Question

Bart, Felix & Jeter (BFJ) LLP completed the audit of Silver Sonic Ltd for the financial year ending 30 June 2021 on 15^th August 2021. The auditor’s report was signed on 22^nd August and given to Silver Sonic’s board of directors and management. Subsequently the company issued the signed audited reports on 30^th August 2021.

Based on risk assessment, BFJ set the materiality level at $100,000 which is 10% of net profit before tax.

 

The following issues were brought to the attention of BFJ after the financial year end.

1 August – A lawsuit was filed against Silver Sonic for damages that allegedly occurred before 30 June 2021. The plaintiff is suing Silver Sonic for $1 million. In the opinion of Silver Sonic’s lawyers, there is a strong possibility that the plaintiff may win the lawsuit.

 

16 August – The auditor discovered that Three Hams, a debtor of Silver Sonic, went bankrupt on 15 August. The most recent sale to Three Hams had taken place on 15 June and no transactions had occurred since that date. The balance of Three Hams account is 8% of the Silver Sonics’ net profits before tax.

 

25^th August – the auditor discovered that legal action commenced against Silver Sonic in relation to faulty products sold in June 2021.

 

5^th October – a fire burnt down one of Silver Sonic’s warehouse, resulting in a loss of 30% of the inventory that was on hand at that date.

 

REQUIRED:

a.       Identify which of the subsequent events are adjusting events and which are non-adjusting events, explaining clearly your reason for your assessment for each event                                (6 marks)

 

b.      For each of the subsequent events identified, discuss what effect each would have on the financial statements, and what effect each would have on the audit opinion if management refuses to make changes to the financial statement. Give reasons for your assessment. In your discussion, include the type of opinion that is likely to be issued for each.                                                               (10 marks)

 

c.       Explain the auditor’s responsibility in relation to the subsequent event that occurred after the auditor’s report was signed but before the audited financial statements were released.       

Answer 1

a)

As per IAS 10, Events after the Reporting Period are favorable and unfavorable events that occur between the end of the reporting period and the date when the financial statements are authorized for issue. Adjusting events provide evidence of conditions that existed at the end of the reporting period. Non- Adjusting events are those that are indicative of conditions that arose after the reporting period.

In this case –

1 August – A lawsuit was filed against Silver Sonic for damages that allegedly occurred before 30 June 2021, which means the condition exists on the balance sheet date, i.e., before 30 June 2021. So, this is an adjusting event.

16 August – The Auditor discovered that Three Hams, a debtor of Silver Sonic, went bankrupt on 15 August. Since no condition exists on the balance sheet date, i.e., 30 June 2021, this is a non-adjusting event.

25 August – the Auditor discovered that legal action commenced against Silver Sonic about faulty products sold in June 2021. As products sold on or before 30 June 2021. So this is an adjusting event.

5 October – a fire burnt down one of Silver Sonic’s warehouses, resulting in a loss of 30% of the inventory that was on hand at that date. As the fire occurred on 5 October, no condition exists on the balance sheet date. So, it is a non-adjusting event.

 b)

Effect on the financial statement –

1 August – The lawsuit is adjusting-event, so the company should record the provision with the total amount of $1 million.

16 August – debtor of Silver Sonic went bankrupt on 15 August, a non-adjusting event, and no entry was required for the year ended 30 June 2021.

25 August – As products sold on or before 30 June 2021. So this is an adjusting event, and the provision is required for compensation of legal action.

5 October – As fire occurred after the balance sheet date. So, no adjustment is required for the year ended 30 June 2021. However, the loss of 30% of the inventory is material, but audited reports were also signed on 30 August 2021. No adjustment for that.

Effect on the audit opinion if management refuses to change the financial statement.

1 August – Auditor should qualify the opinion if management refuses.

16 August – The Auditor should give an unmodified opinion because this is under materiality level, which is 10% of net profit before tax. The balance of the Three Hams account is only 8% of the Silver Sonics’ net earnings before tax.

25 August – Auditor should qualify the opinion if management refuses.

5 October – This occurs after the issuance of the audit report. So, unmodified opinion.

c)

The Auditor should check whether the event is an adjusting or non-adjustment event, and the company posts proper adjustments. If not, Auditor shall modify the opinion accordingly as per auditing standards subsequent events.