Question

Section 1: Subsidiary 1 – Carpets International (USA) Limited

You are involved in the audit of Carpets International (USA) Limited, a subsidiary company of Las Vegas Group Corporation (USA) Limited. The client has presented you with the following draft Statement of Financial Position and Statement of Financial Performance as follows:

	Unaudited 11 months 30/11/X2 $’000	Audited 12 months 31/12/X1 $’000
Current Assets
Cash	58	73
Receivables	4579	3928
Inventories	3624	2047
Total Current Assets	8261	6048
Non-current Assets
Property, plant & equipment	28763	29417
Receivables	2000	2000
Total Non-current Assets	30763	31417
Total Assets	39024	37465
Current Liabilities
Bank borrowings – Secured	5000	7500
Trade Creditors	2500	2473
Provisions	643	610
Total Current Liabilities	8143	10583
Non-Current Liabilities
Bank borrowings – Secured	22000	20000
Provisions	547	510
Total Non-current Liabilities	22547	20510
Total Liabilities	30690	31093
Net Assets	8334	6372
Shareholders’ Equity
Share Capital	5000	5000
Accumulated Profits	3334	1372
Total Shareholders’ Equity	8334	6372
Statement of financial performance
Revenue	20007	19943
Gross profit	6702	4515
Operating expenses	3486	3047
Net Profit before tax	3216	1468
Taxation	1254	572
Net Profit after tax	1962	896
Accumulated profits at the beginning of the year	1372	476
Accumulated profits at the end of the period.	3334	1372

The following additional information is provided:

1. The company is a subsidiary of Las Vegas Group Corporation (USA) Limited which is listed on the New York Stock Exchange.
2. Your firm provides a clearance report to your firm’s Las Vegas Office as well as an audit report on the statutory accounts of the American subsidiary.
3. The company manufactures carpets. Approximately 80% of the company’s sales arise as a result of exports. Where the company sells abroad the customers are invoiced in the currency of that country.
4. The primary raw material used in the manufacture of the company’s product is wool which is purchased in Australia. You have been informed that the company’s profitability has improved due to the recent slump in wool prices.
5. With the exception of the managing director, Mr. L, an American executive, all of the local management is American. Mr. L is on a 5 year secondment from the US parent. He has a reputation for delivering results from subsidiaries which have not performed well in the past. It is his intention to return to the US Company in a year’s time as a director.
6. In the past you have found the financial controller, Mr. C, to be competent in day to day accounting issues but somewhat lacking in assessing the ‘broad picture’. Both management and statutory accounts are subject to Mr. L’s approval. He frequently insists on adjustments to the draft accounts.
7. The US parent’s management was dissatisfied with the company’s 19X1 result and has paid close attention to the company’s performance during 19X2.
8. The company operates a standard costing system and the finished goods inventory is valued at standard cost. Raw materials are valued at actual invoiced cost. Due to the Christmas shutdown no work in progress exists at year end.
9. During 19X2 production has been increased by 10% compared to 19X1 levels. This has resulted in favourable absorption variances which have contributed to the improved profitability during 19X2.
10. Tests on the company’s inventory and debtors controls in prior years have shown the system to be reliable. The systems are capable of producing reports on the ageing of inventory and debtors and the sales history of individual product lines.
11. Approximately 80% of the company’s trade debtors are overseas customers and the debt is denominated in foreign currency. Most of these customers are on 60 day credit terms.
12. Midway through the financial year the previous credit controller resigned. His replacement, Mr. B, was appointed 6 weeks later.
13. Mr. B has informed you that a number of customers have complained about product quality problems.
14. An analysis of the company’s fixed assets is a s follows:

19X2

$’000

                                Property – Factory building                                                                               27000

                                Plant & Equipment (including Vehicles)                                                         1763

                                                                                                                                                                28763

Additions and disposals of fixed assets during 19X2 have not been significant.

The factory was acquired 6 years ago. Since that date no independent valuation has been carried out. Mr. L has assured you that the current market value of the property is not less than $27m.

15.    Bank borrowings are secured by a fixed charge over the company’s buildings.   

       A loan repayment of $5m due on 30 November 19X2 was reduced to $500,000. Mr. L has stated that this was done with the agreement of the bank and that the bank is comfortable with the company’s performance, and points out that the company has made all of its interest payments on time.

16.    The non-current receivables is an Export Market Development grant.

17.    In prior years no serious differences between the auditors and management arose. The audit has always been completed on time and an unqualified opinion issued.

18.    You have just received a memo from Las Vegas office stating that due to the client’s head office management’s desire to issue the results of the group earlier this year they will require clearance on the American company’s accounts by 18 January 19X3. For 19X1 clearance was given on 30 January 19X2.

You are required to complete the following:

1. Specify the analytical review procedures you consider should be carried out as part of your audit planning.

2. Identify what you consider to be the risk factors which will impact on the audit of receivables and inventories.

Answer 1

1. Analytical review to be performed on the below points

Since 80% sales is export and billed in currency of that country, detailed review need to be done on the currency rate used at the time of receipt and the closing balance as on year end.

Mr L director is having substantial interest in subsidiary co

Factory building to be valued at cost or market value which ever is less, hence assets has to valued

2.

Risk factor on receivable: Since 80% sales is export and invoice in the currency of that currency, need to be more alert on the currency rate used for conversion at the time of invoicing, receipts and valuating closing receivable balance

Risk factor on inventory : Since company is operating on standard cost system and valuating its inventory at standard cost, but as per GAAP it should be valued at net realizable value.