You are an audit manager in Olive & Co, a firm of Chartered Certified Accountants, who is
Question:
You are an audit manager in Olive & Co, a firm of Chartered Certified Accountants, who is responsible for the audit of Popeye Co, whose principal operations encompass the manufacture and maintenance of marine vessels. The audit of the company's financial statements for the year ended 30 June 20Y0 is soon to be concluded.
The draft statement of profit or loss recognizes a profit before tax of $65 million and the draft statement of financial position recognizes total assets of $950 million.
You are in the process of reviewing the audit working papers, and the following matters have been highlighted to you by the audit supervisor:
(i) Alternative use for the property
Included in Popeye Co's property, plant and equipment is an industrial complex that the company traditionally used as a depot to service its marine vessels. The company adopts the revaluation model for measuring its properties, and the depot was carried at $75 million in the company's interim financial statements. Current year audit tests revealed that journal entries were made to uplift the depot's fair value, resulting in the depot being valued at $80 million in the company's draft statement of financial position as at 30 June 20Y0. According to the management, this represents the forecasted sales price of the property in light of their plan to convert it into a residential housing complex. The associated conversion costs are expected to be $19.6 million, and the company will also be obligated to pay the municipal council fees of $2.8 million to undertake this development. (6 marks)
(ii) Investment property
Popeye Co has in its possession a warehouse that was previously used to store ship parts. At the beginning of the current financial year, the warehouse had a historical cost net book value of $22.6 million and a fair value of $24.4 million. It was vacated on that date and all the inventory contained therein was shifted to a larger storage facility. Despite vacating the building, the management decided not to dispose of it owing to the potential rental income and capital appreciations that could be derived from it. As at the year-end, the management had not rented out the building and a valuation exercise carried out by an independent firm ascertained the fair value of the building to be $24.7 million. The building has been classified as an investment property and a fair value gain of $2.1 million has been recognized in the company's draft financial statements. No depreciation charge has been made in respect of the building following its classification as an investment property. (6 marks)
(iii) Depreciation
The company also owns property, plant, and equipment which are unrelated to its ship manufacturing and servicing operations. These assets have been recognized in the draft statement of financial position at a carrying value of $32 million. Traditionally, these assets were depreciated over a useful life of 8 years on a straight-line basis. However, on 1 July 20X9, their estimated useful life was revised to 12 years. According to the company's financial controller, the revision to the assets' estimated useful life was made on the grounds that they are going to last longer than initially expected.
A retrospective adjustment was made to the financial statements in respect of the change in the company's depreciation policy, thereby increasing property, plant, and equipment by $10.5 million, and retained earnings by the same amount. A current year depreciation charge of $6 million has been recognized in the draft financial statements (20X9 - $7.5 million). (6 marks)
Required:
Explain the matters to be considered, and the audit evidence that you would expect to find, during your review of the working papers in respect of each of the above issues.
Note: The split of the mark allocation is shown against each of the issues above.
Auditing and Assurance Services Understanding the Integrated Audit
ISBN: 978-0471726340
1st edition
Authors: Karen L. Hooks