question archive Clarinet Co (Clarinet) is a computer hardware specialist and has been trading for over five years
Clarinet Co (Clarinet) is a computer hardware specialist and has been trading for over five years
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Clarinet Co (Clarinet) is a computer hardware specialist and has been trading for over five years. The company is funded partly through overdrafts and loans and also by several large shareholders; the year end is 30 April 2019.
Clarinet has experienced significant growth in previous years; however, in the current year a new competitor, Drums Design Co (Drums), has entered the market and through competitive pricing has gained considerable market share from Clarinet. One of Clarinet's larger customers has stopped trading with them and has moved its business to Drums. In addition, a number of Clarinet's specialist developers have left the company and joined Drums. Clarinet has found it difficult to replace these employees due to the level of their skills and knowledge. Clarinet has just received notification that its main supplier who provides the company with specialist electrical equipment has ceased to trade.
Clarinet is looking to develop new products to differentiate itself from the rest of its competitors. It has approached its shareholders to finance this development; however, they declined to invest further in Clarinet. Clarinet's loan is long term and it has met all repayments on time. The overdraft has increased significantly over the year and the directors have informed you that the overdraft facility is due for renewal next month, and they are confident it will be renewed.
The directors have produced a cash flow forecast which shows a significantly worsening position over the coming 12 months. They are confident with the new products being developed, and in light of their trading history of significant growth, believe it is unnecessary to make any disclosures in the financial statements regarding going concern.
At the year end, Clarinet received notification from one of its customers that the hardware installed by Clarinet for the customers' online ordering system has not been operating correctly. As a result, the customer has lost significant revenue and has informed Clarinet that they intend to take legal action against them for loss of earnings. Clarinet has investigated the problem post year end and discovered that other work-in-progress is similarly affected and inventory should be written down. The finance director believes that as this misstatement was identified after the year end, it can be amended in the 2020 financial statements.
Required:
- Describe the procedures the auditors of Clarinet Co should undertake in relation to the uncorrected inventory misstatement identified above. [[8 marks]
- Explain SIX potential indicators that Clarinet Co is not a going concern.[12 marks]
- Describe the audit procedures which you should perform in assessing whether or not Clarinet Co is a going concern.[12 marks]
- The auditors have been informed that Clarinet's bankers will not make a decision on the overdraft facility until after the audit report is completed. The directors have now agreed to include some going concern disclosures.
Required:Describe the impact on the audit report of Clarinet Co if the auditor believes the company is a going concern but that this is subject to a material uncertainty.[8 marks]
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Question 1
Answer ;
The auditor should perform audit procedures designed to obtain sufficient audit evidence that all events up to the date of the auditor's report that might require adjustment and disclosure in the financial statements have been identified. The uncorrected inventory misstatement identified above is an adjusting event as it provides further audit evidence of the conditions that existed at the end of
the reporting period.
The audit procedures performed by Clarinet Co includes :
A. Reviewing procedures management has established to ensure that all other subsequent events are identified.
B. Discuss the adjusting events with the management
C. The auditors must ensure that the financial statements have been adjusted for the adjusting events.
D. The auditor takes an appropriate action and provide a new auditors report on the amended financial statement.
Question 2
Answers ;
A. The entry of a new competitor who has gained considerable market share from Clarinet through competitive pricing ,and one of Clarinet's larger customers has stopped trading with them and has moved its business to the competitor which affects Clarinet Co's ability to continue in business.
B. Clarinet has just received notification that its main supplier who provides the company with specialist electrical equipment has ceased to trade which poses a great challenge due to shortage in supplies hence making the company not a going concern.
C. The shareholders of Clarinet have declined to finance the company so as to develop new competitive products which makes the company not a going concern.
D. Cash flow forecast provided by the directors shows a significantly worsening position over the coming 12 months which means the company may not be able to pay its short and long term obligations as they fall due hence not a going concern.
E. The inventory held under the work in progress is faulty and should be writen off which leaves the company with no stock considering the main supplier has ceased business making the company not a going concern.
F. One of the company customers intends to take a legal action for supply of an operational online ordering system. The outcome of such a legal action could lead the company to not been a going concern.
Question 3
Answer ;
Audit procedures in assessing the going concern assumptions
A. Analyzing and discussing the entity's latest available interim financial statements for trends and accounting ratios that may indicate an the company's inability to continue in business.
B. Discussing with the company's lawyer about the possible outcome of legal suits and the possible effects on the company's operations.
C. Reviewing the terms of overdrafts and loan agreements and determining whether any have been breached.
D. Obtaining and reviewing reports of regulatory requirements for compliance issues.
Question 4
Answer ;
If the auditor believes that the company is a going concern but subject to a material uncertainty , the auditors gives unqualified opinion on the the financial statements but will include an Emphasis of Matter paragraph highlighting the existence of a material uncertainty and drawing attention to the note in the accounts that includes the going concern disclosures.
