Pretty Face Limited (PFL) is a training institution offering professional beauty courses. It is listed on the Singapore Exchange. PFL has three subsidiaries and two associated companies. You have been assigned by your partner as the audit engagement manager for the audit of PFL for the year ending 30 June 20x1. The projected annualized revenue and profit before tax of PFL group, including its subsidiaries and associated companies, for the year ending 30 June 20x1 are as follows:

*The loss before tax in PFM was due to the loss of a key customer during the year.

The total revenue and profit before tax for the group are expected to approximate the consolidated revenue and profit before tax as there are no material intra-group transactions and balances. The preliminary materiality for the group financial statements was set at S$1.75 million, based on 5% of the projected annualized profit before tax.

Part I:

During your audit planning in March 20x1, your team noted a S$4 million intangible asset recorded in PFCs books. The group management has updated you that the intangible asset relates to development costs paid to a marketing agency, SustainPackaging, to design and develop a range of bio-degradable packaging. SustainPackaging is currently testing prototypes and the results have been encouraging

Required:

(a) Describe the relevant audit procedures that you would require the component auditors of PFC to perform in order to verify the recognition of the S$4 million intangible asset.

Part II:

In July 20x1, the component auditor of PFC reported to you that the S$4 million intangible asset in PFCs books was appropriately capitalised. Subsequently, based on your review of the working papers of the component auditor and additional work performed by you as the group auditor, you concluded that S$3 million out of the S$4 million development costs do not meet the requirement to be capitalised as intangible asset and accordingly, the profit before tax of PFC was overstated by S$3 million. The adjusted profit before tax should be S$10 million, instead of S$13 million as initially reported by the management.

Based on the above and your other interactions with PFC component auditor, you are concerned about the competence of the component auditor in performing the audit of PFC.

Required:

(b) Other than PFL and PFC, explain whether the other components should be identified as significant in the audit of PFL consolidated financial statements using profit before tax as a benchmark.

(c) Explain the impact of the PFC component auditors competency on the group audit and the options available to your firm.

(d) Explain the impact of the PFC S$3 million profit before tax overstatement on your audit of PFL consolidated financial statements.

Revenue S$ million Profit/(loss) before tax S$ million Pretty Face Limited (PFL) 30 11 Subsidiary companies Pretty Face China (PFC) Pretty Face Japan (PFJ) Pretty Face Malaysia (PFM)* 35 13 12 13 5 (4) Associated companies Pretty Face Indonesia (PFI) Pretty Face Thailand (PFT) 8 2 Consolidated 90 35