Questions On Auditing

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FA363 Auditing
Module Answers (May/June 11)

Question 1
(a)
Fundamental accounting concept that the accounts of the company are assumed to be prepared on a going concern basis
This means that the business will carry on its activities in the same way ie there will be continued sales, supplies and sufficient cash to base the business
Foreseeable future vague but usually considered to be between three and five years
If the company is not a going concern then the directors have a responsibility to prepare accounts on a break up basis
May need to contact insolvency practitioner as must cease to trade – wrongful trading can result in personal liability for directors
(b)
Financial indicators
Net liability or net current liability position on the balance sheet
Necessary borrowing facilities have not been granted
Fixed term borrowing nearing maturity without any realistic prospects of its renewal or reliance on short term borrowings to finance long term assets
Debt refinancing
Indication of withdrawal of support by bankers or lenders
Failure to comply with loan conditions or banking covenants
Negative cash flows from current activities
Inability to pay creditors on their due date
Inability to finance new products or product development

Operating indicators
Loss of key management without replacement
Labour difficulties or shortage of key supplies
Loss of major customers
Fundamental changes in the market or in technology to which the company cannot respond
Excess dependence on a few on a few products in a depressed market

Other indicators
Changes in legislation which might adversely affect the business
Major legal claims against the company
(c)
Review the management’s processes for establishing whether or not the company is a going concern
Have to gather sufficient appropriate evidence to satisfy themselves that the going concern basis is appropriate
Examine budgets forecasts minutes of meetings
Assess systems or other means by which directors have identifies warnings of future risks and uncertainties
Examine management accounts and other reports of recent activities
Review all obligations and guarantees
Verify evidence of adequacy of borrowing facilities
Consider values of assets given as security for borrowings
Review correspondence with bankers
Assess assumptions underlying budgets and forecasts

(d)need for directors to prepare accounts which give a true and fair view on a going concern basis. Need for shareholders to understand how that is being achieved. Therefore explanation of how directors are facing the risk of insolvency should be disclosed in the annual report – in the business review and/or in the directors’ report. Details of order book and financing agreements as well as changes in strategy should be explained. Need for disclosure of any information that will affect the employees suppliers customers and the community should also be disclosed.
(e)
NEDs are independent of the executive directorship and their role is a combination of Reviewing performance of board and executive
Taking the lead where potential conflicts of interest arise

Often are or have been executives of other successful companies – this give credibility to a cv

Bring analysis of situations and can bring extra expertise

Limitations based on time available to understand the company – although since the latest guidance following Walker NEDs should not take on multiple roles. Could take additional roles eg membership of committees, remuneration, nomination, risk, audit although the cost of this should be matched to the benefits.

Marking guide Marks
(a) 1 mark per point to a maximum of 4
(b) 1 mark per point to a maximum of 6
(c) 1 mark per point to a maximum of 6
(d) 1 mark per point to a maximum of 3
(e) 1 mark per point to a maximum of 6 25

Question 2
(a) Need to consider whether the firm can take on the work from an ethical, legal and practical point of view.
Ethical
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