Nov 2015 Q3 a.
You are a manager in BS Cipax, a medium-sized firm which offers a range of services to audit and non-audit clients. You have been asked to consider a potential engagement to review and provide a report on the prospective financial information of Filtane Limited, a company which has been an audit client of BS Cipax for six years. The audit of the financial statements for the year ended 31 August 2015 has been completed and your firm issued an unmodified report.
Filtane Limited operates a chain of fashion stores across the country. Currently its merchandise are out of date and it sells clothing which do not reflect the latest and in mode fashion labels which are becoming more popular especially with the youth. Management is planning to revamp its image and stock the latest fashion in Africa and across the other continents. It also intends to invest in the latest technologies to include online real time trading on the internet in order to attract more customers, especially the up-and-coming youth, trendy middle-aged persons and even those far from its shops by attracting them to shop over the internet. The company has sufficient cash to fund half of the necessary capital expenditure, and has approached its bank, Boafo Bank Limited, with a loan application of GHS32 million for the remainder of the funds required. Most of the cash will be used to invest in acquiring inventory and the technology for ensuring secure and safe online trading. The remaining cash will be used for refurbishment of the shops.
Management had informed the Audit team, in the invitation to start the audit, of its intention to use the audited financial statements as the basis for preparing the prospective financial information to be used to seek for the loan from Boafo Bank Limited.
The draft forecast statements of profit or loss for the years ending 31 August 2016 and 2017 are shown below, along with the key assumptions which have been used in their preparation. The audited statement of profit or loss for the year ended 31 August 2015 is also shown below.
The forecast has been prepared for use by the bank in making its lending decision, and was to be accompanied by other prospective financial information including a forecast statement of cash flows.
Note 1: The forecast increase in revenue is based on the following assumptions:
(i) All shops will be stocked with new modern and in mode fashion to attract new customers to the shops and many persons who don’t live in the vicinity of the shops will also be attracted through on-line shopping by December, 2015.
(ii) Prices will increase by an average of 25% in December 2015.
Note 2: Operating expenses include mainly staff costs, depreciation of property and fittings, and repairs and maintenance to the shop fittings and equipment as well as ensuring continuous safe and secure on-line shopping.
Required:
(i) Explain the matters to be considered by BS Cipax before accepting the engagement to review and report on the prospective financial information of Filtane Limited. (5 marks)
View Solution
Before accepting the engagement to review the company’s prospective financial information, there are several matters to be considered. A significant matter is whether it is ethically acceptable to perform the review. The review would constitute a non-assurance service provided to an audited entity, and IESBA’s Code of Ethics for Professional Accountants states that this may create self-interest, self-review and advocacy threats to independence. In this case, the advocacy threat may be deemed particularly significant as Hunt & Co could be perceived as promoting the client’s position to the bank. The review engagement should only be provided if safeguards can be used to reduce the threat to an acceptable level, which may include:
– Having a professional accountant who was not involved with the non-assurance service review the non-assurance work performed or otherwise advise as necessary.
– Discussing ethical issues with those charged with governance of the client.
– Using separate teams to work on the audit and on the review engagement.
As well as ethical matters, ISAE 3400 The Examination of Prospective Information requires that certain matters are considered before a review engagement is accepted. The firm must also consider the specific terms of the engagement. For example, the firm will need to clarify whether the bank has requested a review report to be issued, and what exact information will be included in the application to the bank. It is likely that more than just a forecast statement of profit or loss is required, for example, a forecast statement of cash flows and accompanying narrative, including key assumptions is likely to be required for a lending decision to be made.
ISAE 3400 also requires that consideration should be given to the intended use of the information, and whether it is for general or limited distribution. It seems in this case the review engagement and its report will be used solely in connection with raising bank finance, but this should be confirmed before accepting the engagement.
The period covered by the prospective financial information and the key assumptions used should also be considered. ISAE 3400 states that the auditor should not accept an engagement when the assumptions used are clearly unrealistic or when the auditor believes that the prospective financial information will be inappropriate for its intended use. For example, the assumption that the necessary capital expenditure can take place by September 2014 may be overly optimistic.
The firm should also consider whether there are staff available with appropriate skills and experience to perform the review engagement, and the deadline by which the work needs to be completed. If the work on the shops is scheduled to be completed by September 2014, presumably the cash will have to be provided very soon, meaning a tight deadline for the review engagement to be performed.
(ii) Assuming the engagement is accepted, and the results of the examination procedures show that the prospective financial information have been prepared in accordance with the assumptions and appear reasonable, discuss the issues that will be in the report your firm will issue in respect of the forecast statement of profit or loss. (8 marks)
View Solution
The report by an auditor on an examination of prospective financial information should contain the following:
(a) Title;
(b) Addressee;
(c) Identification of the prospective financial information;
(d) A reference to the ISAE or relevant national standards or practices applicable to the examination of prospective financial information;
e) A statement that management is responsible for the prospective financial information including the assumptions on which it is based;
f) When applicable, a reference to the purpose and/or restricted distribution of the prospective financial information;
g) A statement of negative assurance as to whether the assumptions provide a reasonable basis for the prospective financial information;
h) An opinion as to whether the prospective financial information is properly prepared on the basis of the assumptions and is presented in accordance with the relevant financial reporting framework;
i) Appropriate caveats concerning the achievability of the results indicated by the prospective financial information;
j) Date of the report which should be the date procedures have been completed;
k) Auditor’s address; and
l) Signature.
m) Such a report would
- State whether, based on the examination of the evidence supporting the assumptions, anything has come to the auditor’s attention which causes the auditor to believe that the assumptions do not provide a reasonable basis for the prospective financial information.
e.g.
Based on our examination of the evidence supporting the assumptions, nothing has come to our attention which causes us to believe that these assumptions do not provide a reasonable basis for the forecast. - Express an opinion as to whether the prospective financial information is properly prepared on the basis of the assumptions and is presented in accordance with the relevant financial reporting
framework.
e.g.
Further, in our opinion the forecast is properly prepared on the basis of the assumptions and is presented in accordance with International Financial Reporting Standards (IFRS) - State that actual results are likely to be different from the prospective financial information since anticipated events frequently do not occur as expected and the variation could be material.