Nanyang Technological University

Nanyang Business School

AC3104 Risk Management and Advanced Auditing
Semester 2, 2020-2021

Seminar 12.2 - Auditing of Group Financial Statements II

Learning Objectives
• Develop the ability to assess the risks of material misstatement and determine if sufficient
appropriate audit evidence has been obtained in relation to the consolidation process and
the financial information of components on which to base the group audit opinion
• Evaluate the complexity in audit of group financial statements, including purchase price
allocation, goodwill and components with financial information not prepared in accordance
with the financial reporting framework

Basic Reading
• “Consolidation of a foreign subsidiary” video by A/P(adjunct) Anil J N Shukla
(https://www.youtube.com/watch?v=qwLus80S9To&list=PLaaDOGTJGxLAkAOHcGJZ
mPfCYR7pW-34v&index=13)

Further Readings
• The following sections of ACRA Practice Monitoring Programme Public Reports that can
be downloaded at: https://www.acra.gov.sg/training-and-
resources/publications/reports/practice-monitoring-programme-public-reports
• 14th PMP Public Report (2020) Section 4 Engagement Inspection Findings Theme 2:
Group Audits from pages 23 to 24.
• 13th PMP Public Report (2019) Appendix 1 Case Study 3 from pages 28 to 29.
• 11th Public Report (2017) Appendix I Case Study 4.
• 10th Public Report (2016) Section 4 Theme Four: Group Audits from 4.36 to 4.41.
• 9th Public Report (2015) Section 3B Detailed File Inspection Case Study 8.
• 8th Public Report (2014) Section 3 Key Observations of the PMP Case Studies 7 to 10.
• ISCA Ethics Pronouncement 100 Implementation Guide 3 - Code of Professional Conduct
and Ethics Frequently Asked Questions on Responding to Non-Compliance with Laws and
Regulations paragraph 6 relating to Group Audit. It is available at:
https://isca.org.sg/media/2823876/ep-100-ig-3-for-uploading.pdf

Seminar Requirements

Team Presentation 7
Answer both questions 1 and 2.

1. Audit the Consolidation Process

You are an audit senior assigned to the audit of Tree One Otu Group Pte Ltd (TOO) for the
financial year ended 31 December 2020. TOO had three investments during the year, which

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 the management has accounted for as subsidiary companies. Details of the acquisition and
disposal are as follows:
• Sub1 - Paid for 40% of the share capital on 1 January 2020, the balance 60% will be paid
and transferred on 1 January 2023.
• Sub2 - Acquired 100% on 1 April 2020 from a previous customer of TOO.
• Sub3 - Acquired 100% on 1 January 2020 and disposed 100% on 1 October 2020.

The principal activities of the group are in training and sale of educational products. TOO
manufactures educational products and sells them directly as well as through the subsidiary
companies.

You are reviewing the draft consolidated financial statements and other management-prepared
schedules as part of the planning for the final audit. The consolidated balance sheet and
consolidation journal entry prepared for the first time by the TOO accountant for the year ended
31 December 2020 are shown below.
Consolidation
Parent Subsidiary Companies Adjusting Entry
TOO Sub1 Sub2 Total Dr Cr Group
S$'000 S$'000 S$'000 S$'000 S$'000 S$'000 S$'000
As at 31 Dec 2020
Investment property
100,000 - 120,000 220,000 220,000
(acquired in 2018)
Property, plant and equipment 525,000 50,000 22,000 597,000 597,000
Investment in subsidiaries 250,000 - - 250,000 250,000 0
Goodwill on consolidation - - - 0 10,000 10,000
Accounts receivables 22,000 33,500 29,000 84,500 84,500
Inventories 18,000 23,000 16,000 57,000 57,000
Cash and cash equivalent 15,000 37,000 7,000 59,000 59,000
930,000 143,500 194,000 1,267,500 1,027,500

Accounts payable 19,000 12,000 37,000 68,000 68,000

Loan payable 538,000 - 538,000 38,000
Share capital 200,000 100,000 100,000 400,000 200,000 200,000
Retained earnings, 1 Jan 2020 146,500 25,000 50,000 221,500 40,000 181,500
Profit for the year 26,500 6,500 7,000 40,000 40,000
930,000 143,500 194,000 1,267,500 250,000 250,000 1.027,500

Consolidation adjusting entry

Dr Share capital – Sub1 100,000
Dr Share capital – Sub2 100,000
Dr Retained earnings – Sub1 10,000
Dr Retained earnings – Sub2 30,000
Dr Goodwill on consolidation 10,000
Cr Investment cost – Sub1 50,000
Cr Investment cost – Sub2 200,000
Being elimination of share capital and pre-acquisition reserves

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You understand from the accountant that this is the only consolidation entry pass for the
group consolidation.

Required:

(a) Identify and explain the potential misstatements in the consolidation schedule of TOO
Group prepared by the Accountant. Describe the additional information you may require
or audit procedures to make a better assessment of the potential misstatements.

(b) Describe the audit procedures to be performed on the intra-group receivables and payables.

(c) Describe the audit procedures to be performed to verify the unrealised profit eliminated.

2. Review of Component Auditor’s Working Papers

You are the audit manager of an accounting firm in Singapore in charge of the audit of
ComputerMart Group Pte Ltd (CMG) for the year ending 30 June 20x1. CMG is in the business
of retailing in computer products and has been your firm’s audit client for the last 3 years.
CMG has two subsidiary companies, CMM and CMI, in Malaysia and Indonesia, respectively.
Both subsidiary companies are audited by local audit firms.

Similar to previous years, you have concluded that CMM is a significant component as it
contributes to approximately 40% of CMG’s operations. As part of your audit planning, you
have received the following extract of the Audit Planning Memorandum from the component
auditor, Bagus Assurance (BA).

ComputerMart Malaysia Sdn Bhd

Year ending 30 June 20x1
Extract of Audit Planning Memorandum

Business Updates
ComputerMart Malaysia Sdn Bhd (CMM) is in the business of retailing in computer products.
Besides cash sales at its retail outlets, CMM also sells its products on a consignment basis to
major petrol kiosk chains across the country at a consignment margin of 10% on 30 days’ credit.
Retail and consignee sales each take up 50% of CMM’s total revenue. Maybank provides
CMM with an overdraft facility of RM600,000 at 5% interest rate per annum, and a 10-year
term loan of RM10 million, which is secured on CMM’s property, plant and equipment, at 3%
interest rate per annum.

The business has been very competitive with small computer shops engage in cost cuttings.
Gross profit from retail sales approximates 20%.

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Materiality
• Performance materiality is RM120,000 (aligned to component materiality of S$40,000
assigned by the group auditor)
• Amount that is clearly trivial RM3,000 (based on the trivial amount of S$1,000 assigned
by the group auditor)

Management Accounts and Analytical procedures

The draft management accounts of CMM and analytical procedures are as follows:

Income Statements for the year ending 30 June (extracts)

20x1 20x0
RM’000 RM’000
(Unaudited) (Audited) Analytical procedures
Increase by 40% primarily
attributed to an increase in
Revenue 36,000 25,800
government grant for IT
upgrades (See (a) below)
Cost of sales (28,900) (20,600)
Gross profit 7,100 5,200 Consistent at 20%
Increase was in line with the
Operating expenses (3,040) (1,900)
growth in business
Interest expense (930) (440)
Net profit before tax 3,130 2,860
Taxation (783) (715)
Profit after tax 2,348 2,145

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Balance Sheet as at 30 June (extracts)

30 June 30 June
20x1 20x0
RM’000 RM’000
(Unaudited) (Audited) Analytical procedures
Non-current assets
Property, plant and equipment 18,420 18,205 Comparable to prior year

Current assets
Increase of 75%. The industry is
Inventories 3,980 2,280
fast-moving. (See (b) below)
Increase was in line with the
growth in business and the longer
Account receivables 3,920 680
credit period granted to the
consignees.
Cash 951 820
Total 8,851 3,780
Total Assets 27,271 21,985

Current liabilities
Increase was in line with the
Account payables 5,770 2,260
growth in business
Bank overdraft 600 600
Tax payable 783 715
Other payables 550 190
Total 7,703 3,765
Bank loans 9,000 10,000
Total Liabilities 16,703 13,765

Share capital 1,800 1,800

Retained earnings 8,768 6,420
Total Equities 10,568 8,220

Total Liabilities & Equities

27,271 21,985

Risk of Material misstatements:

(a) Revenue
Sales growth of 40% seems excessive in light of the keen competition. Additional
bespoke audit procedures include:

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 • Perform detailed analyses of sales, margin and inventories by major revenue stream
(retail and consignment) and major retail stores and consignment outlets.
• Review the revenue recognition of consignment sales.

(b) Inventory - Valuation

An increase of 75%, heightened the risk of obsolescence considering that products are
fast-moving and the demand for products is generally short-lived. Additional bespoke
audit procedures include:
• Perform detailed analyses of sales, margin and inventory turnover by major product
categories.
• Review inventory ageing report.
• Perform an extended test of inventory NRV test

Required:

Based on the Audit Planning Memorandum received from the component auditor, discuss
whether you agree with the risks identified and proposed responses. Describe any other
additional risk of material misstatements and audit procedures that you would like the
component auditor to perform.

End of Team 7 Presentation Question

3. Assessment of Control

Your firm has been the auditors of Health Master Group Pte Ltd (HMG). You have been
assigned as the audit senior for the audit of the financial year ended 31 December 2020. HMG
group of companies are in the business of developing, manufacturing and trading of medical
equipment. The materiality for the group financial statements was set at S$100,000.

In January 2020 HMG incorporated HMU in the United States of America (US) to develop and
market a medical product in North America. HMG holds 35% of HMU. Two scientists each
hold 10% of the voting rights of HMU and the remaining voting rights are held by numerous
shareholders, none individually holding more than 1% of the voting rights. Being the single
majority shareholder and having no knowledge that any of the other shareholders has
arrangements to consult one another or make collective decisions, the management of HMG
concludes that it has control over HMU and consolidates it as a subsidiary company.

Required:

You have been tasked to evaluate the appropriateness of management’s conclusion that HMG
has control over HMU. In performing your evaluation, you are required to:

(a) Identify at least two(2) key management’s considerations that support their conclusion of
having control over HMU; and

(b) For each of the key management’s considerations identified, describe one(1) audit
procedure to test the validity of the management’s considerations. Do not repeat the audit
procedures.