Audit Solutions

Audit Solutions

Mr Shariq Barmaky Deputy Chairman, ISCA Audit and Assurance Standards Committee

Partner, Deloitte & Touche LLP

2

This Presentation (the Presentation) has been prepared by ISCA for the exclusive use

of the recipients to whom it is addressed.

Each recipient agrees that it will not permit any third party to, copy, reproduce or

distribute to others this Presentation, in whole or in part, at any time without the prior

written consent of ISCA, and that it will keep confidential all information contained

herein not already in the public domain.

The Preparers expressly disclaim any and all liability for representations or warranties,

expressed or implied, contained in, or for omissions from, this Presentation or any other

written or oral communication transmitted to any interested party in connection with this

Presentation so far as is permitted by law. In particular, but without limitation, no

representation or warranty is given as to the achievement or reasonableness of, and no

reliance should be placed on, any projections, estimates, forecasts, analyses or forward

looking statements contained in this Presentation which involve by their nature a

number of risks, uncertainties or assumptions that could cause actual results or events

to differ materially from those expressed or implied in this Presentation.

In furnishing this Presentation, the Preparers reserve the right to amend or replace this

Presentation at any time and undertake no obligation to update any of the information

contained in the Presentation or to correct any inaccuracies that may become apparent.

This Presentation shall remain the property of ISCA.

Important disclaimer

3

Agenda

Audit of Sweetzz Pte Ltd Inventories

Receivables

Property, plant and equipment (PPE)

Going concern

Subsequent events Audit Report

4

Audit of

Sweetzz Pte Ltd

5

Sweetzz Pte Ltd

Incorporated and commenced operations in January 2009 in Singapore Audit client of Quality Audit Partnership since then In the business of selling imported biscuits, sweets and chocolates

through 2 channels: To local companies / sole proprietorships (e.g. mini marts) Through 1 retail outlet in a small shop house (freehold)

Huge capital investment to set up and renovate the retail outlet Expenses comprise mainly staff costs and depreciation Loss-making and in capital deficiency position Heavily reliant on funding from one of its shareholders

6

Products of Sweetzz The retail shop

7

Financial information of Sweetzz

31 December, 31 December, 2012 2011 $ $ Cash and cash equivalents 260,395 638,826 Trade receivables 141,192 131,937 Inventories 305,511 286,008 Total current assets 707,098 1,056,771 Freehold land and building 1,000,000 1,000,000 Plant and equipment 1,115,236 1,472,084 Total assets 2,822,334 3,528,855 Trade payables 147,193 367,471 Advance from shareholder 6,110,799 6,888,969 Share capital 100,000 100,000 Accumulated losses (3,535,658) (3,827,585) Total liabilities and equity 2,822,334 3,528,855

8

Audit for FY 31 December 2012

Manager Partner

Hi Boss, the audit has been substantially

completed. Generally nothing has

changed from prior year in terms of the

audit approach. No major issues noted.

In fact, the client has been efficient this

year and has provided a draft copy of

the financial statements, which has been

submitted for your review together with

the working papers.

Materiality is determined based on

revenue = $50,000

Clearly trivial threshold (CTT) = $2,500

Thats a job well done! I will review the

file after lunch and

provide comments

before COB today.

9

Reviewing the inventories section

Tackling exceptions in audit sampling

Investigate nature and cause, regardless of materiality. Why?

The One-off Myth: It is

common High degree of certainty

required Additional audit procedures (e.g. extend

sample size, request

management to quantify)

Do not forget to extrapolate

if it is a misstatement

Item Qty Qty Diff per listing per count (qty) Candy (box) 200 200 - Chocolate (bar) 380 358 22 # Biscuit (pkt) 500 432 68 #

#: Value of differences = $124 As amount is immaterial (less than CTT), and is a one-off exception, suggest leave.

Sweetzz Stock Take Count Sheet

10

Reviewing the inventories section

Managements policy: 100% allowance for stocks past expiry dates (manufacturer provides expiry dates) Items nearing expiry dates (~ 3 months) are consolidated into a Best Buy corner. Priced at 1 item for $1 (which is still above cost) to move them at faster rate No allowance required as, based on past experience, most items get sold off when they are in the Best Buy corner Based on this policy, an allowance of $4,888 (2011: $1,688) has been made.

Stocks Obsolescence Assessment

11

Reviewing the inventories section Ways to demonstrate professional skepticism in auditing managements estimates

Underlying data: can it be relied on? Completeness & accuracy How many samples?

The Re-computation trap

Accuracy Reasonable Prudence Reasonable

The Power of Retrospective Review Simple yet powerful to

corroborate/ challenge

managements representations

Audit Procedures and Findings: 1.Inquired management and noted no change in policy from prior year

2.Obtained Products Expiry List from management and recomputed allowance. Noted overprovision of $2,550 (more than clearly trivial threshold). Management explained that there were some products nearing expiry which they believe would not be sold based on experience. Since this is a more prudent assessment, suggest leave.

Stocks Obsolescence Assessment

12

Reviewing the receivables section

Other than walk-in customers, company has 10 corporate customers. Based on sample design, confirmations were sent to 2 customers below: Customer Amt Amt Diff per client per confirmation MeeNee Mart 21,930 18,430 3,500@ MAMA Shop 15,648 Not received # NA

@: Reconciliation obtained and traced material items supporting documents #: See alternative procedures performed

Confirmation of Trade Receivables

Reconciliation: Payment 1 2,500V Payment 2 2,000V1 Sales 1 (400)imm Sales 2 (600)imm 3,500 imm: immaterial

Confirmation differences: Rule of thumb

Regardless of quantum: Reconcile differences Understand nature of reconciling items Verify to supporting documents

13


Audit procedures and findings: 1.Vouched to subsequent receipts, if any. 2.Where there are no receipts, vouched to sales invoices and delivery orders to ensure that sales have been made Customer Amt Subsequent Invoices & Diff per client receipts delivery orders MAMA Shop 15,648 1,200 12,222 2,226#

#: Difference not covered by alternative procedures is immaterial, suggest no further work.

Trade Receivables: Alternative Procedures

Alternative Procedures: The #1 Pitfall

Samples of samples

This is not

consistent with

SSA 505.12 and

ACRA Bulletin

1/2010 and I

specifically

reminded the

team. Let me

call the

manager.

14


Boss, I remember, but you

know we have time pressure

this year. There are so many

invoices of small values. We

have tried our best and the remaining amount is only

$2,226. In addition, we have

not been receiving responses

from this debtor based on past

experience. Is there another way to audit this?

Well think of something for

the next

audit. Now

lets complete the remaining

balance.

Confirmation Tips:

Appropriateness Why use if there will be

no response

Design

Individual invoice vs Total balance: Professional judgment

when to use

Doesnt address completeness. Use in

limited circumstances:

1) No significant risk

2) With other audit procedures

15

Reviewing the PPE section

Indicators of impairment of PPE: Since commencement of operations, Sweetzz has been making net losses and is in a capital deficiency position Ability to recover carrying amount of PPE from future cash flows is uncertain. Management prepared a discounted cash flow (DCF) to determine the value-in-use (VIU), in 000s: VIU = 2,237 Carrying amount of plant and equipment = 1,115 Excess = 1,122 Management concluded no impairment loss is required.

Impairment of PPE Management

should have

compared the

VIU with both

the carrying

amount of

plant and

equipment

and freehold

land and

building.

16

Reviewing the DCF Year 2012a 2013 2014 2015 2016 2017 2018

Sales 1,964 2,160 2,376 2,614 2,875 3,163 3,479

Sales growth rate 10.0% 10.0% 10.0% 10.0% 10.0% 10.0%

Gross margin 703 756 832 915 1,006 1,107 1,218

GPM (%) 30.0% 35.0% 35.0% 35.0% 35.0% 35.0% 35.0%

EBITDA 756 832 915 1,006 1,107 1,218

- Maintenance of PP&E -280 -280 -280 -280 -280 -280

- change in working capital -200 -184 -160 -160 -160 -160 FREE CASH FLOWS - adjusted for tax 276 368 475 566 667 778

Discount period 1 2 3 4 5 6

Discount rate 10.0%

Discount factor

(1/((1+ Discount Rate) (^Discount Period)) 0.91x 0.83x 0.75x 0.68x 0.68x 0.62x

Discounted cash flow (A) 251 304 357 387 456 483

Total value in use 2,237 Sum of A So many numbers..

Im getting a headache

17

Year 2012a 2013 2014 2015 2016 2017 2018

Sales 1,964 2,160 2,376 2,614 2,875 3,163 3,479


Gross margin 703 756 832 915 1,006 1,107 1,218

GPM (%) 30.0% 35.0% 35.0% 35.0% 35.0% 35.0% 35.0%

EBITDA 756 832 915 1,006 1,107 1,218




Discount rate 10.0%

Discount factor



Total value in use 2,237 Sum of A

Dissecting the DCF: The Facts

Agree to final audited numbers

and next years approved budget

Check overall arithmetical

accuracy (request

soft copy)

18

Year 2012a 2013 2014 2015 2016 2017 2018

Sales 1,964 2,160 2,376 2,614 2,875 3,163 3,479


Gross margin 703 756 832 915 1,006 1,107 1,218

GPM (%) 30.0% 35.0% 35.0% 35.0% 35.0% 35.0% 35.0%

EBITDA 756 832 915 1,006 1,107 1,218




Discount rate 10.0%

Discount factor




Dissecting the DCF: The Technicalities

Discount Rate

Type (WACC, interest rate) Value (coys in similar business, Bloomberg)

E.g. WACC of a listed coy in similar business is 10%.

Reasonable for Sweetzz to also be 10%?

Post-tax or pre-tax Consistency with cash flows (FS disclosure is pre-tax)

Model

Composition of cash flows Inclusions and exclusions

Adjustments CAPEX, working capital, depreciation

Period Max. of 5 years, unless a longer

period can be justified

For PPE: remaining useful lives

Should I

engage a

valuation

expert?

19

Year 2012a 2013 2014 2015 2016 2017 2018

Sales 1,964 2,160 2,376 2,614 2,875 3,163 3,479


Gross margin 703 756 832 915 1,006 1,107 1,218

GPM (%) 30.0% 35.0% 35.0% 35.0% 35.0% 35.0% 35.0%

EBITDA 756 832 915 1,006 1,107 1,218




Discount rate 10.0%

Discount factor




Dissecting the DCF: The Business Assumptions

Golden Rule: Corroborate management representations

Retrospective review of historical growth rates, GPM, results Compare against prior year DCF, if any Understand future plans (feasibility, documentary evidence) Compare with other entities in similar industry

Bottomline: Requires deep understanding of clients business and industry as a whole. Partner involvement is

essential to enable exercise of professional skepticism.

20

Year 2012a 2013 2014 2015 2016 2017 2018

Sales 1,964 2,160 2,376 2,614 2,875 3,163 3,479


Gross margin 703 756 832 915 1,006 1,107 1,218

GPM (%) 30.0% 35.0% 35.0% 35.0% 35.0% 35.0% 35.0%

EBITDA 756 832 915 1,006 1,107 1,218




Discount rate 10.0%

Discount factor




Carrying amount of PPE,

freehold land and building 2,115

Excess 122

Dissecting the DCF: Sensitivity Analysis

Look out for small headroom

Sensitivity: What changes will result in impairment loss Discount rate (increase from 10% to 12%)

Sales growth rate (decrease from 10% to 9%) GPM (decrease from 35% to 34%)

21

Not forgetting DISCLOSURES on impairment

After Partner challenged the assumptions, management revised the DCF and

recognised an impairment loss of $800,000. Disclosure in the financial

statements (FS) was also updated:

During the year, the company carried out a review of the recoverable amount of its property, plant and equipment and recognised an impairment loss of $800,000.

What

disclosures are

missing?

22


FRS 36:126,

130

During the year, the company carried out a review of the recoverable amount of its property, plant and equipment, (1) having regard to its capital deficiency and loss-making positions for the current financial year. The review led to the recognition of an impairment loss of $800,000 (2) that has been recognised in profit or loss, and included in the line item other expenses (3) The recoverable amount of the relevant assets has been determined on the basis of their value in use. The discount rate used in measuring value in use was 15%. The discount rate used when the recoverable amount of these assets was previously estimated in 2011 was 10%.

23


Management do not want to include the disclosures in red (previous slide): 1)Obvious from FS that Sweetzz is loss-making and in a capital deficiency position, so not necessary to disclose in this note

2)Does it matter to users where impairment loss is included?

3)Users are most interested in the amount of impairment. The method used or discount rate applied is just secondary.

Disclosure Misstatements How material is a disclosure?

Size and nature often not quantitative

in nature

Consideration of

nature is important

Influence economic

decisions of users Assumed to have

reasonable knowledge

Are these

omissions

immaterial?

24

Going Concern Made Easy:

The

Reviewing the Going Concern Assessment

Management has a part to play Responsibilities under FRS 1

No going concern issues No material uncertainties

Different requirements under SSA

570 Impact audit report (elaborated in later slides)

Letter of financial support: A false

sense of security Meaningless if provider has no

ability: Assess ability of individual?

Other sources of evidence (DCF

for PPE)

Although Sweetzz is in a capital deficiency and loss-making, there are no going concern issues: 1) Sweetzz has strong financial

support from its shareholder, Mr. Rich. Obtained letter of financial support and noted no exceptions.

2) No reasons to believe that financial support is not forthcoming because Sweetzz has been receiving funds from Mr. Rich since incorporation.

Going Concern Memo

25

At 5:30pm and thereafter

15 April @ 5:30pm

Partner review points issued (round 1)

30 April

Partner review points issued (round 2)

18 May

Partner review points cleared

20 May

Financial statements approved

Rep letter received

Sufficient appropriate audit evidence obtained

26

Why no a/cs after

31/3? Anyway

should be ok since

no issues historically Audit report is dated 20 May 2013.

Mr. Partner is getting ready to sign the

audit report and looked at the subsequent events review memo. All appears good.

Finally

Inquired with management on 20 May Reviewed subsequent management

accounts up to 31 March No further work done as there were: No subsequent meetings conducted No management accounts beyond 31

March Noted no subsequent events that require

adjustments to, or disclosures in financial statements.

Subsequent Events Memo Its lunch time and Mr.

Partner decided to read the newspaper prior to signing the report. On

page 10 of the newspaper, he saw:

Mr. Rich, top 100 richest man in

Singapore, declared bankrupt

27

Impact of Subsequent Events Management accounts only available up to 31 March. Subsequent to that, Sweetzz had obtained a short-term loan from a related party of $500,000 to repay Mr. Rich.

Sweetzz is heavily reliant on

Mr Rich for financial support

Going concern to be re-assessed

Huge payable to Mr Rich

Any adjustments required?

Notes to financial statements

Additional disclosures

WHY was this

not picked up in

the subsequent

events review?

What are the alternative

procedures if subsequent

accounts are not available?

Inspection of available books and records, including bank statements (SSA 560:A7)

28

Impact on the Auditors Report

Events or conditions that

may cast significant doubt

on the entitys ability to continue

as a going concern?

Material uncertainty?

Yes

If no other audit evidence obtained during the audit that

suggests otherwise, going concern assumption can be concluded to

be appropriate

No

28

Initial conclusion

prior to discovery

of subsequent

events Clean opinion with no

EOM

29

Impact on the Auditors Report

Events or conditions that

may cast significant doubt

on the entitys ability to continue

as a going concern?

Material uncertainty?

Yes

29

Why yes?

FRS 1:25

Adequate disclosures in

FS?

EOM Yes

Yes Going concern assumption

appropriate?

Yes

Disclaimer

(rare)

Multiple material

uncertainties that

are significant to

the FS

In situations involving

multiple material

uncertainties

may consider it appropriate in extremely

rare cases to express a

disclaimer of opinion

instead of EOM Potential

conclusions after

subsequent event

EOM or Disclaimer

30

Key Take-Aways

Audit of a seemingly simple company may have hidden traps. Exercise of professional skepticism is required throughout the audit. Exceptions in sampling are an exception, not the norm. One-off is easy to document, but hard to prove.

Auditing management estimates is not simply a re-computation exercise. Retrospective review is a powerful procedure to assist our corroboration.

Obtaining external confirmations is quality audit evidence for receivables, but beware when there are differences of confirmed balances or when there is no response, may not always be the most appropriate method.

Auditing the DCF is a challenge, but do not be overwhelmed. Dissect it into auditable bits in a step-by-step approach. Use experts when necessary.

31

Key Take-Aways (contd)

Beware of going concern. The wrong conclusions may have a material impact on the audit report.

Do not underestimate the importance of a proper subsequent events review or leave it as an after-thought.

Going concern (FRS 1) and Subsequent events (FRS 10) are responsibilities of management too. Remind them if need be.

Audit Solutions

Documents

Transcript of Audit Solutions