Audit Planning and Risk Assessment for M&L Limited

Business Operations of M&L's Three Chain Restaurants

Question 1    

M&L Ltd (M&L) is a private Irish registered company who owns a large number of restaurants throughout the country, operating under three well-known brand names. The company’s strategy is to offer a variety of different dining experiences in the restaurants situated in city and town centres, with the objective of maximising market share in a competitive business environment. You are a senior manager in Jackson & Co, a firm of Chartered Certified Accountants, who has acted as auditors for M&L for the last five years. You are planning the audit of the financial statements of M&L Ltd for the year ended 30th November 2020.

The finance director of M&L has provided your firm with the following key operational and financial information:
The Chilli Chappie (CC) restaurants offer a sophisticated dining experience. The emphasis is on high quality South American food served in luxurious surroundings. There are currently 25 CC restaurants and the company is planning to expand this to 40 by June 2021. The restaurants are all situated in prime city centre locations and are completely refurbished every three years. All the restaurants underwent a major refurbishment in February 2020. This refurbishment programme was financed by a significant bank loan. One of the CC restaurants was closed in October 2020 for three weeks following a health and safety inspection which revealed some significant breaches in hygiene standards in the kitchen. The management were completely surprised by the findings of the regulatory authority.

The Kidbuzz (KB) chain of restaurants provides family-friendly dining in an informal setting. The restaurants are all located in busy town centres. Each restaurant has a large children’s play area containing climbing frames and slides, and offers a crèche facility, where parents may leave their children for up to two hours. There was media criticism of the quality of the childcare offered in one crèche earlier this year after a child was slightly injured while playing there. The company is currently conducting a review of operations following the incident.

The Grub-on-the-Go (GG) chain offers fast-food. These restaurants are located at bus/ train stations and airports. In 2020 M&L launched a significant marketing campaign to support the GG brand name. In September 2020 the company began providing nutritional information on its menus in the GG restaurants, following pressure from the government for all restaurants to disclose more information about the ingredients in their food. A new government regulation issued in November 2020 will take effect next year. New advertising regulations coming into force in May 2021, will forbid the advertising of food in a manner specifically aimed at children. 60% of the turnover for this business segment is derived from the sale of ‘Kids Treats’ – self-contained children’s meals which contain a small toy.

Evaluating Business Risks for M&L Limited

Required:
a) Prepare briefing notes to be used at a planning meeting with your audit team in which you:
i) Evaluate the aspects of a client’s business which should be considered in order to gain an understanding of the company and its operating environment. (6 Marks)
ii) Recommend the procedures an auditor should perform and the sources of evidence available to gain business understanding. (4 Marks)
b) Using the information provided, evaluate FIVE business risks facing M&L. (15 Marks)
c) Anlayse FOUR risks of material misstatement in the financial statements of M&L for the year ended 30 November 2020. (16 Marks)
d) Critically assess the impact on the financial statements and the audit report if the auditor believes M&L is facing a going concern significant uncertainty this financial year end.  (9 Marks)

Question 2

a) Auditor liability is extremely concerning in terms of audit quality and the impact on the reputation of the profession.

Required:
Evaluate the effectiveness or otherwise of the use of disclaimer paragraphs to reduce audit firms’ exposure to expensive litigation. (5 Marks)

b) You are the manager responsible for the audit of WorkSpace Co. (WS), a property rental company who leases office space on short term letting contracts. WS has a year ending 31 December 2020. 

The company revenue fell significantly this year as a result of the government imposed lockdown due to the Covid-19 pandemic. Many people who would normally have rented the office spaces were forced to work from home, and revenue for WS fell by approximately 35% as a result. It is envisaged the pandemic, and government imposed restrictions, will continue intermittently for at least the next 12 months.

The company recognises all the rental properties at fair value in the financial statements in accordance with International Accounting Standard (IAS) 40 Investment Property. WS management revalued the properties at the year-end and they are recognised on the statement of financial position at a fair value of €25 million (€25million in 2019). The total assets of WS are €75 million at 31 December 2020 (€68 million in 2019). 

The audit firm plans to use the services of an expert property valuer to provide a current market value for each property.

Required:
i) Define Investment Property according to IAS 40 Investment Property, and analyse the risks of material misstatement in relation to the investment properties in the financial statements of WS as at 31 December 2020. (6 Marks)

ii) Recommend and justify the enquiries the external auditor should make in respect of an external property valuer, before choosing one to provide the service and placing any reliance on their work. (6 Marks)

Analyzing Risks of Material Misstatement in M&L's Financial Statements

iii) Design EIGHT audit procedures to be performed to gather sufficient appropriate audit evidence about the value of the properties. (8 Marks)

Question 3

a) Discuss ‘Advocacy’ as it applies to an auditor. Illustrate your understanding with the identification and analysis of TWO possible examples of such threats. (8 Marks)

b) You are the partner responsible for ethical compliance in your audit firm, Wills & Partners. The following issues have arisen during the ethics review of the audit of two clients:

i) The audit of Minime is almost complete. Due to the impact Brexit has had on its operations, Minime has experienced significant trading problems in the current year and has been forced to substantially reduce the level of trading at a number of its premises. The directors have stated in writing the reduction in trading does not constitute an impairment in the value of any of the premises. 

The audit senior on the Minime audit told those charged with governance that it is likely Wills & Partners will qualify the audit report over this issue. The managing director of Minime has told the audit senior they will seek a second opinion from another audit firm if Wills and Partner does not issue an unmodified opinion. (9 Marks)

ii) Your firm has acted as auditor to Daffodil, an Irish listed company, for a number of years. In 2017 and 2018, the audit opinion was modified due to material misstatements in the financial statements in both years. The audit reports for both years stated that your firm had not been able to obtain all the information it required for the purposes of its audit and the auditors could not ascertain if Daffodil had kept proper accounting records. 

The audit opinion for 2019 was unmodified. Early in the financial year 2020, an investigation by the regulatory authorities revealed the company had overstated revenue and profit figures. The CEO was arrested for fraud and was subsequently fired from the company. (8 Marks)

Required

Identify and evaluate the ethical and professional issues raised in the two scenarios above, and recommend what action, if any, Wills & Partners should take now. (Total 25 Marks)

Question 4
Guidance on subsequent events is provided in International Standards on Auditing (ISA) 560 Subsequent Events.
a) Referring to the guidance given to auditors in ISA 560, analyse the auditor’s responsibilities in relation to subsequent events. (10 Marks)

b) You are the manager responsible for the audit of Lime Ltd, a manufacturing company with a year end 31 January 2021. The draft financial statements show revenue for the year ended 31 January 2021 of €5.5 million, net losses of €1.5 million, and total assets at the year-end are recorded at €66 million.

Minutes of a directors’ meeting held on January 2nd 2021 discuss the poor performance of the company’s manufacturing division, and approve the decision to close this part of the business  in a major restructuring of Lime Ltd, which will take place over the next six months. The restructuring will involve staff redundancies and other related expenses and the estimated cost of closure is €1,500,000. Staff and others affected by the restructuring were informed on February 1st 2021. The directors have not recorded any information in the financial statements in respect of this matter as they believe it is not relevant to the current year financial statements since the restructuring will take place in the next financial year.

Required:
i) Evaluate the impact of the above restructuring announcement on the financial statements of Lime Ltd for the year ending 31 January 2021. (4 Marks)

ii) Design SIX audit procedures to be performed to gather sufficient appropriate audit evidence about the restructuring plan. (6 Marks)

iii) Recommend the actions to be taken by the auditor if the directors refuse to amend the financial statements. (5 Marks)
    (Total 25 Marks)