BDE Company Limited operates a hotel providing accommodation, leisure facilities and restaurants. Its year ends on 31 March. You are the senior associate of ABC and Associates and are currently preparing the audit programmes for the year-end audit of BDE Company Limited. You are reviewing the notes of last week’s meeting between the audit manager and finance director where two material issues were discussed.
Depreciation
BDE Company Limited incurred significant capital expenditure during the year for refurbishing the restaurant facilities for the hotel.
The finance director has proposed that the new leisure equipment should be depreciated over 10 years using the straight-line method.
Food poisoning
BDE’s directors received correspondence in January from a group of customers who attended a wedding at the hotel. They have alleged that they suffered severe food poisoning from food eaten at the hotel and are claiming substantial damages. BDE’s lawyers have received the claim and believe that the lawsuit against the company is unlikely to be successful.
Required:
i) Describe substantive procedures to obtain sufficient and appropriate audit evidence in relation to the above two issues. (6 marks)
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Substantive procedures
Depreciation
- Review the reasonableness of the depreciation rates applied to the new capital expenditure and compare to industry averages.
- Review the capital expenditure plans of any plans by management to refurnish the restaurant facilities in less than 50 years which means the useful life is less than 50 years.
- Select a sample of building facilities and recalculate the depreciation charge to ensure that the non-current asset register is correct.
- Perform a proof in total calculation for the depreciation charged on the restaurant building facilities, discuss with management if significant fluctuations arise.
- Review the disclosure of the depreciation charges and policies in the draft financial statements.
Food poisoning - Review the correspondence from the customers claiming food poisoning to assess whether BDE Co has a present obligation as a result of a past event.
- Send an enquiry letter to the lawyers of BDE Co to obtain their view as to the probability of the claim being successful.
- Review board minutes to understand whether the directors believe that the claim will be successful or not.
- Review the post year-end period to assess whether any payments have been made to any of the claimants.
- Discuss with management as to whether they propose to include a contingent liability disclosure or not, consider the reasonableness of this.
- Obtain a written management representation confirming management’s view that the lawsuit is unlikely to be successful and hence no provision is required.
- Review the adequacy of any disclosures made in the financial statements for any material contingent liabilities.
(Any 3 points)
ii) List and explain the purpose of three items that should be included on every working paper prepared by the audit team during the audit of depreciation and food poisoning of BDE Company Limited. (3 marks)
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- Name of client – identifies the client being audited.
- Year-end date – identifies the year end to which the audit working papers relate.
- Subject – identifies the area of the financial statements that is being audited, the topic area of the working paper, such as receivables circularisation.
- Working paper reference – provides a clear reference to identify the number of the working paper, for example, K5 being the 5th working paper in the audit of cash and cash equivalents (from PCAS).
- Preparer – identifies the name of the audit team member who prepared the working paper, so any queries can be directed to the relevant person.
- Date prepared – the date that the audit work was performed by the team member; this helps to identify what was known at the time and what issues may have occurred subsequently.
- Reviewer – the name of the audit team member who reviewed the working paper; this provides evidence that the audit work was reviewed by an appropriate member of the team.
- Date of review – the date the audit work was reviewed by the senior member of the team; this should be prior to the date that the audit report was signed (Any 3 points).