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ACCA P7 Advanced Audit & Assurance [INT]

Sample Study Note

For exams in June2014

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Lesco Group Limited, April 2015

All rights reserved. No part of this publication may be reproduced, stored in a

retrieval system, or transmitted, in any form or by any means, electronic,

mechanical, photocopying, recording or otherwise, without the prior written

permission of Lesco Group Limited.

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Sample Note Content:

Main study note content [Total Pages: 235] ...................................................... 4

Product Summary .......................................................................................... 7

Live online note sample plan ........................................................................... 8

Live online course timetable: ........................................................................... 9

Chapter 1 Practise management .................................................................... 12

Practice questions relating to practise management in chapter1: ....................... 15

Stage 4 of audit flowchart [Substantive procedures] ......................................... 24

Please note:

This is just the sample study note extracted from the main study note in your tuition study

[This tuition study note is consistent in basic/super/gold package]. There would be more

chapters in the main study note covering the whole ACCA syllabus.

You can also take a look at the content within the main study note below:

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Main study note content [Total Pages: 235]

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Product Summary

content Basic

package

Super

package

Gold

Package

Oxford Brookes BSc in Applied Accoun

ACCA HD quality super tuition videos

ACCA HD quality super revision videos

Last minute revision

ACCA Live online tuition(4sessions)

ACCA Live online revision(14hours)

ACCA Mock exams(with tutor mark)

ACCA Tutor support

ACCA Electronic study note

ACCA Student online forum

Pass Guarantee

ACCA Final revision mock exam paper

ACCA Super Live online session (20-

30hours)

ACCA Super Live online revision

(Super 3 days)

ACCA 1V1 Career Advice

ACCA Extra exam techniques

demonstration

Live online mentoring

http://www.accaapc.com/acca-study-videos.asp?id=6http://www.accaapc.com/acca-study-videos.asp?id=6http://www.accaapc.com/acca-study-videos.asp?id=6http://www.accaapc.com/acca-study-videos.asp?id=6http://www.accaapc.com/acca-study-videos.asp?id=6http://www.accaapc.com/acca-study-videos.asp?id=6http://www.accaapc.com/acca-study-videos.asp?id=6http://www.accaapc.com/acca-study-videos.asp?id=6http://www.accaapc.com/acca-study-videos.asp?id=6http://www.accaapc.com/acca-study-videos.asp?id=6http://www.accaapc.com/acca-study-videos.asp?id=6http://www.accaapc.com/acca-study-videos.asp?id=6http://www.accaapc.com/acca-study-videos.asp?id=6http://www.accaapc.com/acca-study-videos.asp?id=6http://www.accaapc.com/acca-study-videos.asp?id=6http://www.accaapc.com/acca-study-videos.asp?id=6http://www.accaapc.com/acca-study-videos.asp?id=6http://www.accaapc.com/acca-study-videos.asp?id=6http://www.accaapc.com/acca-study-videos.asp?id=6http://www.accaapc.com/acca-study-videos.asp?id=6http://www.accaapc.com/acca-study-videos.asp?id=6http://www.accaapc.com/acca-study-videos.asp?id=6http://www.accaapc.com/acca-study-videos.asp?id=6http://www.accaapc.com/acca-study-videos.asp?id=6http://www.accaapc.com/acca-study-videos.asp?id=6http://www.accaapc.com/acca-study-videos.asp?id=6http://www.accaapc.com/acca-study-videos.asp?id=6http://www.accaapc.com/acca-study-videos.asp?id=6http://www.accaapc.com/acca-study-videos.asp?id=6http://www.accaapc.com/acca-study-videos.asp?id=6http://www.accaapc.com/acca-study-videos.asp?id=6http://www.accaapc.com/acca-study-videos.asp?id=6http://www.accaapc.com/acca-study-videos.asp?id=6http://www.accaapc.com/acca-study-videos.asp?id=6http://www.accaapc.com/acca-study-videos.asp?id=6http://www.accaapc.com/acca-study-videos.asp?id=6http://www.accaapc.com/acca-study-videos.asp?id=6http://www.accaapc.com/acca-study-videos.asp?id=6http://www.accaapc.com/acca-study-videos.asp?id=6http://www.accaapc.com/acca-study-videos.asp?id=6http://www.accaapc.com/acca-study-videos.asp?id=6http://www.accaapc.com/acca-study-videos.asp?id=6http://www.accaapc.com/acca-study-videos.asp?id=6http://www.accaapc.com/acca-study-videos.asp?id=6http://www.accaapc.com/acca-study-videos.asp?id=6http://www.accaapc.com/acca-study-videos.asp?id=6http://www.accaapc.com/acca-study-videos.asp?id=6http://www.accaapc.com/acca-study-videos.asp?id=6http://www.accaapc.com/acca-study-videos.asp?id=6http://www.accaapc.com/acca-study-videos.asp?id=6http://www.accaapc.com/acca-study-videos.asp?id=6http://www.accaapc.com/acca-study-videos.asp?id=6http://www.accaapc.com/acca-study-videos.asp?id=6

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Live online note sample plan

Live online tuition note plan for June2014 P7 Exam

[Only for super / gold package (there would be a unique plan for gold package)]

Live sessions: [2 hours/session---live online + recorded after class]:

Live session1: Practice management knowledge +Questions go through

Live session2: Audit plan + Group issues+ P7 question1 go through

Live session3: Key Accounting issues (likely to be examined in June2014)

Live session4:Stage 5+ stage 6+ key non audit assignments + key current

issues[highly examinable in June2014]

Live revision note for June2014 P7 exam: [will be available since mid April 2014]:

Live revision1+2: [There would be a separate live revision note detailing all

past exam questions with answers to go through]

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Live online course timetable:Live session/revision for F4-P7

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*Please Note: This Timetable may be subjected to future changes.Kindly check regularly for any possible updates.

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Chapter 1 Practise management

In this chapter we will be going through:

1. Advertisement issues

2. How to draft a tendering document

3. Professional appointment issues

4. Quality control issues

5. Regulatory issues

The best way to learn this chapter is to copy note from tuition video.

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These 2 pages are left blank intentionally in order for you to copy the note

from tutor:

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Practice questions relating to practise management in chapter1:

Chapter 1 Advertising: (DEC2010 Q4) Neeson&Co

An advertisement could be placed in national newspapers to attract new clients.The draft advertisement has been given to you for review:

Neeson & Co is the largest and most professional accountancy and audit

provider in the country. We offer a range of services in addition to audit,

which are guaranteed to improve your business effi ciency and save you

tax.

If you are unhappy with your auditors, we can offer a second opinion on

the

report that has been given.

Introductory offer: for all new clients we offer a 25% discount when both

audit

and tax services are provided. Our rates are approved by ACCA.

Required:

Evaluate each of the suggestions made above, commenting on the ethical and

professional issues raised. 8marks

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Answer to Neeson&Co: [Tutors own answer]

Back up

Any comments made by the advertisement should be backed up with evidence. For

example it says Neeson&Co is the largest and most professional accountancy

provider in the country so sales revenue and number offices should be made to

back up this evidence.

Definitely clear

The advertisement should be definitely clear.The business efficiency can not be

guaranteed by the firm and this seems that its not honest by Neeson.

The second opinion offered by Neeson&Co may imply that the audit work done by

Neeson&Co is low and as a result client would not be happy with the first opinion

given and hence second opinion would be issued again. And this comment in the

advertisement is not professional.

Ensure to comply with laws and regulation

The advertisement should comply with laws and regulation.

The guarantee to save tax means maybe Neeson would use some tricks to help

client save time which may not comply with laws and regulation because not in

every circumstance that the tax can be saved.

Fundamental ethics

Neeson&Co cant quote rates are approved by ACCA because ACCA does not

approve any rates and this would be seen as unprofessional.

Legal obligation

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It seems that if taxes cant be saved and also business efficiency hasn't been

improved so that client may take potential legal action against Neeson&Co resulting

in further future cash outflow from Neeson&Co.

Low balling

The 25% of introductory fees is low balling and its not prohibited but Neeson&Co

should need to make sure by charging such a low amount of fees the quality of the

work should be maintained, ie, following ISAs to do the audit work.

Chapter 1 (June 2004)Hawk Assocaite

Displaying business cards alongside those of local tradesman and service providersin supermarkets and libraries. The cards would read:

Hawk ACCA Associates

For PROFRSSIONAL Accountancy, Audit,

Business Consultancy and Taxation services

Competitive rates. Money back guarantees.

(4marks)

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Answer to June2004 Hawk Associate:

Advertisement in the super markets and libraries is not professional and theyshould advertise their firm using eg, financial magazines.

Professional is in capital and this implies only their firm is professional whileothers are not and firms shouldntcriticize others.

Competitive rate is vague and compare to whom? So this information is

misleading.

Money back guarantees may mean they can help company save tax and if notthey would give money back to them and this will:

Firstly involving some illegal techniques to help company save tax and hence

its a breach of laws and regulations.

Secondly it implies that the quality of services provided to the company may

not be good and hence give their money back.

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Chapter 1 tendering+Fees (June09 Q2)

The Dragon Group is a large group of companies operating in the furniture retail trade. The

group has expanded rapidly in the last three years, by acquiring several subsidiaries each

year. The management of the parent company, Dragon Co, a listed company, has decided

to put the audit of the group and all subsidiaries out to tender, as the current audit firm is

not seeking re-election. The financial year end of the Dragon Group is 30 September 2009.

You are a senior manager in Unicorn & Co, a global firm of Chartered Certified Accountants,

with offices in over 150 countries across the world. Unicorn & Co has been invited to tender

for the Dragon Group audit (including the audit of all subsidiaries). You manage a

department within the firm which specialises in the audit of retail companies, and you have

been assigned the task of drafting the tender document. You recently held a meeting with

Edmund Jalousie, the group finance director, in which you discussed the current group

structure, recent acquisitions, and the groups plans for future expansion.

Meeting notes Dragon Group

Group structure

The parent company owns 20 subsidiaries, all of which are wholly owned. Half of the

subsidiaries are located in the same country as the parent, and half overseas. Most of

the foreign subsidiaries report under the same financial reporting framework as Dragon

Co, but several prepare financial statements using local accounting rules.

Acquisitions during the year

Two companies were purchased in March 2009, both located in this country:

(i) Mermaid Co, a company which operates 20 furniture retail outlets. The audit opinion

expressed by the incumbent auditors on the financial statements for the year ended 30

September 2008 was qualified by a disagreement over the non-disclosure of a

contingent liability. The contingent liability relates to a court case which is still on-going.

(ii) Minotaur Co, a large company, whose operations are distribution and warehousing.

This represents a diversification away from retail, and it is hoped that the Dragon Group

will benefit from significant economies of scale as a result of the acquisition.

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Other matters

The acquisitive strategy of the group over the last few years has led to significant

growth. Group revenue has increased by 25% in the last three years, and is predicted to

increase by a further 35% in the next four years as the acquisition of more subsidiaries

is planned. The Dragon Group has raised finance for the acquisitions in the past by

becoming listed on the stock exchanges of three different countries. A new listing on a

foreign stock exchange is planned for January 2010. For this reason, management would

like the group audit completed by 31 December 2009.

Required:

(a)Recommend and describe the principal matters to be included in your firms

tender document to provide the audit service to the Dragon Group. (10 marks)

(b) Explain FOUR reasons why a firm of auditors may decide NOT to seek re-

election as auditor. (6 marks)

(c) Using the specific information provided, evaluate the matters that should be

considered before accepting the audit engagement, in the event of your firm

being successful in the tender. (7 marks)

Professional marks will be awarded in part (c) for the clarity and presentation of the

evaluation. (4 marks)

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Answer to June2009 Q2a-c:

(a)

Recourses

Detailed background of our firm should be included for example the expertise and

clients we serve.

Clients needs

Because Dragon group is going to go listed onto the stock exchange and so we can

provide non audit services such as corporate governance advice relating to the

listing.

We have offices in over 150 countries across the world so we can deal with audit

with your subsidiaries all around the world more effectively.

Way to do the audit

We should include how we perform the audit service to ensure appropriate quality

of work maintained such as following ISA to do the risk assessment.

Also we ensure quality during the audit by having appropriate quality control

procedures during the audit such as hot review on the audit work we have done.

Extra benefit

We can provide recommendation to address internal control weakness to

management in the management letter as an extra service for example.

Fees

Fees should be broken down into how its calculated by clearly laying out different

classes of staff involved, such as hourly rate for audit manager and partner.

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(b)

Overdue fees

Where a client hasn't paid their fees there has been outstanding for some time and

such overdue fees would be seen as loan to client which may cause a self interest

threat, ie, in order to keep the loan auditor may issue whatever opinion that client

wants so that a safeguard for this is not to seek re-election.

Resources

As the company expands the audit firm may not have enough resources to do the

audit any more. Such as the company is listing on a stock exchange and the audit

firm is a lack of relevant experts who know the regulation of the stock exchange

and so the firm may not seek re-election.

Integrity

When the management doesn't comply with specific accounting standards such as a

deliberate failure to provide a provision in the financial statements and this action

would be seen as a lack of integrity.

So in order for the audit firm to remain good reputation they should not seek re-

election.

Conflict of interest

Such as the existing company we are auditing is damaging the environment and

didn't disclose the fact.

Another company is waiting for out firms tendering but they are competitors and if

we audit both companies which would cause a conflict of interest so we should

resign the first company as by continuing to be an auditor for this would damage

our firms reputation.

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(c)

Evaluation of matters to be considered:

Recourses

As dragon group has expanded rapidly in the last three years so we must ensure we

have enough audit staff to audit those components.

Management integrity

As a qualified opinion issued by previous auditor over a deliberate non-disclosure of

contingent liability we should question managements integrity and if they not

integrate then we should not accept the engagement service because if afterconducting the service and we find information we obtained is fake then it will still

have an impact on our audit opinion.

Previous auditor

It would be necessary to contact previous auditor to gather information regarding

the non disclosure of contingent liability with clients permission of whether it

should be disclosed in the individual financial statements of Mermaid Co, and at

group level.

Experiences

Given Minotaur Co is involved in distribution and warehousing but this is not a very

complicated industry for Unicorn&Co because it has its offices over 150countries

and it should have relevant experience into auditing this eg, bringing in staff from a

different department more experienced in clients with distribution operations

Time

There will be only 3months for Unicorn&Co to complete the audit and Unicorn&Co

should consider whether to allocate more recourses to this engagement given this

client is large and it needs to spend more time into it.

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Stage 4 of audit flowchart [Substantive procedures]

This is the main content within your p7 study.

Your examiner expects you to have a solid understanding of accounting

standards and the related audit procedures to them and hence make sure

you are able to master all those accounting standards in your study note.

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IAS 11 Construction Contracts

Accounting Issues:

1,When youre trying to build this tower it may take you more than 1 year to finish.

After finishing off this tower and you may try to sell off to the client.

So before finishing off this tower will you keep it as a inventory?(IAS2)

The answer is no! Remember inventory is current asset which is less than 1

accounting year.

2,Next question is because the contractor is building this tower so he may have topay for material, labor costs etc. So when is the cost being recognized?

The contractor can get the sales revenue only when after selling off this tower to

client. So before selling off this tower, the contractor gets no cash from the client.

So does the contractor recognize no revenue at all?

To answer this question:

According to Prudence concept, the sales revenue should be recognized after

this tower has been sold off to the client.

According to Accruals concept,the expenses relating to the building of the

tower should be matched with the revenue from the tower.

So one is contradict with another. But here in this case, Accruals concept wins.

3,But how much does the revenue and expenses should be recognized?

IAS 11 Construction Contract gives us the guidance.

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4,

Guidance by IAS 11 construction contract (Diagram)

yes

No

yes

No

yes

5, Stage of completion

Recognize based on stage of

completion

Outcome is certain?

Profit making contract?

Fixed Price or Mark up?

Revenue=costs(no profit/loss)

Recognize loss in full

Profit=price(cost+mark up)-

cost

Mark up

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Sales basis method (work certified method):

work certified to date

Contract price

Cost method:

Costs incurred to date

Total contract costs

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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 $25 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 companys 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 consideredin relation to the treatment of these two

issues in the financial statements, and also explain the risks of material misstatementrelating to them. I also want you to recommend the planned audit proceduresthat

should be performed in order to address those risks.

(8 marks)

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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 thereforematerial 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:

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.

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:

Inspect the customer-signed contract to verify the fixed price and any penalty clausesrelating to late completion.

Recalculate the budget for the Bridgetown development to verify the accuracy of theschedule and confirm the expected loss of $150,000.

Inspect report made by the architect regarding the structural improvements to verify theestimate of the additional costs.

Discuss the additional costs with contractors to assess if the estimate appearsreasonable.

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Review Bill Cos cash flow forecast to ensure adequate funds to cover the additional costs.

Chapter2 Q7: 8,IAS12 Income Taxes

Accounting issues:

In the statement of profit or loss and other comprehensive income:

$

Sale revenue 1,000

Cost of sales (300)

Gross profit 700

Expenses (100)

Profit before tax 600

Tax expense (@30%) (50)

Profit after tax 550

You can see although tax rate is 30% but we use 30%Xprofit before

tax which does not equal to 50, why?

The reason being within the tax expense there are 3 components:

(mnemonics:CPD)

Current tax payable (based on last year taxable profit)

Provision (under/(over))

Deferred tax movement

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Because of permanent and temporary difference which leads to the difference in taxable profit

calculation and accounting profit calculation.

Permanent differences are the amounts which represent income or expense for accounting purposes

but are not taxable/allowable for tax purposes. Example: client entertaining.

Temporary differences are amounts which represent income or expense for accounting purposes and

tax purposes but in difference periods. Example: depreciation and capital allowances.

Notice: The deferred tax transfer is not cash flow!!!

Before we look at deferred tax, why not start off by looking at current taxation? (this is what you have

already learnt in F3, just a recap.)

Current tax:

Companies have to pay tax on taxable profits. The tax charge is normally

ESTIMATED at the end of the financial year and charged to the statement of

comprehensive income, and paid in the following year.

The double entry for taxation would be:

DR Taxation expense (Statement of comprehensive income)

CR Taxation liability (Statement of financial position)

The double entry for when the tax is paid a few months later:

DR Taxation liability (Statement of financial position)

CR Bank (Statement of financial position)

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Since the amount paid is likely to differ from the estimated tax charge originally

recognized, a balance will be left on the taxation liability account being an under or

over provision of the tax charge.

Deferred tax:

What is deferred tax?

Illustrate with an example:

Imagine you have a building with a carrying value of $1000. During the year you

have revalued this building to $1,100 then you make a profit from it of $100 which

is not realized yet.

DR NCA 100

CR revaluation reserve 100

So for the tax mans perspective, because you will somehow in the future realized

this profit when sold so they may require you to provide for a future tax

obligation(deferred tax) of $100Xtax rate although you are not paying money nowbut you will in the future.

Concept:

So we know that deferred tax is a future obligation to be settled by company

depending on the future tax law. So deferred tax does not necessarily fulfill the

liability definition (present obligation).

Deferred tax arises because of temporary differences (TD). Temporary difference is

the difference between CV and TB.

DT=TD* X CT%

*TD=CV - TB

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TD: Temporary difference between carrying value and tax base

CV: Carrying value of asset/liability.

TB: tax base in the tax mans book.(in real practice we will try to refer to

different tax regulations to calculate the tax base)

DT: Deferred tax liability/asset

CT%: Corporation tax rate

Deferred tax is a future liability recognized today. And deferred tax is based on

temporary difference (timing difference between accounting and tax law). So the

amount we owe to the tax authority will be finally paid back to them in thesubsequent years.

Typically, in P7, Deferred Tax Asset is most commonly tested.

The recoverability of Deferred Tax Asset will be limited depending on the forecast

profit company will make.

Audit Works: [Q11:DEC2008 Q1] Income taxes IAS 12

So we usually focus on the profit forecast, management accounts for the company

performance to estimate the company future profit making ability to establish if it

can utilize the deferred tax asset (unutilized losses) to set against the future profit.

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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

Agree figures in the current and deferred tax calculation to tax correspondence.

Inspect profitability forecast to agree there is enough forecast taxable profit to offsetagainst the loss.

Perform analytical procedure by evaluating assumptions used in the forecast to ensureits in line with auditors business understanding.

Perform analytical procedure by assessing time taken to generate profit to recover taxlosses and if it takes many years to generate such profit and the recognition of deferredtax asset would be restricted.

Inspect tax correspondence to verify theres no restriction for company to carryforwardand use losses against future taxable profits.

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Chapter2 Q7: 9,IAS16 Property, Plant and Equipment

Accounting Issues:

Initial measurement:

Capital expenditure

Capital expenditure is the costs of acquiring non-current assets.

According to IAS 16 the following costs may be capitalised in the statement of

financial position on acquisition of a non-current asset:

(Mnemonic: IIIID)

Initial cost (purchase price)

Import duty not refundable(if asset is bought from other country)

Installation costs

Intended use relating costs (lawyer, surveyor costs)

Delivery costs

Finance cost (IAS 23 see F7 & P2)

Revenue expenditure

Revenue expenditure is expenditure on maintaining the capacity of noncurrent

assets. Costs that are regarded as revenue expenditure should be expensed in the

statement of comprehensive income and may not be capitalised according to IAS 16

are:

(Mnemonic: RIM)

Repairs expenses

Insurance expenses

Maintenance expense

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After weve purchased the non current asset the accountant needs to record that

non current asset into the non- current asset register.

A non-current asset register is generally maintained in the finance department.

Companies can purchase specifically designed packages or a register can simply be

maintained on an Excel spreadsheet.

And this is used to reconcile the NCA in the NCA register to the individual asset in

place, ie, an example of control procedure by company.

Sample of Non-current asset register:

Asset

type

Date purchased Description Cost Depreciation Carrying

value

Disposal

proceeds

Disposal date

Machine 1 July 2013 Drink

machine

$7m

Year ended 31 DEC 2013 $700,000 $6.3m

Year ended 31 DEC 2014 $3m Jan-2014

Subsequent measurement

Cost model: cost-accumulated depreciation*=carrying value

Depreciation method should be reviewed each year to see whether or not it is

reasonable. A change in depreciation method should be treated as a change in

accounting estimate and prospective adjusting method according to IAS 8 should be

applied. Ie, disclose the depreciation method in the note of the financial statements.

Revaluation Model: revalued amount

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IAS 16 the test was whether the expenditure was Capital or Revenue e.g. an improvement

could be capitalised but maintenance or repair could not be capitalized.

The following circumstances should be capitalized:

(mnemonics: LOSE)

L: Life extension

O:major overhaul cost

S:separate component, eg, new enguine for an aircraft

E:energy saving, eg, improving production capacity

Basic idea:

1, economic benefits are excessed

2, component treated seperatly

3, major overhaul cost

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Revaluation

Basic Idea:

As time goes by initial costs of asset may be very different from their market value.

Eg, if a company purchased a property 35 years ago and therefore subsequently

charged depreciation for 35 years, it would be safe to assume that the carrying

value of the asset would be significantly different from todays market value.

If revaluation policy per IAS 16 may be adopted (i.e. the business has a choice),

and if so the following rules must be applied per the standard: (mnemonic: CRRR)

1, No Cherry picking(If a company chooses to revalue an asset they must revalue all assets in that category.)

2, Regular (Revaluations must be regular but IAS 16 doesn't specify how often)

3, Revalued amount(Subsequent depreciation must be based on the revalued amounts.)

4, Revaluation Reserve (Gains from revaluations are taken to revaluation reserve rather than retained earningsunless they are sold)

Calculation:

$

Revalued amount X

CV of asset on revaluation date (X)

Revaluation gain/(loss) X/(X)

Journal

DR Asset cost (Statement of financial position)

DR Accumulated depreciation (Statement of financial position)

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CR Revaluation reserve (Statement of financial position)

Audit work:

IAS16 PP&E does not test it much, but if the asset involves finance cost and then

make sure its capitalized correctly.

Also, if it involves impairment issue ,then make sure an impairment test is properly

conducted by management. Also the discount rate used by management to

determine value in use of the asset should be verified for reasonableness.

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Chapter2 Q7: 10,IAS17 Leases

Accounting issues:

Introduction

You want to have a photocopier and you have two choices:

1, you can buy it and then you become the owner of the photocopier;

2, you can lease it from the lessor and then you would become the lessee.

Long term-finance lease

Short term-operating lease

But the key to differentiate between them is not just the time length it takes but

rather substance over form.

IAS 17 leases describes two types (forms) of leases:

*Finance lease: lease that transfers the risks and rewards of the asset from the

lessor to the lessee.

*Operating lease: any leases other than finance lease.

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5 senarios

So the substance over form concept behind it can be summarized as follows:

IAS 17 prescribes there are 5 common scenariosthat the lease is a finance lease.

(one of them fulfilled then its a finance lease and if none of them fulfills then its an

operating lease.)

1, ownership of asset has been transferred from lessor to lessee.

2, lessee has the option to purchase asset at a price which is sufficiently lower than

its FV.

3, lease term is almost the same as the major part of economic life of asset.

(IFRS doesn't specify the period but US GAAP has given us guidance of >75%.)

4, at the start of the lease, PV of minimum lease payment is close to FV of asset.

(again, IFRS doesn't specify the percentage but US GAAP has given us a guidance

of >90%.)

5, leased assets are specified nature and can only be used by lessee and they can

be used by others if any significant modification to assets occurs.

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Risks and rewards

But the idea behind it is when the majority risks and rewards has been transferred

from the lessor to lessee then its considered to be a finance lease.

So the typical risks and rewards may include:

Risks:

costs of repairing, maintaining and insuring the assets.

Risk of obsolescence

Risks of losses from idle capacity of the asset (if machine breaks down then lessee

bears the loss)

Rewards:

Use of assets for almost all of its useful life.

Use of the assets is not disrupted.

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Accounting Treatment:

Lessee Lessor

Finance lease:

Initial measurement DR PPE

CR lease liability

DR lease receivable

CR lease asset

Subsequent measurement PPE:

DR I/S-depre expense

CR accumulated

depreciation

Lease liability:

DR lease liability

DR I/S-finance cost

CR cash

DR cash (from lessee)

CR lease receivable

CR I/S-interest income

Operating lease:

Expense the lease

payment on a straight

line basis

DR I/S

CR cash

Expense the lease revenue

received on a straight line basis

DR cash

CR I/S

Keep the assets in FS and

depreciates it.

DR I/S-depreciation expense

CR accumulated depreciation

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Sale and leaseback transaction:

Idea: any abnormal gain/loss would be deferred and released back as income over

the life of the lease.

Accounting question:

Q: Finco Ltd

Finco Ltd has 4 sale and leaseback transactions during the year which can be shown

as follows:

Description Sale proceeds

$m

Fair value

$m

Book(carrying) value

$m

1, sale and finance lease back 50 50 32

2, sale at fair value operating lease back 80 80 55

3, sale at overvalue and operating lease

back

85 65 70

4, sale at undervalue and operating lease

back

65 85 60

Required:

Show how to deal with the above transactions.

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Audit work:

1The main piece of audit evidence is the lease agreement, as this will allow the

auditor to:

1Agree the length of the lease

2Agree the lease payments

3Assess how much of the rights and obligations of ownership have been

transferred.

2 For operating leases, any prepayment or accrual should be recalculated.

3 For finance leases, the present value of minimum lease payments should be

recalculated and the discount rate agreed as appropriate.

[June2009Q3] leases

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Audit question1: [June2009Q3] leases

Robster Co is a company which manufactures tractors and other machinery to be

used in the agricultural industry. You are the manager responsible for the audit of

Robster Co, and you are reviewing the audit working papers for the year ended 28

February 2009. The draft financial statements show revenue of $105 million, profit

before tax of $32 million, and total assets of $45 million.

Two matters have been brought to your attention by the audit senior, both of which

relate to assets recognised in the statement of financial position for the first time

this year:

Leases

In July 2008, Robster Co entered into five new finance leases of land and buildings.

The leases have been capitalized and the statement of financial position includes

leased assets presented as non-current assets at a value of $36 million, and a total

finance lease payable of $32 million presented as a non-current liability.

Required:

(a) In your review of the audit working papers, comment on the matters

you should consider, and state the audit evidence you should expect to find

in respect of:

(i) the leases (8 marks)

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Answer to audit question1 [June2009Q3] leases

Matters to consider

Materiality

The amount recognised in non-current assets accounts for 8% of total assets, and the total finance

lease payable accounts for 71% of total assets so they are material to statement of financial position.

Accounting treatment

Whether this is finance lease or operating lease and the key is to see whether risk andreward of ownership of assets has been passed from lessor to lessee.

Indicators where risks and rewards have been transferred:

1. Robster Co is responsible for repairs and maintenance of the assets

2. Robster Co can obtain this asset at nominal value at the end of asset life.

3. The lease period is almost the same as useful life of the assets

4. The present value of the minimum lease payments is amounts to most of the fair value of the

asset.

Finance cost associated with leases would need to be expensed to statement of profit orloss.

Leased asset should be depreciated over the shorter of lease term and economic useful

life of assets.

The finance lease payable recognised of $32 million should be split between current andnon-current liabilities in the statement of financial position.

Audit evidence

A review of the lease contract including consideration of the major clauses of the leasewhich indicate whether risk and reward has passed to Robster Co.

A calculation of the present value of minimum lease payments and comparison with thefair value of the assets obtained from lease contract at the start of the lease.

A recalculation of the finance charge expensed during the accounting period, andagreement of the interest rate used in the lease contract.

Agreement to the cash book of amounts paid to the lessor.

A recalculation of the depreciation charged, and agreement that the period used in thecalculation is the shorter of the lease term and the useful life of the assets.

A recalculation and confirmation of the split of the total finance lease payable between current andnon-current liabilities.