P7 Notes

Training Costs:
The costs of training staff should always be treated as an expense, as they do not
meet the definition of an asset, which requires that the entity has control of the
asset. This is very unlikely to be the case with training costs, as the staff will probably
have the right to leave the company, meaning that Banana Co would not receive any
subsequent economic benefit from having trained them.

Receivables – Financial Instrument

IFRS 9 Financial Instruments requires receivables to be recognized at fair value. I.e if
25% of receivables are not paid due to customer insolvency then this will be
recorded as impairment loss in the income statement. Then the FV of receivables is
the 75 % that the customer will pay.

Money laundering:
It is the process by which criminals attempt to conceal or disguise the true origin and
ownership of money obtained through illegal activities so it looks like it was obtained
from legal sources allowing them to maintain control over the proceeds and
providing a legitimate cover for their sources of income.
Responsibilities of members toward the Money laundering:
 Internal controls and policies relating to staff training
 Client identification procedures
 Record keeping (minimum five years)
 Recognition of what constitutes suspicion
 Reporting of suspicious transactions
 Not tipping-off potential suspects

Capitalization of Expenses:
The capitalization would be correct in accordance with IAS 16 PPE if the expenditure
restores the economic benefits of the fixed asset.

Related Party Trx:

IAS 24 states a party is related to an entity when the party 'controls, is controlled by,
or is under common control with, the entity'. Any member of key management
would be a related party.
Related party transactions may be material in substance rather than size, so difficult
to detect using ordinary audit procedures. It may also be difficult for the auditor to
determine whether transactions are material to related parties.
IAS 24 requires the following to be disclosed for a related party transaction.
 Names of the transacting related parties
 A description of the relationship
 A description of the transaction and the amounts included
 The amounts due to or from the related party at the end of the year
 Any other element of the transaction necessary for an understanding of the
financial statements.

Examples of Risks: Matters to consider

Internally Generated Brands: IAS 38 Intangible Assets states that internally
generated brands cannot be capitalized unless they have ascertainable market value.
Debentures: IAS 32 requires the company to split the debentures into a debt
component calculated at the present value of the debenture on maturity and an
equity component calculated at the present figure.
Loss Making Contract: in accordance with IAS 11 construction contracts the loss from
contracts should be recognized immediately when expected costs exceed revenue.
Possible Penalties: the situation may result in penalties and these should be
provided for in accordance with IAS 37 provisions, contingent liabilities and
contingent Assets.
Discontinued Operations: the sale of the division appears to be discontinued
operation in accordance with IFRS 5 current assets Held for sale and discontinued
operations. It meets IFRS 5's requirement as it is an independent business division
which can be distinguished operationally and for financial reporting purposes.
The division's results for the year should be presented separately as a discontinued
operation on the face of the income statement. Comparatives will also need to be
restated.
Held for Sale: IFRS 5 requires that a disposal group is recognized as Held for sale
where ( SALE ) : S:the company has intention to sale , A: the asset is available for sale
in its present condition, L: the company is locating a buyer, E: the sale is highly
expected and these conditions are met before the year end.
In accordance with IFRS 5 the assets in the disposal group should be "reviewed for
impairment" measured at the lower of their carrying amount and their FV less costs
to sell and SHOULD NO LONGER BE DEPRECIATED. They should be presented
separately in the financial position.
International Structure: the company operates in Africa, South America and the Far
East. Inherent risks may be increased by the diverse nature of geographical locations.
Future Losses: IAS 37 Provisions, contingent liabilities and contingent assets prohibits
the recognition of provisions for future losses as there is no obligation to incur losses
at the end of the reporting period.
Segmental Information: if the branch constitutes 10 % of total revenue or operating
losses so it is a reportable segment under IFRS 8 operating segments. There is a risk
that the disclosures required by IFRS 8 have not been made. There should be a note
to the FS disclosing information about the performance of each segment.
Associates: There is an inherent risk that these investments have been classified
incorrectly as associates. IAS 28 Investments in associates and joint ventures requires
Grissom to have significant influence over the investee. If this is not the case, the
investments should be treated as trade investments. Alternatively they may be joint
arrangements if control is shared jointly with one or more other entities.
Dismantling Costs: IAS 16 Property, Plant and Equipment requires the dismantling
costs to be capitalized as non-current assets, and a provision created against them.
Account should be taken of the effect of discounting if this is material, and a finance
charge included in the statement of profit or loss to represent the unwinding of the
discount.
Government grant: IAS 20 Accounting for Government Grants and Disclosure of
Government Assistance requires that the grant income is matched to the costs it is
intended to compensate for. This will result in deferred revenue being held on the
statement of financial position. There is a risk that this has not done, leading to
liabilities being understated and profit being overstated.
IAS 20 also requires that a grant is recognized only when there is reasonable
assurance that Hodges will meet the condition specified by the government. Where
there is doubt over this, a provision should be recognized in line with IAS 37. The risk
is that this has not been done, and that liabilities are understated and profits
overstated.
Mid-Year Consolidation: The subsidiary was acquired mid-year, and there is a risk
that its results have not been consolidated from the correct date. If they are included
from too early a date and the company is profitable, then group profits may be
overstated.
Consolidation in general: The acquisition should be accounted for in line with IFRS 3
Business combinations. There is a risk that goodwill has not been calculated
correctly, and that the fair values of Brass Co.'s assets and liabilities have not be
estimated reliably.
Accounting Standards in Consolidation: Brass Co.'s accounts must be restated so
that they are in line with the group's accounting policies, which should conform to
IFRS. There is a risk that Brass Co.'s accounts may not be in line with IFRS.
Intra-group trading (Consolidation): Brass Co supplies about half of Willow Co.'s
ingredients. There are therefore a significant number of intra-group transactions
which need to be eliminated from the group accounts. There may also be inventories
Containing unrealized profit, which needs to be provided for. The risk is that this has
not been done, potentially overstating revenues, expenses, assets and liabilities.
Goodwill: the plan will need to address the calculation and accounting treatment of
goodwill. GW must be calculated by comparing the cost of investment and the FV of
net assets of the subsidiaries at the acquisition dates.
Support letters: in the context of group accounts, the parent and subsidiaries are
seen to be a single entity, so if the group as a whole is a going concern then this is
sufficient. It is some times the case that a subsidiary, when considered in isolation,
does not appear to be a going concern. In such a case the auditor may request a
support letter from the directors of the parent company. This letter states then the
intention of the parent is to continue to support a subsidiary, for example, if
problems regarding its viability subsequently arose. (Banks also often require this
type of confirmation).
This letter represents documentary evidence and is normally approved by the parent
company bored and minuted. If there is a limitation on the time for which the
support is to be provided other evidence may be required that the subsidiary will be
able to continue after this date.
The auditor will also need to ensure that the parent company is in a position to
provide the support which it is claiming to give in the letter. This can be confirmed by
the review of the group statement of cash flows.

COMPLETING THE AUDIT

1- Review of Audit Files and Evaluation of Misstatements:
all audit work should be subject to
review. This is a basic quality control requirement of ISA 220, Quality Control for
 an Audit of Financial Statements, and serves to ensure that sufficient appropriate
audit evidence has been obtained in respect of transactions and balances
included in the financial statements.
2- FINAL ANALYTICAL PROCEDURES: one of the objectives of the auditor in complying with
ISA 520 is to design and perform analytical procedures near the end of the audit
that assist in forming an overall conclusion as to whether the financial statements
are consistent with the auditor’s understanding of the entity.
3- SUBSEQUENT EVENTS AND GOING CONCERN: the auditor to perform audit procedures to
obtain sufficient appropriate audit evidence that all events occurring between the
date of the financial statements and the auditor’s report that require adjustment
of, or disclosure in, the financial statements have been identified. Secondly, ISA
570, Going Concern states that the auditor shall remain alert throughout the audit
for audit evidence of events or conditions that may cast doubt on the entity’s
ability to continue as a going concern.
4- WRITTEN REPRESENTATIONS AND COMMUNICATION WITH THOSE CHARGED WITH GOVERNANCE:
Written representations are necessary audit evidence, and therefore the auditor’s
opinion cannot be expressed and the auditor’s report cannot be dated before the
date of the written representations. Significant subsequent events may come to
light very late in the audit, and therefore the written representations should cover
all of the subsequent events period, right up to the date at which the audit report
is dated. Important outputs of the audit are the matters to be communicated in
accordance with ISA 260, Communication with Those Charged with Governance.
The matters to be communicated include significant findings from the audit and
matters relating to auditor’s independence.
5- AUDIT CLEARANCE MEETING: at the conclusion of the audit, a meeting will usually be
held between the auditor and management and/or those charged with
governance of the client. At this clearance meeting the audit or will explain the
various matters that have been discussed in this article, and any other matters to
be discussed in respect of the financial statements and the audit.
 GROUP AUDITING

STAGE ONE – GATHERING EVIDENCE ON THE COMPONENTS

Planning and risk assessment
It is imperative that the group auditor has a good understanding of the structure of the
group, the significance (ie materiality) of each component of the group, the mechanics
of the consolidation process, and the risk of material misstatement presented by each of
the company’s financial statements. Materiality levels should be established for the
group in aggregate, and for the individually significant components.

Involvement in the work of component auditors

In a group, it is likely that some companies will be audited by a different firm of auditors.
The group auditor has two issues to resolve. First, the group auditor cannot simply rely
on another auditor’s opinion on the financial statements of the company. In other
words, if the other auditor has concluded that the financial statements of the
component are free from material misstatement, the group auditor should not just rely
on this opinion and assume that the figures taken from the company’s financial
statements into the consolidated financial statements are correct. A material
misstatement in the financial statements of a company could become a material
misstatement in the financial statements of the group.

For all companies within the group, regardless of materiality, the group auditor should
review a report of work done by the component auditor. This report of work done could
be in the form of an executive summary, or a memorandum of audit issues arising from
the audit of the company. Alternatively, the group auditor may issue a questionnaire, to
be completed by the component auditor, which would highlight key issues arising from
the audit of the component. Following this review, the group auditor will need to decide
on the extent of any further actions which need to be taken, or any further work which
needs to be carried out, in order to ensure that the financial statements are free from
material misstatement. Such actions could include:
 a review of the component auditor’s overall audit strategy
 performing a risk assessment at the company level
 participating in closing meetings with the component auditor and the
management of the company
 a review of relevant parts of the component auditor’s audit working papers.
Where a company is material to the group financial statements, the group
auditor should carry out further actions, including:
 discussing with the component auditor, and/or the management of the company,
the business activities that are significant to the group
 discussing with the component auditor the susceptibility of the company’s
financial statements to material error or deliberate misstatement
 reviewing the component auditor’s documentation of identified significant risks,
and the conclusions reached on these risks.

It may be the case that, having performed the actions outlined above, the
group auditor concludes that further audit work is required on the financial statements
of a company, or that a memorandum of audit issues arising from the audit of the
company is needed. For example, the group auditor may consider that an element of
the financial statements of the company could be materially misstated, and that further
audit evidence is necessary.

The group auditor should determine the nature of the work necessary, and whether the
work should be carried out by the group auditor or the component auditor.

Having taken the actions outlined above, the group auditor should now have obtained
sufficient evidence to show that the individual company financial statements are free
from material misstatement, and are a sound basis for the preparation of the
consolidated financial statements.

STAGE TWO – AUDITING THE CONSOLIDATION

The consolidation process
The group auditor must plan the audit procedures to be performed on the consolidation
process. For some groups, the consolidation will be complex and is likely to involve some
areas of judgement, and so there is a high degree of audit risk. Thorough planning will
be essential to ensure that audit risk is minimised. The types of audit procedures that
could be performed include:
 checking that figures taken into the consolidation have been accurately extracted
from the financial statements of the components
 evaluating the classifications of the components of the group – for example,
whether the components have been correctly identified and treated as
subsidiaries, associates, or joint ventures
 reviewing the disclosures necessary in the group financial statements, such as
related party transactions and minority interests
 investigating the treatment of any components which have a different financial
year end from that of the rest of the group
 gathering evidence appropriate to the specific consolidation adjustments made
necessary by financial reporting standards, including, for example :
– the calculation of goodwill and its impairment review
 – cancellation of inter-company balances and transactions
– provision for unrealised profits as a result of inter-company transactions
– fair value adjustments needed for assets and liabilities held by the component
– re-translation of financial statements of components denominated in a foreign
currency.
Some of the evidence required to meet the above objectives will be gathered by the
component auditor, and it is the group auditor’s responsibility to communicate to the
component auditor the evidence that they are expected to gather. This communication
ideally occurs at the audit planning stage.

The group auditor must have a sound knowledge of the relevant financial reporting
standards, which include:
 IFRS 3, Business Combinations
 IAS 28, Investments in Associates
 IAS 31, Interests in Joint Ventures
 IAS 32, Financial Instruments: Presentation
 IAS 39, Financial Instruments: Recognition and Measurement.

Candidates are advised that, for the purposes of study for Paper P7, they must be very
familiar with the above financial reporting standards. Particularly important are the
accounting regulations relating to subsidiaries regarding goodwill, inter-company
transactions, and fair value adjustments, as well as the financial reporting implications
on the acquisition and disposal of a subsidiary. Candidates must also be aware of the
principles of accounting for associates, joint ventures, and foreign subsidiaries.

It is also important to remember that the parent company’s individual financial

statements will contain balances and transactions pertinent to the components of the
group. The parent company’s statement of financial position (balance sheet) will carry
the investments as non-current assets, and the statement of comprehensive income is
likely to contain dividend receipts and other group transactions. The auditor expressing
an opinion on the parent company’s individual financial statements must gather
sufficient appropriate evidence regarding these items, paying particular attention to the
carrying value of the investments. Candidates are reminded that IFRS 3 contains
detailed guidance on the treatment of group investments, particularly on the calculation
of the cost of investment.