Lexon Institute provides tuition for accountancy studies writing professional examinations. You are the audit manager of DAR and Co. Chartered Accountants. The following were identified during the financial audit of Lexon. Revenue is GH¢30m, Profit before tax is GH¢10 million and total assets is GH¢25 million.
Required:
Discuss each of these issues and describe the impact on the audit report if the below issues remain unresolved.
i) The regulator of the Accountancy profession has filed a lawsuit against Lexon Institute for GH¢3.9 million alleging a non-compliance with the Regulators rules and regulations for running a tuition center. This case is ongoing and will not be resolved prior to the audit report being signed. The matter is disclosed as a contingent liability. (4 marks)
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Lawsuit
- Lexon Institute is being sued by the Regulator for breach for non-compliance with rules and regulations for running tuition provision. This matter has been disclosed as a contingent liability. In accordance with IAS 37 Provisions, Contingent Liabilities and Contingent Assets, if the economic outflow to discharge the obligation is probable, then a provision must be recognised in the financial statements. If the economic outflow is possible, then a contingent liability must be recognised as the provision is material. A qualified opinion “except for” opinion should be given for non-recognition of provision or non-disclosure of contingent liability.
- Basis for qualified opinion should be placed immediately before the opinion paragraph in accordance with the requirements of ISA 705 Modification to the opinion in an independent auditor’s report, but after the opinion paragraph in line ISA 701 Key audit matters. This should explain the material misstatement in relation to either non-recognition of provision or non-disclosure of contingent liability.
- The lawsuit is for GH¢3.9m which represents 39% of profit before tax (3.9m/10m) and hence is a material matter. This is an important matter which needs to be brought to the attention of the users of the financial statements. The outcome of the case must be considered and it impact on the financial statements.
ii) Depreciation has been calculated on the total of land and buildings. In previous years it has only been charged on buildings. Total depreciation is GH¢2·5 million and the element charged to land is GH¢2 million. (4 marks)
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- Depreciation has been provided on the land element of property, plant and equipment and this is contrary to IAS 16 Property, Plant and Equipment, as depreciation should only be charged on buildings.
- The error is material as it represents 20% of profit before tax (2m/10m) and hence management should remove this from the financial statements. If management refuse to amend this error then the audit report will need to be modified. As management has not complied with IAS 16 and the error is material but not pervasive then a qualified opinion would be necessary.
- A basis for qualified opinion paragraph would need to be included explaining the material misstatement in relation to the provision of depreciation on land and the effect on the financial statements. The opinion paragraph would be qualified ‘except for’ – due to material misstatement.
- Basis for qualified opinion should be placed immediately before the opinion paragraph in accordance with the requirements of ISA 705 Modification to the opinion in an independent auditor’s report, but after the opinion paragraph in line ISA 701 Key audit matters.
iii) Lexon Institute’s computerised purchases is backed up daily, however for a period of three months the purchases records and the back-ups have been corrupted, and therefore cannot be accessed. Purchases for these three months amounted to GH¢4m. (4 marks).
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- Lexon Institute’s purchases program has been corrupted leading to a loss of purchases data for a period of three months. The auditors should attempt to verify purchase in an alternative manner. If they are unable to do this then purchase for the whole year would not have been verified.
- Purchases for the three month period represents 40% of profit before tax (4m/10m) and therefore is a material balance for which audit evidence has not been available.
- The auditors will need to modify the audit report as they are unable to obtain sufficient appropriate evidence in relation to a material, but not pervasive, element of purchases and therefore a qualified opinion will be required.
- A basis for qualified opinion paragraph will be required to explain the limitation in relation to the lack of evidence over three months of purchase records. The opinion paragraph will be qualified ‘except for’ – due to insufficient appropriate audit evidence.