Week 3 Q - Audit Risk assessment Evaluating risk Concept of materially PDF

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Audit Risk assessment
Evaluating risk
Concept of materially...

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Question 1

A client, Candy Cones Ltd has presented you with the following information at 30 June:

Revenue Net profit after tax Long term borrowings Accounts payable Contingent liability Cash at Bank

• • • •

2019 $’000 12,500 900 1,950 500 130 450

2018 $’000 14,750 2,200 700 1,300 450 2,000

Additional information: The long term borrowings are due to be repaid in instalments. In 2020 $500 is due to be repaid The long term borrowings are subject to debt covenants in relation to interest coverage and the gearing ratio. The company is in the technology industry. It is currently developing a new smart phone which it believes will be extremely popular. The company has plans to launch the phone in six months. The company currently pays a cash dividend. Required: Assume you are the auditor of Candy Cones Ltd. Provide four (4) indicators that Candy Cones: i) ii)

May be a going concern May NOT be a going concern

Indicators that Candy Cones may not be considered a going concern: 1. 2. 3. 4.

Profits are falling Borrowings have increased Slowdown in number of days to pay accounts payable Cash at bank is significantly lower

Indicators that Candy Cones may be considered a going concern 1. Sales are expected to increase as a result of the development of a new smart phone. 2. Loan is payable by instalment – therefore at the end of 2019, it is likely that Candy Cones will be able to pay the instalment of $500 in the 2020 financial year. 3. Cash dividends are still being paid. 4. Company is still profitable (even though there has been a significant decline) 5. Contingent liabilities are lower than prior year, which reduces the likelihood of the entity having to make a cash payment in the future.

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Question 2 Channel 56 is an Australian television network which operates three free-to-air television stations. It owns a valuable 4G mobile spectrum license. It has struggled to maintain viewers in recent years due to the growth of streaming services. It has experienced a significant fall in advertising revenue and despite reducing staff levels, was unprofitable in the current year, 30 June 2019. The company plans to further reduce costs in the next financial year and is budgeting to make a small profit in the 30 June 2020 financial year. Channel 56 funded its earlier growth by borrowing heavily from banks and other large lenders. A large amount of debt is due to be repaid in December 2020. The banks have stated that they will only agree to loan more funds to the company if the wealthy Directors personally guarantee the loans. While dividends paid to shareholders were considered generous in the early years, the pressure to meet interest payments on the loans resulted the interim dividend being cancelled in the current year. Channel 56 is listed on the Australian Securities Exchange and the cancellation of the dividend has adversely affected the share price. The auditors have been interviewing Channel 56 staff during the planning phase of the 2019 audit. They have been made aware of the pressure staff face in finding costs to cut and ensuring that debt covenants are not breached. Required: (a)

Explain the factors that suggest that Channel 56 was a going concern at 30 June 2019. 1. The entity plans to reduce costs in the future and is budgeting to make a profit. 2. At this stage, the entity is receiving funding from banks and other lenders. Hopefully, this will be able to continue in the foreseeable future to sustain the operations of the entity if the Directors personally guarantee the loans. In other words, the entity seems to have access to further funding.

(b)

Explain the factors that suggest that Channel 56 was not a going concern at 30 June 2019. 1. Due to the competitive nature of the industry, the entity is currently not making a profit. 2. The entity is borrowing heavily from the bank/lenders and must make a significant payment in December 2020. This places additional cash flow/liquidity strain on the entity. 3. The entity has cancelled its dividend payment, which again shows the current cash flow/liquidity issues. 4. The cancellation of the dividend has had a negative effect on the share price of the entity and raises potential concerns surrounding the future viability of the entity. 5. The entity must adhere to debt covenants. Any breach of these covenants could result in significant financial penalties for the entity. 6. The entity is currently experiencing problems when it comes to paying interest payments on the loans. This again shows that the entity is suffering cash flow problems.

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