Audit question [june2011 Q2] IAS11:

 

Construction Contract(attachment1)

In the last week, two significant issues have arisen at Bill Co. The first issue concerns a major contract involving the development of an old riverside warehouse into a conference centre in Bridgetown. An architect working on the development has discovered that the property will need significant additional structural improvements, the extra cost of which is estimated to be $350,000. The contract was originally forecast to make a profit of $200,000. The development is currently about one third complete, and will take a further 15 months to finish, including this additional construction work. The customer has been told that the completion of the contract will be delayed by around two months. However, the contract price is fixed, and so the additional costs must be covered by Bill Co.

Forecast profit before tax is $2·5 million.

Hello

Thanks for taking on the role of audit manager for the forthcoming audit of Bill Co.

(i) I have just received some information on two significant issues that have arisen over the last week, from Sam Compton, the company’s finance director. This information is provided in attachment 1. I am asking you to prepare briefing notes, for my use, in which you explain the matters that should be considered in relation to the treatment of these two issues in the financial statements, and also explain the risks of material misstatement relating to them. I also want you to recommend the planned audit procedures that should be performed in order to address those risks.

(8 marks)

Answer to [june2011 Q2] IAS11

Matters to be considered

Materiality:

The loss on the contract of $150,000 represents 6% of the forecast profit before tax and is therefore material to the statement of profit or loss.

Accounting treatment:

  1. The $150,000 loss needs to be recognized immediately to the statement of profit and loss and other comprehensive income.
  2. The delay completion of contract would result in penalties and this should be accounted for under IAS37 provision, contingent liabilities and contingent asset.

Risks of material misstatement:

  1. There is a risk that loss of $150,000 has not been recognized in the statement of profit or loss and hence overstate the profit figure by $150,000.
  2. There is also a risk that a failure to provide for a provision or disclose contingent liability in the note of the FS and this would result in understatement of liability and expense or under disclosure.

Audit procedures:

  1. Inspect the customer-signed contract to verify the fixed price and any penalty clauses relating to late completion.
  2. Recalculate the budget for the Bridgetown development to verify the accuracy of the schedule and confirm the expected loss of $150,000.
  3. Inspect report made by the architect regarding the structural improvements to verify the estimate of the additional costs.
  4. Discuss the additional costs with contractors to assess if the estimate appears reasonable.
  5. Review Bill Co’s cash flow forecast to ensure adequate funds to cover the additional costs.

 

Audit question: [Q11:DEC2008 Q1] IAS 12

 

(b) Describe the principal audit procedures to be carried out in respect of the following:

(ii) The recoverability of the deferred tax asset. (4 marks)

Answer to [Q11:DEC2008 Q1] Income taxes IAS 12

(ii) Principal audit procedures – recoverability of deferred tax asset

  1. Agree figures in the current and deferred tax calculation to tax correspondence.
  2. Inspect profitability forecast to agree there is enough forecast taxable profit to offset against the loss.
  3. Perform analytical procedure by evaluating assumptions used in the forecast to ensure it’s in line with auditors’ business understanding.
  4. Perform analytical procedure by assessing time taken to generate profit to recover tax losses and if it takes many years to generate such profit and the recognition of deferred tax asset would be restricted.
  5. Inspect tax correspondence to verify there’s no restriction for company to carry forward and use losses against future taxable profits.