Qn
You are the auditor of Oil Rakers, a limited liability company which extracts, refines and sells oil and petroleum related products.
The audit of Oil Rakers for the year ended 30 June 2005 had the following events:
Date
Event
15 August 2010
Bankruptcy of major customer representing 11% of the trade receivables on the balance sheet.
21 September 2010
Financial statements approved by directors.
22 September 2010
Audit work completed and auditor’s report signed.
1 November 2010
Accidental release of toxic chemicals into the sea from the company’s oil refinery resulting in severe damage to the environment. Management had amended and made adequate disclosure of the event in the financial statements.
23 November 2010
Financial statements issued to members of Oil Rakers.
30 November 2010
A fire at one of the company’s oil wells completely destroys the well. Drilling a new well will take ten months with a consequent loss in oil production during this time.
Required:For each of the following three dates:
15 August 2010;
1 November 2010; and
30 November 2010
(i) State whether the events occurring on those dates are adjusting or non-adjusting according to IAS 10 Events after the Balance Sheet Date, giving reasons for your decision;
(ii) Explain the auditor’s responsibility and the audit procedures that should be carried out.
Audit procedures to be used prior to the audit report being signed include:
Reviewing procedures established by management to try and ensure that subsequent events are identified.
Reading minutes of the meetings of directors, the audit committee and shareholders and enquiring into unusual items.
Obtaining and reading the company’s latest interim accounts as well as any budgets and cash flow forecasts.
Obtaining additional evidence if possible from the company’s lawyers concerning litigation and claims.
Asking management as to whether any subsequent events have occurred such as
New borrowing commitments
Significant sales of assets
New shares or debentures issued
Assets being destroyed by flood fire etc or impounded by the government
Unusual accounting adjustments made or being contemplated
Checking whether any events have occurred that could call into question the validity of the going concern assumption.
(a) 15 August 2010
The bankruptcy of a major customer provides additional evidence of conditions existing at the balance sheet date. The customer will not be able to pay debts due, therefore receivables are overstated and the bad debt provision on the profit and loss account is understated. An adjustment for the amount of the receivable should be made in the financial statements.
The bankruptcy of the major customer takes place after the end of the year but before the financial statements and the auditor’s report are signed. As the auditor’s report has not been signed, the auditor is responsible for identifying material events that affect the financial statements. This means that audit procedures should be carried out which are designed to identify this event.
Specific procedures undertaken include:
Confirming that the customer will not pay to a letter from the receiver or similar authorised person
Confirming the amount due from the customer to invoices raised prior to the year end, and if possible to a positive direct confirmation letter
Auditing the adjustment to the financial statements decreasing the receivable balance and increasing the bad debt write off in the profit and loss account
Including the amount in the management representation letter to confirm no other amounts are due from the customer
1 November 2010
The accidental release of toxic chemicals occurred after the balance sheet date. Assuming that the inventory was not on the balance sheet at the year end, then the spill is indicative of conditions that arose subsequent to the year end. No adjustment appears to be necessary. However, the event may be significant in terms of the operations of the company (a large legal claim could arise) and so disclosure of the event would be expected.
The accidental release of toxic chemicals takes place after the auditor’s report has been signed but before the financial statements are sent to the members. At this stage of the audit, the auditor does not have any responsibility to perform procedures or make inquiries regarding the financial statements. The management of Oil Rakers is responsible for telling the auditor about any significant events, such as this one.
However, as the auditor is now aware of the event and this materially affects the financial statements in terms of disclosure being required, the auditor does have to discuss the event with management.
Specific procedures to be undertaken include:
Obtain information concerning the chemical release from management, reading local press and if possible the company’s lawyers – the latter may be able to indicate whether there is any legal liability.
Discuss the appropriate accounting treatment with the directors, confirming that disclosure is required in the circumstances.
Read the disclosure note to confirm that the matter is adequately explained in the financial statements.
Obtain an updated letter of representation from the directors confirming that there are no other events requiring disclosure.
Amend the auditor’s report to include an emphasis of matter paragraph to draw attention to the full disclosure noted in the financial statements. Date the new auditor’s report no earlier than the date of the amended financial statements.
30 November 2010
The fire at an oil well means that Oil Raker’s oil production and presumably profits will fall in the next financial year. The fire though does not provide additional evidence of conditions existing at the balance sheet date as at this time there was no indication that this would occur. The event is therefore non-adjusting in the financial statements. However, disclosure of the event should be made so that the financial statements do not give a misleading position.
The fire at an oil well takes place after the financial statements have been issued. At this time, the auditor has no obligation to make any inquiry at all regarding the financial statements.
If the auditor becomes aware of the event, then the potential effect on the auditor’s report must be considered.
Specific procedures undertaken include:
Checking the board minutes, insurance claims and similar documents to ensure that the fire will be covered by insurance and there is no contingent liability for replacing non-current assets or clearing up any environmental damage.
Inquiring of the directors how the members will be informed of the situation.
If the directors plan to re-issue the financial statements, ensure that appropriate disclosure is made of the event.
If the directors do not intend to amend the financial statements, and you consider the matter to be material to understanding the accounts, consider attempting to contact the members directly, depending on the methods available in your country.
If necessary, contact the auditor’s lawyers to discuss what action can be taken regarding the lack of disclosure.
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