You are carrying out the audit of ACB Computers limited for the year...

      

You are carrying out the audit of ACB Computers limited for the year ended 31 December 2003. The company assembles microcomputers purchased from the Far East and sells them to retailers, and to individuals and other businesses. In the current year, there has been a recession and strong competition, which has resulted in a fall in sales and the profits. This has led to a trading loss and the company is experiencing going concern problems.
Required:
a) Describe the factors, which indicate that a company may not be a going concern. Your list should include all factors and not just those, which relate to ACB Computers Limited.
b) Consider the form of audit report (i.e. qualified or unqualified) you would issue of ACB Computers limited if you conclude that the company is experiencing serious going concern problems, in the following two situations: I) You conclude that the financial statements give sufficient disclosure of the going concern problems.
II) There is no disclosure of the going concern problems in the financial statements and you believe there is a serious risk that the company will fail in the foreseeable future.

c) State the parties who may successfully sue you as auditor for negligence, and consider the arguments you could include in your defense when: I) The financial statements of ACB Computers Limited for the year ended 31 December 2003 do not mention any going concern problems and your audit report on these financial statements was unqualified and II) The company fails on 15 February 2004

  

Answers


johnson
a) The indications or risk that continuance as a going concern may be questionable
could come from financial statements or from other sources
Financial indicators
? Liabilities are more than the assets of the company;
? Borrowings with fixed repayment dates approaching maturity without realistic
prospects of renewal or repayment, or excessive reliance on short-term
borrowings to finance long-term projects undertaken by the company.
? Adverse key financial ratios e.g. current ratio below one;
? Substantial operating losses.
? Inability to pay creditors on due dates.
? Difficulty in complying with terms of loan agreements e.g. failure to pay interest
and principal on due dates.
? Change from credit to cash on delivery transactions with suppliers.
Operating Indicators
? Loss of key management without replacement.
? Loss of major market or customer.
? Labour difficulties or shortage.
Other Indicators
? Non-compliance with capital or other statutory requirements. This could lead
to the company being wound up under the law.
? Pending legal cases against the entity that may, if successful result in judgments
that could not be met.
? Changes in legislation or government policy that adversely affects the client’s
business.

b) Where there is adequate disclosure in the financial statements
I) According to ISA 700 the auditors report on financial statements, the
going concern problem is a fundamental uncertainty i.e. it is uncertain
whether the company will continue to trade to 31 December 2004, and if
the company failed, the consequences of the failure would have a
fundamental effect on the financial statements. Since the financial
statements have given adequate disclosures about the uncertainty created
by the going concern problem the auditor should issue an unqualified
opinion with an emphasis of matters paragraph. The emphasis of matters
paragraph will disclose the going concern problems and refer to the
relevant notes in the financial statements. Normally, the paragraph will say
that the continuation of the business will depend on the company
becoming profitable and the bank and creditors continuing support to
ACB Computers Limited.
II) If there is no disclosure of the going concern problem in the financial
statements then the financial statements are misleading since the effect of
the disagreement is so material and pervasive. The auditor should issue an
adverse opinion. The opinion paragraph should give details that have led
to the qualification i.e. the need for the company to become profitable and obtain support from the creditors and the bank and also because of the
failure to include details of the going concern problems, the financial
statements do not show a true and fair view of the company’s affairs as at
31 December 2003 and of its loss for the year then ended.

c) Since ACB Computers Limited has failed within a year and the auditor had given
an unqualified report, certain parties may be able to successfully sue him for
negligence. The decision in the Caparo case is that only the company and the
shareholders as a body can bring a claim for negligence against the auditor. It is
possible that the court will refer to the ISA that indicates that the audit report
should have mentioned the going concern problems. As the auditor did not
mention them, the claim for negligence could be successful. In the situation, the
going concern problems were apparent during the audit and this reduces the
strength of the auditor’s defense. There are a variety of arguments the auditor
could make in defense against a negligence claim, but these depend on the
circumstances. If ACB failure was caused by a sudden event or one that occurred
after the audit report was signed and was not expected to occur at the time the
audit report was signed, then the auditor may have a good defense against the
negligence claim. These could include a legal claim against ACB, a substantial loss
on a contract entered into after 31 December 2003. If the failure was not foreseen
as at 31 December 2003 then the auditor can avoid a claim for damages.
johnson mwenjera answered the question on August 4, 2018 at 12:03


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