Question

QUESTION 2

Spinner Ltd is a bedding manufacturer that achieved a net profit before income tax of $1 842 000 for the year ended 30 June 2018. Spinner Ltd has a major loan from Greater Western Bank (GWB) for financing daily and other operations, carrying an interest rate of 7 per cent per annum.

Spinner Ltd is required to adhere to financial covenants imposed by GWB and in the event that the covenants are breached the annual interest rate on the loan will increase to 10 per cent. Spinner Ltd has disclosed these details in the notes to the financial report.

You are satisfied that the note in the financial report complies fully with the accounting standards; however, you form the view that your audit report should draw attention to this note.

In addition you have identified the following matters from your audit work:

1. Spinner Ltd’s inventory amounted to $1 941 000 at 30 June 2018. In order to move some of its old stock, in July 2018 the company sold 25 per cent of its finished goods inventories held at 30 June 2018 for $82 189 below their original cost. Management has indicated that as the sales occurred after 30 June 2018, it believes that the value of finished goods at that date should remain at cost. The remainder of the inventory has only been purchased recently and is in great demand.
2. Spinner Ltd’s accounts payable at 30 June 2018 amounted to $1 726 000. Subsequent payments testing revealed that in July 2018, invoices totalling $53 751 were paid that related to June 2018 purchases of inventories. The relevant invoices were omitted from the balance of accounts payables at 30 June 2018. Management has indicated that it does not intend to adjust the financial report in relation to this issue.
3. Spinner Ltd’s accounts receivable balance at 30 June 2018 amounted to $2 540 000. Your testing has revealed that the accountant used an incorrect exchange rate to translate overseas debtors at 30 June 2018. As a result, the balance of the accounts receivable account was overstated by $75 650. Again, management has indicated that it does not intend to adjust the financial report in relation to this issue.

Required:

1. Explain the two circumstances under which a modified audit opinion is issued and explain the three different types of modified opinions.
2. Explain whether drawing attention to the note will result in the expression of a modified audit opinion. Justify your answer.
3. Explain whether the issues arising from your audit work (matters 1 to 3 above) will individually have any effect on your audit opinion. Justify your answer, using calculations.
4. Identify the type of audit opinion that you will include in your auditor’s report for Spinner Ltd for the year ended 30 June 2018. Justify your answer.

Answer 1

(a) Circumstances under which a modified audit opinion is issued are:

1. The auditor, having obtained sufficient appropriate audit evidence, concludes that misstatements, individually or in the aggregate, are material, but not pervasive, to the financial statements.

2. The auditor is unable to obtain sufficient appropriate audit evidence on which to base the opinion, but the auditor concludes that the possible effects on the financial statements of undetected misstatements, if any could be material but not pervasive.

(b) Three different types of modified opinions are:

1. Qualified Opinion: The auditor shall express a qualified opinion when the auditor is having obtained sufficient appropriate audit evidence or is unable to obtain sufficient appropriate audit evidence on which to base the opinion, but the auditor concludes that the possible effects on the financial statements of undetected misstatements, if any could be material but not pervasive.

2. Adverse Opinion: The auditor shall express an adverse opinion when the auditor, having obtained sufficient appropriate audit evidence concludes that misstatements, individually or in the aggregate are both material and pervasive.

3. Disclaimer of opinion: The auditor shall express a disclaimer of opinion when the auditor is unable to obtain sufficient appropriate audit evidence on which to base the opinion, but the auditor concludes that the possible effects on the financial statements of undetected misstatements can be material and pervasive.

2. As the note given in the financial report complies fully with the accounting standards and the company is regular in making the payments to the other party, just the note given to draw the attention of the user will not amount to a modified of opinion.

3. Effects on Adit opinion for the matters raised during the audit work

Inventory Valuation: The company has sold the 25% inventories in the subsequent month below its cost. According to standards issued by the respective boards of different countries, when such a situation arises in the subsequent period the company is required to make a valuation on Net Realisable Value. This matter will have an important role while forming an audit opinion.

Trade payables Valuation: The company has not shown purchase worth $ 53,751 which is not shown in the financials which amounts to omittance of a transaction which directly can have effect on the financials which can make the financials unreliable. This matter will have an important role while forming an audit opinion.

Trade receivables Valuation: The company has overstated the trade receivables $ 75,650 by considering the wrong exchange rates which have the direct impact on the financials and can increase the profit of the company which which makes the financials unreliable.

(d) All the matters, when taken in aggregate, makes the financials untrue and not reliable to the stakeholders.

It depends on the auditors professional judgement what he thinks that the matters are pervasive or not.

No doubt the matters have a direct impact on the financial statements but pervasiveness of the above matters depends on professional judgment.

If the auditor concludes that the matters in aggregate are pervasive, he shall issue an Adverse Opinion.

Otherwise Qualified opinion will be issued.