Questions:
Question 1
Mason Air Services is a company that provides specialist helicopter support to the emergency services and the coastguard. Two owner managers (directors) set up the company nine years ago. You are the audit senior and you are planning the audit for the year ended 30 September 2021.
Following a recent visit to the client you have ascertained the following information. The company maintains a helicopter fleet comprising a range of aircraft types and carrying specialist equipment. The company also trains and provides specialist pilots. Under the terms of a five-year contract, they charge an annual fee to their customers to cover the maintenance, storage and testing of the aircraft and equipment. The annual fee is payable in advance each year with the first annual payment being paid on the date the contract commences. Customers are then also charged an additional fee per ‘flying hour’ based on the usage of an aircraft.
This charge per flying hour is also set out in the contract. However, when preparing sales invoices, rather than going back to the contract, the financial controller said they use the last invoice to pick up the hourly charge. Their customers comprise solely of the police, the ambulance service, the fire service and the coastguard. The contracts in place are all of a similar value and are considered by management to be very profitable. The company has always made a healthy profit before interest and tax.
However, Mason Air Services owns the helicopters and funded the original purchase of each aircraft with a secured loan carrying substantial interest charges. As a result, the anticipated draft profits for 2021 after interest and tax are relatively modest at around $800,000 for the year when compared with the expected revenue of $45m.
The contract with the police force expires in March 2022 and the police are trying to substantially reduce the amount they pay annually and per flying hour in the wake of government cuts. It is thought that the contract will be put out to tender, and another aircraft provider may also bid for the contract.
A new contract for the provision of air ambulances was signed during the year with increased flying hour charges.
Although no new helicopters have been purchased during the year to 30 September 2021, there has been a lot of re-fitting, replacement and adding of specialist equipment to some of the aircraft. This has been necessary to keep up with the latest developments in search and rescue, and to maintain the aircraft to the high standard required under the contracts in place.
The company maintains around $2m of aircraft spares which is included within inventory. Approximately a quarter of this value is made up of specialist equipment taken out of aircraft when it was replaced by newer or more advanced equipment. The directors have estimated the value of this equipment and have included it within inventory as they say it still works as well as it did when it was installed.
Question 2
You are an audit manager in XYZ & Co, a large audit firm which specializes in the audit of retailers. The firm currently audits Golden Limited, a food retailer, but Golden Limited’s main competitor, Mutton Limited, has approached the audit firm to act as auditors. Both companies are highly competitive and Golden Limited is concerned that if XYZ & Co audits both companies then confidential information could pass across to Mutton Limited.
Required:
(a) Explain the safeguards that your firm should implement to ensure that this conflict of interest is properly managed. (4 marks)
(b) It is five months since the year end of your audit client Golden Limited and you are reviewing the work of your audit assistant on the audit file. The finance director of Golden wants to have some additional disclosures to the financial statements in respect of going concern, as the bank has not renewed the overdraft facility and the directors are currently negotiating with different banks to obtain alternative facilities. The directors are confident that they will obtain suitable finance to continue operating for the foreseeable future. The auditors have obtained evidence about this situation.
Required
Identify and explain the steps the auditor should take and the effect on the audit report in the following situations:
(i) The auditor agrees with the basis of preparation of the financial statements and adequacy of the disclosures the Finance Director has made. (3 marks)
(ii) The auditor agrees with the basis of preparation of the financial statements but believes that the disclosure is inadequate. (4 marks)
(iii) The auditor disagrees with the basis of the preparation of the financial statements. (4 marks)
