CORPORATE REPORTING Time allowed 3 hours Total marks 100 [N.B. The figures in the margin indicate full marks. Questions must be answered in English. Examiner will take account of the quality of language and of the manner in which the answers are presented. Different parts, if any, of the same question must be answered in one place in order of sequence.] Marks 1. (a) Good ethical behavior may require acting beyond the requirement of the law. In a highly competitive complex business world, it is essential that professional accountants maintain their integrity and remember the trust and confidence which is placed in them by whosoever relies on their objectivity and professionalism. Moreover, professional accountants, accounting fraternity and auditing profession are condemned for various reasons. To fix the issues involved, Govt. of Bangladesh has enacted Financial Reporting Act (FRA) 2015 and formed Financial Reporting Council (FRC) under this act. FRC will issue accounting, auditing, valuation and other standards in Bangladesh. In addition, FRC will issue code of ethics for the professional accountants in Bangladesh to ensure accountability, transparency and high standards of accounting and auditing profession in Bangladesh. Explain why the code of ethics is important to professional accountants in Bangladesh. 5 (b) At Saturday evening, a text message arrives to you from your audit manager, Shahriar Kabir, stating: 'Please check your email urgently'. On checking your email, you find the following message: I hope you had a good weekend. Instead of coming into the office tomorrow morning I would like you to go to a client called Air Bangla Ltd.. I know you have not worked on this client before so I am emailing you some background information (Exhibit 1). One of our audit juniors, Mehedi Hasan, was at Air Bangla's head office last week working on the interim audit and he has come up with a schedule of issues that are worrying me (Exhibit 2). Mehedi does not have the experience to deal with these, so I would like you, as a senior, to go out there and prepare a memorandum for me which sets out: - the ethical issues that arise from these issues and the audit procedures required for each of these issues; and - the financial reporting implications of each of these issues I will visit Air Bangla on Tuesday to speak to the directors. Regards, Shahriar Requirement: Prepare the memorandum requested by your audit manager. 25 Exhibit 1: Background information Air Bangla Ltd. operates a fleet of ten jets available for private hire. The jets are based in South Asia, the Europe and the Middle East. The company is resident in Bangladesh. The jets can be hired for specific flights, for short periods or for longer periods. For insurance purposes, all planes must use a pilot employed by Air Bangla. All the jets are owned by Air Bangla. Air Bangla is listed on Dhaka Stock Exchange. Ordinary share capital consists of 50 million BDT 10 shares. The ownership of share capital at 1 January 2018 was: Directors 30%; Institutional Investors 41%; Best Airlines Ltd. 9%; Individuals 20%. The company uses an interest rate of 12% to discount the cash flows of all projects. The accounting year-end is 31 December. Exhibit 2: Interim audit issues Prepared by Audit Junior: Mehedi Hasan In respect of the interim audit of the financial statements for the year to 31 December 2018 the following issues have arisen. Page 1 of 6
i. Air Bangla appears to have inadvertently filed an incorrect tax return for last year showing a material understatement of its corporation tax liability for that year and has therefore paid significantly less corporation tax than it should have. Our firm is not engaged as tax advisers. The directors are now refusing to inform Tax office of the underpayment as they say that it is in the past now. I am not sure of our firm's obligations in this matter. ii. One of the directors, Badol Sarker, owns a separate travel consultancy business. He buys unused flying time from Air Bangla to sell to his own clients. In the year to 31 December 2018 to date he has paid Air Bangla BDT 1,000,000 for 1,000 hours of flying time made available. iii. On 16 September 2018 a major customer, Dream Travel & Tour Ltd, gave notification to Air Bangla that the service it had been receiving was poor and it was therefore considering terminating its long-term contract with the company. The contract amounted to 15% of Air Bangla's revenue and 25% of its profit in 2017. The directors did not make an immediate announcement of this and so the share price did not initially change. Four directors sold a total of 2,000,000 shares in Air Bangla Ltd. on 2 October 2018. Dream Travel & Tour Ltd. terminated the contract on 1 November 2018 and the directors disclosed this to the Dhaka Stock Exchange the same day. The price per share then fell immediately from BDT 75 to BDT 60. iv. I have selected a sample jet to be physically inspected. I selected this jet because it does not appear to have flown since December 2017. The jet in question cost BDT 60 million on 1 January 2010 with a useful life of ten years and a residual value of BDT 10 million. Each jet is expected to generate BDT 20 million income per year net of expenses. The directors say that this jet is located in the UK, but they have offered to fly a member of our audit team out there in one of their executive jets. They insist that a jet needs to go there anyway so there would be no cost to Air Bangla by making transport available to us. v. On 28 August 2018, Best Airlines Ltd. a large, listed company which operates a discount airline acquired 10 million shares in Air Bangla from financial institutions. On 20 October 2018 Best Airlines announced to the Dhaka Stock Exchange that it intends to make a bid for the entire share capital of Air Bangla and at the same time requested that our firm, as Air Bangla's auditors, should carry out the due diligence work in respect of the bid. 2. You are an assistant audit manager working for a firm of Chartered Accountants, ABC & Co. You have been assigned to the audit of OTB, a Bangladeshi Company which sells home electronic appliances. In July 2018, your team completed audit planning and interim audit procedures on OTB for its year ending 31 December 2018. You prepared a file note (Exhibit 1) outlining the key elements of your planned audit approach. The ABC & Co. audit manager for the OTB audit engagement gives you the following briefing: On 31 August 2018, OTB was acquired by a listed multinational company, Giant Ltd.. I have received an email from the OTB chief financial officer (CFO) (Exhibit 2) which provides information that may affect our audit plan. Giant has told the CFO to make some adjustments to OTB s financial statements for three matters. These matters are included in an attachment to the email. Giant is audited by Sinha & Kader and today I received a telephone call from the Sinha & Kader s audit partner. The telephone call raises issues for our audit approach and I have summarised it in a brief note (Exhibit 3). Instructions from the ABC & Co. audit manager I need to respond to the CFO s email (Exhibit 2) and consider its implications for the OTB audit. To help me, please prepare a briefing note in which you: (1) Explain, for each of the three matters in the email attachment (Exhibit 2), the appropriate financial reporting treatment in the financial statements of OTB for the year ending 31 December 2018. Identify any additional information you need to finalise the accounting entries required. Ignore any adjustments for current and deferred taxation. (2) Identify and explain the changes that we need to make to each element of the planned audit approach summarised in the file note (Exhibit 1). You should also consider any additional key areas of audit focus and risk using all the information available. Requirement: Respond to the ABC & Co. audit manager s instructions. 30 Page 2 of 6
Exhibit 1: File note planned approach for OTB audit prepared by audit senior in July 2018 The key elements of our planned audit approach for OTB for the year ending 31 December 2018 are set out below. We have: Agreed engagement terms and an audit fee of BDT 1,200,000, giving us an inflationary increase from the prior year. Established planning materiality at BDT 16,000,000 based on a forecast profit after tax of BDT 320 million for the year ending 31 December 2018. Considered factors affecting the inherent risk associated with the client, noting: - no new business risks; - no unusual pressures on management; and - no factors which cause us to question the effectiveness of the general control environment. Assessed the risk of material misstatement, identifying the following balances and assertions as key areas of audit focus: - the accuracy and cut-off of revenue recognition; and - the valuation of future obligations for the defined benefit pension scheme. Evaluated the design of the controls over revenue and trade receivables. We also performed testing to ensure that these controls had been implemented and we also tested their operating effectiveness for the six months ended 30 June 2018. No exceptions were identified from this work so we plan to rely on the operating effectiveness of controls over revenue and trade receivables. Scheduled our final audit visit for March 2019 in line with the timing of our audit procedures in previous years. During this final visit, we plan to update our testing of operating effectiveness to cover the operation of controls in the six months ending 31 December 2018. Exhibit 2: Email from OTB CFO To: ABC & Co. audit manager From: OTB CFO Date: 6 November 2018 Subject: Information and attachment including adjustments required by Giant Change in ownership of OTB OTB was acquired by Giant on 31 August 2018. As a result, there have been some changes in OTB s staff, systems and procedures. With effect from 1 November 2018, responsibility for routine accounting was transferred to the Giant shared service centre. This now processes all our accounting transactions. As OTB CFO, I still have overall responsibility for the OTB financial statements. I am responsible for reviewing the draft financial statements and for processing journal entries for judgemental, complex or one-off items. Giant does not get involved in detailed operational matters but expects the OTB board to achieve the forecast results. Giant has made it clear that OTB will face cuts in staff if we fail to do so. Cost control is very tight under our new owners so I am unlikely to be able to approve any increase in the BDT 1,200,000 audit fee already agreed. Pension scheme Giant asked its actuary to provide a valuation of the OTB defined benefit pension scheme at 31 August 2018, as it questioned the assumptions that OTB s actuary used last year. Because of changes in the actuarial assumptions used, the revised valuation resulted in a reduction of BDT 210 million in the net pension obligation recognised at 31 August 2018. The Giant auditor has reviewed the actuarial calculations and is happy with them. The Giant actuary has confirmed that he expects his actuarial assumptions to be very similar at 31 December 2018 and he plans to use the same assumptions at that date. Re-organisation and bonus costs Because of Giant s acquisition of OTB, there are several employees whose services will not be required. A redundancy programme was announced on 1 October 2018 and 12 members of the finance and administration staff have already left the company, together with three directors and six other members of senior management. They received redundancy payments totalling BDT 25 million, which will be recognised in our October 2018 management accounts. Page 3 of 6
A further 50 members of staff are due to leave on 28 February 2019, by which time we hope to have signed off our financial statements. They will receive redundancy payments totalling BDT 12,700,000. There is a new executive bonus scheme for me and the two other remaining directors of OTB. If the company exceeds its forecast operating profit of BDT 680 million, we will each receive a bonus payment of BDT 2,000,000. I have not accrued for this cost, as the bonus will be payable in 2019. Financial performance I summarise below key financial data from OTB s management accounts for the nine months ended 30 September 2018. The results for October 2018 are not yet available. I hope to provide these in early December 2018. 9 months ended 30 September 2018 Actual BDT million Year ending 31 December 2018 Updated forecast BDT million Year ended 31 December 2017 Actual BDT million Revenue 3,500 5,486 4,280 Gross profit 1,020 1,524 1,284 Operating profit 378 680 428 Profit after tax 294 520 322 Net assets 1,062 1,498 768 Performance for the 8 months to 31 August 2018 was in line with the forecast and the previous year. In September 2018, revenue increased by around BDT 300 million because of sales of OTB products to Giant subsidiaries outside of the Bangladesh. These sales represent our first international revenue and are expected to continue at the same level for the rest of the year. The gross margin is lower than on OTB s other sales, as the prices charged to group companies are lower than those charged to third parties. I have updated the whole forecast to reflect these sales. There have been no changes to costs and revenue other than the additional international sales. Attachment to CFO s email adjustments required by Giant Peter Watson (the Giant group financial controller) has reviewed OTB s accounting policies and estimates at the acquisition date, 31 August 2018. He has told me to adjust OTB s financial statements for the year ending 31 December 2018 for the three matters set out below. Brand At 31 August 2018, an expert valued the OTB brand at BDT 400 million and Peter expects to see this asset in the OTB statement of financial position. We have not previously recognised any value for the brand and I am unsure as to what costs were incurred to acquire or develop it. Investment property Giant has a policy of measuring both its investment properties and all other land and buildings at fair value and it requires OTB to adopt the same policy, although we have historically used the cost model for all property, plant and equipment (PPE). Giant valued OTB s PPE as at 31 August 2018. There was no difference between the carrying amount and fair value of PPE, except for OTB s head office property. The carrying amount of the property at 31 August 2018 was BDT 26 million, including land at BDT 14 million. The property had a remaining useful life of 30 years at that date. Because there are plans for OTB to vacate the head office property and to rent it to tenants, Giant wants us to treat it as an investment property. At 31 August 2018, Giant valued the head office property at BDT 74 million, including land at BDT 14 million, based on anticipated rental income. The head office property has three identical floors and each floor can be rented to tenants separately. Until 1 September 2018, OTB occupied the whole building. At that date, it signed a 10-year lease with a tenant for the third floor, at an annual rental of BDT 800,000. OTB continues to occupy the other two floors. Trade receivables allowance Historically, OTB has made only small impairment allowances for specific trade receivables which it does not expect to recover in full. Peter has now also asked us to establish a general allowance based on the ageing of receivables that, at 31 August 2018, amounts to BDT 27 million. A general allowance calculated on the same basis as at 31 December 2017 would have amounted to BDT 1,6000,000. Page 4 of 6
I would welcome your advice as to what, if anything, we should adjust. I am not sure Peter has really considered the effect on OTB s single company financial statements. The above three matters are not recognised in OTB s management accounts. Exhibit 3: Note of my telephone call with Sinha & Kader s audit partner prepared by ABC & Co. audit manager I received a telephone call today from Sinha & Kader s audit partner, Giant s auditor. Sinha & Kader expects to sign off the group audit opinion by 28 February 2019. OTB is a significant component of the Giant group. By 15 February 2019, Sinha & Kader needs us to do a full audit of OTB s financial statements for the year ending 31 December 2018, based on the component materiality of BDT 60 million, and to prepare a reporting memorandum to Sinha & Kader. The partner confirmed that Sinha & Kader has completed audit procedures on the defined benefit pension scheme obligations at 31 August 2018, so we may not need to perform separate procedures on these. He will send an email confirming the work done and that no issues were noted. The Giant board is interested only in ensuring that there is no material misstatement at group level. Therefore, it expects ABC & Co. to adopt component materiality of BDT 60 million for the single company OTB audit. 3. Meghna Ltd, a parent company, requires sets of management information, including key ratios, from all of its subsidiaries. The most recent sets of information for two of its subsidiaries, Sky Ltd. and ABC Ltd. two manufacturing companies, show the following: Sky Ltd. ABC Ltd. Return on capital employed (ROCE) Gross profit percentage 5% 30% 13% 35% Net margin 13% 10% Current ratio 2.5:1 3:1 Quick ratio 1.8:1 2.7:1 Trade receivables collection period 60 days 45 days Trade payables payment period 40 days 50 days Inventory turnover 60 days 20 days Gearing (debt/equity) 55% 100% Interest cover 4 times 2 times Cash return on capital employed (cash ROCE) 7% 8% Additional information (1) Each company is treated as a mainly autonomous unit, although they share an accounting function and Meghna Ltd. does determine the dividend policy of the two subsidiaries. Companies in the group must use the same accounting policies. (2) It is group policy to record all assets at cost less accumulated depreciation and impairment losses. However, Sky Ltd. has revalued its freehold property and included the results in the recent management information above. (3) ABC Ltd. has recently leased a specialized item of plant and machinery. In the management information above the lease rentals have been recognized as an expense in profit or loss. The Managing Director has said that this is a finance lease and the group directors are aware that the year-end published financial statements will need to reflect this. (4) Sky Ltd. and ABC Ltd. trade with other companies in the group. At the instigation of ABC Ltd. Sky Ltd. has supplied one of the other companies in the group with goods with a selling price of Tk.200,000. These are no longer in group inventories but Sky Ltd. has been told that the goods will not be paid for until the liquidity problems of the company are resolved. Requirements: (a) Comment on the relative financial performance and position of Sky Ltd and ABC Ltd. from the above information. 8 (b) Identify what further information you would find useful to help with your commentary in (a) providing reasons. 5 (c) It transpires that the Managing Director of ABC Ltd, who was previously head of the accounting function for both companies, was aware, at the time of preparing the above information, that Meghna Ltd. is considering selling its stake in one of these companies and that Meghna Ltd. intends to use the information to help it in making its decision. Comment on the information above in the light of this and set out any additional information which would help you to form a view on the situation. 7 Page 5 of 6
4. (a) Accounting policy of Kanka Ltd. revealed the following: The company adopts revaluation model of IAS 16: Property, Plant & Equipment and the fair value model of IAS 40: Investment Property. Kanka Ltd. chooses to recognise any fair value gains or losses arising on its equity investments in other comprehensive income as permitted by IFRS 9: Financial Instruments. The following transactions relate to Kanka Ltd. for the year ended 31 March 2018. i) Kanka Ltd owns a piece of property it purchased on 1 April 2015 for Tk.3.7 million. The land component of the property was estimated to be Tk.1.2 million at the date of purchase. The useful economic life of the building on this land was estimated to be 25 years on 1 April 2015. The property was used as the corporate head office for two years from that date. On 1 April 2017, the company moved its head office to another building and leased the entire property for five years to an unrelated tenant on an arm s length basis in order to benefit from the rental income and future capital appreciation. The fair value of the property on 1 April 2017 was Tk.4.1 million (land component Tk.1.9 million), and on 31 March 2018, Tk.4.8 million (land component Tk.2.1 million). The estimated useful economic life remained unchanged throughout the period. Land and buildings are considered to be two separate assets by the directors of Kanka Ltd. as per IAS 1. ii) Kanka Ltd. holds a portfolio of equity investments the value of which was correctly recorded at Tk.12 million on 1 April 2017. During the year ended 31 March 2018, the company received dividends of Tk.0.75 million. Further equity investments were purchased at a cost of Tk.1.6 million. Shares were disposed of during the year for proceeds of Tk.1.1 million. These shares had cost Tk.0.4 million a number of years earlier but had been valued at Tk.0.9 million on 1 April 2017. The fair value of the financial assets held on 31 March 2018 was Tk.14 million. Requirement: You are newly appointed Financial controller of Kanka Ltd. Convince the management on how to account for the above transactions with reference to the relevant IAS and IFRS. 8 (b) Exim Bangladesh Ltd. is a conglomerate which operates in different sectors of the economy. The company has many subsidiaries and associates across the six continents of the world and its head office is located in Dhaka, Bangladesh. The shares of the company are listed on the Dhaka Stock Exchange. The company is trying to finalize its financial statements for the year ended June 30, 2018 and the following accounting issues are being considered by the chief accountant based on the submission by the assistant accountant who is yet to complete her professional examinations with the Institute of Chartered Accountants of Bangladesh. The functional and presentation currency of Exim Bangladesh Ltd. is Taka. The following transactions relate to the company: i. On May 1, 2017, Exim Bangladesh Ltd. bought an investment property in United States for $1,000,000. The company uses fair value model of IAS 40 to account for the investment property and the fair value at April 30, 2018 is determined to be $1,200,000. The assistant accountant is unsure which exchange rate to use in translating the investment property at the year end and how to recognize any exchange difference that may arise. ii. On May 1, 2017, Exim Bangladesh Ltd. acquired a wholly owned subsidiary in United States of America. The goodwill that arose on the acquisition of this subsidiary is $400,000. In addition, the company invested in an equity instrument on the same date which is measured at fair value through other comprehensive income (OCI) in accordance with the requirements of IFRS 9. Requirements: (i) In accordance with the requirement of IAS 21: Effect of Changes in Foreign Exchange Rates, discuss the treatment of foreign currency transactions and the gain or loss arising therefrom. 4 (ii) Discuss how the transaction in (i) will be accounted for in the financial statements of Exim Bangladesh Ltd. for the year ended June 30, 2018 in accordance with IAS 21 4 (iii) Discuss how the transaction in (ii) will be accounted for in the financial statements of Exim Bangladesh Ltd. for the year ended June 30, 2018 in accordance with IAS 21. 4 Page 6 of 6