QUESTION 1

You are Ibrahim Ali working as an audit senior for Alvi and Co, a firm of chartered accountants. You have been asked to assist with planning the audit of a new client for the year ending 30 June 2019.

In Appendix 1, the audit manager, Zakia Ahmed, provides background information and instructions on the work that is required. Appendix 2 provides the key extracts from the budgeted financial statements for the year ending 30 June 2019.

Appendix 3 includes the specific transactions that Alvi and Co identified after the initial audit strategy was determined.

Requirements

Read the information provided in Appendices and prepare a working paper in which you:

1. explain the financial reporting issues arising from your review of the transactions

included in Appendix 3. (08 marks)

Note: Ignore the tax impact of these transactions.

2. identify and explain the audit risks arising from the financial reporting issues and discuss the impact of the issues on our audit strategy, including resources and budget implications. (12 marks)

Total: 20 marks

APPENDIX 1 BACKGROUND INFORMATION AND INSTRUCTIONS FROM

AUDIT MANAGER

To: Ibrahim Ali

From: Zakia Ahmed

Re: Audit planning AG Textiles

Dear Ibrahim,

AG Textiles is a new audit client and consequently we have begun the audit planning process well before the year-end. The audit was put out to tender as the previous auditor was a small audit firm. The previous auditor gave us professional clearance and also granted us access to review their working papers.

AG Textiles is a non-listed company that designs and manufactures textiles that are sold to wholesale customers. The company is currently family owned but they have plans to seek additional investment to grow the business. The only investment of AG Textiles is in MM Silk which produces the silk that AG Textiles uses in its manufacturing process.

We have identified that the controls in place at AG Textiles are weak and our audit approach is to rely on substantive testing.

The planning process for AG Textiles has identified some specific transactions that we were not aware of when we accepted the engagement and have not been included in our current assessment of risk and audit strategy. I am particularly concerned that there may be implications for resources and the audit budget.

I would like you to review the specific transactions in Appendix 3 and explain the financial reporting implications, identify and explain the key audit risks and discuss the impact on the audit strategy. At this stage I do not require any audit procedures apart from your assessment of the significance of the transactions and the implications for our audit planning and budget.

Regards

Zakia Ahmed

APPENDIX 2 EXTRACTS FROM BUDGETED FINANCIAL STATEMENTS

	30 June 2019	30 June 2018
	Budgeted	Actual
	-------- Rs. in	million --------
Total assets	1,200	815
Revenues	800	680
Profit before tax	360	224

APPENDIX 3 TRANSACTIONS

Foreign sales

In May 2019, AG Textiles began to make sales to wholesalers located in a variety of foreign countries. AG Textiles has previously sold only in the domestic market. AG Textiles agreed that it would invoice the customers in their local currency and this area of business has expanded more than expected.

Acquisition of investment

On 1 June 2019, AG Textiles acquired a controlling interest in MM Silk for Rs. 300 million. AG Textiles had previously owned 25% of the issued shares of MM Silk and had previously accounted for this investment using equity method as it had significant influence over MM Silk.

The initial planning work was carried out before the acquisition was undertaken. MM Silk was identified as an associate and the audit strategy was developed on this basis. Our initial planning shows the following figures for MM Silk:

	30 June 2019 Budgeted
	Rs. in million
Total assets	345
Revenue	180
Profit before tax	86

MM Silk is audited by another firm who will perform the audit for the year ending 30 June 2019.

Development costs

As part of our audit planning, the review of management information identified an unusual cost during January 2019. This was discussed with management and they explained that it related to a failed development project. The costs relate to development of a new waterproof fabric and management explained that they had encountered technology problems that meant the waterproofing qualities were no better than existing products.

In January 2019, AG Textiles judged that the development would be halted and it expensed all of the costs incurred to date of Rs. 34 million, of which Rs. 22 million relates to amounts that had been capitalised as development costs in the prior year.

Our review of the previous auditor's working papers indicates that the audit evidence gathered was based on discussing the technical feasibility with the production team. The auditors obtained evidence over early prototypes that showed promising waterproof qualities. Management additionally provided the auditors with a management representation that, in their judgement, all of the criteria within IAS 38 Intangible Assets had been met to allow capitalisation.

No additional evidence was found in our review of previous auditor's working pape