You are a manager in KPMG, responsible for the audit of Sharjah LLC which is a listed company. The Sharjah LLC's main activity is steel manufacturing and it comprises a parent company and five subsidiaries. KPMG currently audits all components of the Sharjah LLC.
You are working on the audit of the Sharjah LLC's financial statements for the year ended 30 June 2012. This morning the audit engagement partner send an email to you:
‘Hello
The audit senior has provided you with the draft consolidated financial statements and accompanying notes which summarise the key audit findings and some background information.
At the planning stage, materiality was initially determined to be OMR900,000 and was calculated based on the assumption that the Sharjah LLC is a high risk client due to its listed status. During the audit, a number of issues arose which meant that we needed to revise the materiality level for the financial statements as a whole. The revised level of materiality is now determined to be OMR700,000. One of the audit juniors was unsure as to why the materiality level had been revised.
The Sharjah LLC's draft consolidated financial statements, with notes referenced to key audit findings, are shown below:
Draft consolidated statement of comprehensive income
Note 30 June 2012 30 June 2011
Draft Actual
OMR'000' OMR'000'
Revenue 1 98,795 103,100
Cost of sales (75,250) (74,560)
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Gross profit 23,545 28,540
Operating expenses 2 (14,900) (17,500)
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Operating profit 8,645 11,040
Share of profit of associate 1,010 900
Finance costs (380) (340)
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Profit before tax 9,275 11,600
Taxation (3,200) (3,500)
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Profit for the year 6,075 8,100
Other comprehensive income/expense for the year, net of tax:
Gains on property revaluation 3 800 -
Actuarial losses on defined benefit plan 4 (1,100) (200)
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Other comprehensive income/expense (300) (200)
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Total comprehensive income for the year 5,775 7,900
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Notes: Key audit findings - statement of comprehensive income
1. Revenue has been stable for all components of the Group with the exception of one subsidiary, Al Ain LLC, which has recognised a 25% decrease in revenue.
2. Operating expenses for the year to June 2012 is shown net of a profit on a property disposal of OMR2 million. Our evidence includes agreeing the cash receipts to bank statement and sale documentation, and we have confirmed that the property has been removed from the non-current asset register. The audit junior noted when reviewing the sale document, that there is an option to repurchase the property in five years' time, but did not discuss the matter with management.
3. The property revaluation relates to the Sharjah LLC's head office. The audit team have not obtained evidence on the revaluation, as the gain was immaterial based on the initial calculation of materiality.
4. The actuarial loss is attributed to an unexpected stock market crash. The Sharjah LLC's pension plan is managed by Fujairah LLC - a firm of independent fund managers who maintain the necessary accounting records relating to the plan. Fujairah LLC has supplied written representation as to the value of the defined benefit plan's assets and liabilities at 30 June 2012. No other audit work has been performed other than to agree the figure from the financial statements to supporting documentation supplied by Fujairah LLC.
Draft consolidated statement of financial position
Note 30 June 2012 30 June 2011
Draft Actual
OMR'000' OMR'000'
ASSETS
Non-current assets
Property, plant and equipment 81,800 76,300
Goodwill 5 5,350 5,350
Investment in associate 6 4,230 4,230
Assets classified as held for sale 7 7,800 -
-------- --------
99,180 85,880
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Current assets
Inventory 8,600 8,000
Receivables 8,540 7,800
Cash and cash equivalents 2,100 2,420
-------- --------
19,240 18,220
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Total assets 118,420 104,100
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EQUITY AND LIABILITIES
Equity
Share capital 12,500 12,500
Revaluation reserve 3,300 2,500
Retained earnings 33,600 29,400
Non-controlling interest 8 4,350 4,000
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Total equity 53,750 48,400
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Non-current liabilities
Defined benefit pension plan 10,820 9,250
Long-term borrowings 9 43,000 35,000
Deferred tax 1,950 1,350
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Total non-current liabilities 55,770 45,600
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Current liabilities
Trade and other payables 6,200 7,300
Provisions 2,700 2,800
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Total current liabilities 8,900 10,100
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Total liabilities 64,670 55,700
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Total equity and liabilities 118,420 104,100
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Notes: Key audit findings - statement of financial position
5. The goodwill relates to each of the subsidiaries in the Group. Management has confirmed in writing that goodwill is stated correctly, and our other audit procedure was to arithmetically check the impairment review conducted by management.
6. The associate is a 30% holding in Dubai LLC, purchased to provide investment income. The audit team have not obtained evidence regarding the associate as there is no movement in the amount recognised in the statement of financial position.
7. The assets held for sale relate to a trading division of one of the subsidiaries, which represents one third of that subsidiary's net assets. The sale of the division was announced in May 2012, and is expected to be complete by 31 December 2012. Audit evidence obtained includes a review of the sales agreement and confirmation from the buyer, obtained in July 2012, that the sale will take place.
8. Two of the Sharjah LLC's subsidiaries are partly owned by shareholders external to the Group.
9. A loan of OMR8 million was taken out in October 2011, carrying an interest rate of 2%, payable annually in arrears. The terms of the loan have been confirmed to documentation provided by the bank.
Required:
A. You are required to respond to the email of the audit engagement partner in the form of a Report, there are two matters you need to deal with:-
1. Explain why auditors may need to reassess materiality as the audit progresses.
2. Assess the implications of the key audit findings(KEY AUDIT FINDING FROM NO. 1 TO 9 ABOVE) for the completion of the audit. Your assessment must consider whether the key audit findings indicate a risk of material misstatement. Where the key audit findings refer to audit evidence, you must also consider the adequacy of the audit evidence obtained, but you do not need to recommend further specific procedures. (Min. 2000 words including introduction, lit review etc.)
B. The audit engagement partner now sends a further note regarding the Sharjah LLC:
‘The Group finance director has just informed me that last week the Group purchased 100% of the share capital of Hadi Company, a company located overseas in Turkey. The Group audit committee has suggested that due to the distant location of Hadi company, a joint audit could be performed, starting with the next financial statements for the year ending 30 June 2013. Hadi company's current auditors are a small local firm called MKM LLC who operate only in Turkey.'
Required:
Discuss the advantages and disadvantages of a joint audit being performed on the financial statements of Hadi Company.(Min 500 words).