F8 SCENARIO QUESTION DISCUSSIONS – Q5 (b & c), June 2008. Topic: GOING CONCERN

This is a discussion relating to Q5 (b & c), June 2008. I am working from the UK paper but both the UK and INT papers are similar. For a link to the international paper, go here:

https://www.accaglobal.com/pubs/students/acca/exams/f8/past_papers/int/f8int_2008_jun_q.pdf

Since parts (a) and (d) are theoretical, we will omit them from this discussion and go straight to the scenario.

All key points are highlighted in bold.

The annual audit is nearly complete. As audit senior you have reported to the engagement partner that Smithson is having some financial difficulties. Income has fallen due to the adverse effect of two high-profile court cases (1), where Smithson’s services to assist the prosecution were found to be in error. Not only did this provide adverse publicity (1) for Smithson, but a number of clients withdrew their contracts (1). A senior employee then left Smithson (2), stating lack of investment in new analysis machines (2) was increasing the risk of incorrect information being provided by the company.

A cash flow forecast prepared internally shows Smithson requiring significant additional cash within the next 12 months (3) to maintain even the current level of services. Smithson’s auditors have been asked to provide a negative
assurance report on this forecast.

Eight points will be enough for us to gain full marks on part (b) which asks for the audit procedures that may be carried out to try to determine whether or not Smithson is a going concern.

If a business is a “going concern” it means that it is economically viable.

Let’s see what we can draw from the scenario.

(1) Court case
– Consider the impact that loss of certain clients’ services will have on Smithson.
– Obtain a solicitor’s letter. From this, try to deduce the financial impact of any legal claims against Smithson, and whether insurance is available for covering such claims.

IN BRIEF: Loss of clients, solicitor’s letter

(2) Senior employee leaving
– The auditor can enquire about “lack of capital investment” that the departing employee claimed existed within the company. He can enquire about purchase policy with the directors, and look into the level of investment rival companies are carrying out.
– How important was the senior employee to Smithson? Can he be replaced? And if so, how soon?

IN BRIEF: Lack of capital investment, importance of employee

(3) Cash flow
– Obtain a copy of the cash flow forecast. Discuss with directors.
– Have the directors identified any other forms of finance that can make up the additional cash flow required?

IN BRIEF – Discuss cash flow forecast, other forms of finance

Additionally, here are some general points for you:

– Obtain the directors’ views on whether or not Smithson can continue as a Going Concern. Ask them why they believe what they do, and try and confirm the accuracy of their beliefs.
– Review any other events after year end to see if they have any impact on Smithson.

Part (c) deals with the audit procedures the auditor may take where the auditor has decided that Smithson Co is unlikely to be a going concern.

It’s a more general question, this one. Four marks are available. Here’s some possible answers in brief:

– Discuss situation again with directors. Should additional disclosures in the financial statements be necessary?
– If there’s no additional disclosures, discuss the need to modify the audit report.
– Consider the need for an emphasis of matter paragraph.
– Consider the need for a qualification (unable to obtain sufficent audit evidence) or qualification (material misstatement).

Hope this helps!

Si80