Question: QUESTION 2 You are Ibrahim Ali and work as an audit se QUESTION 2 You are Ibrahim Ali and work as an audit senior for a firm of chartered accountants based in Karachi. You have been assigned to replace the existing audit senior on the audit of Karachi Textiles (Private) Ltd, which is a subsidiary of a public company, for the year ended 30 September 2019. You were previously involved in the planning phase for this client and are now working on the audit field work, which is close to completion. The audit manager, Zakia Ahmed, has asked for your assistance in the finalisation of some areas before the final client meeting. Appendix 1 is an email from Zakia with the details of the work required while Appendix 2 provides extracts from the draft financial statements. In Appendix 3, the outstanding issues have been summarised. Requirements Prepare a note that: 1. Identifies and explains the financial reporting implications of the issues identified in Appendix 3, on the financial statements of Karachi Textiles for the year ended 30 September 2019. Outline any actions required prior to signing of the audit report 1. 2. Evaluates the impact of the issues identified in (a) (i) on the auditor's report. Consider each issue separately. 2. Evaluate the completeness of directors' report in accordance with the Companies Act and TFRS 1 APPENDIX 1 - EMAIL FROM AUDIT MANAGER To: From: Ibrahim Ali Zakia Ahmed Audit completion of Karachi Textiles 30 November 2019 Subject: Date: Hi Ibrahim, Thank you for agreeing to help with the completion of the audit of Karachi Textiles as the audit sign off is close. The audit senior has had to go on study leave. You are ideally placed to take over as you were involved in the planning of the audit. The previous audit senior has provided a summary of some areas that we need to consider before we sign the audit report. I would like you to provide a summary of the financial reporting implications of each of the issues and the actions that we need to take before signing off. I would then like you to explain the potential impact of each of the issues on the auditor's report but consider each issue separately at this stage. Finally, I have reviewed the draft directors' report and noted that there is no information on any defaults that have occurred in the year, nor is there any statement about the adequacy of internal controls. Regards, Zakia APPENDIX 2 - EXTRACTS FROM THE DRAFT FINANCIAL STATEMENTS Statement of profit or loss for the year ended 30 September 2019 Rs. in million Profit before tax 495 Statement of financial position as of 30 September 2019 Rs. in million Current assets Inventory 75 Trade receivables 120 Cash 15 210 Non-current liabilities Bank loan 625 Provisions 325 Deferred tax 86 1,036 Current liabilities Overdraft 290 Bank loan 60 Trade and other payables 86 Income tax payable 25 461 APPENDIX 3 - OUTSTANDING ISSUES The following is the summary of the outstanding issues on the audit of Karachi Textiles: (1) Long-term loan Included within Karachi Textiles' bank loans is a loan of Rs. 250 million, of which Rs. 190 million is currently classified as non-current liabilities. The amounts and classification are in agreement with the original repayment schEDULE During the year, Karachi Textiles defaulted on a payment, which as per the loan agreement, means the whole loan balance becomes immediately repayable on demand. Audit evidence has been obtained that confirms the default, the loan agreement terms and correspondence with the bank. Negotiations with the bank were concluded on 15 November 2019 and the bank agreed not to demand full and immediate repayment as a result of the breach. As the waiver was agreed before authorising the financial statements, the finance director has not amended the financial statements and the liability of Rs. 190 million is classified as a non-current liability. Karachi Textiles has not even disclosed the details of the breach in its financial statements. 2. Bank overdraft Karachi Textiles is reliant on a bank overdraft from another bank that is due for renewal in January 2020. Correspondence with the bank was reviewed and whilst renewal of the overdraft facility is under discussion, audit evidence concluded that Karachi Textiles is a going concern provided the overdraft facility is renewed. However, this uncertainty needs to be disclosed. 3. Fraud A fraud was discovered in November 2019. A member of staff had been misappropriating raw materials as a result of lack of controls over goods leaving the building. He had managed to conceal the fraud by falsifying the inventory count sheets. Karachi Textiles has calculated that the amount of inventory at year end is overstated by Rs. 0.5 million but no adjustment has been made to the financial statements. We have sufficient audit evidence to confirm that the extent of the fraud is not greater than this amount. 4. Inventory valuation The audit on inventory valuation has identified items in inventory that have not been sold by the date of testing. These items relate to fashion clothing that Karachi Textiles sells to resellers, which had an original cost of Rs. 20 million when it was produced in June 2019. The audit team's review of sales during the year shows that, on average, similar fashion items which are held for more than four months, sell for 20% of the original cost. The sales manager was confident that these items would sell for more than they cost but could not produce any additional evidence. The directors were not interested in discussing this as they said they left these decisions to the sales manager who has much greater knowledge of these items and the selling price