An Emphasis of Matter (EoM) paragraph is a paragraph in the auditor’s report that is appropriately presented or disclosed, but which is so important that special emphasis is needed for users.

An EoM is different from a modification to the auditor’s opinion. An EoM paragraph does not modify the opinion; indeed it should state clearly that this is the case. An auditor should only include an EoM if s/he has sufficient appropriate audit evidence that the matter is not materially misstated.

The EoM should provide a clear reference to the matter, and to where the appropriate disclosures and other information can be found in the financial statements.

Examples of when an EoM should be used include:

• An uncertainty relating to the future outcome of exceptional litigation
• Early application of a new accounting standard that has a pervasive effect on the financial statements.
• A major catastrophe that has had a significant effect on the entity’s financial position
• Significant going concern issues

An Other Matter (OM) paragraph has in common with the EoM the fact that it does not modify the auditor’s opinion. However, whereas the EoM refers to a matter within the financial statements, and OM refers to information that is rightly not present in the financial statements, but which is so important for users’ understanding of them that it needs to be highlighted in the auditor’s report.

Examples of situations include:

• Law, regulation or generally accepted practice may require or permit the auditor to elaborate on matters that provide further explanation of the auditor’s responsibilities or report.
• The auditor may be reporting on more than one set of financial statements (eg a set of statements prepared under national reporting framework, and a set of statements prepared under International Financial reporting standards).
• Any restriction on the distribution of the auditor’s report

The OM is thus a means for the auditor to communicate with users, and should state explicitly that the matter referred to is not required to be included in the financial statements.

To              : Chief Executive Officer
From         : Financial Controller
Subject      : Performance Analysis of Water Limited from 2016 to 2018
Date          : 4th November 2019

Introduction
This performance report relates to the financial statements of Water Limited for the period 2016 to 2018. The report covers the profitability, operating efficiency, liquidity and solvency positions of Water Limited over the period under review. An appendix is attached to this report which shows the ratios calculated as part of the performance review.

Profitability
The gross profit margin has remained relatively static over the three year period, although it has risen by approximately 1% in 2018. ROCE, while improving very slightly in 2017 to 21.5% has dropped dramatically in 2018 to 17.8%. The net profit margin has also fallen in 2018, in spite of the improvement in the gross profit margin. This marks a rise in expenses which suggests that they are not being well controlled. The utilization of assets compared to the turnover generated has also declined reflecting the drop in trading activity between 2017 and 2018.

Operating Efficiency
It is apparent that there was a dramatic increase in trading activity between 2017 and 2018, but then a significant fall in 2018. Revenue rose by 17% in 2017 but fell by 7% in 2018. The reasons for this fluctuation are unclear. It may be the effect of some kind of one-off event, or it may be the effect of a change in product mix. Whatever the reason, it appears that improved credit terms granted to customers (receivables payment period up from 46 to 64 days) has not stopped the drop in sales.

Liquidity
Both the current ratio and quick ratio demonstrate an adequate working capital situation, although the quick ratio has shown a slight decline. There has been an increased investment over the period in inventories and receivables which has been only partly financed by longer payment periods to trade payables and a rise in other payables (mainly between 2016 and 2017).

Solvency/Gearing
The level of gearing of the company increased when a further GH¢64m was raised in long-term loans in 2017 to add to the GH¢74m already in the statement of financial position. Although this does not seem to be a particularly high level of gearing, the debt/equity ratio did rise from 18.5% to 32.0% in 2017. The interest charge has risen to GH¢19m from GH¢6m in 2016. The 2017 charge was GH¢15m, suggesting that either the interest rate on the loan is flexible, or that the full interest charge was not incurred in 2017. The new long-term loan appears to have funded the expansion in both fixed and current assets in 2017.

Where capital employed = shareholders’ funds plus payables falling due after one year and any long-term provision for liabilities and charges. It is possible to calculate ROCE using net profit after taxation and interest, but this admits variations and distortions into the ratios which are not affected by operational activity.

2 marks for the structure of the report = 2 marks
2 marks for analysis of performance x 4 areas covered = 8 marks
4 marks for Appendix (12 ratios computed: 4 ratios x 3 years) = 4 marks

Areas for further investigation include the following;
i) Long-term loan: There is no indication as to why this loan was raised and how it was used to finance the business. Further details are needed of interest rate(s), security given and repayment dates.
ii) Trading activity: The level of sales has fluctuated in quite a strange way and this requires further investigation and explanation. Factors to consider would include pricing policies, product mix, market share and any unique occurrence which would affect sales.
iii) Further analysis: It would be useful to break down some of the information in the financial statements, perhaps into a management accounting format. Examples would include the following.
** Sales by segment, market or geographical area
** Cost of sales split, into raw materials, labour and overheads
** Inventory broken down into raw materials, work in progress and finished goods
** Expenses analysed between administrative expenses, sales and distribution costs.
iv) Accounting policies: Accounting policies may have a significant effect on certain items. In particular, it would be useful to know what the accounting policies are in relation to intangible assets (and what these assets consist of), and whether there has been any change in accounting policies.
v) Dividend policy: Water Limited has maintained the level of dividend paid to shareholders during the three year period. Presumably, Water Limited would have been able to reduce the amount of long-term debt taken on if it had retained part or all of the dividend during this period. It would be interesting to examine the share price movement during the period and calculate the dividend cover.                 (3 areas well explained and related to the question @ 2 marks: 6 marks)

• Integrity: In the light of the information Nana Yaw Kawula have, he must ensure that he act honestly, and that he is open and straightforward towards those with whom he comes into contact with. The CEO proposes misrepresenting information about the company in the financial statements, which would be contrary to the fundamental principle of integrity as defined for all ICAG members.
  Nana Yaw Kawula cannot simply do what has been asked of by the CEO because the principle of integrity requires a professional accountant not to be associated with information that they believe to be false or misleading. Relying on the potential buyer’s due diligence to identify the overvaluation is not appropriate. You are responsible for the honest presentation of the accounts, and you should not transfer that responsibility to either the buyer or the auditors.
• Objectivity: Can Nana Yaw Kawula act without bias, despite the significant threats in the form of self-interest and intimidation from others like in this case. In this case, there is self-interest threat to the finance director’s objectivity, which arises from the financial benefit that Nana Yaw Kawula is likely to receive if the company is sold under the proposed deal. Nana Yaw is also feeling intimidated by the CEO. The CEO appears to be suggesting that the future employment of other employees depends upon the proposed deal being successful and, therefore, upon the results shown by the financial statements. The CEO is also putting the finance director under pressure to account for inventory at a higher value than that with which he feels comfortable.
• Professional competence and due care: The finance director must act diligently. Does Nana Yaw Kawula have sufficient information to be able to determine the appropriate value of the inventory to be included in the financial statements in order not to misstate it? In this case, the first step is to ensure that the finance director have sufficient information. This would include the establishment of the basis of valuation of the company’s inventory, investigating the system for counting and evaluating inventory, and discussing with the warehouse manager the reason why the inventory is slow moving. The finance director may also need to discuss the realisable value with someone else, such as the sales director.
• Professional behaviour: All members of ICAG including Nana Yaw Kawula are required to account for the inventory in accordance with relevant accounting standards. In this case IAS 2 inventory. Inventory is valued at the lower of cost and net realizable value under IAS 2, which the finance director should be comfortable with. The finance director must ensure that any of the actions he considers taking should not discredit the profession in the opinion of an informed third party.
• Confidentiality: The finance director has to be mindful that actions he takes both internal and external including consulting others does not amount to given information of the company without obtaining proper permission.                                                                        (1 mark for each brief discussion up to a maximum of 5 marks)

• The first step is to ensure that the finance director has sufficient information. This would include establishing the basis of valuation of the company’s inventory, investigating the system for counting and evaluating inventory, and discussing with the warehouse manager the reason why the inventory is slow moving. You may also need to discuss the realisable value with someone else, such as the sales director.
• The finance director should discuss the matter with the CEO. If, in his opinion, the CEO continues to insist on an inflated inventory valuation being incorporated into the financial statements.
• The finance director should consider how best to raise the issue with the other board members. Initially, he could suggest that both Nana Yaw Kawula and the CEO raise the matter with the other board members. If he feels it appropriate to discuss the matter with anyone else within the company, however, the finance director must bear in mind the need for appropriate confidentiality and be clear about his reasons for raising the matter.
• Discussions with the CEO may be made easier by reference to the company’s own code of ethics, if it has one. If it does not, the finance director should make the CEO aware of the ethical requirements of ICAG as a professional body of which Nana Yaw Kawula is member.
• The finance director could possibly suggest that the company engages an independent expert to value the inventory.
• At each stage, the finance director should consider the need to follow meetings with email or other written correspondence to record his points of view. This would be particularly appropriate if you are of the opinion that the CEO or the board has not been sympathetic to the finance director’s concerns.
• The finance director might have to consider raising the issue externally, for example alerting the auditors to the existence of the slow-moving inventory, or seeking advice from ICAG as professional body, which the finance director belongs.
• If the situation remains unresolved, Nana Yaw Kawula may have to remove himself from the conflict. The clearest way is to disassociate himself from misleading financial statements would be to resign. However, this would only be an option to be exercised, as a last resort, in the most extreme circumstances. Resignation alone would not help to resolve this kind of situation. It would be advisable to take legal advice before considering resignation.
• The finance director should document, in detail, the steps that he has taken in resolving the issue, in case his ethical judgement is challenged in future periods.                  (1 mark for each action taken up to a maximum of 5 marks)
  

• The debt issue must be accounted for under IFRS 9 Financial Instruments. Initial recognition is at fair value. However this would ordinarily be the amount of cash received.
• As the debt is Duakwanta’s own debt and is not held for trading purposes, it should ordinarily be held at amortised cost.
• The change in fair value of the debt on the market due to change in credit risk is not therefore adjusted in Duakwanta’s financial statements. However, it will be disclosed under IFRS 7 Financial Instruments: Disclosures.

Tutorial note: If the debt were held at fair value through profit or loss (which is unlikely in this case), the change in fair value relating to changes in the entity’s own credit risk would be recognised in other comprehensive income rather than profit or loss.

Initial recognition of financial instrument is at fair value under IFRS 9  : 1 mark
Duakwanta’s own debt held at amortised cost                                          : 1 mark
Disclosure of fall in fair value                                                                   : 2 marks

The contract to supply is not sufficient to recognise revenue. It is necessary that control of the goods have actually transferred to the customer. This is the case for 30,000 units.

The deferred payment does not prevent revenue from being recognised, but the consideration needs to be measured at the fair value, on the transaction date, of the amount receivable. The fair value needs to reflect a discount allowing for the time value of money, as a result of the extended credit period. The discount rate will be 10%, Mankranso’s cost of capital. Hence revenue will be recognised as follows: 30,000 units * GH¢10 * 1/1.10 = GH¢272,727.

The discount will be recognised as finance income as time passes, on a time-apportioned basis. As the sale took place on 31 March 2019, no time has yet passed to trigger the recognition of finance income.

Journal:                               GH¢                  GH¢
Dr trade receivables          272,727
Cr Revenue                                                 272,727
(recognition of revenue and trade receivables at fair value of consideration receivable)

Initial revenue recognition           : 2 marks
Treatment of initial recognition   : 1 mark

Again, the same principles apply. Revenue is recognised when control of the goods or services are transferred to the customer.

Here, cash was received in advance. Nevertheless, revenue is only recognised when the service is delivered to the customer. Any excess cash retained is recognised as deferred income, a liability. If the cash is non-refundable, this does not change the timing of recognition of revenue. However, if the customer’s right to the service expires, and the customer has no right to a refund, the revenue should then be recognised.

Total cash received in year ended 31 March 2019: 2000 * GH¢100 = GH¢200,000
Total room nights provided 400
Revenue recognised = 400 * GH¢100 = GH¢40,000
Deferred revenue = 200,000 – 40,000 = 160,000

Journal:                                       GH¢ 000                GH¢ 000
Dr Cash                                            200
Cr Revenue                                                                    40
Cr Deferred revenue                                                  160
(recognition of revenue, deferred revenue and cash received)

Initial revenue recognition    : 1 mark
Deferred revenue                  : 1 mark
Journal entries                     : 1 mark

The shares allotted are included from the date the cash is receivable (1 October), IAS 33 para 21(a).
Basic earnings per share = (GH¢478,000)/4,150,000 = 11.5 pesewas loss per share.

As the preference shares are redeemable, they are accounted for as a financial liability under IAS 32 Financial Instruments: Presentation and therefore the dividend payment is treated as a finance cost, so no further adjustment to earnings is required as the dividend is included in finance costs.

Determination of weighted average number of shares   : 2 marks
Profit attributable to ordinary shareholders                   : 1 mark
Basic earnings per share                                                 : 2 marks

Under IFRS 9’s – amortised cost model, the financial liabilities should initially be recognised at the fair value of the cash received. Any directly attributable costs to the bond issue should be offset against the carrying amount of the liability.

The initial recognition and measurement of the financial liabilities has been carried out correctly in Kaduna’s financial statements.
The journal entires are:
Dr Cash                                                                   950,0000
Cr Financial Liability                                                                          932,000
Cr Broker Fees Payable (Transaction costs)                                    18,000
However, IFRS 9’s amortised cost method requires the bonds to be amortised over the bond term using the effective interest rate.

Kaduna has failed to amortise the bond using the effective interest rate, instead expensing the coupon payment in the profit or loss. Therefore, the following correcting journal entry is required:
Dr Interest expense (P&L)                  GH¢21,018
Cr Non-current liability (SOFP)                                 GH¢21,018

Initial recognition of bond                       : 1 mark
Justification for the correct treatment     : 0.5 mark
Bond schedule                                          : 3 marks
Reversal of wrong entry of finance cost   : 0.5 mark

• A discontinued operation is a component of an entity that either has been disposed of, or is classified as held for sale, and
• represents a separate major line of business or geographical area of operations,
• is part of a single co-ordinated plan to dispose of a separate major line of business or geographical area of operations or
• is a subsidiary acquired exclusively with a view to resale.      (Any 2 points @ 1 mark each)

Accounting Treatment

• Discontinued operations are presented separately at the end of profit or loss by including the profit after tax generated by discontinued operations. This figure should include the post-tax gain or loss on disposal of the assets of the operation or the gain or loss on remeasurement following transfer to “held for sale”.
• A component of an entity comprises operations and cash flows that can be clearly distinguished, operationally and for financial reporting purposes, from the rest of the entity. In other words, a component of an entity will have been a cash-generating unit or a group of cash-generating units while being held for use.
• An entity shall not classify as held for sale a non-current asset (or disposal group) that is to be abandoned. This is because its carrying amount will be recovered principally through continuing use.       (Any 2 points)
  

• IAS 21: The Effects of Changes in Foreign Exchange Rates governs the treatment of transactions in foreign currency. The invoice should be recorded as a sale and a receivable on 1 December 2018 at the spot exchange rate at the date, i.e. at GH¢9,814,602 (100m/10.1889).
• The amount paid in advance is initially recorded as deferred income at GH¢5,010,874 (50m/9.9783). On 1 December 2018 an exchange gain of GH¢103,573 (GH¢5,010,874 – GH¢4,907,301 (50m/10.1889)) is recognised in profit or loss when 50 million rand of the translated 100 million rand receivable is derecognised.
• The remaining 50 million rand receivable is retranslated at 31 December 2018 as GH¢4,760,227 (50m/10.5037) generating an exchange loss of GH¢147,074 (GH¢4,907,301 (50m/10.1889) – GH¢4,760,227).
• The two forward rate agreements are recognised at their fair value of GH¢148,000 (an asset as the rand has depreciated in value) in the statement of financial position.
• Given that they are fair value hedges the change in value of GH¢148,000 is a credit to profit or loss, eliminating the exchange loss recognised on the receivables.

Sale value on 1 December 2018                                   : 2 marks
Deferred income (amount received in advance)          : 1 mark
Exchange gain on deferred income to profit or loss    : 1 mark
Retranslation of receivable                                          : 1 mark
Fair value hedge credited to P& L                              : 1 mark