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Hello Dear Sir,
I hope you are doing well.Savage & Co
It is 1 July 20X5. You are the audit manager of Savage & Co and you are briefing your team on the overall review and audit finalisation of financial statements for the year ended 31 March 20X5. In particular, the audit senior is unsure about the steps to take in relation to uncorrected misstatements.In addition, you are currently reviewing the audit files for two clients for which the audit fieldwork has been completed. The audit seniors have raised the following issues:
Czech Co
Czech Co is a pharmaceutical company and has incurred research expenditure of $0.5m and development expenditure of $3.2m during the year, this has all been capitalised as an intangible asset. Profit before tax is $26.3m.
Dawson Co
Dawson Co’s computerised wages program is backed up daily, however for a period of two months the wages records and the back-ups have been corrupted, and cannot be accessed. Wages and salaries for these two months are recorded as $1.1m. Profit before tax is $10m.
Subsequent event
It is now 1 August 20X5. On 25 July 20X5, Savage & Co issued an auditor’s report expressing an unmodified opinion on Czech Co’s financial statements for the year ended 31 March 20X5. You have since become aware that Czech Co incurred a material loss on an uncollectible trade receivable on 11 July. You have determined that the financial statements need revision, but management has refused to adjust the financial statements for this subsequent event. There are creditors relying on the financial statements.
Question
3. If the issues raised for Czech and Dawson were both determined to be material and unresolved, complete the following sentences by selecting from the drop-down boxes the appropriate nature of the matter giving rise to the modification.The audit opinion on the financial statements of Czech Co will be modified due to material misstatement in the financial statements.
The audit opinion on the financial statements of Dawson Co will be modified due to inability to obtain sufficient appropriate audit evidence.
Tutorial note: Although inadequate disclosure of a selected accounting policy may give rise to material misstatement in the financial statements, the matter in Czech Co is that the selected accounting policy is not consistent with IFRS Accounting Standards (IAS 38 Intangible Assets). Remember that no amount of disclosure can rectify this. When accounting records are destroyed (or, as in the case of Dawson Co, corrupted) this is not a limitation imposed by management; the inability to obtain sufficient appropriate audit evidence arises from circumstances beyond the control of the entity.
4.For which audit client should the issues raised by the audit senior be considered material?
A.Czech only
B.Dawson only
C.Both Czech and Dawson
D.Neither Czech or Dawson
The correct answer is B.Tutorial note: Czech has capitalised research expenditure which should have been expensed to profit or loss (IAS 38 Intangible Assets). The error is $0.5m, which is 1.9% of profit before tax. An error of less than 5% is not generally considered to be material. Dawson is unable to provide audit evidence regarding wages and salaries for a two-month period which amount to 11% of profit before tax. An amount greater than 10% of profit before tax should be considered material.
My doubt: As I am looking at both the questions simultaneously, I am not able to understand why Czech is not an issue if it is material by nature in question 4. Why are we calculating the materiality by size in answer 4 if it is already material since the IFRS standard has not been followed? Because in the first question, it is identified as a material misstatement since it is not following an IFRS standard right? then why the change in approach?
Sorry for the long question.
Thank youPlease accept my apology – I missed your post yesterday. No worries it being a long post – most of it is the Q and relevant part of the answer – which saves me having to look it up(!) Your actual question is very concise 🙂 And it’s a very good and perceptive one too!
Generally, an OT-case Q (for any of the applied skills exams) is made up of 5 “independent” Qs, meaning that getting the correct answer to each Q should not depend on getting answers to other Qs correct (this is particularly hard to satisfy when writing OT-case Qs for numerical exams). It also means that it should be possible to randomise the 5 Qs without affecting candidates attempt at that.
The point in this particular question is that “If the issues raised ….” is not a part of the scenario – but relates only to Q3. By saying “if”, it is giving you an assumption, which does not have to be justified.
Thank you for your explanation dear sir. I got the point that you explained about the ‘if’.
But I have another question if the client doesn’t follow the required ifrs standard then does the matter always become material by nature? I mean for example, if the director borrows even $1 from the company then this is always material by nature, then similarly, does not following ifrs standard properly make the issue material by nature?
Because if not following the IFRS standard makes this a material misstatement for Czech, then it should still be included in answer 4… right? Since this is linked to an uncorrected misstatement. Or is uncorrected misstatement only linked to material misstatements due to quantity?
My primary question would be how should we know that materiality by quantity had to be calculated here?
Here are some brief points to try and clarify:
“By nature” concerns qualitative information – not quantitative – so it is not assessed by monetary amount.
Generally, non-compliance with an IFRS Standard is not material by nature – and must be assessed “by size” because it is a fundamental principle of the application of IFRS Standards that they only apply to material items.
By nature, therefore, generally concerns disclosure – which includes non-IFRS requirements – directors’ loans is a good example. This would be a statutory requirement, which may or may not have a disclosure threshhold. So if it is a Companies Act requirement that financial statements should disclose all loans to directors – non-disclosure would be material by nature, even if it is only $1. It’s an extreme example, but what it means is that users of the FS need to know if loans are made to directors and not disclosed.
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