You are a manager in the audit department of Nidge & Co, a firm of Chartered Certified Accountants, responsible for the audit of Darren Co, a new audit client operating in the construction industry. Darren Co’s financial year ended on 31 January 2015, and the draft financial statements recognize profit before tax of $22•5 million (2014 – $20 million) and total assets of $370 million, including cash of $3 million. The company typically works on three construction contracts at a time. The audit is nearly complete and you are reviewing the audit working papers. The audit senior has brought several matters to your attention:

(a) Darren Co is working on a major contract relating to the construction of a bridge for Flyover Co. Work started in July 2014, and it is estimated that the contract will be completed in September 2015. The contract price is $20 million, and it is estimated that a profit of $5 million will be made on completion of the contract. The full amount of this profit has been included in the statement of profit or loss for the year ended 31 January 2015. Darren Co’s management believes that this accounting treatment is appropriate given that the contract was signed during the financial year, and no problems have arisen in the work carried out so far. (8 marks)

(b) A significant contract was completed in September 2014 for Newbuild Co. This contract related to the construction of a 20-mile highway in a remote area. In November 2014, several large cracks appeared in the road surface after a period of unusually heavy rain, and the road had to be shut for ten weeks while repair work was carried out. Newbuild Co paid for these repairs, but has taken legal action against Darren Co to recover the costs incurred of $40 million. Disclosure on this matter has been made in the notes to the financial statements. Audit evidence, including a written statement from Darren Co’s lawyers, concludes that there is a possibility, but not a probability, of Darren Co having to settle the amount claimed. (6 marks)

(c) For the first time this year, the financial statements are presented as part of an integrated report. Included in the integrated report are several key performance indicators, one of which states that Darren Co’s profit before tax has increased by 20% from the previous year. (6 marks)

Required:

Discuss the implications of the matters described above on the completion of the audit and on the auditor’s report, recommending any further actions which should be taken by the auditor. Note: The mark allocation is shown next to each of the matters above. (20 marks)