Question

You are the audit senior working on the assurance engagement of Wix Ltd (“Wix”) for the year ended 30 November 2019. Wix provides building services under fixed-price short-term contracts. The majority of the company’s business is conducted on a sub-contract basis for large construction companies in the U.K and Europe. In the construction industry it is common for companies to pay 95% of the contract value on completion and withhold the 5% balance by the customer for 6 months as a ‘retention’ which is security against problems with the work undertaken.

Wix made an operating loss for the year ended 30 November 2019. This is mainly due to a substantial provision for work relating to a contract for Large plc (“Large”), one of Wix long standing and major customer. The contract was completed in early November 2019 but failed to meet the customer’s specification. Furthermore in December 2019, Wix received notification that Large had made a claim against the company for a large value of compensation for alleged damage to the customer’s business. No provision has been made by Wix for this compensation as the directors of Wix have instructed the legal advisors to fight the claim.

The company is currently trading at its overdraft limit and the directors have been negotiating with the bank to increase its borrowings. The directors have prepared profit and cash flow forecasts for the three years ending 30 November 2022 in support of the request for funding. The bank requires this information to be reviewed by independent accountants and the board of directors has asked that your firm undertakes this review.

c) In relation to the information provided above, explain the matters which give cause for concern.

Answer 1

The main cause for concern is the claim for a large amount of compensation made by Large plc against Wix for alleged damage to the customer's business. Though the Directors of Wix have instructed the legal advisors to fight the claim, in case Wix loses the case, there will be large outflow in the form of payment of compensation to Large plc. In such an event, the company will run out of funds. At least the company should make a provision for Contingent Liablity in its books.