than to external distributors may raise
transter pricing questions in respect of tax and potentially increase the risk of an incorrect
tax charge.
The pension obligation risk remains a key judgement but has been enhanced both by the
changes in assumptions applied by a new valuer and by the fact that the valuation to be
used will be that pertormed at an interim date rolled forward, thus increasing the risk that
it does not represent the best estimate of the position at the year end.
In addition, the extensive redundancies are likely to give rise to a past service cost/
benefit which will need to be considered with appropriate actuarial input, so a simple roll
forward is unlikely to be appropriate.
While the work done by the group auditors will be a usetul starting point, it may not have
been based on an appropriate level of materiality so additional work may well be
necessary.
The valuation of the head office building is inherently judgemental. The complexity of
accounting for the head office property also gives rise to additional risk both in terms of
the classitication and disclosure of the property and accounting correctly for depreciation
and lease income. As tor the pension fund, this will require assessment of a new valuer.
There appears to be an increased risk of unpaid trade receivables. An allowance

calculated on the same basis as prior year is much higher at 31 August 20X7 than at 31
December 20X6 and this was before any increase in revenue arising from the new sales
channel. This implies that the ageing has deteriorated and that there may be underlying
ISSues either with the customers ability to pay or with revenue recognition arising too
early. Although the additional provision will cover some of this risk, the amounts involved
are material and the judgements in this area both in respect of potential under and over
provisioning give rise to an area on which the audit should focus.
The measurement, classitication and timing of recognition of the reorganisation and bonus
payments gives rise to an additional area of audit focus as these are one off transactions
where the finance team may be untamiliar with accounting guidance. The CFO has already
demonstrated that he does not understand the need to accrue tor estimated bonus
paymentS relating to the period.
Going concern basis of preparation - If there is a detinite plan to wind up the company
and transter its trade to the parent in place by year end then it may be inappropriate to
continue to prepare the financial statements on a going concern basis - this should be
reviewed at the year end.
52 Page 77
Requires a loan
Loan 10
Invest to P&M
20X6 20X7 Adjust

Performance information for the year ended 30 September
Revenue 34,500 35,400 -750 34,650
Gross profit 9,660 10,020 -750 9,270
Cash generated from operations 3,990 6,320 6,320
Extracts from statement of financial position at 30 September 20X6 20X7

Total assets 33,560 35,670 27 -43 35,654
Total liabilities 8,730 8,490 750 351 -145 9,446
Equity 24,830 27,180 26,208 The adjusted figure for equity is (£35,654- £9,446): £26,208
Net debt 450 450
Non-current assets available as security at 30 September 20X7 20X7

Land 1,000 1,000
Buildings 18,200 18,200
Financial assets: fair value through OC 430 -43 387
Financial assets: fair value through profit or loss 192 27 219
Plant and equipment 8,678 8,678
28,500 28,500
Key ratios 20X7
Gearing (Net debt/equity) x 100 1.70% 450/26,208 x 10 1.70%
Gross profit margin 28.30% 9,270 / 34,650 26.75%
Return on capital employed (Operating profit/net debt + equity) x 100 16.00% 13.70% Return on capital employed (operating profit/net debt + equity) x 100
20X7 (3,660/ [450 + 26,208) x x 100
20X7 20X6 (Operating profit: 4,440-30-750)
Cash generated from operations (Note) 6,320 3,990.00
Tax paid -810 - 790.00
Net cash from operating activities 5,510 3,200
Cash flows trom investing activities

Dividends received 30
Purchase of PPE -2,408 -2,656
Purchase of financial asset -192 -430
-2,570 -3,086
Dividends paid -3,000
Directors interestfree loan accounts repaid -1,000
-4,000 0
Net change in cash and cash equivalents -1,060 114

Cash and cash equivalents brought forward 610 496
Cash and cash equivalents carried forward -450 610
Note: Reconciliation of profit before tax to cash generated from operations
Profit before tax 4,440 4,040
Investment income -30 0
Depreciation charge 1,100 690
Decrease (increase) in inventories 250 -400
Decrease (increase) in trade receivables 330 -360
Increase in trade payables 230 20
Cash qenerated from operations
6,320 3,990
At 30 September 20X6 £1-ASS1.4

At 1 January 20X7 £1-ASS1.3
At 30 September 20X7 £1 AS$1.6
Financial Instrustments
PSN
Sept X6 2%
Shares 2,000
OCI 430,000
Share price 310
AS $ paid 620,000
transalted at Sport rate (date) 387,500
value of shares increased the ex rate was

430,000
387,500
FX -42,500
The investment in PSN, held at fair value through other comprehensive income, has increased its fair value, and
the increase should be recognised through OC. Ihe asset is measured at 30 September 20X/ at:
DEBIT Other components ot equiy 43

CREDIT FVTOCI financial asset 43
LXP
Jan X7 1%
Shares 50,000
Share price 5
Investment recognised 192,000
quoted price 7
The investment in LXP is classified as at fair value through profit or loss (FVIPL) and so any change in fair value
is recognised in profit or loss.
AS Paid 350,000
At 30 September 20X7 £1 AS$1.6
£ value 218,750
value of shares increased the ex rate was

192,000
218,750
FV increase 26,750
DEBIT FVTPL financial asset 27

Revenue
31 July X7 4,500,000
two year fixed service
Sales 3,750,000
services 750,000
52 Page 78
Service per month 31,250

Service 3 months 93,750
Deferred income 656,250
IFRS 15, Revenue from Contracts with Customers sets out the steps that must be taken in recognising and
measuring revenue, one of which is to identity separate performance obligations. In this case, the sale of goods is
separate trom the performance obligation to provide services in future.
t seems clear that there are separate components, and that the components are capable of being measured by
reference to the price of the goods. I he service component should therefore be treated as a contract liability
(deferred revenue), to be recognised in the future in the period(s) in which the service is carried out and therefore
the performance obligation is satisfied. The value of the service element to be deferred is £750,000.
The journal entry required is:
DEBIT Revenue 750

CREDIT Contract liability 750
This transaction affects profit before tax, and therefore the opening item in the reconciliation of profit before tax to
cash generated from operations. Because no costs have been incurred in respect of the service revenue, no
adjustment is required to the cost of sales
Deferred tax
Land and building
Bfwd 1,200,000
Land and building cost 11,400,000

Land and building rev 19,200,000
tax on capital gains 20%
Gain 7,800,000
charge 1,560,000
Change 360,000
deferred tax charge is recognised as an increase in the deferred tax liability, and a decrease in the amount
recognised through other comprehensive income and reserves in respect of the revaluation.
when the land and buildings are eventually disposed of, tax will arise on the gain calculated as the difference
between sale proceeds and original cost. At 30 September 20X/, therefore, the deterred tax balance in this
respect is: (£19,200,000- £11,400,000) x 20% = £7,800,000 x 20% - £1,560,000. The balance brought forward
Temporary differences arising in respect of gains/losses on financial assets
Wayte has sustained a fair value loss in respect of the investment in PSN, held at fair value through other
comprehensive income. This is recognised in other comprehensive income in the year ended 30 September 20X7.
he tax base of the asset is £430,000, but the carrying amount is f387,000. Ihe deductible temporary ditference is
therefore £43,000. At an income tax rate of 20% this creates a deferred tax asset of (E43,0O00 x 20%) f8,600,
Tax base 430,000

Carry amount 387,500
Difference - 42,500
deferred tax - 8,500
rounded to £9,000. This amount is recognised as a deferred tax asset and is credited to other comprehensive
income. The related deferred tax effect is also recognised in OCl so has no impact on profit or loss.
The treatment of the increase in fair value of the investment in LXP is different however. This is recognised in profit
or loss in the year ended 30 September 20X7, and a current tax charge is increased in respect of the gain. This is
because, in this jurisdiction, tax treatment follows accounting treatment in respect of recognition of gains and
losses through profit or loss. At an income tax rate of 20% this increases the current tax charge by (£27,000 x 20%) = 5,400
Tax base 192000

Carry amount 218750
Difference 26750
current tax charge 5,350
Temporary differences arising in respect of the contract liability

The service income has been received. But, because it is now being treated as a contract liability it is not subject to
immediate taxation (because tax treatment follows accounting treatment in respect of income recognition). Ihe
current tax charge and current tax liability are therefore reduced by an amount of £750,000x 20%-£150,000.
services 750,000
tax charge 150,000
Journal entries required are as follows:
DEBIT Revaluation reserve (i) (Head office revaluation) 360

CREDIT Other components of equity 9
DEBIT Current tax charge (i) (LXP) 5
CREDIT Current tax liability (i) (LXP) 5
CREDIT Current tax charge (ii) (deferred revenue) 150
DEBIT Current tax liability (ii) 150
CREDIT Deferred tax () (360-9) 351
515 515
53 Page 79
SB UK AIM
Subsidarys
Investment called CG
YE Sept X7
PBT 5.3
Materiality 0.265
Trade payables
Additional investment in CG
1 June X5 2000000
Share cap
John Troon 600,000 60%
Ken Troon - John's son 200,000 20%
Sharon Troon - Ken's wife 100,000 10%
SB 100,000 10%
1,000,000
All directors that people until Jan X7
FV of 2,000,000
FV X6 2,500,000
Increase recognised OCI 500,000 Sept X6
Sale 600,000 15,000,000

Purchase 1 Jan X 240,000 6,000,000
Call option 360,000 9,000,000 1 Jan X7
SB appointed 2 directors on board

Investment recognised at 8,500,000
Associate?
SB holds 10% + (40% x 60%)24% - 34% of the shares of CG at 30 September 20X7. This would indicate that SB
has signiticant intluence as this is presumed it an investor holds 20% or more of the voting power. urther
evidence of significant intluence is that CG has a representative on the board of directors and is eftectively two of
the four board members. There are other indicators too - for example:
CGis a key supplier of SB so there are material transactions between the investor and the investee; and
Ken and Sharon have roles as directors with SB so there is an interchange of management personnel between
CG and SB.
Significant infiuence would require SB to account for CG as an associate and to equity account for the investment
under IAS 28.
Is CG a subsidiary?
SB has signed a call option which means that they will own 70% of the shares in CG on 1 January 20X8. IFRS 10
requires an investor to consider potential voting rights in considering whether it has control and whether it has the
practical ability to exercise the voting rights.
Although SB does not have the majority of the voting rights, it seems likely that it may still have control at 30
September 20X7 as SB has two out of four members of the board.
Recommended financial reporting treatment

It would theretore seem likely that control is established. SB should be accounted as a subsidiary which means that
100% of the net assets and liabilities will be consolidated within the group financial statements. The profit or loss
account is consolidated from the date of control.
The acquisition represents a step acquisition which crosses the control boundary as a previously held investment is
increased to a controlling holding.
A profit on the deemed disposal of the previously held shareholding should be recognised in other
comprehensive income. Ihis is calculated by comparing the tair value of the previously held equty with its
carrying amount at the date of disposal. Gains previously taken to other comprehensive income cannot be
recycled to profit or loss.
Goodwill is calculated by comparing the net assets at the date control is established (1 January 20X7) with the
consideration plus non-controlling interests, and the fair value of the previously held equity.
Share option
1 Jan X9 K & S 32,000 SB shares
28,000 Cash equal to SB shares
1 Jan X7 FV of shares £20
1 Jan X7 MV of shares £22
30 Sept X7 MV of shares £24
53 Page 80
Fair value cash £616,000 22 x 28,000

Fair value shares £640,000 20 x 32,000
Fair value of equity £24,000
take 9/24 as 2 years long 9 month to YE £9,000
IFRS 2 requires an entity to recognise share-based payments in its financial statements. Iherefore, the fact that no
cash is involved is not a reason for not recognising an expense.
This transaction involves a choice of settlement and results in a compound financial instrument.
Fair value at YE £24 £252,000 24 x 28,000 x 9/24
DR Expense £252,000
CR Liabiliy £252,000
DR Expense £9,000
CR Equity £9,000
Disclosure implications of share-based payments:

SB will need to disclose the nature and extent of the share-based payments in the period to help users of the
financial statements to understand how the fair value is measured and the impact on the earnings per share.
Share-based payments are also disclosed in accordance with IAS 24, Related Party Disclosures.
Share-based payments will also impact on the earnings per share (EPS).

The weaknesses in audit procedures performed by Ann have resulted in the audit assertions of accuracy and
valuation not being appropriately tested.
GRNI accrual
The audit team has identified a control weakness which revealed that the incorrect goods had been matched to
the purchase invoice - no tests ot detail have been performed by Ann in respect of this weakness.
Sample sizes should have been increased in response to the control weakness being identified.
t is not clear whether Ann has agreed the GRNI list to GRN or linked this to work on supplier statement
reconciliations. Iheretore, she has not tested accuracy of the GRNI accrual.
Ann has selected just 10 GRNI from the list to make sure they are pre- year end, but she has not linked this to
purchase invoices and the payables ledger to ensure appropriate valuation and cut off. Audit procedures (tests of
detail) are required to match invoices to GRNS pre-and post-year end and vice versa to ensure completeness and
accuracy.
There is no justification for the sample size of 10.
Ann has only agreed to bank payments and confirmed that no invoices have been received - she has not tested
accuracy and authorisation by agreeing to GRN.
No work has been completed on supplier statement reconciliations to obtain third party evidence of
completeness, valuation and accuracy.
Examining key supplier statements may identify that a significant proportion of the accrual can either be
substantiated or confirmed as not required.
Audit procedures have not been focused on older and material items in the list of unmatched GRNs.
£290,000 for debit balance on MAK

The audit procedures on the t290,000 allowance for the debit balance are inadequate and lead to inaccurate
recording ot cost of sales.
There has been no cross check to the accuracy of the accrual and to identify whether the adjustment for the debit
balance is double couted with the GRNI accrual-the results of the data analytics would suggest that this is the
case (see below).
No testing has been carried out on the timing of these payments to ensure that they are not paying against earlier
invoices.
Dashboard data Data

Number of purchase orders 7,246
Number of GRNs raised and matched to purchase orders 6,884
6,884/7,246 x 100 95%
95% of purchase orders raised are matched to GRN.
The difference could be a timing difference. However, as
liabilities are not recognised based on a purchase order but
are recognised when control is transferred to SB, no
accounting adjustment is required.
This percentage does however provide some comfort that
goods received are authorised by a purchase order and
reduces the audit risk of misstatement due to authorisation
Average time from GRN to receipt of purchase invoice 10 days

53 Page 81
The audit team reported that controls in the agreeing of GRN

to purchase invoices are ineftective.
The data analytics graph suggests that the problem is related
mainly to one outlier supplier MAK Ltd.
The average time to match the GRN to an invoice is 10 days
and only MAK is exceeding the average time and by 11 days
at 21 days.
Number of GRNs not invoiced 311

This number represents the GRNs which have been matched
to purchase orders evidencing that goods received are
authorised, but the liability has not been recorded in the
financial statements as the suppliers' invoices have not been
received and hence are not yet recorded on the system.
311/6,884 x 100 = 4.5%
This means that 4.5% of total GRNs matched to purchase

orders are not matched to a suppliers' invoice and should be
accrued as a liability and a cost.
(SB has established an accrual for GRNI based on the GRNI list
at 30.9.20X7 (see below).)
Of the 311 unmatched GRN 142 relate to MAK. Of the 156
unmatched GRNs over 2 months, 122 relate to MAK
Number of GRN unmatched to invoice over 2 months 156

156/6,884 x 100-2.3%
2.3% of GRN unmatched are over 2 months old.
Test for MAK Ltd

Number of purchase orders 771
Number of purchase orders matched with GRN 732
732/771 x 100 95%
95% of MAK purchases orders are matched to GRN. This is
equal to the general population. This provides some
assurance that purchases are authorised. MAK is SB's large
supplier.
Average time from GRN to receipt of purchase invoice 21 days

The analytics supports the information received elsewhere on
controls testing thata specific problem regarding invoicing at
MAK is one of the reasons for the large GRNI accrual.
Number of GRNs not invoiced at 30 September 20X7 142

142/732 x 100 19%
This represents 19% of total GRNs matched to purchase
orders compared to 4.5% for the total population.
Number of GRNs unmatched to invoice over 2 months old 122

122/732 x 100 16.6%
16.6% of MAK GRNI are over 2 months old-
142/307 x 100-46%
469% of all GRNI relate to MAK GRNs.
Audit risks
Delay in invoicing accuracy and completeness
As there is a delay of 10 days between GRN and recording of invoices, there is an audit risk that delays in invoicing
could lead to inaccurate recording of inventory valuations and purchases. I his is increased for MAK where the
delay is up to 21 days.
Unmatched GRN over 2 months - overstatement

GRN unmatched over 2 months increase the risk that purchases and payables are overstated and not accurately
recognised. The analytics supports the information received elsewhere on controls testing that a specific problem
regarding invoicing at MAK is one of the reasons for the large GRNI accrual. Procedures performed by Ann are
inadequate and do not confirm the accuracy and completeness of the GRNI accrual and the adjustment for the
debit balance on MAK.
There is a risk that the purchases and payables (accruals) have been overstated by E290,000 because the accrual
for the debit balance and the GRNI accrual both include the costs of goods supplied by MAK Ltd.
Using the above analysis, the expected GRNI accrual can be calculated approximately as follows:
53 Page 82
MAK GRNI 142 x £2,040 289,680

Other unmatched GRNI 311 - 142= 169 x £1,900 321.1
610,780
Accrual GRNI 610,000
Difference 780
Control weakness - measurement and accuracy

Control testing identified weakness in controls by staff matching the GRN to the correct purchase invoice. The risk
therefore exists that invoices have been recorded for goods not received or more likely that the GRNI accrual is
Overstated.
SB has recorded an adjustment for payments made to MAK without invoices of £290,000 which would represent
142 MAK orders based on the average order value of £2,040. There is a total of /32 MAK purchase orders
matched to GRN.
An expected number of unmatched GRN based on the whole population would be 732 x 10 days/365 days - 20.
As the total of unmatched GRN tor MAK is 142, it suggests that the adjustment for unmatched payments has been
double counted in the GRNI accrual and the accrual for the debit balance should be reversed.
Additional audit procedures

Further controls testing should be undertaken on the matching of GRN to invoice to confirm whether the
control weakness applied to other suppliers.
MAK GRNs included in the GRNI should be tested 100% to ensure that they are appropriately accrued. In
addition, audit procedures should be focused on older and material items from other suppliers in the list of
GRNI. Any unmatched GRN's should be removed from the GRNI accrual and an audit adjustment calculated.
Obtain the MAK supplier statement and agree invoices received post year end to the GRNI accrual.
Other key supplier statements should be agreed to invoices and GRN pre- and postyear end.
Agree a sample of purchases invoices to purchases orders to ensure accuracy and valuation.
Review supplier terms for each large supplier and assess whether the time delay is normal for each suppliers'
invoice terms.
Ensure appropriate valuation procedures are pertormed on inventory to record the correct cost of inventory.
Perform invoice cut oft procedures by agreeing invoices pre- and postyear end to inventory records and
payables accounts to ensure correct recognition of payable and accruals and inventory.
54 Page 83
Disposal of Luka Ltd
Paid 10.5 75%
SC 0.1
Sold Now 15% 7.9

FV of 15% 1
Investment 15% @ 2.1

They have treated as discounted operation
Losses 0.5
Disposal recognised as 10.5 x 60/75 - 7.9
2/4 board members are directors in Luka

Luka has 1 board member of EC
100% of purchases from another subsidary
Uses group share service centre ie marketing and accounting
Loss before taxation -890

Income tax 140
Loss after taxation -750
Loss on disposal of shares in Luka -500
Loss from discontinued operations -1,250
Net assets at YE 9.25

Tax loss 1.5 arose evenly
Loss for period ie 6/12 0.75
Net assets at 1 Dec X7 10

The directors have made a judgement that EC Ltd no longer has control or significant influence over Luka and
have recognised its shareholding in Luka as a simple investment
The key judgement area here is whether EC retains a significant influence over Luka.
Significant intluence is detined as the power to participate' but not to control.
Significant influence is presumed to exist if an investor holds 20% or more of the voting power of the investee
unless it can be shown that this is clearly not the case.
EC now owns just 15% and there are only two other shareholders- Walter Brown, the CEO clearly holds the
majority of the voting shares. However, there are other facts which may establish significant infiluence for EC.
Together with the Japanese minority shareholder, EC could control the board of directors with majority decisions
as two of its board members are also on the Luka board.
There are material transactions between the two companies - the filters for Luka's product are specific to Luka's
product and are provided by a 100% owned subsidiary of EC Ltd. Also, EC continues to provide support services
to Luka.
The above would suggest that Luka is an associate of EC and IAS 28 requires the use of the equity method to
accounting tor investments in associates. I he results of the subsidiary are included until disposal.
The loss on disposal calculated in protit or loss as part of discontinued operations of E500,000 has been calculated
incorrectly and is the amount hich should be recognised in the parent company financial statements not the
group profit or loss - it is incorrect regardless of whether the investment is treated as an associate or an investment.
Because the shareholding crosses the control boundary, the retained interest is measured at the fair value at
disposal, and the gain is measured by reference to the net assets at the date of disposal.
Proceeds 7900
FV of 15% 1000
8900
Net asset 10,000
Goodwill 0 full impaiared
Less NCI -2500
7,500
Profit on disposal 1,400
£1.5 million x 6/12 x 15% = £112,500
Treatment as discontinued?
lo be presented as discontinued the sale of EC's shares in Luka need to be part of a single coordinated plan to
withdraw trom a major business line - the level of commercial links between EC and Luka would indicate that this is
not a discontinued operation and its results should be presented in continuing operations to the date of sale which
54 Page 84
is 1 December 20X7.
6-months results tor Luka are included on a line by line basis in the statement of proit or loss until the date of sale-
1 December 20X7.
As Luka is to be presented on the SOFP as an associate using equity accounting, the group's share of the
associate's loss should be presented also as continuing operations.
£1.5 milionx 6/12 x 15%- £112,500
As an associate, Luka would be a related party of EC and disclosure would be required of transactions and services
between the two parties.
Intercompany trading may give rise to adjustments for unrealised profit.
Audit risks
The key audit risk is that the group tinancial statements will be presented incorrectly, omitting the results ot the
subsidiary trom continuing operations and calculating the loss on disposal incorrectly and the presentation of the
remaining shareholding as an investment instead of equity accounted as an associate.
Audit procedures required:

Obtain and test the key assumptions made by management regarding the level of significant intluence
Agree costs to the sales agreement and ensure that they have been recognised correctly and that the
consideration has been fairly stated in accordance with the agreement
Agree the accuracy of the accounting entries and confirm the profit on disposal is correctly stated and
repertorm the calculations for revenue and expenses to ensure that they have been correctly time apportioned.
Agree the calculations of fair value of the remaining interest and confirm that they are calculated in accordance
with IFRS 13. Test the assumptions of the cash flow projections and the appropriateness of the discount rate
used.
Verity consideration to contract and agree to bank.
Contingent Liability
fraud for bribery and corruption investigation
takes 5 years to resolve
estimated likelihood
No fines payables 52%
£1.00 38%
£1.50 10%
0.53

IAS 37 states that a provision should be recognised it an entity has a present obligation as a result of a past event
which will result in a transter of economic beneftit which will be probable and a reliable estimate can be made of
the amount of the obligation.
The issue here is whether the company should be providing for potential costs in the first instance and then to
determine if the uncertainty means that the current treatment as a contingent liability is correct and whether the
disclosure is sutticient
The contingent liability disclosure sets out the nature of the liability and states that its financial effect cannot be
estimated reliably. Audit procedures set out below should confirm whether the disclosure is adequate.
Legal advice suggests that the outcome may not be probable at 52% - which means that it is a 48% probability that
fines would be payable - this is a very narrow margin and audit procedures would need to challenge the
assumptions made by the internal legal team (the management's expert). Should a provision be required it would
be established at the most likely outcome.
With respect to the provision for future operating losses of f433,000, the directors appear to have incorrectly
included a provision for future operating losses as the costs relate to continuing business and there is no
obligating event either legal nor constructive at the reporting date. We should recommend that this amount be
adjusted by debiting provision and crediting profit or loss.
Audit risks
The key audit risk is that liabilities are incorrectly stated, disclosure in respect of the contingent liability is not
appropriate or in proportion to the risk as described by the directors within other sections of the financial
statements - eg, directors' review of risks.

Evaluate and test the Group's policies, procedures and controls over the selection and renewal of
intermediaries and responses to suspected breaches of policy.
Identify and test payments made to intermediaries during the year and ensure that payments are only made in
compliance with the Group's policies.
Enquire of management, the Audit Committee and the Board as to whether the Group is in compliance with
laws and regulations relating to bribery and corruption in the countries in which EC operates.
Discuss the areas of potential or suspected breaches of law, including the ongoing investigations, with the Audit
Committee and the Board as well as the Group's legal advisers and assess related documentation.
Communicate with relevant component auditors to ensure that vigilance and scepticism is maintained to
identity possible indications of significant non-compliance with laws and regulations relating to bribery and
54 Page 85
corruption whilst carrying out our other audit procedures.

Evaluate whether the disclosure in the contingent liability note to the financial statements is adequate for the
users to understand the Group's exposure to the financial effects of potential or suspected breaches of law or
regulation.
Conclude on whether it is the case that the investigations remain at too early a stage to assess the
consequences and whether a provision should be included in the financial statements. Challenge
management's estimations of the probability of the outcome of the investigation.
Sale of manufacturing division in Spain Factory Office Plant and

(including land) (including equipment
Cost at 31 May 20X7 and 31 May 20x8 4,385 4,640 4,850
Accumulated depreciation at 1 June 20X7 -685 -800 -1,986
Depreciation for the year ended 31 May 20X8 -137 -160 -286
Carrying amount at 31 May 20XX8 3,563 3,680 2,578
Depn 25.00 25.00 10%

Method SL SL RB
Revaluation in euro March X8 5040 5570

30 June 20X8
1 March 20x8 £1 €1.20

31 May 20X8 £1 €1.10
30 June 20x8 £1 -€1.12
Continuing operations
Revenue 31,170
Profit before tax 1,896
Income tax expense (Note 1) -380
Profit from continuing operations 1,516
Discontinued operations
Loss from discontinued operations (Note 2) -1,250
Sale of manutacturing operation

The directors' treatment of the non-current assets of the manutacturing operation is incorrect.
IFRS 5, Non-current Assets Held for Sale and Discontinued Operations requires non-current assets to be held for
sale if the carrying amount is recovered principally through a sale transaction rather than through continuing use.
In respect of the factory building and the plant and equipment, the criteria appear to have been satisfied. The
factory has been advertised for sale and an offter has been received tor the equipment.
These assets should be classified as held for sale at fair value and should not be depreciated after the decision to
sell the assets on 1 March 20X8. The assets should be measured in current assets at the lower of the carrying
amount and the fair value - the fair value is in the case of IFRS 5 defined as the fair value less costs to sell - there is
no requirement to follow the detinition in IAS 36, Impairment of Assets to determine the recoverable amount.
Depreciation for the last three months should be reversed as follows
DEBIT Accumulated depreciation Plant and machinery 72

DEBIT Accumulated depreciatio Factory building 34
CREDIT Operating profit 106
Subject to the valuation being appropriate, the factory does not appear to be impaired.
Cost at 1 June 20X7 4385
Less: Depreciation f685,000+ for 9 months/12 months x 137= £103,000 -788
3597
Fair value
EURO offer - 5040 / 1.2 (exchange rate) 4200
Therefore, the tactory should be held at the carrying amount of £3,597,000.

The plant and equipment however may be impaired if the offer received on 30 June 20X8 is indicative of its fair
value at the year end.
54 Page 86
Cost at 1 June 20X7 4850

less depen 1986 + 9/12 x 286 -2201
2649
Fair value
EURO 2519 / 1.12 2249
Impairment 2649 - 2249 400
The office should not be recognised as held for sale - Instead the office should be accounted
for as an Investment property as per IAS 40.
The property should be revalued at the date the change of use occurred to tair value anda revaluation gain
recognised in accordance with IAS 16.
The depreciation charqe for the final three months should be written back to profit or loss as follows:
DEBIT Office building accumulated depreciation 40

CREDIT Operating profit 40
A gain on reclassification Is calculated as follows: 4640

Cost at 1 June 20X7 -920
Less: Depreciation f800,000 +9 months/12 months x £160,000 = £120,000 3720
Fiar vlaue
EURO 5570 / 1.2 4642
Audit risks
There is an increased risk associated with the assets being purchased in a different currency and located in
ditterent jurisdictions. There is specitic risk over the valuations and the valuation methods used which would lead
to the assets not being correctly recognised in the financial statements.
No mention has been made of how the lease has been recognised and the financial reporting treatment of this
may also be incorrect.

Evaluate the design and implementation of controls around property valuations by considering the involvement
of the EC board of directors and the expertise of the board members
Obtain the valuation report prepared by the Spanish surveyor and test its integrity by:
Comparing the valuation tor the factory with the surveyor' s evidence of the recent sale of the similar property
in the area.
Agreeing the price per square metre to other properties for sale in the area.
Appoint an auditors' expert to agree the valuations.
For the oftice building valuation, obtain the surveyor 's calculation and test the inputs to the valuation by:
contirming the rental price per square metre with properties advertised for let in the area and
agreeing the accuracy of the calculation and the reasonableness of the occupancy rates.
Arrange a meeting with the valuer and assess the independence of the scope of the work they have performed
tor EC. Agree the sunveyor's qualitications and ensure appropriate level of expertise to carry out the valuations.
Agree the valuation of the plant and machinery to evidence of the offer made by the Spanish company.
Obtain a copy of the lease agreement to ensure that the classification of the office is correct as an investment
property.
Enquire of management how the lease agreement has been accounted for in the financial statements.
profit on disposal
Luka and
results for associate's
6m profit Provision Depn Impairment
Revenue 31170 7500 38,670
Profit before tax 1,896 -890 1400 433 146 -400 2,585
Income tax -380 140 -240
Profit from continuing operation 1,516 -750 766
Post-tax loss of associate -113 -113
Profit on disposal of shares

Ihe profit on disposal of the shares is not taxable and therefore will not change the current tax nor the deferred
ax.
Write back of provision for operating losses

Because tax and accounting rules are the same an adjustment made to the accounting profit will be reflected in
the income tax expense by increasing the current tax charge -therefore the write back of the provision for future
operating loss will result in an increase in the accounting proftit and theretore an increase in the current tax
expense.
54 Page 87
Depreciation for buildings

The decrease in the depreciation expense for the factory and the office building are disallowable expenses and
will not be compensated for by a deferred tax timing difference. Any cost for depreciation of a building recognised
in the income statement is added back to profit to calculate current tax and no timing ditterence is required for
deterred tax purposes.
Plant and equipment- write back of depreciation and impairment

The depreciation and impairment in respect of the plant and equipment will give rise to a temporary timing
difference -therefore the reduction in the cost tor depreciation will cause the accounting profit to increase but the
impairment will cause the profit to fall - however both costs are added back to calculate current tax. Deferred tax is
calculated based on the timing difference arising between the accounting base and the tax base. The carrying
amount of the plant and equipment at the year end is compared to the tax written down value and a deterred tax
adjustment calculated. Therefore, an adjustment to the deferred tax liability will need to be calculated. Further
intormation concerning the rate of tax depreciation is required.
Office building revaluation

The revaluation is taken to OCl and reserves. As the accounting base is different from the tax base a deferred tax
adjustment is required - the increase in the deterred tax liability is debited to OOCl and credited to the deferred tax
liability included in non-current liabilities.
Associate profit
Each company is assessed to tax on its own profits - therefore this adjustment already includes the group's share of
the associate's tax charge and has no impact on the current tax expense.
55 Page 88
Extracts from statement of comprehensive income for the year ended 30 April 20x8
Profit betore tax 2300
Other comprehensive income 0
Revised profit before tax 2300

As originally stated 92
Gain on financial asset -1,320
Depreciation (1,028 + 292) 540
Correction of rental charge to P/L -100
Impairment expense 1,749
Gain on disposal of sale and leaseback asset -208
Interest on lease liability -148
Interest cost pension scheme -390
Current service cost pension scheme -120
Past service cost pension scheme 141
Interest on pension scheme assets 575
Correction of misposting
Net total of adjustments 811 difference
Revised profit before tax 3,111 811
Other comprehensive income

As originally stated 0
Recognition of financial asset (1,923 -706) 1,217
Impairment (Production line) -700
Net actuarial loss on pension scheme -132
Revised other comprehensive income 385
Non-current assets JN1 JN2 JN3 JN4 JN5 Change PL Revised

Property, plant and equipment 53,860 8772 -800 -7000 51,881
-1923
-1028
rou 2919 - 292 2627 2,627
Suspense account-one 6,757 -6757 0
Financial asset 706 1309 0
-2015
Current assets 61,323
Total assets 20,859 20,859
82,182 75,367
Equity
Share capital (£1 ordinary shares) 200 200
Separate components of equity 12 12
Retained earnings 25,920 811 26,731
Revaluation reserve 6,200 -700 5,500
Cash flow hedge reserve 706 1217 0
-1923
Other reserves 600 -132 468
33,626
Loans 18,650 18,650
lease liability 3490 3,490
Fension- net defined benetit liability 136 649 210
-575
Suspense account -two 10,000 -10000 0
28,786
Current liabilities 19,770 -12 348 20,106
Total equity and liabilities 82,182 75,367
348 = current lease liability
Cash flow hedge

Machine cost 50 1 Marhc X7 paid 31 July X7
Forward contract 50 1 to $7.4
Financial assets 705,930
DEBIT Suspense account- one (R$50,000,000/5.7) 8,771,930

CREDIT Cash 8,771,930
DEBIT Cash 2,015,173
CREDIT Suspense account -one 2,015,173
55 Page 89
Forward
Spot (for delivery on 31 July 20X7)
1 March 20x7 £1-R$7.3 £1-R$7.4
30 April 20x7 £1-R$6.5 £1-R$6.7
31 July 20X7 £1- R$5.7 f1-R$5.7
Asset recognised 30 April X7

Year end 31 April X8
Correctly reported at 30 April 20X7.

At 30 April 20X7, provided that the cash flow hedge was effective, it was correct to recognise a financial asset
and a matching credit in other comprehensive income. The amount of £705,930 was calculated as follows:
Value of contract at 30 April 20X7 (RS50,000,000/6.7) 7,462,687 Last accounting period

Value of contract at inception on 1 March 20X7 (RS50,000,000/7.4) 6,756,757 contract start date
705,930
The change in the tair value of future expected cash flows on the hedged item is calculated as tollows:
Value of hedged item at 30 April 20X7 (RS50,000,000/6.5) 7,692,308
Value of hedged item on 1 March 20X7 (RS50,000,000/7.3) 6,849,315
Gain on contract 842,993
As this change in the fair value is greater than the gain on the forward contract, the hedge is deemed to be
fully effective and the whole of the gain on the forward contract is recognised through OCI.
The IFRS 9 criteria to use hedge accounting have been met, so it was valid to use hedge accounting.
Remeasurement of financial asset at 31.7.2OX7

At 31 July 20X/, the settlement date, the further gain and change in value of tuture expected cash tlows on
the hedged item are recalculated:
Value of contract at 31 July 20X7 (RS50,000,000/5.7) 8,771,930

Value of contract at 30 April 20X7(RS50,000,000/6.7) 7,462,687
Gain on contract 1,309,243
Value of hedged item at 31 July 20X7 (RS50,000,000/5.7) 8,771,930

Value of hedged item on 30 April 20X7 (R$50,000,000/6.5) 7.692,308
1,079,622
As this change in the fair value of the hedged item is less than the gain on the forward contract, part of thee
gain on the forward contract is said to be inetective and this part of the gain on the forward is recognised in
profit or loss.
The efective part of the hedge is calculated on a cumulative basis by comparing the cumulative gain on the
forward contract at inception of the hedge with the cumulative gain in tair value of the hedged item from the
inception.
The cumulative gain on the forward contract is (E705,930 + £1,309,243)) £2,015,173.

The cumulative change in value on the hedged item is (f842,993+ £1,079,622) £1,922,615.
The ineffective portion of the hedge is f2,015,173 - £1,922,615 - £92,558, and this is recognised in profit or
loss. The remainder, the ettective portion, is recognised in other comprehensive income: £1,309,243 -
£92,558 £1,216,685.
Cumulative value of forwards 705,930 1,309,243 2,015,173

Cumulative value of hedge 842,993 1,079,622 1,922,615
PL charge 92,558
OCI 1,309,243 92,558 1,216,685 recognised as OCI
Journal entries are as tollows:

DEBIT Financial asset 1,309,243
CREDIT Other comprehensIve income 1,216,685
CREDIT Profit or loss 92,558
Subsequent treatment of cumulative gain

A cumulative gain of £1,922,615 (ie, 705,930 recognised in year ended 30.4.20X7 + £1,309,243 the
55 Page 90
additional gain in the three months to settlement less £92,558 recognised in profit or loss as the ineffective
portion) has been recognised in other comprehensive income and is held in equity.
This is a cash flow hedge of a new machine, which is a non-financial asset. Therefore, IFRS 9 requires that the
amount accumulated in the cash tlow hedge reserve is transterred to be included in the initial cost or carrying
amount of the non-financial item. This is not a reclassification adjustment and does not affect the other
comprehensive income of the pernod.
Recognition of asset and depreciation

At the date of purchase, 31 July 20X7, the machine asset is recognised at its fair value. The effects of the cash
transactions at 31 July 20X7 in respect of the purchase of the machine and the settlement of the forward
contract have been recognised in a suspense account. Ihis suspense account is now eliminated by the
following entries.
DEBIT PPE (RS50,000,000/5.7) 8,771,930

CREDIT Suspense account 8,771,930
DEBIT Suspense account 2,015,173
CREDIT Financial asset 2,015,173
The net credit to the suspense account is (£8,771,930 - E2,015,173) £6,756,757, and so the suspense account
is eliminated.
IFRS 9 requires that the amount of the cash flow hedge reserve be deducted from the amount of thee
capitalised value of the machine (£8,771,930).
This is recorded by the following journal entry:
Cumulative value of hedge 842,993 1,079,622 1,922,615
DEBIT Cash flow hedge reserve 1,922,615

CREDIT Property, plant and equipment 1,922,615
In the financial year ended 30 April 20X8, nine months' worth of depreciation is charged:
E(8,771,930-1,922,615) x 5 years x 9/12- £1,027,397 8,771,930
This is recorded by the following journal entry: -1,922,615
6,849,315
Depn 1,027,397 5 year and 9/12
DEBIT Profit or loss 1,027,397
CREDIT Depreciation 1,027,397
Issue of ordinary shares YE April X8

Share cap
1 May X7 200,000
1 Nov X7 goods 2,000 FV

for 50 new £1 shares in Raven
2 year period
total shares to be recognised 1,200
value 4,800
shares at YE 300
DR COS 12000
CR TP 12000
correcting jounral
CR SC 12000
DR TP 12000
Ihe issue of shares to Ester Ltd constitutes an equity-settled share-based payment transaction. Because the
shares are being issued to a third party, the transaction is recognised at the fair value of goods provIded,
which in this case is £12,000, with a debit of that amount to cost of sales, and a credit to equity. Iheretore, the
accounting entry already made is partly correct, but the credit should be to equity rather than to trade
payables. The credit is normally to either a separate component of equity or to retained earnings. If the credit
is to a separate component of equity, the correcting journal entry is as follows:
NCA fixed production line

Cost 1 May X2 8,000
depn 10 year 800
55 Page 91
revalued 30 April X5 6300

30 April X8 Impairment
FV less cost to selll 2,600
value in use 2,800 use higher
New depn 1050

CA at X8 3150
Value in use 2,800
CA in April 5600
RR 700
Carry amount 6300

7 years left and 4 year pass 3600 x 4/7
value in use 2,800
Impairment 800
DEBIT Revaluation reserve 700,000

CREDIT PPE 800,000
This asset was revalued on 30 April 20X5, three years after purchase, when its carrying amount was
(E8,000,000 x //10) £5,600,000. The amount of the revaluation was theretfore (t6,300,000 - £5,600,000)
£700,000. Because Raven does not have a policy of making annual transters from revaluation reserve to
retained earnings, the revaluation amount of t/00,000 relating to the production line still forms part of
Raven's revaluation reserve at 30 April 20X8.
The carrying amount of the asset at 30 April 20x8, before impairment, was:
£6,300,000 x 4/7 - £3,600,000
The recoverable amount of the asset at that date was the higher of fair value less costs to sell (£2,600,000)
and value in use of f2,800,000. The amount of impairment to be recognised at 30 April 20X8 was therefore
(E3,600,000 - £2,800,000) f800,000. This is offset first against the amount of £700,000 relating to this asset in
revaluation reserve, and then the balance is recognised as an expense in profit or loss. Ihe journal entry Is as
follows:
Lease asset
Sale 10,000,000 FV at 1 May X7
Lease back over 10 years
CA 7,000,000
Annual rent 540,000
Useful life 50 years
Interest 5%
ROU 4,169,880
Reverse
DR Cash 10,000
CR Suspense 10,000
This transaction must be accounted for in accordance with the sale and leaseback rules of lFRS 16, whereby a
right-of-use asset is recognised for the rights retained and a gain on disposal is recognised tor the rights
transferred. The present value of the future lease payments using the 5% interest rate implicit in the lease is
£540,000 x 7.722 - £4,169,880.
A three-stage process is applied

Stage 1: Measure the right-ot-use asset arising from the leaseback as a proportion of the previous carrying
amount of the asset that relates to the right of use retained by the seller/lessee
Carrying amount x PV of future lease payments at transfer date / fair value of asset at transfer date
£7,000,000x £4,169,880 / £10,000,000 = £2,918,916
The remaining carrying amount of £4,081,084 (7,000,000-2,918,916) represents the transferred asset.
Stage 2: Recognise the amount of any gain on the sale that relates to the rights retained by the seller:
Total gain on sale £10,000,000- £7,000,000 £3,000,000
Gain relating to rights retained: £3,000,000 x £4,169,880 + £10,000,000 = £1,250,964.
Stage 3: Recognise the amount of any gain on the sale that relates to the rights transferred to the buyer:
The gain relating to the rights transferred is the balancing figure. Therefore, gain relating to rights transferred
is £3,000,000- f1,250,964 - £1,749,036.
55 Page 92
DEBIT Right-of-use asset 2,918,916

DEBIT Bank 10,000,000
CREDIT PPE 7,000,000
CREDIT Gain on disposal 1,749,036 balance
CREDIT Lease liability 4,169,880
ROU 2,918,916
Year depn over 10 291,892
DEBIT Depreciation expense 291,892

CREDIT Right-of-use asset 291,892
The lease liability is amortised, going one year turther to determine current versus non-current:
1 May 20XInterest at Repayment Closing bal

Open bal 4,169,880 208,494 -540,000 3,838,374
Lease pay 3,838,374 191,919 -540,000 3,490,293 non current
348,081 current
Amortisation for the year ended 30 April 20X8 is recognised by:

DEBIT Finance charge 208,494
DEBIT Lease liability 331,506
CREDIT Bank 540,000
Of the total lease liability at 30 April 20x8, 540,000 -191,919 - £348,081 (capital repayment) is current and
£3,490,293 is non-current.
Journal entries are required as follows to record the disposal and to clear the suspense account:
DEBIT Suspense account 10,000,000

DEBIT Right-of-use asset 2,918,916
CREDIT PPE 7,000,000
CREDIT Lease liability 4,169,880
CREDIT Gain on disposal 1,749,036 balance
To record the disposal and leaseback on 1 May 20X7

DEBIT Depreciation expense 291,892
CREDIT Right-of-use asset 291,892
To record depreciation of right-of-use asset in the year ended 30 April 20X8

The lease payment of f540,000 made on 30 April 20X8 should not have been recorded in profit or loss, so an
adjustment is required:
DEBIT Finance costs 208,494

DEBIT Lease liability 331,506
CREDIT Profit or loss (operating costs) 540,000
To record correction of incorrect charge of lease rental to profit or loss.
Pension scheme
Denefied benefits pension
Obligation Assets
Opening balance - 2,966.00 2,830.00 - 136
Interest - 148.30 141.50 DR Interest cost PorlL CR Interest cost PorL
Contrubtions 575.00 Adjust for misposting to PorL
Past service - 120.00 DR PorL
Service cost - 390.00 DR PorL
Benefits paid out 330.00 - 330.00
- 3,294.30 3,216.50
- 163.30 31.50 - 132 Gain/loss to OCl (net loss of £131,800)
Actuary FV - 3,457.60 3,428.00 - 30
CR Staff cost 575

DR Planned as 575
Amount debited staff cost
Explanation
55 Page 93
The posting of the contribution to staff costs does not reflect the correct financial reporting treatment under
IAS 19. The opening obligation should be adjusted to retlect the service cost which is the increase in the
present value of the defined benefit obligation resulting from employee services during the year and the
interest cOsts which represents the 'unwinding of the present value of the obligation.
The net defined benefit obligation needs to be remeasured to calculate the actuarial gains and losses and
actual return on plan assets which are taken to reserves through OC.
The journal entries required are as follows:
DEBIT Interest cost 148,300

DEBIT Profit or loss (salaries) 390,000
DEBIT Profit or loss (salaries) 120,000
DEBIT Reserves 131,800
CREDIT Interest cost 141,500
CREDIT Net pension obligation 648,600
Correction of misposting of contributions to profit or loss (salaries)

DEBIT Net pension obligation 575,000
CREDIT Profit or loss (salaries) 575,000
Example of pension
Assets Obligation
Opening balance 22 -60 -38
Interest 1.1 -3
Contro 6.4
Redudancy -4.2
Service cost -5.9
Benefits paid -2.1 2.1
Sub total 27.4 -71
Gain/loss re measure recog OCI 5.2 -3.5
At year end 32.6 -74.5
56 Page 94
Interm review
Materiality 50,000
5% of PBT
Exhibit 1: Report from Cromer Bell specialist data analytics team on MRL's operating expenses for the 10 months ended 30 June 20X8
MRL's financial statements for the 10 months ended 30 June 20X8 include total operating expenses as shown below.
10 months to 30 10 months to
June 20x8 30 June 20X7
£'000 £'000
Wages and salaries for administrative staff 2,324 2,159 7.6%
Other staff expenses 495 540 -8.3%
Insurance, electricity, gas and other utilities 1,140 1,275 -10.6%
Depreciation of oftice equipment 180 200 -10.0%
Movement in allowance for receivables 80 200 -60.0%
Profit on sale of branch office -300 0
Legal and professional fees 210 50 320.0%
Movement in provision for claims and other legal matters 40 180 -77.8%
Start-up costs for MP Ltd 230 0
Other administrative expenses 76 63 20.6%
Total operating expenses 4,475 4,667 -4.1%
Client data
In February 20X8, a credit entry of tl100,000 was made to the impairment allowance for receivables.
In June 20X8, a credit entry of £300,000 was made in respect of the protit on the sale of the branch office.
December 20X7 expenses include a one-off legal fee of f150,000.
October 20X7 expenses include start-up costs of f230,000.
Movements in the provision for claims and other legal matters were:
a credit entry of £40,000 in February 20x8
a debit entry of £80,000 in March 20x8.
April 20X8
DEBIT Wages and salaries for administrative staff £50,000
CREDIT Accruals £50,000
Half-year bonus for MRL executive team.
(2) In May 20X8:

DEBIT Other staff expenses £9,000
CREDIT Cash £9,000
New tablet.comnuters for finance team
Financial reporting issues and audit risks

Trade receivables allowance
The expense relating to the allowance for receivables is lower than in the prior year, although there is still a net charge for the year to date of f80,000. The level of this allowance is an area of
Judgement and the movement booked by Gil in February 20x8 highlights that it is also open to potential manipulation by management.
Gil has provided an explanation for his decision to reduce the allowance in February but this needs further follow up. The IFRS 9 model for calculating the impairment of receivables is based on
expected losses, rather than incurred losses. Historic levels of debt written off are one relevant factor in determining the allowance but it is also important to look at the ageing and at whether
irrecoverable debt is just remaining on the receivables ledger rather than being written oft.
In addition, it is clear from the meeting with Gil that there has been a change in MRL's customer base. As a result, the historic level of write offs may not be a good basis to determining the current
required level of allowance.
As this is a judgemental area which is open to manipulation where change has occurred both in what has been booked and the underlying business, an audit risk has been identified.
Sale and leaseback of branch office

The treatment of the sale and leaseback is incorrect. Under IFRS 16, only the gain on the rights transferred may be recognised. First we calculate the gain on the rights retained:
Total gain x PV of future lease payments at transfer date/ fair value of asset at transfer date
Total gain on sale - £300,000 (per question).
Present value of future lease payments £120,000 x 7.020 f842,400
Fair value (per question)-£1,000,000
Gain relating to rights retained: £300,000x £842,400 / £1,000,000 £252,720
FV 1,000,000
PV of lease 842,400 120,000 x 7.02
ROR 589,680 (700k x PV ) / 1,000,000
Gain in sale 300,000
Gain relating ot Right retrained 252,720 (300k x PV) /1,000,000

Less gain 300,000
47,280
The gain relating to the rights transferred is the balancing figure. Therefore, gain relating to rights transferred is £300,000 - £252,720 - £47,280.
The credit to profit or loss should be reduced by f252,720 to £47,280.
The transaction took place on the last day of the 10-month period, but for the final 2 months, and in subsequent years, depreciation will be calculated on the right-of-use asset and the lease liability
amortised. The right-of-use asset is also apportioned and only the rights retained by the seller are recognised in the statement of tinancial position:
Carrying amount x PV of future lease payments at transfer date/fair value of asset at transfer date
£700,000 x f842,400 + £1,000,000 - £589,680
Legal and professional fees

The significant legal and professional fees in December 20X7 are not explained by the notes of the meeting and need to be followed up. They could be indicative of a legal claim or of a signiticant
planned transaction which could give rise to enhanced audit risk or a financial reporting matter.DEBIT
Start-up costs
The start-up costs relate to the new company set up with Peerless and appear to relate to an amount subscribed as initial capital. It theretore appears incorrect that this should have been treated as an
operating cost.
The relevant accounting guidance to consider is that concerning joint arrangements. MP is a separate entity and will have Articles setting out the contractual arrangements between the parties. As
50:50 shareholders, neither Peerless nor MRL will have control. MP will have its own assets and liabilities and the arrangement is therefore a joint venture rather than a joint operation. it shouldd
therefore be accounted for using the equty method in the consolidated accounts for the Milcomba GroupP
The initial capital represents an investment in the JV and should have been shown in the statement of financial position as an investment and not accounted for as an operating cost. In MRL's separate
financial statements, the investment will in accordance with IAS 27, be held at cost less any impairment in value or in accordance with IFRS 9. An impairment seems unlikely as MP is profit making.
For the Milcomba consolidated accounts, the investment value will increase by MRL's share of the profit made by MP (50% of £50,000 - £25,000 (less any tax). This, together with any associated tax
charge, wil be reflected in the group statement of profit or loss.
MRL will also have transactions with MP to pay its share of the ongoing trading costs and we will need to ensure that these are properly accrued and accounted for - and this represents a clear audit
risk. It should eliminate from its costs any unrealised profits - this could arise where costs in respect ot an ongoing recruitment job are incurred in MP and carried on the SOFP of MRL Only haltf of the
profit is eliminated as the other halt accrues to the other investor, Peerless..
Provision for legal claims

While the net movement on this provision is not material, there have been movements in the year and the completeness ot the provision is an audit risk.
Revenue recognition and WIP

Recruitment fees are invoiced when the position is filled which is the point at which MRL becomes entitled to a tee. However, the costs will have been incurred over a period of time before that date.
IFRS 15, Kevenue from Contracts with Customers requires revenue to be recognised when a pertormance obligation is satistied. Ihe pertormance obligation in this case is the service to the customer
which is tilling the position so an initial recognition point at the date on which an ofter is accepted seems reasonable, providing the amount of the revenue can be reliably determined at that date.
Direct costs incurred prior to that point must be expensed as incurred under IRS 15, and may not be carried in work in progress.
Refunds are payable if the employees recruited leave their positions within three months. There may be established expectations for refunds from the financial services industry but MRL's knowledge
of refund levels for the new sectors it has moved into will be less extensive and it may be ditticult to estimate retund levels.
The inherent uncertainty of refund levels is a key audit risk and financial reporting issue, as is cut-off and ensuring that costs and revenue are recorded in the right periods.
Risk of management override of controls

There was an incentive at the half year to meet targets so that management bonuses were paid. Although Gil will not get a bonus himself, he may have been under pressure from the rest of his team to
ensure that their bonuses were earned. Incentives to achieve certain results will lead to increased audit risk and there is also evidence of pressure from the Group finance department. It is important
that all incentive schemes are understood as part of the audit and that pressures on management are considered in shaping the audit response to the risk of management override of controls which is
a presumed audit risk.
The tact that the finance director can post journals also increases the risk in this area and we need to plan a focused audit response which includes all journals and not just those attecting operating
expenses.
Audit approach to operating expenses

Substantive analytical procedures are likely to be a good audit procedure to test populations where there is a large volume of transactions which is predictable over time.Whether they are a good test
56 Page 95
also depends on other factors Such as whether a reliable estimate can be developed from reliable data in order to make a prediction as a benchmark expectation against which to Judge actual results.
In addition, we need to consider whether substantive analytical procedures alone will provide sufticient evidence or whether they are or need to be supported by other audit evidence. In most cases,
the work on the expenses will be supported by work on liabilities or provisions.
tis also necessary to consider whether they are likely to be the most etticient audit test.
Wages and salaries for administrative staff

These meet the criteria for substantive analytical procedures as there is a large volume of transactions and the costs are generally predictable based on data such as the prior year costs (already
audited), changes in staff numbers (which can be tested) and the wage rise (which can generally be agreed to support unless very variable across the population)
Substantive analytical procedures are therefore a good way to test most of this balance, supported by detailed tests on the data used to develop that substantive analytical procedure and a
reconciliation of the overall costs to the detailed payroll records.
Certain elements ot the balance such as bonus payments and any termination payments are not so predictable and should be tested in detail. The work will include review of any tormal agreements
to ensure that the coOsts recorded are complete, in line with authorised amounts and recognised in the correct period.
Other staff expenses

Other administrative expenses
These are typically not predictable balances. It may be possible to scope them out having gained an understanding of the balance. However there has been at least one item identitied as being of
audit interest the tablet computers- and this suggests some detailed sample testing may be appropriate.
Depreciation
Substantive analytical procedures would normally be ettective to test this balance based on movements in the non-current assets and the expected usetul lives. Ihe amount will increase in tuture years,
due to the additional depreciation on the right-of-use asset relating to the branch office sold and leased back.
Utilities
This is made up of several different charges each of which should be reasonably predictable. Substantive analytical procedures on each element of the balance basing an expectation on the prior year
charge and external data about price rises should be a good way to test that balance assuming that there has been no signiticant change in operations.
Receivables allowance
Substantive analytical procedures could be used here for modelling deterioration of credit risk since the inception of the loan.
The charge here results from movements in the allowance which will be tested as part of our procedures on receivables. Those procedures will need to include the following:
Obtain an understanding of the basis for the allowance and whether that has been applied consistently.
Agree the ageing of receivables to source documentation and confirm that ageing is appropriately calculated.
Agree cash collected after the year end to year-end balance and ensure correct allocation to the customer ageing.
Review historical data for write-offs and whether that can be applied to a changing population of customers.
Document and understand client's procedures tor identitying any new risks arising tor new customers.
Provision for claims and other legal matters
The expense is equal to the net addition to a judgemental provision which will need to be tested in detail. Procedures will include:
Understanding the nature of the claims which are being provided for and obtaining legal or other input to support the amount of the provision
Considering whether all claims have been provided for by reviewing board minutes, legal letters etc
Discussing with management outside the finance department whether there are matters for which provisions should be made
Start-up costs
These should be reversed and will not be tested as part of operating expenses. Substantive analytical procedures are not appropriate for this balance.
57 Page 96
AUDIT Z PLC
audio equipment to subs and customers
30 Sept X7
Ineed you to prepare a working paper which addresses the following:

(1) For each matter in Exhibit 1:
(a)set out and explain the appropriate tinancial reporting treatment for KJL's financial statements for the year ended 30 September 20X;
(6) identify and explain any weaknesses in the audit procedures completed by Welzun; and
()set out any additional audit procedures that should be performed by DB and by Welzun to provide assurance for the group audit opinion.
(2) Set out and explain the appropriate adjustments for the financial reporting queries raised by Janet (Exhibit 2) for the year ended 30 September 20X7 for:
(a) the individual financial statements of Zmant
(b) the consolidated financial statements of Zmant
(3) Calculate goodwill to be recognised for KJL in Zmanť's consolidated tinancial statements for the year ended 30 September 20X/. Asume Zmant uses the proportion of net assets method to value
the non-controlling interest in KJL.
Materiality $ 1,800,000
Zmant group KJL

Equity £ O$'000
Share capital 10,000 25,000
Retained earnings at 1 October 20X6 9,200 45,000
Profit for the year 2,200 15,000
21,400 85,000
Investment in KJL
based OS used $
Brought 60%
Con $ 52,800,000 1 Jan X7
Share capital 25,000 25,000

Retained earnings at 1 October 45,000 45,000
Profit for the year 15,000 3/12 3750
73,750
Con $ 52,800
NCI 40% x 73,750 $ 29,500
FV of NA $ -73,750
Goodwill $ 8,550
AT HR 6 $ 1,425
AT CR 4.8 $ 1,781
Exchange rate gain $ -356
Loan to KJL
Loan to them $ 21,000,000
Interest 6%
Repayable Sept X9
Interest $ 945,000
Loan £ £ 3,500,000
Rate at loan $ 6.00
YE rate $ 4.80
YE £ value £ 4,375,000
Gain -£ 875,000 recognised in the profit and loss account of subsidary
Def tax $ -175,000
Deferred tax and current tax implications

Because for income tax purposes, tax is not payable on exchange differences, there are no current tax liability implications. However, because tax liabilities will be higher in the future when the gain is
taxed, a temporary taxable difference will arise.
In the financial statements for Zmant the deferred tax adjustment for the temporary taxable difference would be taken to the tax charge. This is because IAS 12 requires current tax and deferred tax
adjustments to be recognised in profit or loss except if they arise from a transaction which is recognised outside of profit or loss.
Temporary taxable difference
f875.000 x 20%- f175.000
Journals
Parents financial statements:
DEBIT Loan to KJ 875
DEBIT Income tax- P orL 175
CREDIT Deferred tax liability 175
On consolidation, the exchange difference will be removed from the consolidated profit or loss and it will be recognised as other comprehensive income and recorded in equity in the combined
statement of financial position.
Consolidation adjustments:
DEBIT Retained earnings f875,000 - £175,000 700
CREDIT Foreign exchange reserve 700
The loan should be presented as a receivable in Zmant's financial statements and it will cancel on consolidation. As the loans will cancel on consolidation, the following consolidation adjustment will
DEBIT Non-current liabilities 4,375
CREDIT Loan to KJL 4,375
Janet's query was in relation to the receivable balance of £3,500,000 - she also needs to investigate the treatment of the interest. The loan has an annual interest rate of 6%. She needs to ensure that 9
months of interest have been accrued or charged in KJL and credited in Zmant's individual financial statements. If the interest is outstanding at the year end there would be implications for the forex
gain and, depending on the tax treatment, a deferred tax implication.
On consolidation the interest would require translation at the average rate.
There will also be a consolidation adjustment to cancel the finance cost and income.
Inventory adjustment - PURP adjustment and deferred tax adjustment on consolidation only
Parent purchase of sub
Purchase price 5,500,000 9/12 of the year 4,125,000
Sub brought from parent Mark up 35%

Value 2,500,000
Cost 1,851,852
Profit 648,148 /1.35 * .35
Deferred tax asset at 20% 129,630 20%
An adjustment is required for the profit on goods in Zmant's inventory. This is because in the consolidated income statement this profit is not realised and therefore should not be reflected in the
combined results of the two entities. Once the inventories are sold to a third party, this adjustment will no longer be required.
Ihe accountant's calculation is incorrect-for example the accountant has adjusted for profit on goods bought from KJL not on the goods held in inventory.
This is an adjustment to the consolidated financial statements and not the individual company accounts.
The unrealised profit is calculated as follows:
£2,500,000 x 359%/1359%- £648,148
The temporary difference results in a deferred tax asset as in the group accounts there is a tax charge for a non-existent asset which needs to be removed.
Although no adjustment is required to the individual financial statements, a deferred tax asset would be included in the consolidated financial statements as follows:
Journal required on consolidation:

DEBIT Cost of sales 648,148
CREDIT Inventory 648,148
DEBIT Deferred tax asset 129,630
CREDIT Deferred tax asset 129,630
This is a consolidation adjustment and will impact the consolidated reserves; NCI and inventory.
Assuming goods are purchased evenly over the year, an adjustment will also be required to remove intra group trading.
DEBIT Revenue £5,500,000 x 9/12 f4,125,000
CREDIT COS £5,500,000 x 9/12 £4,125,000
57 Page 97
The cleints journal is:

Profit on goods bought by Zmant from KJL = £5,500,000x 35% £1,925,000
Profit on goods bought by Zmant from KJL for 9 months from 1 January 20X7 to 30 September 20X7 - £1,925,000 x 9/12 1,443,750
£1,443,750 translated at the average rate for the period from 1 January 20X7 to 30 September 20X7 of f1 - OS5.7 O$8,229,375
DEBIT KJL Retained earnings O$8,229,375
CREDIT Inventory O$8,229,375
THIS NEEDS TO BE REVERSED
Significant matters
R&D expense $ 10,700,000
Project sound $ 7,900,000
Comments
Materials for prototype model 1,725 Capilisited R&D
New computer equipment - bought on 1 January 20X7 1,700 PPE and depn
Salary costs of development staff
incurred after 1 April 20X7 1,270 Capilisited R&D
incurred before 1 April 20X7 790 PL charge
Registraition fee for depn 910 Capilisited R&D
Car used for speaker testing - bought on 1 January 20X7 555 PPE and den
Allocated general overheads 950 PL charge
7,900
Remove computer equipment -1,700 2 year depn applied Depn charge 9/24 -637.5
Allocated general overheads -950 Director uses and result personal tax liab
Car used for speaker testing - bought on 1 January 20X7 -555
incurred after 1 April 20X7 -790
3,905
Financial reporting implications

The project appears to meet the detinition of development expenditure and the costs that meet the criteria for capitalisation under para 5/ should be capitalised under AS 38 as an intangible asset.
The project involves adapting existing technology for the car industry. Provided that the technology satisties the general recognition criteria that there are expected future economic benetits
attributable to the technology and that the costs can be reliably measured, an intangible asset shall be recognised (AS 38 para 21).
There is judgement involved in this initial assessment but there is clear external evidence in the initiation from an external customer for the product and signiticant orders have been received from the
same customer.
The judgement involved here is not just about whether this expenditure is deemed to be research or whether it is development expenditure. Ihe project does involve the design and preproduction of
a prototype which is a specific example of development expenditure given in the standard. Ihe judgement also involves deciding when the criteria are met.
IAS 38 para 65 makes clear that development costs can only be capitalised from the date when the criteria are first met. Because the customer placed a large order on 1 April this would seem to be the
appropriate date - however the auditors have not carried out audit procedures to confirm this - see below. Thus, assuming 1 April is the appropriate date, any of the costs incurred between 1 January
and 1 April (other than capital/PPE costs) should not be capitalised.
Recognition criteria per IAS 38 Points to indicate capitalisation from 1 April 20X7
Technical feasibility? Question says -adapting an existing speaker
Intention to complete and sell? Specitic request from an existing customer
Ability to use or sell intangible asset? Company using the development cost to make a product to sell tor which they have a firm order from a
Generate probable future markets? Customer
Adequate technical - financial resources?
Measure reliably? Nothing in question to say the company cant measure reliably - further information is required
TAS 38 states that the development costs comprise all directly attributable costs. These include materials for the prototype O$1,725,000, the salary costs of the development staff OS1,270,000 and the
tees to secure the legal right to the design OS910,000. If the costs meet the recognition criteria for development expenditure the standard says the costs must be capitalised.
We should be sceptical about the motivation for expensing which has significant tax benefits for the company.
Amortisation of these costs should commence once the product is ready for sale. To advise on an adjustment, more information will be needed on amortisation rates.
The allocated general overhead potentially should be written off unless these are specific to the development of the technology. It is however questionable whether this expernditure would meet the
criteria of research expenditure.
Further information should be obtained to determine how this cost has been calculated and whether they are specific to the development asset
With respect to the computer equipment and the car, both these assets meet the definition of an asset and should be capitalised. Management comment is unacceptable regarding the hiding of the
cost of the car from the tax authorities to prevent personal tax liability tor CEO.
The computer costs of O$1,700,000 should be capitalised as part of PPE and depreciated over two years. Assuming that this was purchased on 1 January 20X7 depreciation of 9/24 x OS1,700,000
OS637,500 should be recognised in the statement of profit or loss -it is possitble to include depreciation within the research and development costs and more information should be obtained.
The car too should be capitalised and the cost less residual value depreciated over its useful economic life. Further information is required.
Project entertain $ 2,800,000

involves sale stuff and peronnel entertain customers
Paid this amount to public relation company GetGo
Reclassied needed not R&D Selling and marketing
More entertainment
Financial reporting implications
The recognition of this cost in the profit or loss account is correct because it appears to represent selling and marketing costs from which the entity will not derive a future economic benefit. The report
will also not satisty the general recognition criteria of being capable of future economic benefits and being separable/identitiable. Ihe newspaper article in Exhibit 3 further suggests that the costs are
no more than entertainment costs and are largely for the benefit of KJL's directors and there is limited invitation to customers.
These costs do not meet the criteria for research costs and have therefore been presented incorrectly in the statement of profit or loss.
Including these costs as research costs has resulted in the company benefiting from additional tax relief and potentially fraudulently obtaining a tax refund.
Income tax receivable balance $ 8,025,000

The income tax receivable balance is in respect of a tax refund for RocD expenditure.
250% x R&D in PL x 30% tax rate
Income tax receivable balance O$8,025,000

The calculation of this balance assumes that all costs recorded as research costs in the statement of profit or loss quality under Otherland tax rules for the tax refund. Clearly if these costs have been
misstated then this balance too is misstated, and further audit procedures are required to substantiate the accuracy of this balance and whether the amounts are recoverable from the Otherland tax
authorities.
Weakness in audit procedures

Materiality
The materiality level used is the component materiality which has been determined by DB, the group auditor. For group reporting purposes this is acceptable. However, Welzun's explanation shows a
lack of understanding of materiality.
ISA (UK) 320 (Revised June 2016), Materiality in Planning and Performing an Audit states that the auditor's frame of reference for materiality should be based on the relevant reporting framework (ISA
(UR) 320.3). KJL reports under IFRS and IAS 1 gives the following definition of materiality: Omissions or misstatements are material if they could individually or collectively influence the decisions that
the users make based on the financial statements.
Welzun should have made their own assessment of materiality based on nature, value and impact and set a performance materiality to reduce the possibility that an aggregate of uncorrected
misstatements exceeds materiality tor the financial statements.
nature Given the profit for the year recorded in retained earnings (See Exhibit 2) is $15 million a cost of $10.7 million is material by value and, as it includes the cost of a car used by the CEO, also material by
Furthermore, grouping the costs together results in a balance which exceeds component materiality level regardless of whether pertormance level materiality has been set by Welzun.
R&D
Project Sound
The clear weakness here is that Welzun has not carried out any audit procedures to determine the risk of material misstatement at the assertion level as per ISA (UK) 315 (Revised July 2020).
Project Entertain
The auditors have not carried out audit procedures to determine the nature of these costs as research costs. Incorrect classification of the costs could resut in tax evasion since the impact is a larger
claim for tax to be refunded. The assertion of classification therefore has not been substantiated.
It also seems extremely questionable that the report has not been received and yet KJL has accepted the obligations to pay tor this service.
Confirmation to invoice and bank statement confirms the audit assertion of occurrence but does not confirm completeness. Are there any further costs to be recorded?
As the report has not been received, there is no confirmation that the cut off assertion has been satisfied.
The auditors have accepted management statements without challenge and corroboration.
Income tax receivable
Accepting the work of Welzun's own tax department for the income receivable balance is also not sufficient. Ihis does not challenge management assumptions about the nature of the costs included
in the claim.
The tax department may not have oversiaht of the nature and classification of these costs.
Additional procedures
Group auditor responsibilities
The group auditor cannot discharge their responsibility to report on the group financial statements by unquestioning acceptance of the component's financial statements (ISA (UK) 600 (Revised) para.
11).
The initial assessment of welzun pertormed at the audit planning stage should be reviewed to ensure that DB believes that sufficient audit evidence on which to base a group audit opinion can be
obtained from the work performed on KJL by Welzun. We should question whether DB's involvement at the planning stage was appropriate.
57 Page 98
If the group auditor does not consider that sutticient appropriate audit evidence has been obtained then the group auditor or the component auditor should pertorm one or more of the tollowing:
a full audit using component materiality
an audit of one or more account balances, classes of transactions or disclosures
specified procedures (SA (UK) 600 (Revised) para. 27)
DB should consider the evidence and determine whether a revision of the audit plan is needed and whether it has correctly assessed Welzun's ability to complete audit procedures of sufficient
standard to enable an opinion on the group financial statements to be made. Depending on this assessment, additional procedures should be identified. Ihese could be completed by the group
auditor or by the component auditor (ISA (UK) 600 (Revised) para. 31).
Project Sound
Specific procedures would be:
Confirm existence of computer equipment and car by physical inspection and agree the cost to purchase invoice to confirm occurrence.
Evaluate depreciation and amortisation policies to ensure appropriate to the asset and consistent with accounting policies.
Agree costs recorded for other expenditure to supporting documentation such as invoices, payroll records to contirm accuracy and cut oft.
Obtain schedule of allocated general overheads and re-pertorm the calculations, applying professional scepticism to ensure the reasonableness of underlying assumptions.
Project Entertain
Whilst it is possible that the report has been delayed, completeness of the costs can be ascertained by agreeing to a contract between KJL and GetGo-this will also enable contirmation of the
appropriate classification of the costs.
Obtain direct confirmation of costs with GetGo to ensure appropriate cut off.
Income tax receivable

Although it is reasonable to consult Welzun's tax department, the audit team should also make their own assessment of the claim, agreeing to relevant tax legislation and re-performing the
calculations to ensure accuracy.
Welzun should challenge the assumptions management have made regarding the classification of the costs as research costs considering their knowledge gained on the audit.
Consider the appointment of an auditor's expert to review the research and development claim.
Ihere are potentially deterred tax adjustments if the tax and accounting treatment of these adjustments require further intormation.
58 Page 99
Year end 31 Oct 2015

owns transport goods to company customers
7 years steady profit
less profitable Oct 2016 and 2017
Directors 60%
7 inst inestory 40% no more than 5%
Bonds finance the company

mature at Oct X9 20X5 20X6 20X7 Adjust
Final Final Draft
Draft statement of profit or loss and OCI £'000 £'000 £'000
Revenue 35,700 31,800 30,600 30,600
Cost of sales -25,444 -23,044 -22,803 -22,803
Gross profit 10,256 8,756 7,797 7,797
Operating costs -6,996 -7,904 -8,235 -8,235
Finance costs -609 -617 -500 -124 -624
(Loss/profit before tax 2651 235 -938 -1062
Tax -530 -47 178 24 202
(Loss/profit for the year 2121 188 -760 -100 -860
Other comprehensive income 46 -273 347 347
Additional information
Earnings per share 0.212 0.019 TBC
Dividend per ordinary share 0.02 0.01 Nil
Chelle share price at 31 October 1.711 1.139 0.98
Tax 19%
Draft statement of financial position

Non-current assets
Property, plant and equipment 48,574 51,497 53,675 53,675
Financial asset 1,776 1,503 1,503 347 1,850
Current assets
Inventories 3,307 2,910 2,770 2,770
Trade receivables 7,997 7,503 7,710 7,710
Tax asset 178 24 202
Cash 2,273 525
Total assets 63,927 63,938 65,836 66,207
Equity
Share capital (£1 shares) 10,000 10,000 10,000 10,000
Other components of equity 1,689 1,416 1,416 347 1,763
Retained earnings 37,966 38,054 37294 -100 37,194
Long-term liabilities (5% convertible bonds) 9,486 9,603 9,603 124 9,727
Current liabilities 0
Trade payables 4,256 4,818 6,304 6,304
Tax payable 530 47 0
Bank overdraft (limit £5 million) 1,219 1,219
Total equity and liabilities 63,927 63,938 65,836 66,207
Draft statement of cash flows

Net cash inflows from operating activities 10,516 11,173 11,316
Net cash (outflows) from investing activities -8,462 -12,821 -13,060
Net cash (outflows) from financing activities -200 -100
Change in cash 1,854 -1,748 -1,744
Cash brought forward 419 2,273 525
Cash carried forward 2,273 525 -1,219
Convertible bond instrument

31-Oct-11
Convertible bond 10,000
5% rate 5%
Par 8 years Oct 2019
1 SC for £10 1000
Market interest 6.50%
Long-term liabilities (5% convertible bonds) 9,603

Interest paid and finance cost 624.195
624 rounded
Interest paid -500
PV 9,727
Although interest of £500,000 has been recognised in the draft financial statements, an adjustment is required to increase finance costs to reflect the effective interest rate and to increase the amount
of the bond to present value.
Bond present value at 31 October 20X6: £9,603,000
Finance cost on £9,603,000 at 6.5%- £624,195, rounded to f624,000
Bond present value at 31 October 20X7: (E9,603 + £624-£500 interest paid);: £9,727,000
Journal entry required:
DEBIT Finance costs (f624 -£500) 124
CREDIT Bond 124
Equity investment
Investment in equity
Consid 100
SC 1500
Acc gain and loss 2015 1776
Share price 2017 18.5
MV at 17 1850
-18.5
1831.5
MV at 17 1850
347
The financial controller has not recognised a gain or loss in respect of the equity instrument. The value of the holding in Spence plc at 31 October 20X7 is £18.50 x 100,000 - £1.85m. This is an
increase of (E1,850-£1,503) - £347,000.
The journal entry required to recognise this gain is as follows:
DEBIT Financial asset 347

CREDIT OC/oCE 347
Current tax effects of adjustments

The adjustments made above increase the loss before tax:
Loss as stated in draft financial statements -938

Additional finance costs -124
-1,062
The tax credit to be recognised is: f1,062 x 19% = £202,000 (rounded). f178,000 has already been recognised, so an additional amount of (£202 - £178) £24,000 should be recognised.
The journal entry required is as follows:
DEBIT Tax asset 24
Earnings per share and diluted eanings per share

Chelle is loss-making therefore a loss per share is reported in respect of the year ended 31 October 20X7.
Loss before tax (as calculated above) -1,062

Tax credit 202
Loss after tax -860
58 Page 100
Basic EPS is calculated as: 860 0.086

Profit/(loss) attributable to ordinary equity holders of the parent top/bottoms 10,000
weighted average number of ordinary shares outstanding during the period
Basic loss per share (860) / 10,000 (8.6)p per share
As there are bonds which are convertible into ordinary shares at a future date, a diluted earnings/(loss) per share must be calculated. If the effect of the additional shares would be dilutive, diluted
earnings per share must be disclosed.
Upon maturity of the bond, the bondholders can opt to receive one ordinary share for every £10 of bond held. The maximum number of shares that could be issued is £10,000,000/10 1,000,000.
The total number of shares in the denominator of the calculation is therefore 11 million.
Computation of the diluted earnings involves adding back the after-tax etect of the finance cost saved. In the year ended 31 October 20X7 interest at the effective rate is t624,000 (calculated earlier).
Interest paid and finance cost 624.195
The after-tax effect is (E624 x 81%) £505,000. 505.598
Diluted loss per share

Profit 860 (860)+ 505)/11,000-(3.22)p per share
after tax 505.59795 0.0322
1,365.60
No of shares 11,000
Deliuted 0.0322
The diluted loss per share is reduced, and therefore antidilutive, and does not require disclosure.
Report
Liquidity and efficiency
The current and quick ratios contim that the business is not facing any immediate liquidity crisis, although they have worsened significantly over the three-year period. Ihe £5 million overdraft limit
helps to cushion any shortage of working capital funds. However, there are some worrying signs in the etticiency ratios. Inventory seems to be well under control, but both receivables and payables
provide cause for concern. Receivables days are at an even higher level by the year end compared with the previous years. Chelle's customers include supermarket chains which are notoriously slow in
paying, but even taking this into account, 90 days is a very long element of the working capital cycle. Ihe trade payables collection period has worsened, too, and suppliers may be inclined to put
pressure on Chelle for payment when the average outstanding period is 101 days.
Long-term liabilities: bonds

The bonds are due for redemption or conversion in slightly under two years' time. The share price at the 20X5 year end must have suggested to the board that bondholders would opt for conversion
on 31 October 20X9. A holder of a f10 bond at that date would be entitled to convert to a share worth f17.11p. However, by 31 October 20X7, the conversion option has become much less attractive.
At a share price of only £9.80 a bondholder would quite probably want repayment of the bonds.
If the share price does not recover over the next two years, Chelle may be taced with the need to raise further finance to repay the bondholders. However, if this does happen, raising turther long-term
finance may not be too difficult. Ihe strong cash flow performance would help to encourage lenders, and Chelle's gearing level is not particularly high at around 22% (at the end of October 20K/).
Borrowing seems the most likely solution to the problem of redemption. In current conditions, it seems unlikely that shareholders would wish to contribute further funds.
Equity investors
Chelle's investors have seen their share price reduced at 31 October 20X7 to only 57% of what it was two years' previously. In the meantime, they have received a dividend of only 1p per share and 2p
in 20x5 (0p in the 20X/ tinancial year). Chelle s performance, at least as tar as profitability is concerned, has not been encouraging. It is arguable that the payment of a dividend, which would currentily
have to be paid out of overdraft, would make little difference. However, please see the separate document [section 4 of answer| which addresses the extent to which a distribution could be made.
Performance
he trend in business performance, as evidenced by the statement of profit or lss, has cleariy been disappointing over the last three years. Gross, operating and net profit margins have tallen, and the
increased cost of supplies from other countries has no doubt had a part to play in the disappointing pertormance. However, adverse exchange rates are only one element.
One striking factor is the downturn in sales revenue. Revenue fell by almost 11% between 20X5 and 20X6, and by almost 4% between 20X6 and 20X7. This is, according to the MD, the result of
increased competition. However, it would be worth investigating this further to contim that this is the reason and/or to identity other factors. For example, it Chelle and the retailers it supplies have
attempted to pass on increased product costs to customers in higher prices there may have been a consequent volume reduction in sales. Ihere is a tall in GP% which presumably relates to the
change in exchange rates.
Operating costs have risen by 17.7% over the period 20X5 to 20X7. Presumably, most of these costs are incurred in the UK, and therefore there would be no adverse exchange rate effects. This is an
area that would require detailed further investigation.
At its best level over the three-year period the return on capital employed in 20X5 was only 5.7%, with return on shareholders' funds in 20X5 even lower at 4.27%. This performance has worsened in
20X6 and 20X/. The poor return on investment trom a shareholder point of view may help to account for the fall in share price and the evident lack of shareholder confidence in the company
Cash flow
Chelle's performance from a cash flow point of view is much better than the profitability ratios suggest. The cash return on capital employed at around 19% has varied very little over the three-year
period. Ihe extracts from the draft statement of cash flows show that the cash generated has been utilised almost entirely in investing activities. As financial assets have remained stable over the three-
year period, it is evident that the investment activity has been in respect of property, plant and equipment (PPE). The statement of financial position contirms that PPE has risen each year. However, the
PPE does not appear to have been utilised as intensively in recent periods. The non-current asset turnover ratio has worsened significantly over the period. It may be that the non-current assets have
not been fully functional over the period, or that the nature of the investment has changed, but further investigation is needed.
If revenue and profitability continue to decline the company's share price is likely to continue its downward trajectory. Any distribution threatens the company's cash position, so it is unlikely to be able
to make a significant difterence to shareholder attitudes by means of dividend. A continuing weakening of f sterling would make a bad situation worse as Chelle would become less competitive. If
strong competition in the market continues to be a tactor Chelle's downward slide could be very ditficult to arrest.
If the company's cash position worsens then its status as a going concern could ultimately be threatened. However, as noted above Chelle's gearing level is relatively low and it may not be too difticult
to obtain further borrowings, to repay the bonds in two years' time and to finance working capital.
Conclusion
Chelle continues to produce strong positive cash tlows, although its protitability has suttered. The fall in sales is a matter of concern, especially when compared to the significant investments that have
been made over the last three years in property, plant and equipment. Chelle's long-term borrowings mature in two years' time and it currently seems likely that bondholders will opt for redemption.
This would put Chelle into the position of having to fund a £10 million cash outilow. Directors should start planning for this eventuality now.
Appendix: ratio calculations
Distributable profit at 31 October 20X7

For most companies, distributable profits is the total of accumulated realised profits less accumulated realised losses. However, for public limited companies such as Chelle, there is a potential further
restriction. A public company may only make a distribution it its net assets are not less than the aggregate of its called up share capital and undistributable reserves. Undistributable reserves include
share premium account, capital redemption reserve, any surplus of accumulated unrealised profits over accumulated unrealised losses (known as a revaluation reserve) and any other reserve which
the company is prohibited from distributing by its constitution or any law.
Chelle has realised profits in the form of retained earnings, and also in the form of the accumulated gains and losses on the equity investment, totalling (E850,000 + £37,194,000 revised) £38,044,000.
This can be confirmed as tollows for Chelle as a public company. The company's net assets (revised) are f48,957,000. The net assets cannot be reduced below the total of its aggregate of called up
share capital and undistributable reserves of (f10,000,000 + £913,000) £10,913,000. So, the distributable amount is £38,044,000 (E48,957,000- £10,913,000).
Distributable profits is the total of accumulated realised profits less accumulated realised losses.
The amount distributable is calculated and explained in the following table:

Item of reserves Distributable
£'000
Accumulated gains and losses on equity investment 850 This is
This is likely
treatedto as
beathe
realised profit
element and so calculated
of equity would be distributable.
under the split accounting' rules for
Other components of equity (remainder) 0 hybrid
Provided financial instruments
that this in lAS only
item comprises 32, Itrealised
is not distributable.
profits (which is likely to be the case) then
Retained earnings 37,194 it is fully distributable.
Total 38,044
Chelle's directors should bear in mind that the table above shows amounts that are legally distributable. The constraint for Chelle in paying dividends is not the amount that is distributable, but rather
the absence of cash.
59 Page 101
Solvit PLC - listed
supply accounting software and eduction
purchase software and maintence
Materiality 5% pBT
Materiality 1m
key audit matters

Revenue recog
bundles sold together
management based the FV attrubutable to revenue
Error 1.3,
most pay 1 off license fee
complex with custom, intergrate and main service
quoted price list
IFRS 15 is new standard and challeging to apply
6 month to Sept X7 same leve last year
5m lower than forecast
eduaction has slowed down - but this should be split evenly
eduction is competitive
Large discounts are offers maitenece for 3 years
Why key audit matter is still relevant

It is a presumed key risk under auditing standards and there appears to be no good reason to challenge this in Solvit's case.
It was identified as a key audit matter in the prior year and there is no reason to believe that the level of audit effort this year will be lower.
Revenue is a very material balance in the financial statements.
Some of the revenue transactions made by the company are complex, involving multiple elements.
There is judgement involved in allocating revenue to elements and this will attect the timing of revenue recognition where not all elements have been delivered at year end.
An audit adjustment was identified in this area in the prior year
There is a relatively new revenue accountant and it is this individual who made an error in the prior year. The previous auditors raised doubts about his level of experience.
Changes this year

There are indications that the company has struggled to apply IFRS 15. Ihere also appears to have been reliance on the revenue accountant whose expertise has been called into question.
There is a new education sector product which may be sold on ditterent terms to other products and for which additional discounts for future maintenance have been given.
he new product has had issues, including problems in the sottware which means there is a heightened risk of returns and credit notes and reputational damage.
Relevant financial reporting standard

he relevant financial reporting standard is IFRS 15, Kevenue from Contracts with Customers.
Under IFRS 15 there is a five-step model for revenue recognition. This requires the following:
ldentitication of the contract with the client (unlikely to be an issue in the case of Solvit as we would expect contracts with each customer)
Identification of the separate pertormance obligations in the contract - in Solvit s case there appear to be contracts with three separate elements, all of which are also supPplied separately-software,
services, maintenance. Sotware can be sold separately but other integration services and maintenance will introduce complexity here as these would not be sold separately but it does provide the
customer with a separate right.
Determine the price -that will be the total payable for all elements included in the initial contractual arrangement and may become more complex where, for example, discounts are oftered for
future years.
Allocate the transaction price between the performance obligations - software, services and maintenance - this will be done in relation to the stand-alone prices for each element - the price for
sottware sold on its own; the day rates for services sold on their own; the renewal rate tor maintenance per the standard price list.
Recognise revenue when or as the pertormance obligations are satistied, ie, when the service is provided. kor standard sottware that is likely to be when it is delivered. For customised sottware the
question is more complex and it is necessary to consider whether there is an obligation to deliver the customised product and recognise revenue on delivery or separate obligations to deliver
standard product and then services. kor maintenance, the obligation is likely to be satistied over time and so the revenue will be spread over the maintenance period.
Specific audit objectives of our audit procedures to provide assurance in respect of revenue recognition
The application ot IFRS 15 is the key tocus of the revenue recognition risk for the 20XIIK8 audit, although the risk is also enhanced by the operational tactors.
In particular, the audit objectives of our audit procedures on this key audit matter are
to ensure that any prior period adjustment has been accurately calculated and that all relevant contracts have been considered
to examine if sotware and services are separate performance obligations where Solvit is delivering a customised software product
to ensure that the allocation of the total price between the elements of larger, multi-element contracts is pertormed accurately using prices which are those applied when the elements are sold
separately
to identify if sales have been made to customers who have been given the rights to future discounts; and
to identity revenues where there appears to be delay in Customer payment and consider whether this is indicative of any early revenue recognition. In particular there IS a risk that revenue may be
recognised for faulty software which the customer has not accepted and which Is not fit for purpose.
Audit procedures
ldentity contracts where not all elements have been delivered at the year end, as such contracts are the ones where revenue recognition will be affected by allocation between delivered and
undelivered elements. Ihey should agree that revenue has been recognised appropriately for these contracts
Ferform analytical procedures on the pattern of revenue recognition over the year for each type of revenue and investigate unusual items - these might include variations in maintenance revenues
which might be expected to be spread evenly over the year or peaks in the recognition of software or services revenues which might be indicative of cut-oft issues or manipulation of the results.
ldentity revenue postings not generated by cash, trade receivables or from reversal ot a contract liability as these are inherently unexpected transactions worthy of tollow up.
Trade rec & Allowance in aged receivables

Error 700k
eduction slower to settle debts
TR days 45 31 March X7
TR days 75 30 Sept X7
created allowance for 12m credit losses with IFRS 9 Fin Instu
keeping same level 31 March X7
Allowance for aged receivables

Factors leading to selection of the matter as a key audit matter
There was an identified mis-statement in the prior year which was not material this was an over-provision.
Ihere is a new type of customer this year- the educational sector customers and Solvit has far less history of dealing with such customers and therefore less evidence to support any provision or
lack thereot.
Days sales outstanding have increased significantly at 30 September 20X7.
Accounting for sale and leaseback
This is a material one-off transaction.
Ihe accounting for it is not straightforward and not routine for the accounting team. Consequently, because the inance Director is undecided as to how to treat this transaction, it represents an
area of key audit focus.

The relevant financial reporting standard is IFRS 9, Financial Instruments.
The impairment model in IkRS9 Is based on the premise of providing for expected losses. Ihe financial statements should reflect the general pattern of deterioration or improvement in the credit
quality of financial instruments within the scope of IFRS 9. Expected credit losses are the expected shortall in contractual cash flows, defined in IFRS 9 as the weighted average of credit losses with the
respective risks of a default ocurring as the weights.
Solvit's policy in respect of the trade receivables is incorrect. For trade receivables which do not have an IFRS 15 financing element, IFRS 9 requires a simplitied approach to the expected loss model.
The loss allowance is measured at the litetime expected credit losses from initial recognition. Should a receivable exceed the credit limit in the tuture it is likely that the allowance established based on
expected credit losses at initial recognition should be increased. Ihis is a prior period error, which should be corrected retrOspectively and comparative amounts tor the prior period should be
restated.
Specific audit objectives of our audit procedures to provide assurance in respect of the trade receivables allowance
The objectives of our audit procedures are to address the following risks:
To ensure that adequate allowance is made for receivables from educational sector clients
To ensure that the allowance is based on the best information available or reassessed fully to consider the balances and circumstances at 31 March 20X8
Our audit procedures should do the following:
Perform analytical procedures to identity trade receivables with a deterioration in ageing.
ldentify factors which might be distorting the ageing reported such as unmatched credit notes or cash receipts.
ldentify any amounts on the receivables ledger which relate to the prior financial year so that the adequacy of the prior year allowance can be fully assessed.
Management bonus -incentive to manipulate results

Material misstatement from management on overide of controls
lower budget revenue 6 month to YE
lower profit
need to go expection to meet target
59 Page 101
59 Page 102
they have accrualed max bonus and think they can do it

Last year management incentive was not identified as a key audit matter but the facts have changed as this year Solvt is struggling to meet its plan and is not currently on target to meet the
pertormance targets necessary to trigger the maximum management bonus. Ihe resuts for the first halt are lower than plan despite no increase in the aged debtor allowance.
Management therefore has a much greater incentive to manipulate results and judgemental areas (such as bad debt allowance) and one-off items such as sale and leaseback provide potential
opportunities for them to do so.

IAS 19, Employee Benefits sets out the measurement basis for the employee bonus. This is based on whether Solvit has a legal or constructive obligation to pay the bonus based on achieving targets-
an expense will be recognised in the year ending 31 March 20X8 if the targets are judged to be met.
Specific audit objectives of our audit procedures to provide assurance in respect of the management bonus
The objectives of our audit procedures are to address the following risks:
Management understating judgemental provisions or consistently setting provisions at the lowest acceptable point in a range, meaning that the position overall is aggressive and does not truly
represent the best estimate.
Management making accounting entries with the sole purpose of boosting results.
The bonus being inappropriately recognised.
Our audit procedures should do the following
Review closing and other journal entries to identity items of audit interest. These will include journals booked by senior management who do not normally make detailed accounting entries; round
sum amounts which might be indicative of estimates of overall adjustments; journals booked outside of normal working hours to conceal them; journals which are unusual in some way such as an
entry in DEBII non-Current assets and CREDII revenue which would not normally be expected.
Re-perform the calculation of the management bonus at the year end- agree to contracts of employment to ensure that the calculation is in line with the contract
Sale and lease back

1 Apirl X7
Sold property 15,000
At FV and lease back
Term 10 years
rent 600
PV of future lease 5118 600 x 8.53
Carry amount 11,000
Useful life 20 years 20
Depn 550
Interest 3%
Discount factor 8.53
PV of future lease 5,118

Carry amount 11,000
FV 15,000
Right of use 3,753 5.118/15000 x 11000 Step 1
Gain 4,000 15,000 - 11,000 Step 2
Gain to rights retained 1,365 5.118/15000 x 4,000 (gain) step 3
gain related to rights transferred 2,635 4,000 - 1364.8
DR ROU 3,753
DR Cash 15,000
CR PPE 11,000
CR Gain on disposal 2,635
CR Lease liability 5,118 PV of lease payments
The right-of-use asset will be depreciated over the lease term of ten years: £3,753,200/10 - £375,320 (this is shorter than the estimated remaining useful life of the building, which is 20 years).
ROU depn over 10 years
ROU 3,753
Depn 375.32
DR Depn 375.32
CR ROU 375.32
Amoirsation of lease
Interest Lease
bf 3% payment cf
X7 5,118.00 153.54 - 600.00 4,671.54
X8 4,671.54 140.15 - 600.00 4,211.69
446.46 459.85 Current
4,211.69 Non current
DR Fin charge 153.54

DR Lease Liability 446.46
CR Bank - 600.00
Of the total lease liability at 31 March 20X8, 600,000 -140,146 = £459,854 (capital repayment) is current and f4,211,686 is non-current
Accounting for sale and leaseback

This is a material one-off transaction.
Ihe accounting for it is not straightforward and not routine for the accounting team. Consequently, because the inance Director is undecided as to how to treat this transaction, it represents an
area of key audit focus.
The relevant financial reporting standard is IFRS T6, Leases.

This transaction must be accounted for in accordance with the sale and leaseback rules of IFRS 16, whereby a right-of-use asset is recognised for the rights retained and a gain on disposal is
recognised for the rights transferred. The present value of the future lease payments using the 3% interest rate implicit in the lease is f600,000 x 8.530 - £5,118,000.
Athree-stage process is applied:
Stage 1: Measure the right-of-use asset arising from the leaseback as a proportion of the previous carrying amount of the asset that relates to the right of use retained by the seller/lessee:
Carrying amount x (PV of future lease payments at transfer date + Fair value of asset at transfer date)
-11,000,000 x (£5,118,000 + £15,000,000)- £3,753,200
The remaining carrying amount of £7,246,800 (11,000,000 - 3,753,200) represents the transferred asset.
Stage 2: Recognise the amount of any gain on the sale that relates to the rights retained by the seller:
Total gain on sale £15,000,000-f11,000,000- £4,000,000
Gain relating to rights retained: £4,000,000 x (E5,118,000 + £15,000,000) - £1,364,800
Stage 3: Recognise the amount of any gain on the sale that relates to the rights transferred to the buyer:
The gain relating to the rights transferred is the balancing figure. Therefore, the gain relating to rights transferred is f4,000,000 - £1,364,800= £2,635,200
Specific audit objectives of our audit procedures to provide assurance in respect of the sale and leaseback
The objective of our audit procedures is to eliminate the risk of a material misstatement arising trom the incorrect financial reporting treatment of this complex transaction. Specifically, this would
include:
Confirmation that the disposal is a genuine sale in accordance with IFRS 15
Confirmation of the accounting treatment of the lease arrangements under IFRS 16
Our audit procedures should do the following:
Obtain a copy of the sale and leaseback contract to confirm the parties involved, the date of the transaction and the sale value of f15 million.
Reconcile sale proceeds to bank statements and disposal to non-current asset register.
- Inspect contract to determine the substance of the sale and leaseback arrangement (ie to confirm that control of the property has been passed to the buyer, who now becomes the lessor).
Confirm the terms of the lease with the contract (such as the rights conferred, the term, the rental amounts of f600,000, their frequency and the implicit interest rate).
Challenge management over the remaining useful life of the property.
Discuss the accounting treatment of these events with the Finance Director of Solvit to agree on the accounting entries required.
Obtain further evidence from an independent source about the likely renewal of the lease after 10 years.
Evaluate the need to appoint an auditor's expert to agree tair value.
59 Page 102

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Chp 15 Page 1

Number of staff 500

Provision for redudancy not taken into account

DR PL staff cost 8.568

Insepc employment contract to verify underlying terms of bonus

confirm with HR records how many EE left by 3 Dec

At year endObligation 37,360

CR Obligation 3,138 gain

Deferred tax part of this not taken into account

The correcting journal

Valutaion of plan assets and liability may be incorret in the FS

Interest should based high quality of corporate bonds and is this

Reconsiling to receviables ledger

5m/£125 x 40 1.6m shares issue Dec 07

EPS Covertiable DEPS

Earnings = 408,000 x (100-20%) = 326,4000

2.5m /£100 x 50 1,250,000

Net assets 250,000

PPE FV > CA 50,000

NCI on propertion of net assets

CA of D assets compared to recoverable amount

carrying amount of goodwill of D of impariment los

Good will of D 280,000

Carrying amount of NCI in M after impairmetn loss

CA of M Net assets 700,000

15/85 x 205k 36,176

Acq of B At Dec 17 the goodwill

Disposal from 95% to 5%

Gain on disposal 6,000

net assets 650 550

CA of net assets 550 550

Carrying value after impairment

The 150 is goodwill and notional goodwill ie 60 + 90 = 150

Date of acq RE at acq Consid SC Prop of FV of NCI

Goodwill at June X9 NA = 450 + 300

Profit on decrognition of investment

Nov X& Contract sell $

Cost of loan 10,000,000

Year Balance bfdw Fin cost 10% Cash paid Bfwd

Inventory recognised at lower of NRV and cost

(2) A deferred tax liability of f800 is recognised in respect of the inventory.

(b) Accumulated depreciation for a machine in the FS is

(c) A penalty payable is in the statement of financial position.

Property 1,500,000 Jan X6

Dec X7 revalu 2,160,000

tax base is the legal cost of the property

tax charge 162000

Because the revaluation surplus is recognised as other comprehensive income and

Tax loss Dec X7 4,700,000

Limited loss 4 year 2,200,000

A deferred tax asset shall be recognised tor the carry forward of

Fair value adjustment

Carry amount at June 2015 15

The fair value uplift is subsequently depreciated such that by the

DEBIT Group retained earnings (80% x £15m) £12m

Deferred tax liability

By the reporting date, f15 million of this temporary difference

DEBIT Deferred tax liability 2.4m

Tax loss bfwd

tax base 6.5