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14 marks /24 mlr Warior Limited is an online gamo compeny listod In Hong Kong. The company Is engaged In the provision of onlina geming for te online players. In 2022、 it expanded rapldly through acquisitions ot various online geme oompanles in Singapore, Vletnam, and Ukraine. Shortly after the year end date in Jenuery 2023, the auditot of Wemior Lmited tendered its resignation because it could not reach Oonsensus with the manegemont regarding audit fees. You are Janice Lee, senlor managor of an audit firm. The Chief Financial Officer of Warrior Limited has approached your firm to cl as auditor for its financial statements for the year ended 31 December 2022. Below Is n overvlew oi the revenue and profitabllity of each significant subsidiary where its principal business Is loceted in the respective country for your firm's consideration: 2022 2021 Revenue Profit/(loss) Revenue Profit/(loss) HK$$'000 HK$$'000 HK$$'000 HK$$'000 400,000 140.000 Hono Kong 200.000 74.000 Singapore 150.000 50.000 Viotnam 103,000 40.000 Ukraing 97.000 54.000 Tolal 284.000 750.000 200.000 74,000 Reguired: Prepare a client and engagement acceptance memo for Richard Wong, your audit partner, to analyse the above situation of Warrior Limited and apply the considerations relating to management characteristics and integrity, organisation and management structure, IT environment, audit team resources, and any other relevant aspects in the memo. Note: A maximum of 2 marks for communication skills and 2 marks for analytical skills will be awarded. (14 marks)
SECTION AICASE BACKGROUND EGVU Lighting Limited ("ELL") is a private entity which is incorporated in Hong Kong. Its principal business is the manufacturing and sales of LED lights. ELL leases factory premises in Mainland China also leases a warehouse in Hong Kong for storage of excess raw materials and finished goods. The takes four weeks to complete a job order under full utilisation. LED chip is ELL's major raw material which is also the highest value item among all of its raw materials. ELL sources LED chips from overseas suppliers and other raw materials from Mainland China suppliers. ELL recruits approximately 2,000 workers in its factory. During the year, the demand for LED lights has increased. To meet the rising demand, ELL has started subcontracting some of its production orders to third party subcontractors in Mainland China. Under these subcontracting arrangements, ELL is responsible for the supply of raw materials. The subcontractors are responsible for recruiting labour and providing factory premises and machinery for the manufacturing process. Each subcontractor will enter into a subcontracting agreement with ELL to agree the terms of the subcontracting arrangement. Subcontracting fees are charged based on two components - (i) an agreed mark-up on the actual labour cost incurred by the subcontractors and (i) a fixed monthly fee for the rental of machinery and factory determined by the respective parties. The actual labour cost will be determined based on the actual incurred amounts reported by the subcontractors. ELL continues to own the titles of the raw materials, work-in-progress and finished goods throughout the manufacturing process, though these inventories are located at the subcontractors' premises. subcontracting arrangement is relatively less efficient when compared to ELL's self-manufacturing. Even worse, a higher wastage was noted when production was conducted by the subcontractors. Accordingly, year end date. To finance the increasing demand for working capital, a five-year term loan was arranged with a bank during the year. In accordance with the loan agreement, ELL is required to maintain a current ratio of greater than “"1" for each financial year until the loan is fully repaid. If ELL does not meet this condition, an immediate repayment of the loan could be demanded by the bank. Management lights in the long term, and therefore decided to acquire a piece of land to construct a new factory premise. The land was financed by additional capital injection by ELL's existing shareholders. ABC ＆ Co is the auditor of ELL, auditing its financial statements for the year ended 31 December 2018. During the audit planning, the audit team observed significant changes in ELL. Below are the excerpts of the work papers prepared by the audit team. Internal control "...During the year, ELL lost a few key accounting for the recording of purchases and trade payables is now also responsible for issuing cheque payments o ELL's creditors. A lack of segregation of duty is noted." verview of ELL's production costs_The following information represents the significance of cost mponents attributable to ELL's production costs. 2018 2017 55% Raw materials 70% Direct labour costs 15% 20% 8% Overhead costs 10% Subcontracting fees 22% 100% Total 100% Overview of ELL's trade payables at the year end date_The following information represents the significance of ELL's creditors attributable to its trade payables at the year end date. 2018 2017 60% Suppliers of LED chips 75% 13% Other local suppliers 20% Subcontractors 24% 3% Logistic companies and others 5% 100% Total 100% Overview of ELL's inventories at the year end date The following information represents the significance of different forms of ELL's inventories at the year end date. 2018 2017 Raw materials 35% 20% Work-in-progress 30% 30% 25% Finished goods 50% Goods-in-transit 10% 100% Total 100% 15 marks /27 min The audit team is currently preparing the audit plan for ELL's purchases, trade payables and subcontracting fees. Required: (a) Identify any fraud risk which would cause material misstatements of ELL's purchase and trade payable process. (2 marks) (b) Evaluate the control risk of material misstatements in ELL's purchase and trade payable process. (3 marks) (c) Evaluate the risk of material misstatements of ELL's subcontracting fees in terms of accuracy assertion. (5 marks) (d) Propose substantive procedures to audit the completeness of ELL's trade payables at the year end date. (5 marks) agi
SECTIONAICASEBACKGROUND Delicacies Limited (Delicacies") is a well-known food and beverage company listed in Hong Kong. It owns over 200 Chinese, Asian and Western restaurants and bakery shops, the premises of which are all leased from third parties. It also produces a wide range of festive products, such as rice cakes, mooncakes and rice dumplings in its own food factory premises in Hong Kong and Shenzhen. Delicacies has a board of directors with years of experience in the food and beverage industry and a dedicated management team. Both the board of directors and the management team set the tone at the top which places a high value on ethics and is not aggressive on accounting. Delicacies has structured processes and controls in place in its daily operation from good quality control, sales, procurement, cash management, staff management, to financial reporting. The roles and responsibilities of each staff member, from senior management to shop staff, are well-defined. The remuneration of the board of directors is measured on both financial and non-financial performance indicators. The remuneration and performance evaluation of the senior management and shop staff are set with reference to their roles and responsibilities. Detailed procedures manuals are available to assist staff to carry out their daily work in standard processes and controls. Delicacies also has an experienced internal audit team which reports directly to the Audit Committee of Delicacies. The internal audit team has extensive knowledge of food and beverage operations and provides constructive recommendations to management on improving the processes and controls for daily operations. There were no control deficiencies reported by the external auditor to the Audit Committee in the past years. Delicacies is profitable with a strong and healthy cash flow. All sales transactions in the restaurants and shops are settled by cash, credit cards or Delicacies, has been used for many years and is directly interfaced with the general ledger. All the restaurants and bakery shops of Delicacies use the Pos system. There were no POs system issues reported by the external auditor to the Audit Committee in the past years. The internal audit team also past years. Delicacies first launched certain festive products in 2017, which were very well-received by the market. So as to better manage the production schedule of the festive products, the management of Delicacies arranged to pre-sale the festive products by way of vouchers. Customers were required to pre-pay for the vouchers to redeem festive products. These festive product vouchers were available for sale online five restaurants and bakery shops by either presenting a paper voucher or e-voucher with a QR code. Delicacies sold over 3,000,000 vouchers last year. These festive product vouchers were tracked under a separate voucher management system which currently had no direct interface with the Pos system. All redeemed vouchers were sent back to the headquarters on a regular basis. The vouchers issued, sold and redeemed were centrally reconciled at the headquarters. The internal audit team in their report to audit findings indicated that the voucher records were not reconciled to the festive products sales records and cash receipt records relating to voucher sales on timely basis. ABC ＆ Co has been the Committee has decided to rotate the auditor in the year. The Chief Financial Officer of Delicacies has therefore approached DEF ＆ Co for an audit service proposal and would like to nominate DEF ＆ Co as their new auditor. Below are extracts of financial information of Delicacies for the year ended 31 December 2017 and the six months ended 30 June 2018. 鸣软教育 31 December 30 June 2018 2017 Unaudited Audited HK$$'000 HK$$'000 Revenue - Food and beverage sales (i) Restaurants 800,000 1,500,000 (ii) Bakery shops 80,000 160,000 25,000 -Festive productsales 42,000 Cost of sales 100,500 -Food and beverage costs 180,400 -Festiveproductcosts 10,000 16,800 - Rental expenses 271,800 510,600 167,800 - Staff costs 331,600 40,000 - Depreciation 80,000 Statement of financial position Property, plant and equipment 220,000 240,000 Inventories 21,000 20,000 62,000 Accountsreceivables 60,000 Prepayments and other receivables 30,000 32,000 Cash and bank balances 293,000 -Bank deposits 273,200 7,000 -Cash inrestaurantsand bakeryshops 6,800 15,000 Other assets 13,000 16,000 Accounts payables 15,000 Accruals and other payables 85,000 80,000 13,000 Advancedreceiptsfromvouchersales 6,000 22,000 Other liabilities 21,000 Number of stores (i) Restaurants (ii) Bakery shops 22 marks/40 min (a) Relating to food and beverage sales in restaurants and bakery shops, evaluate the risk of material misstatements relating to revenue recognition of food and beverage sales. (9 marks) (b) Relating to festive product sales and related voucher management, (i) propose six relevant control activities over the voucher management of Delicacies Limited. (6 marks) (i) propose relevant audit procedures in response to the risk of material misstatements relating to revenue recognition of festive product sales. (7 marks)
SECTION AICASEBACKGROUNO engaged in cleaning services. Fortune's customers are mainly rotailers. It has achieved a year-to-year growth in sales of 25% during the last fivo years. Servico contracts can be structured on a projecf basis, monthly besis or yeerly basis, depending on the request from its customers. Starting from December 2019. is sales have doubled compared to the sales in November 2019 because Fortune has oommonced a new service contract with a retail chain comprising a network of 60 outlets. Staff costs are Fortune'slargest cost oomponent.The relevant financial information of Fortune's staff costs for the fiscal years 2018 and 2019 ara shown below: 2019 2018% Increasel HK$$'000 HK$$'000 (decrease) 18,035 Direct labour wages 12,882 40% 4,888 5,200 Managementcompensation (6%) 5,341 4,951 Administrativestaffsalaries 8% 2,453 2,328 Discretionarybonus 5% Retirement benefits 31.088 25.705 Total staff costs 21% Total costs 41,451 34,736 19% 49,746 39,646 Sales 25% 6,790 4,184 Profit before tax 62% Fortune has three types of employees: direct labour (i.e. workers), administrative staff and the management. The workers work on the part-time basis. Every day, a project supervisor records the names and the working hours of each worker in a job order register. The project supervisor is also responsible for the daily physical head counts. The project supervisor submits the job order register to the account clerk for calculating the wages. Wages for workers are paid on the 25th of each month by the monthly wages ofthese part-time workers on cash basis. The management and administrative staff receive fixed monthly salaries, which are also paid on the 25th and administrative staff every month. The management and administrative staff are entitled to discretionary bonus and retirement benefits. The account clerk will estimate the year end amounts of the discretionary bonus and retirement benefits before Fortune closes the books. Discretionary bonus is determined by the management, depending on the profitability of Fortune in that year, and is paid in February every year. Although it is on discretionary basis, Fortune never stops paying this bonus to its employees since it was established. Fortune has offered a retirement scheme for its management and salary as the retirement benefits. Below is the information of Fortune's direct labour wages for the year ended31December2019obtainedfromitsrelevantrecords: Working days Total wages Number of Monthly wages per worker workers HK$$'000 per worker (HK$$) CIA Number of Working days Total wages Monthly wages perworker workers per worker HKS'000 (HKS) CIA January 1.540 30.800 Februany 10.593 March 1.235 19.919 April 1,240 15.309 Mey 1.255 14.593 June 1,200 13.636 JulY 3.375 38.352 1.335 August 17.338 1.390 September 16.353 October 1.485 16.875 November 1,520 19.487 December 1.835 29.597 18.035 Monthly average 1.503 20.238 the year ended 31 December 2019. Possible cut-off errors in direct labour wages have been identified by your team. Reguired: (a) Justify why cut-off errors are identified in direct labour wages, but not in management compensation, administrative staff salaries, discretionary bonus and retirement benefits. Explain why these cut-off errors may possibly cause material misstatements in Fortune's financial statements. (7 marks) (b) Propose procedures to quantify the cut-off errors identified in Question 1(a). (3 marks)
SECTION AICASEBACKGROUNO engaged in cleaning services. Fortune's customers are mainly rotailers. It has achieved a year-to-year growth in sales of 25% during the last fivo years. Servico contracts can be structured on a projecf basis, monthly besis or yeerly basis, depending on the request from its customers. Starting from December 2019. is sales have doubled compared to the sales in November 2019 because Fortune has oommonced a new service contract with a retail chain comprising a network of 60 outlets. Staff costs are Fortune'slargest cost oomponent.The relevant financial information of Fortune's staff costs for the fiscal years 2018 and 2019 ara shown below: 2019 2018% Increasel HK$$'000 HK$$'000 (decrease) 18,035 Direct labour wages 12,882 40% 4,888 5,200 Managementcompensation (6%) 5,341 4,951 Administrativestaffsalaries 8% 2,453 2,328 Discretionarybonus 5% Retirement benefits 31.088 25.705 Total staff costs 21% Total costs 41,451 34,736 19% 49,746 39,646 Sales 25% 6,790 4,184 Profit before tax 62% Fortune has three types of employees: direct labour (i.e. workers), administrative staff and the management. The workers work on the part-time basis. Every day, a project supervisor records the names and the working hours of each worker in a job order register. The project supervisor is also responsible for the daily physical head counts. The project supervisor submits the job order register to the account clerk for calculating the wages. Wages for workers are paid on the 25th of each month by the monthly wages ofthese part-time workers on cash basis. The management and administrative staff receive fixed monthly salaries, which are also paid on the 25th and administrative staff every month. The management and administrative staff are entitled to discretionary bonus and retirement benefits. The account clerk will estimate the year end amounts of the discretionary bonus and retirement benefits before Fortune closes the books. Discretionary bonus is determined by the management, depending on the profitability of Fortune in that year, and is paid in February every year. Although it is on discretionary basis, Fortune never stops paying this bonus to its employees since it was established. Fortune has offered a retirement scheme for its management and salary as the retirement benefits. Below is the information of Fortune's direct labour wages for the year ended31December2019obtainedfromitsrelevantrecords: Working days Total wages Number of Monthly wages per worker workers HK$$'000 per worker (HK$$) CIA Number of Working days Total wages Monthly wages perworker workers per worker HKS'000 (HKS) CIA January 1.540 30.800 Februany 10.593 March 1.235 19.919 April 1,240 15.309 Mey 1.255 14.593 June 1,200 13.636 JulY 3.375 38.352 1.335 August 17.338 1.390 September 16.353 October 1.485 16.875 November 1,520 19.487 December 1.835 29.597 18.035 Monthly average 1.503 20.238 the year ended 31 December 2019. management discovered that the actual bank balances were significantly lower than the book balances because the account clerk misappropriated the company's funds by creating fake workers and falsifying payroll payments to these non-existent workers. Required: (a) Identify the internal control weaknesses of Fortune for its payroll payment process which caused the incident. (4 marks) (b) Propose measures and internal controls on the payroll process that Fortune can implement to safeguard its assets. (8 marks) (c) Advise changes to your audit strategies after discovering this incident of misappropriation of funds. (4 marks)
SECTIONAICASEBACKGROUND Insight Medical Limited ("nsight") is one of the leading ophthalmic service providers in Hong Kong, which isowned byDrJohnWongand Dr PeterChan.Dr WongandDrChanarethefounders andtheboardof directors of Insight. They are responsible for setting the business strategy and making all key business decision for Insight. Insight has a team of five ophthalmologists including Dr Wong and Dr Chan. Each ophthalmologist supervises one clinic with designated nurses and other health professionals. The accounting team of Insight is supervised by a newly recruited accounting manager who has five years of accounting and auditing experience mainly in Hong Kong. Currently Insight has five leased clinics located in Central, Tsim Sha Tsui, Mongkok, Kwun Tong and Tsuen Wan. Insight provides (i) Insight's website and at the reception of the clinics. All clinics of Insight are equipped with advanced diagnostic and treatment equipment for providing ophthalmic diagnoses and treatment to the patients. Surgery services can either be provided at the clinics or private hospitals at the request of patients or and related costs are communicated and agreed with the patients before the surgery is carried out. Insight use "Accounting Plus" which is a packaged software to keep track of the sales and accounting records as well as the general ledgers. Access to "Accounting Plus" is restricted to designated nurses in each clinics and the accounting team of Insight. Patient records with sensitive personal data are stored ophthalmologists and a few designated nurses and health professional only. The designated nurses are responsible for maintaining the personal details of the patients in the system while the five ophthalmologists and the health professional have different rights in the system to update the patients' health records. Over 80% of patients pay with credit cards for the services while the rest pay cash. Though patients may make insurance claims on the services, patients still need to pay in full at the clinic either by cash or credit card. However, the clinic will provide valid paper work to patients to assist them in making the claims to the insurance companies. Sales transactions are recorded into "Accounting Plus" with sales receipts that are generated simultaneously. All sales receipts are pre-numbered. The nurses provide patients with sales receipts after payments. The consultation certificates endorsed by doctors will also be provided upon request by patients. There was neither bad debt written off nor provision for doubtful debt made in the past. During the year, Insight advanced HK$$1o million to Dr Wong's brother for his purchase of a property in Tin Hau. The advance is not secured, with no fixed repayment terms and is interest-free. In November 2019, there were news that Insight and Dr Wong were blamed for negligence in carrying out a surgery for a young patient in early 2019. Extract of the financial information of Insight: 2019 2018 (unaudited) (audited) HK$$'000 HK$$'000 73,000 Consultationandothermedical servicesfee 64,500 Surgery fee 131.085 125.950 Total revenue 204.085 190,450 32,654 Doctors'consultationfees 32,377 Cost of inventories and consumables 32,654 30,472 Staff salaries and allowances 24,490 22,854 2019 2018 (unaudited) (audited) HK$$'000 HK$'000 Rent and rates 16,327 17,141 Depreciation 12,245 11,427 Others 4.082 3.809 Total cost of revenue 122,452 118.080 Central 27,756 24,602 Tsim Sha Tsui 26,939 23,439 17,143 Mongkok 16,783 Kwun Tong 17,958 16,189 Tsuen Wan (8.163) (8.643) Total gross profit by clinic 81.633 72.370 40% 38% Net proft 36,735 36,186 18% 19% Property,plantandequipment 62,000 61,000 (including right-of-use assets) Trade receivables 20,500 19,100 Otherreceivables 10,000 Inventories 3,200 2,800 Cash and bank 34,000 30,000 Others 10,000 9.500 Total assets 139.700 122,400 Trade and other payables 1,800 1,700 Leased liabilities 3,000 Others 3.000 4.000 7.800 Total liabilities 5.700 Total equity 131,900 116,700 Note: The 2019 financial information is extracted from the management accounts of Insight for the year statements of Insight for the year ended 31 December 2018. HKFRs 16 Leases became effective from 1 January 2019. Insight adopted HKFRs 16 retrospectively from 1 January 2019, but has not restated comparatives for the 2018 reporting period, as permitted under the specific transitional provision in the standard. The right-of-use assets are included in the property, plant and equipment. Lee ＆ Co has been the auditor of Insight since financial year ended 31 December 2017. During the pre-final audit conducted underlying calculation of the lease liabilities and related right-of-use assets with no issue identified. 17 marks /31 min (a) Evaluate the risk of material misstatements by each of relevant assertion in relation to trade receivables with the facts provided in the case. (9 marks) (b) Propose relevant audit procedures in addressing the risk of material misstatements identified in Question 1(a). (8 marks)
SECTIONAICASEBACKGROUND Natural Beauty Limited ("Natural Beauty") together with its subsidiaries, trading as "Natural Beauty", set up its first self-owned retail store in Hong Kong 20 years ago and listed on the main board of Hong Kong Stock Exchange four years ago. Natural Beauty's business purpose is to provide their customers with cosmetics and skin products made from natural ingredients. It currently has over 1,o00 products. Natural Beauty's headquarters is in Hong Kong and operates over 3,oo0 self-owned stores in mainland China, Hong Kong and Japan. It also has mainland China, and warehouses in Guangzhou, Hong Kong and Tokyo. Natural Beauty's products are very well received by the market in general, especially the products high and there are no aged inventories. Natural Beauty usually offers discount sales once or twice a year during the festive seasons. As business has grown significantly in recent years, Natural Beauty engaged a subcontractor in Japan for some manufacturing processes two years ago. Natural Beauty provides the subcontractor with all raw materials. The subcontractor provides subcontracting services to Natural Beauty and some other customers. Historically, 30% of Natural Beauty's production has been labour and manufacturing overhead costs. During the year, Natural Beauty set up another research and development centre in Japan to develop certain new products to be released. These development costs include material costs, staff cost, depreciation of fixed assets and overhead costs incurred in the research and development centre. performs sample checks after the full counts are completed by production staff and store managers. Based on the prior year's stock count records, no significant stock count discrepancies were noted and variances were adjusted in the stock ledger after management's investigation. The prior year's audit results did not reveal any control deficiencies relating to stock count, but there were internal control Reconciliation of raw materials used by and stored with the subcontractor is performed on a monthly Subsequent to 31 December 2020, Natural Beauty decided to acquire an 80% equity interest in the growth of the business. The transaction was considered as a major acquisition under the Hong Kong Listing Rules. Immediately after the completion of the acquisition, Natural Beauty started integrating the management team as well as aligning the processes ＆ controls and IT systems between the subcontractor and Natural Beauty. Wong ＆ Co was the reporting accountant of Natural Beauty, assisting the company in completing the initial public offering ("iPo"). Wilson Wong, a senior partner of Wong ＆ Co, was the engagement partner ofNaturalBeauty'sIPOproject.Wong＆CohasbecometheauditorofNaturalBeautysincethen,with support and advice to Natural Beauty over the years, assisting Natural Beauty in strengthening its internal controls as well as operation effectiveness. Extraci of menagement aooounts of the group for the year ended 31 December 2020 are as below: 2020 (Unaudited) (Audited) HK$$'m HK$$'m Revenue 3,030 2,879 Cost of goods soild (902) (834) 2.128 Gross profit 2.045 70% 71% (601) Sefling, marketing and logistics expenses (582) (322) Administrstive and general expenses (302) (65) Research and development expenses (262) (12) Other operating (expenses)/ income, net (51) Finance expenses, net (50) (1.051) (1.186) 1.077 Profit before tax 36% 30% 6,499 Property, plant and equipment 6,503 Intangible assets Trade receivables Other receivables 1,283 Inventories 1,240 Cash and bank Others 9.533 Total assets 8,274 Trade and other payables Bank borrowings and other liabilities 3.621 3.504 4,243 Total liabilities 4.088 Total equity 5.290 4.186 (a) Evaluate the risk of material misstatements relating to the inventory balance in the consolidated financial statements of Natural Beauty in terms of the relevant assertions. (6 marks)
SECTIONAICASEBACKGROUND Natural Beauty Limited ("Natural Beauty") together with its subsidiaries, trading as "Natural Beauty", set up its first self-owned retail store in Hong Kong 20 years ago and listed on the main board of Hong Kong Stock Exchange four years ago. Natural Beauty's business purpose is to provide their customers with cosmetics and skin products made from natural ingredients. It currently has over 1,o00 products. Natural Beauty's headquarters is in Hong Kong and operates over 3,oo0 self-owned stores in mainland China, Hong Kong and Japan. It also has mainland China, and warehouses in Guangzhou, Hong Kong and Tokyo. Natural Beauty's products are very well received by the market in general, especially the products high and there are no aged inventories. Natural Beauty usually offers discount sales once or twice a year during the festive seasons. As business has grown significantly in recent years, Natural Beauty engaged a subcontractor in Japan for some manufacturing processes two years ago. Natural Beauty provides the subcontractor with all raw materials. The subcontractor provides subcontracting services to Natural Beauty and some other customers. Historically, 30% of Natural Beauty's production has been labour and manufacturing overhead costs. During the year, Natural Beauty set up another research and development centre in Japan to develop certain new products to be released. These development costs include material costs, staff cost, depreciation of fixed assets and overhead costs incurred in the research and development centre. performs sample checks after the full counts are completed by production staff and store managers. Based on the prior year's stock count records, no significant stock count discrepancies were noted and variances were adjusted in the stock ledger after management's investigation. The prior year's audit results did not reveal any control deficiencies relating to stock count, but there were internal control Reconciliation of raw materials used by and stored with the subcontractor is performed on a monthly Subsequent to 31 December 2020, Natural Beauty decided to acquire an 80% equity interest in the growth of the business. The transaction was considered as a major acquisition under the Hong Kong Listing Rules. Immediately after the completion of the acquisition, Natural Beauty started integrating the management team as well as aligning the processes ＆ controls and IT systems between the subcontractor and Natural Beauty. Wong ＆ Co was the reporting accountant of Natural Beauty, assisting the company in completing the initial public offering ("iPo"). Wilson Wong, a senior partner of Wong ＆ Co, was the engagement partner ofNaturalBeauty'sIPOproject.Wong＆CohasbecometheauditorofNaturalBeautysincethen,with support and advice to Natural Beauty over the years, assisting Natural Beauty in strengthening its internal controls as well as operation effectiveness. Extraci of menagement aooounts of the group for the year ended 31 December 2020 are as below: 2020 (Unaudited) (Audited) HK$$'m HK$$'m Revenue 3,030 2,879 Cost of goods soild (902) (834) 2.128 Gross profit 2.045 70% 71% (601) Sefling, marketing and logistics expenses (582) (322) Administrstive and general expenses (302) (65) Research and development expenses (262) (12) Other operating (expenses)/ income, net (51) Finance expenses, net (50) (1.051) (1.186) 1.077 Profit before tax 36% 30% 6,499 Property, plant and equipment 6,503 Intangible assets Trade receivables Other receivables 1,283 Inventories 1,240 Cash and bank Others 9.533 Total assets 8,274 Trade and other payables Bank borrowings and other liabilities 3.621 3.504 4,243 Total liabilities 4.088 Total equity 5.290 4.186 (a) In response to the business development of Natural Beauty, Wong ＆ Co has evaluated the risk of material misstatements relating to the capitalisation of research and development expenses of Natural Beauty in its consolidated financial statements as high. Identify the impacted relevant financial statement line items with relevant assertions, and advise on whether you agree with Wong ＆ Co's assessment conclusion and explain your rationale. (5 marks)
SECTIONAICASEBACKGROUND Go-VR Limited ("Go-VR") was set up in 2011 and built the first virtual reality (VR) park in Hong Kong. Go-VR's park offers attractions made up of VR games. Go-VR is a wholly-owned subsidiary of a Japanese company (the "parent" company). Go-VR has a sole director who is seconded by the senior management from the parent company. Because its parent company is engaged in the manufacturing of VR games and machinery, Go-VR can only source VR determined based on a cost-plus margin of 30%. is required to pay a fixed monthly management fee to its parent company. These fees are approximately 50% of Go-VR's total administrative expenses. widest variety of VR games in comparison to other VR parks in the region. Go-VR reached its peak in the park began to face severe competition. Immediately, its ranking dropped. Number of visitors is a key performance indicator for management because it is linked to the annual management bonus. In order to boost sales, Go-VR has introduced various promotional offers with a variety of discounts and different price cuts. The following visitor information is published by Go-VR on its website: Year 2013 2011 2012 2014 2015 1.2 2.4 3.5 Number of visitors (in millions) 0.9 3.2 Year 2016 2017 2018 2019 2020 2.7 2.3 1.8 3.0 Number of visitors (in millions) 0.5 In December 2020, Go-VR acquired an adjacent Go-Karting centre ("Go-Kart") aiming to attract more visitors through a synergy effect. The acquisition of Go-Kart was financed by a bank loan. Go-Kart had been operating profitably for the preceding three years prior to its acquisition by Go-VR. After this acquisition, Go-Kart has become Go-VR's subsidiary. Go-VR has a year end date of 31 December and its financial statements are primarily used by its parent company, the tax bureau and creditors like banks. planning the audit of Go-VR for the year ended 31 December 2020. Extract of Go-VR's management accounts which exclude the financial information of its subsidiary, Go-Kart, for the fiscal years 2019 and 2020 are shown below. 2020 2019 (Unaudited) (Audited) HK$$'000 HK$$'000 Revenue 58,900 74,105 (55.366) Cost of sales (51.727) Gross profit 3,534 22,378 Other income and gains 1,092 1,079 2020 2019 (Unaudited) (Audited) HK$$'000 HKS'000 Marketing expenses (4,357) (4,220) (5,456) Administrativeexpenses (5,342) (1,200) Management performance bonus (500) (153) Finance costs (166) (6,540) (Loss)/ Profit before tax 13,229 (133) Income tax expense (775) (6.673) (Loss)/Profitfortheyear 12.454 2020 2019 (Unaudited) (Audited) HK$$'000 HK$'000 Non-current assets Property, plant and equipment 28,683 36,375 Right-of-use assets 4,563 5,576 Investment in Go-Kart Limited 20.000 53,246 41.951 Current assets Prepayment and other receivables Inventories Tradereceivables 4.749 Cash and cash equivalents 3.665 6.398 5.648 Current liabilities Tradeand otherpayables Lease liabilities Interest-bearingbankborrowings 2,000 Tax payable 3.926 2.080 Non-current liabilities Lease liabilities 3,607 4,597 Interest-bearing bankborrowings 18.000 21.607 4.597 34.111 40.922 厚agicallyand Efficiently,youwill pass HKICPA with ME During the audit planning meeting, Mr Donald Ho, the audit partner, instructed the audit engagement team to analyse the information of visitors published by Go-VR. He also instructed the team to identify which accounts as set out in the 2020 management accounts of Go-VR and the related assertions are considered as signiflcant risks. Prepare a memorandum to the audit partner to explain your answers. Note: A maximum of 2 marks for communication skill and 2 marks for analytical skill will be awarded. (12 marks)
SECTIONAICASEBACKGROUND Go-VR Limited ("Go-VR") was set up in 2011 and built the first virtual reality (VR) park in Hong Kong. Go-VR's park offers attractions made up of VR games. Go-VR is a wholly-owned subsidiary of a Japanese company (the "parent" company). Go-VR has a sole director who is seconded by the senior management from the parent company. Because its parent company is engaged in the manufacturing of VR games and machinery, Go-VR can only source VR determined based on a cost-plus margin of 30%. is required to pay a fixed monthly management fee to its parent company. These fees are approximately 50% of Go-VR's total administrative expenses. widest variety of VR games in comparison to other VR parks in the region. Go-VR reached its peak in the park began to face severe competition. Immediately, its ranking dropped. Number of visitors is a key performance indicator for management because it is linked to the annual management bonus. In order to boost sales, Go-VR has introduced various promotional offers with a variety of discounts and different price cuts. The following visitor information is published by Go-VR on its website: Year 2013 2011 2012 2014 2015 1.2 2.4 3.5 Number of visitors (in millions) 0.9 3.2 Year 2016 2017 2018 2019 2020 2.7 2.3 1.8 3.0 Number of visitors (in millions) 0.5 In December 2020, Go-VR acquired an adjacent Go-Karting centre ("Go-Kart") aiming to attract more visitors through a synergy effect. The acquisition of Go-Kart was financed by a bank loan. Go-Kart had been operating profitably for the preceding three years prior to its acquisition by Go-VR. After this acquisition, Go-Kart has become Go-VR's subsidiary. Go-VR has a year end date of 31 December and its financial statements are primarily used by its parent company, the tax bureau and creditors like banks. planning the audit of Go-VR for the year ended 31 December 2020. Extract of Go-VR's management accounts which exclude the financial information of its subsidiary, Go-Kart, for the fiscal years 2019 and 2020 are shown below. 2020 2019 (Unaudited) (Audited) HK$$'000 HK$$'000 Revenue 58,900 74,105 (55.366) Cost of sales (51.727) Gross profit 3,534 22,378 Other income and gains 1,092 1,079 2020 2019 (Unaudited) (Audited) HK$$'000 HKS'000 Marketing expenses (4,357) (4,220) (5,456) Administrativeexpenses (5,342) (1,200) Management performance bonus (500) (153) Finance costs (166) (6,540) (Loss)/ Profit before tax 13,229 (133) Income tax expense (775) (6.673) (Loss)/Profitfortheyear 12.454 2020 2019 (Unaudited) (Audited) HK$$'000 HK$'000 Non-current assets Property, plant and equipment 28,683 36,375 Right-of-use assets 4,563 5,576 Investment in Go-Kart Limited 20.000 53,246 41.951 Current assets Prepayment and other receivables Inventories Tradereceivables 4.749 Cash and cash equivalents 3.665 6.398 5.648 Current liabilities Tradeand otherpayables Lease liabilities Interest-bearingbankborrowings 2,000 Tax payable 3.926 2.080 Non-current liabilities Lease liabilities 3,607 4,597 Interest-bearing bankborrowings 18.000 21.607 4.597 34.111 40.922 厚agicallyand Efficiently,youwill pass HKICPA with ME (a) Evaluate the risks of material misstatement in Go-VR's financial statements that result from the related party relationships and transactions between Go-VR and its parent company. (6 marks)
SECTIONAICASEBACKGROUND Dymi Limited ("Dymi"), together with its subsidiaries ("Dymi Group"), is a listed company on the Stock Exchange of Hong Kong Limited. Its principal business is sales of stylish and innovative home appliances such as air purifiers, vacuum cleaners, electric fans, dehumidifiers, hair dryers and LED lights. adults by emphasising its products' excellent designs and functions. Its products have recently become very popuiar. Dymi has a long business relationship with its distributors. Dymi hes no self-owned manufacturing facilities. It has a small factory in Hong Kong and an innovation team mainly responsible for product design and prototyping. Its product manufacturing activities are all outsourced to third party suppliers who specialise in original equipment manufacturing. Dymi has a team in Shenzhen working closely with the outsourced manufacturers on procurement and quality control. ABC ＆ Co has been the auditor of Dymi for years and is very familiar with Dymi's business operation and its management team. John Chan is the engagement leader of Dymi's audit. To plan for the coming annual audit, John had a meeting with Dymi's Chief Executive Officer ("CEO") and Chief Financial extract from the meeting notes: During the first half of 2021, Dymi further expanded its number of self-operated stores from five to eight. The three newly opened stores are different from the previous stores. Each new concept store is over 10,o00 square feet and contains a showroom, cafe, and activity rooms for workshops and events. In addition to demonstrating Dymi's new products, the new concept stores also aim to and provided Dymi with a new revenue stream. The CEO commented that the concept stores have turned from breakeven to profit-making in just 4 months' time and provide Dymi with good cash flow. Most of the transactions in the concept stores are settled by electronic payments, and Dymi usually receives the cash from the payment service providers within a month. Dymi launched its Dymi customer loyalty programme in February 2021. Customers who purchase HK$$20. Dymi club members can use these coupons toward their next purchase, to buy a meal at a Dymi café, or to pay for Dymi club activities. Dymi points will expire automatically at the end of each calendar year. The CEO considers the Dymi club customer loyalty programme to be a big success and says that it has helped boost sales during the year. - To facilitate the launch of the Dymi customer loyalty programme and the opening of the concept connects to all of its online and offline stores and stores operated by the chain distributors. Dymi has also upgraded its mobile application ("Dymi APP"), which now shows customers their points earned and cash coupons redeemed, used and expired. The new point-of-sales system and the upgraded Dymi APP provide Dymi's management with instant and transparent data on product sales in each location. The new point-of-sales system and the Dymi APP directly interface with Dymi's general ledger, which enhances the preparation of management accounts in terms of revenue and deferred revenue recognition. - Dymi has further strengthened its due diligence procedure on accepting new distributors. There is no new distributor during the year. Dymi's policy allows no return of goods from distributors. During the year, two of Dymi's distributors in Hong Kong and Taiwan have experienced financial difficulty due to the prolonged impact of pandemic. For prudence's sake, management has decided to make a full provision against these trade receivables of HK$$30 million in aggregate. The CFO also explained that the trade receivable turnover day will increase for the year as there are delays of settlement from certain distributors in Taiwan and Singapore. Historically, Dymi has experienced no default of be considered for the trade receivables due from the distributors other than the two distributors which are in financial difficulty. Extract of Dymi Group's consolidated financial statements for the year ended 31 December 2021 Consolidated statement of financial position 2021 2020 Change Change (Unaudited) (Audited) HKS'million HKS'million HKS'million Fixed assets 15% Right-of-use assets 733% Inventory 60% Trade receivables 138% Prepayment and other receivables 7% (20) Cash and bank (10%) Other assets (3) (43%) Total assets 32% Lease liabilities 667% Trade payables 32% (2) Accrual and other payables (12%) Other liabilities (17%) Total liabilities 49% Net assets 24% Consolidated statement of profit or loss 2021 2020 Change Change (Unaudited) (Audited) HK$$'million HKS'million HK$$'million Sales of products - HK self-operated stores 20% - HK distributors 30% - Taiwan distributors 10% - Singapore distributors 30% Sales of services and meals NIA Total revenue 1,178 31% Cost of sales 33% Gross profit 27% 2021 2020 Change Change (Unaudited) (Audited) HKS'million HK$$'million HK$$'million 36% Gross profit margin 37% Selling and distribution expenses 31% General and administrative expenses 20% Profit before tax 27% Profit tax 18% Profit after tax 29% John calculated the overall materiality using the financial figures in the consolidated financial statements of Dymi Group and determined that the overall materiality amounted to HK$13 million, calculated as 5% of the profit before tax. (a) Evaluate the risk of material misstatements relating to revenue recognition in the consolidated financial statements of Dymi in terms of occurrence. (3 marks) (b) In response to the launch of the customer loyalty programme and implementation of the new point-of-sales system and the Dymi APP, ABC ＆ Co has assessed that the risk of material misstatements relating to revenue recognition in the consolidated financial statements of Dymi in terms of accuracy is high. (i) Explain ABc ＆ Co's risk assessment of the above. (5 marks)
SECTIONAICASEBACKGROUND Dymi Limited ("Dymi"), together with its subsidiaries ("Dymi Group"), is a listed company on the Stock Exchange of Hong Kong Limited. Its principal business is sales of stylish and innovative home appliances such as air purifiers, vacuum cleaners, electric fans, dehumidifiers, hair dryers and LED lights. adults by emphasising its products' excellent designs and functions. Its products have recently become very popuiar. Dymi has a long business relationship with its distributors. Dymi hes no self-owned manufacturing facilities. It has a small factory in Hong Kong and an innovation team mainly responsible for product design and prototyping. Its product manufacturing activities are all outsourced to third party suppliers who specialise in original equipment manufacturing. Dymi has a team in Shenzhen working closely with the outsourced manufacturers on procurement and quality control. ABC ＆ Co has been the auditor of Dymi for years and is very familiar with Dymi's business operation and its management team. John Chan is the engagement leader of Dymi's audit. To plan for the coming annual audit, John had a meeting with Dymi's Chief Executive Officer ("CEO") and Chief Financial extract from the meeting notes: During the first half of 2021, Dymi further expanded its number of self-operated stores from five to eight. The three newly opened stores are different from the previous stores. Each new concept store is over 10,o00 square feet and contains a showroom, cafe, and activity rooms for workshops and events. In addition to demonstrating Dymi's new products, the new concept stores also aim to and provided Dymi with a new revenue stream. The CEO commented that the concept stores have turned from breakeven to profit-making in just 4 months' time and provide Dymi with good cash flow. Most of the transactions in the concept stores are settled by electronic payments, and Dymi usually receives the cash from the payment service providers within a month. Dymi launched its Dymi customer loyalty programme in February 2021. Customers who purchase HK$$20. Dymi club members can use these coupons toward their next purchase, to buy a meal at a Dymi café, or to pay for Dymi club activities. Dymi points will expire automatically at the end of each calendar year. The CEO considers the Dymi club customer loyalty programme to be a big success and says that it has helped boost sales during the year. - To facilitate the launch of the Dymi customer loyalty programme and the opening of the concept connects to all of its online and offline stores and stores operated by the chain distributors. Dymi has also upgraded its mobile application ("Dymi APP"), which now shows customers their points earned and cash coupons redeemed, used and expired. The new point-of-sales system and the upgraded Dymi APP provide Dymi's management with instant and transparent data on product sales in each location. The new point-of-sales system and the Dymi APP directly interface with Dymi's general ledger, which enhances the preparation of management accounts in terms of revenue and deferred revenue recognition. - Dymi has further strengthened its due diligence procedure on accepting new distributors. There is no new distributor during the year. Dymi's policy allows no return of goods from distributors. During the year, two of Dymi's distributors in Hong Kong and Taiwan have experienced financial difficulty due to the prolonged impact of pandemic. For prudence's sake, management has decided to make a full provision against these trade receivables of HK$$30 million in aggregate. The CFO also explained that the trade receivable turnover day will increase for the year as there are delays of settlement from certain distributors in Taiwan and Singapore. Historically, Dymi has experienced no default of be considered for the trade receivables due from the distributors other than the two distributors which are in financial difficulty. Extract of Dymi Group's consolidated financial statements for the year ended 31 December 2021 Consolidated statement of financial position 2021 2020 Change Change (Unaudited) (Audited) HKS'million HKS'million HKS'million Fixed assets 15% Right-of-use assets 733% Inventory 60% Trade receivables 138% Prepayment and other receivables 7% (20) Cash and bank (10%) Other assets (3) (43%) Total assets 32% Lease liabilities 667% Trade payables 32% (2) Accrual and other payables (12%) Other liabilities (17%) Total liabilities 49% Net assets 24% Consolidated statement of profit or loss 2021 2020 Change Change (Unaudited) (Audited) HK$$'million HKS'million HK$$'million Sales of products - HK self-operated stores 20% - HK distributors 30% - Taiwan distributors 10% - Singapore distributors 30% Sales of services and meals NIA Total revenue 1,178 31% Cost of sales 33% Gross profit 27% 2021 2020 Change Change (Unaudited) (Audited) HKS'million HK$$'million HK$$'million 36% Gross profit margin 37% Selling and distribution expenses 31% General and administrative expenses 20% Profit before tax 27% Profit tax 18% Profit after tax 29% John calculated the overall materiality using the financial figures in the consolidated financial statements of Dymi Group and determined that the overall materiality amounted to HK$13 million, calculated as 5% of the profit before tax. 12 marks (22 min) consolidated financial statements of Dymi to be low. Required: (a) Advise on whether you agree with Sean's risk assessment. Please state your reasons. (5 marks)
SECTIONAICASEBACKGROUND Dymi Limited ("Dymi"), together with its subsidiaries ("Dymi Group"), is a listed company on the Stock Exchange of Hong Kong Limited. Its principal business is sales of stylish and innovative home appliances such as air purifiers, vacuum cleaners, electric fans, dehumidifiers, hair dryers and LED lights. adults by emphasising its products' excellent designs and functions. Its products have recently become very popuiar. Dymi has a long business relationship with its distributors. Dymi hes no self-owned manufacturing facilities. It has a small factory in Hong Kong and an innovation team mainly responsible for product design and prototyping. Its product manufacturing activities are all outsourced to third party suppliers who specialise in original equipment manufacturing. Dymi has a team in Shenzhen working closely with the outsourced manufacturers on procurement and quality control. ABC ＆ Co has been the auditor of Dymi for years and is very familiar with Dymi's business operation and its management team. John Chan is the engagement leader of Dymi's audit. To plan for the coming annual audit, John had a meeting with Dymi's Chief Executive Officer ("CEO") and Chief Financial extract from the meeting notes: During the first half of 2021, Dymi further expanded its number of self-operated stores from five to eight. The three newly opened stores are different from the previous stores. Each new concept store is over 10,o00 square feet and contains a showroom, cafe, and activity rooms for workshops and events. In addition to demonstrating Dymi's new products, the new concept stores also aim to and provided Dymi with a new revenue stream. The CEO commented that the concept stores have turned from breakeven to profit-making in just 4 months' time and provide Dymi with good cash flow. Most of the transactions in the concept stores are settled by electronic payments, and Dymi usually receives the cash from the payment service providers within a month. Dymi launched its Dymi customer loyalty programme in February 2021. Customers who purchase HK$$20. Dymi club members can use these coupons toward their next purchase, to buy a meal at a Dymi café, or to pay for Dymi club activities. Dymi points will expire automatically at the end of each calendar year. The CEO considers the Dymi club customer loyalty programme to be a big success and says that it has helped boost sales during the year. - To facilitate the launch of the Dymi customer loyalty programme and the opening of the concept connects to all of its online and offline stores and stores operated by the chain distributors. Dymi has also upgraded its mobile application ("Dymi APP"), which now shows customers their points earned and cash coupons redeemed, used and expired. The new point-of-sales system and the upgraded Dymi APP provide Dymi's management with instant and transparent data on product sales in each location. The new point-of-sales system and the Dymi APP directly interface with Dymi's general ledger, which enhances the preparation of management accounts in terms of revenue and deferred revenue recognition. - Dymi has further strengthened its due diligence procedure on accepting new distributors. There is no new distributor during the year. Dymi's policy allows no return of goods from distributors. During the year, two of Dymi's distributors in Hong Kong and Taiwan have experienced financial difficulty due to the prolonged impact of pandemic. For prudence's sake, management has decided to make a full provision against these trade receivables of HK$$30 million in aggregate. The CFO also explained that the trade receivable turnover day will increase for the year as there are delays of settlement from certain distributors in Taiwan and Singapore. Historically, Dymi has experienced no default of be considered for the trade receivables due from the distributors other than the two distributors which are in financial difficulty. Extract of Dymi Group's consolidated financial statements for the year ended 31 December 2021 Consolidated statement of financial position 2021 2020 Change Change (Unaudited) (Audited) HKS'million HKS'million HKS'million Fixed assets 15% Right-of-use assets 733% Inventory 60% Trade receivables 138% Prepayment and other receivables 7% (20) Cash and bank (10%) Other assets (3) (43%) Total assets 32% Lease liabilities 667% Trade payables 32% (2) Accrual and other payables (12%) Other liabilities (17%) Total liabilities 49% Net assets 24% Consolidated statement of profit or loss 2021 2020 Change Change (Unaudited) (Audited) HK$$'million HKS'million HK$$'million Sales of products - HK self-operated stores 20% - HK distributors 30% - Taiwan distributors 10% - Singapore distributors 30% Sales of services and meals NIA Total revenue 1,178 31% Cost of sales 33% Gross profit 27% 2021 2020 Change Change (Unaudited) (Audited) HKS'million HK$$'million HK$$'million 36% Gross profit margin 37% Selling and distribution expenses 31% General and administrative expenses 20% Profit before tax 27% Profit tax 18% Profit after tax 29% John calculated the overall materiality using the financial figures in the consolidated financial statements of Dymi Group and determined that the overall materiality amounted to HK$13 million, calculated as 5% of the profit before tax. new lease contracts entered into with the respective landlords in the year. The CFO explained thaf the terms and conditions set out in the lease contracts regarding rental period, rent-free period, rent per month, rental payment date, eto, are clearly specified. Dyml also successfully negotiated with the landiords the following terms: Dymi has the sole discretionary right to extend the lease contracts for another 3 years upon expiry of the original contract terms of 3 years. Dymi has the right to terminate the lease contracts anytime during the contract periods as long as a 6-month notice has been given to the landlord(s) in advance. Required: (a) Evaluate the risk of material misstatements relating to right-of-use assets in the consolidated financial statements of Dyml in terms of accuracy and completeness. (5 marks)
SECTIONAICASE BACKGROUND Halo Motors Limited (the "Company') is a company listed on the Hong Kong Stock Exchange, Mhs Company, together with its subsidiaries, (hereafter collectively known as the "Group") is the authoriss dealer of a few European brands automobiles in mainland China. The Group usually enters into a dealership agreement with each car manufacturer. The Group is grarts the authorised dealership to sell specific brands or models of vehicles within mainland China. The Goup is also responsible for the selling and marketing activities, and their related costs, and the provision of warranties and repairand maintenance services to the car owners. The Group makes direot purohases of vehicles from the car manufacturers and resells them through s retail showrooms. Usually, the purchases are denominated in Euro or Us dollars. The Group fg responsible forthe shipment costs and all the in-country storage costs. Sales of vehicles are only authorised in mainland China. All sales are invoiced in Renminbi (RMB) Vehicle sales have a quick turnaround of cash because the buyers either settle in cash or apply for Car loans so that the full amounts are settled by the banks within 7 days. Once sales are made, the Group Accordingly, the Group does not have long outstanding trade receivables. The functional currency of the Group is RMB. Exchange differences arising from transacfions denominated in foreign currencies other than RMB are charged to the profit and loss accounf as exchangedifferencesforthatyear. CPA Limited is the auditor of the Company and is engaged in performing the audit of the Company's consolidated financial statements for the year ended 30 June 2022. Bob is one of the engagement managers and supervises 5 audit staff to work on the account balances of "lnventories" and "Provisions and accruals". Bob is responsible for reporting his work to Alice Ma, the engagement senior manager. Below are the management schedules prepared by the Group's accounts department relating fo "Inventories" and "Provisions and accruals" which are extracted from the sub-ledgers: I. Inventories 30 June 2022 30 June 2021 Unit cost RMB'000 Unit cost RMB'000 Quantity Quantity (RMB) (Unaudited) (RMB) (Audited) 745,000 Model A 93,125 720,000 72,000 120,825 810,000 Model B 895,000 61,560 Model C 677,000 88,010 550,000 44,000 22,760 Model D 569,000 650,000 65,000 950,000 19,000 950,000 Model E 23,750 15,000 Parts and accessories 12.000 358,720 Gross balance 278,310 Less: provision for net realisable value (3.000) and obsolescence 355.720 Net balance 278.310 According to the Group's accounting policies, inventories are stated at the lower of cost and net realisable value. Costs of inventories are determined using the first-in, first-out method. Net realisable value represents the estimated selling price for inventories less all estimated costs of completion and attributable to the sale and non-incremental costs which the Group must incur to make the sale. As at the reporting date, provision for net realisable value amounting to RMB3 million was made, which was related to Model E. Due to keen competition in the market, the selling price of Model E dropped significantly during the year. The provision for net realisable value was calculated based on its selling price as of the year-end date. Il. Provisions and accruals 30 June 2022 30 June 2021 RMB'000 RMB'000 (Unaudited) (Audited) (i) Provision for warranties 23,000 23,400 (ii) Provision for penalties 30,000 (ii) Accrued selling and marketing expenses 12,000 11,500 (iv) Accrued sales incentives 14.000 9.000 Total 79.000 43.900 (i) Provision for warranties - The Group provides 3-year warranties for car owners. Each year, the Group charges provision for warranties to the profit and loss account based on management estimation with claims are made by customers, the provision balance will be deducted and indicated as "claims during the year" in the movement below: 2022 2021 RMB'000 RMB'000 (Unaudited) (Audited) Balance at 1 July 23,400 19,000 (20,100) Claims during the year (5,600) 19.700 Provision for the year 10.000 23.000 Balance at 30 June 23.400 Claim rates for the last five years 2022 1.20% 2021 0.60% 0.60% 2020 0.55% 0.55% 2019 0.53% 0.53% 0.52% 2018 0.52% 2017 N/A 0.45% 0.68% Average claim rate 0.53% (i) Provision for penalties - As continuous loss from the sale of Model E had incurred, the Group's management decided to terminate its dealership agreement with the car manufacturer early. According to the dealership agreement which originally would have expired on 30 June 2025, any party which terminates the agreement early is required to pay a penalty of RMB25 million per year to the other party for the remaining period (i.e., 3 years) unless the parties agree otherwise. During the year, the management started negotiations with the car manufacturer for an overall settlement amount of the penalties at RMB3o million. However, as of yet, the Group has not obtained agreement from the car manufacturer. marketing activities conducted before the year-end date but not yet paid. Subsequent to the year-end date, all these unpaid selling and marketing expenses have been paid. (iv) Accrued sales incentives - This represents the accrual for sales incentives payable to the salesmen. As part of the bonus system, salesmen who can meet the sales quantity targets of certain car models can obtain a bonus equivalent to 1-to-3 months of his/her monthly salary. Evaluate the risk of material misstatements for each of the following provisions and accruals of the Group. Present your answer by ranking the risk based on your assessment in the order from the highest to lowest risk. Correct ranking will score 2 marks. 。 Provision forwarranties 。 Provision for penalties 。 Accrued selling and marketing expenses 。 Accrued sales incentives (16 marks)
SECTIONAICASE BACKGROUND Halo Motors Limited (the "Company') is a company listed on the Hong Kong Stock Exchange, Mhs Company, together with its subsidiaries, (hereafter collectively known as the "Group") is the authoriss dealer of a few European brands automobiles in mainland China. The Group usually enters into a dealership agreement with each car manufacturer. The Group is grarts the authorised dealership to sell specific brands or models of vehicles within mainland China. The Goup is also responsible for the selling and marketing activities, and their related costs, and the provision of warranties and repairand maintenance services to the car owners. The Group makes direot purohases of vehicles from the car manufacturers and resells them through s retail showrooms. Usually, the purchases are denominated in Euro or Us dollars. The Group fg responsible forthe shipment costs and all the in-country storage costs. Sales of vehicles are only authorised in mainland China. All sales are invoiced in Renminbi (RMB) Vehicle sales have a quick turnaround of cash because the buyers either settle in cash or apply for Car loans so that the full amounts are settled by the banks within 7 days. Once sales are made, the Group Accordingly, the Group does not have long outstanding trade receivables. The functional currency of the Group is RMB. Exchange differences arising from transacfions denominated in foreign currencies other than RMB are charged to the profit and loss accounf as exchangedifferencesforthatyear. CPA Limited is the auditor of the Company and is engaged in performing the audit of the Company's consolidated financial statements for the year ended 30 June 2022. Bob is one of the engagement managers and supervises 5 audit staff to work on the account balances of "lnventories" and "Provisions and accruals". Bob is responsible for reporting his work to Alice Ma, the engagement senior manager. Below are the management schedules prepared by the Group's accounts department relating fo "Inventories" and "Provisions and accruals" which are extracted from the sub-ledgers: I. Inventories 30 June 2022 30 June 2021 Unit cost RMB'000 Unit cost RMB'000 Quantity Quantity (RMB) (Unaudited) (RMB) (Audited) 745,000 Model A 93,125 720,000 72,000 120,825 810,000 Model B 895,000 61,560 Model C 677,000 88,010 550,000 44,000 22,760 Model D 569,000 650,000 65,000 950,000 19,000 950,000 Model E 23,750 15,000 Parts and accessories 12.000 358,720 Gross balance 278,310 Less: provision for net realisable value (3.000) and obsolescence 355.720 Net balance 278.310 According to the Group's accounting policies, inventories are stated at the lower of cost and net realisable value. Costs of inventories are determined using the first-in, first-out method. Net realisable value represents the estimated selling price for inventories less all estimated costs of completion and attributable to the sale and non-incremental costs which the Group must incur to make the sale. As at the reporting date, provision for net realisable value amounting to RMB3 million was made, which was related to Model E. Due to keen competition in the market, the selling price of Model E dropped significantly during the year. The provision for net realisable value was calculated based on its selling price as of the year-end date. Il. Provisions and accruals 30 June 2022 30 June 2021 RMB'000 RMB'000 (Unaudited) (Audited) (i) Provision for warranties 23,000 23,400 (ii) Provision for penalties 30,000 (ii) Accrued selling and marketing expenses 12,000 11,500 (iv) Accrued sales incentives 14.000 9.000 Total 79.000 43.900 (i) Provision for warranties - The Group provides 3-year warranties for car owners. Each year, the Group charges provision for warranties to the profit and loss account based on management estimation with claims are made by customers, the provision balance will be deducted and indicated as "claims during the year" in the movement below: 2022 2021 RMB'000 RMB'000 (Unaudited) (Audited) Balance at 1 July 23,400 19,000 (20,100) Claims during the year (5,600) 19.700 Provision for the year 10.000 23.000 Balance at 30 June 23.400 Claim rates for the last five years 2022 1.20% 2021 0.60% 0.60% 2020 0.55% 0.55% 2019 0.53% 0.53% 0.52% 2018 0.52% 2017 N/A 0.45% 0.68% Average claim rate 0.53% (i) Provision for penalties - As continuous loss from the sale of Model E had incurred, the Group's management decided to terminate its dealership agreement with the car manufacturer early. According to the dealership agreement which originally would have expired on 30 June 2025, any party which terminates the agreement early is required to pay a penalty of RMB25 million per year to the other party for the remaining period (i.e., 3 years) unless the parties agree otherwise. During the year, the management started negotiations with the car manufacturer for an overall settlement amount of the penalties at RMB3o million. However, as of yet, the Group has not obtained agreement from the car manufacturer. marketing activities conducted before the year-end date but not yet paid. Subsequent to the year-end date, all these unpaid selling and marketing expenses have been paid. (iv) Accrued sales incentives - This represents the accrual for sales incentives payable to the salesmen. As part of the bonus system, salesmen who can meet the sales quantity targets of certain car models can obtain a bonus equivalent to 1-to-3 months of his/her monthly salary. and trading of electronic toys. DEF is very profitable and accumulates abundant cash. The management of DEF therefore keeps looking for investment opportunities with the aim of bringing additional return to the shareholders of DEF. The management of DEF has decided to invest in cryptocurrencies and has made two related investments for the year ended 30 June 2022: Investment A: - In August 2021, DEF bought 10,000 units of a listed investment fund at a consideration of HK$$10 million. - The fund with asset under management ("AUM") exceeds USs1.5 billion investing in Bitcoin and Ethereum. - The fund is audited by a registered public accountant with the Public Company Accounting Oversight Board ("PCAOB"). DEF bought the fund online through its investment account opened at one of its principal banks. Monthly statements are available from the bank. - As of 30 June 2022, Investment A carries at HK$$20 million in DEF's management accounts. Investment B: In February 2022, DEF made an investment of HK$$10 million in a private equity fund operated in Singapore, representing 18% equity interest of the fund. - DEF, as a limited partner of the fund, does not participate in the operation and investment decisions of the fund. - The fund invests in many less popular and infrequently traded coins and tokens with market quotes that may not be available. The investments made by the fund are consistent with the investment strategy and scope as written in the fund documents. available. On a quarterly basis, the fund administrator (a well-known asset manager and fund administrator in the industry) sends a statement to DEF reporting changes within the asset portfolio of the fund in the period, the assets held by the fund, and the fair values of the fund at the quarter end. - As of 30 June 2022, Investment B carries at HK$$20 million in DEF's management accounts. Both investments are accounted for as financial assets at fair value through profit and loss in the financialstatementsofDEF. The total assets of DEF as of 30 June 2022 approximated HK$$1.2 billion and the profit before tax of DEF for the year then ended approximated HK$$180 million. Yu ＆ Co, the auditor of DEF, has determined that the overall materiality of the 2022 audit is HK$18 million. Required: Based on the facts provided above, evaluate the risk of material misstatements of both investments in terms of existence and valuation to the financial statements of DEF Limited. (10 marks)
SECTION AI CASE BACKGROUND Your firm is the auditor of Kape Limited ('Kape") for certain years. You are the audit engagement manager of Kape, and you are now planning the audit for the year ended 31 December 2022. Kape, together with its subsidiaries ("the Group"), engages in the development and management of real estate properties in mainland China. Throughout 2022, the COVID-19 pandemic persisted and strict travel restrictions remain in place in most countries. This has imposed numerous difficulties on your firm members and their ability to take business trips to other countries. Kape currently holds ten retail malis in Hong Kong, Japan, and the United Kingdom for investment investment properties are accounted at fair value. The Group has engaged Global Appraisal Advisory Limited ("GAAL") to perform the investment properties valuation. During the year, the Group continued to record a significant decline in gross rental income from leased in Hong Kong. As such, Kape offered two-months' rent concessions to its tenants from 1 July 2022 to 31 August 2022. July 2019 to construct residential buildings. The estimated total construction costs (including the land and the expected completion date is June 2023. The Project is mainly financed by bank borrowings, as detailed below. The audit engagement team noted that there are no other new borrowings that have been entered into by the Group since then. During the past year's audit, there was no significant audit issue related to the bank borrowing balance. Galaxy Bank Silver Bank HK$$800.000.000 Principal amount HK$$200.000.000 Interest rate 8% per annum 6% per annum Whole facility drawdown on Whole facility drawdown on Drawdown date 1 December 2019 1 June 2020 30 June 2024 Maturity date 30 June 2024 - Secured by one investment - Project's completion date cannot be property with fair value of not less later than 31 July 2023, otherwise the than HK$$300 million in Hong Kong Major securities/ loan will be repayable on demand covenants - Kape needs to obtain consent from - Except above, no repayable on Silver Bank for any new or modified demand clause financing arrangement Extracts of Kape's consolidated financial information for the fiscal years 2021 and 2022 are shown below: 2022 2021 (Unaudited) (Audited) HK$$'000 HK$$'000 Assets Non-current assets 2022 2021 (Unaudited) (Audited) HK$$'000 HK$$'000 2,299,123 Investment properties 2,229,233 Property, plant and equipment 147,114 177,246 Right-of-use assets 12.105 14.762 2.458.342 2.421,241 Current assets Properties under development for sale 629,353 457,346 Trade receivables 21,342 12,256 Financial assets at fair value through profit or loss 85,600 91,826 347.352 Cash and bank balance 802.912 1.083.647 1,364,340 3.541.989 3.785.581 Liabilities Current liabilities Short-term borrowings 193,284 214,012 Lease liabilities 15,241 11,918 Trade and other payables 64,345 58,081 Current tax payable 27.054 12.084 299.924 296.095 Non-current liabilities Long-term borrowings and other interest-bearing liabilities 1,010,000 1,247,817 11,.912 Lease liabilities 14.626 1.021,912 1262.443 1,321,836 1,558.538 2,220,153 Net assets 2,227,043 Net current assets 783,723 1,068,245 2022 2021 (Unaudited) (Audited) HK$$'000 HK$'000 Revenue 198,432 - Rental income 179,303 - Management services fee 10,537 9,753 Changes in fair value of investment properties (10,110) 13,169 (Loss)/ Profit for the year (6,890) 5.810 Aiagicallyand Efficiently,youwillpassHKiCPAwithME had construction defects and did not meet the requirements of the approved design. The incidents December 2023. immediately, as the delay in the completion date will breach one of the covenants in the borrowing and the consequences of the breached covenant. (a) Evaluate the risk of material misstatements relating to the investment properties in Kape's consolidated financial information in terms of existence and valuation assertions. Note: Assessment of control risks is not required in your answer. (4 marks)
SECTION AI CASE BACKGROUND Your firm is the auditor of Kape Limited ('Kape") for certain years. You are the audit engagement manager of Kape, and you are now planning the audit for the year ended 31 December 2022. Kape, together with its subsidiaries ("the Group"), engages in the development and management of real estate properties in mainland China. Throughout 2022, the COVID-19 pandemic persisted and strict travel restrictions remain in place in most countries. This has imposed numerous difficulties on your firm members and their ability to take business trips to other countries. Kape currently holds ten retail malis in Hong Kong, Japan, and the United Kingdom for investment investment properties are accounted at fair value. The Group has engaged Global Appraisal Advisory Limited ("GAAL") to perform the investment properties valuation. During the year, the Group continued to record a significant decline in gross rental income from leased in Hong Kong. As such, Kape offered two-months' rent concessions to its tenants from 1 July 2022 to 31 August 2022. July 2019 to construct residential buildings. The estimated total construction costs (including the land and the expected completion date is June 2023. The Project is mainly financed by bank borrowings, as detailed below. The audit engagement team noted that there are no other new borrowings that have been entered into by the Group since then. During the past year's audit, there was no significant audit issue related to the bank borrowing balance. Galaxy Bank Silver Bank HK$$800.000.000 Principal amount HK$$200.000.000 Interest rate 8% per annum 6% per annum Whole facility drawdown on Whole facility drawdown on Drawdown date 1 December 2019 1 June 2020 30 June 2024 Maturity date 30 June 2024 - Secured by one investment - Project's completion date cannot be property with fair value of not less later than 31 July 2023, otherwise the than HK$$300 million in Hong Kong Major securities/ loan will be repayable on demand covenants - Kape needs to obtain consent from - Except above, no repayable on Silver Bank for any new or modified demand clause financing arrangement Extracts of Kape's consolidated financial information for the fiscal years 2021 and 2022 are shown below: 2022 2021 (Unaudited) (Audited) HK$$'000 HK$$'000 Assets Non-current assets 2022 2021 (Unaudited) (Audited) HK$$'000 HK$$'000 2,299,123 Investment properties 2,229,233 Property, plant and equipment 147,114 177,246 Right-of-use assets 12.105 14.762 2.458.342 2.421,241 Current assets Properties under development for sale 629,353 457,346 Trade receivables 21,342 12,256 Financial assets at fair value through profit or loss 85,600 91,826 347.352 Cash and bank balance 802.912 1.083.647 1,364,340 3.541.989 3.785.581 Liabilities Current liabilities Short-term borrowings 193,284 214,012 Lease liabilities 15,241 11,918 Trade and other payables 64,345 58,081 Current tax payable 27.054 12.084 299.924 296.095 Non-current liabilities Long-term borrowings and other interest-bearing liabilities 1,010,000 1,247,817 11,.912 Lease liabilities 14.626 1.021,912 1262.443 1,321,836 1,558.538 2,220,153 Net assets 2,227,043 Net current assets 783,723 1,068,245 2022 2021 (Unaudited) (Audited) HK$$'000 HK$'000 Revenue 198,432 - Rental income 179,303 - Management services fee 10,537 9,753 Changes in fair value of investment properties (10,110) 13,169 (Loss)/ Profit for the year (6,890) 5.810 Aiagicallyand Efficiently,youwillpassHKiCPAwithME had construction defects and did not meet the requirements of the approved design. The incidents December 2023. immediately, as the delay in the completion date will breach one of the covenants in the borrowing and the consequences of the breached covenant. (a) Evaluate the risk of misstatements relating to the long-term borrowings in Kape's consolidated financial information in terms of completeness and classification assertions. Note: Assessment of control risks is not required in your answer. (4 marks)
SECTIONAICASEBACKGROUND ISPS Limited ("ISPs") is a start-up private company which ofers Innovative Solar Panel Solutions to its customers. It specialises in building mini-scale solar energy systems for small grid homes, schools, factories, and commercial buildings. IsPs provides sales of solar panels and installation services to its customers. Since incorporation, ISPs has successfully signed four contracts with its customers. The details of the contracts are set out below: Contract Contract Gross profit/ Total costs Expected time Date of contract sum Margin% qumber (HKS) (loss) (HK$$) of completion (HK$$) C-001 1 August 2022 600.000 650.000 (50.000) (8.3%) April 2023 C-002 600.000 380.000 220.000 36.7% 3 October 2022 May 2023 C-003 15 October 250.000 125.000 125.000 50.0% December 2022 2022 28 October C-004 950.000 450.000 500.000 52.6% July 2023 2022 2,400.000 Total: 1.605.000 iSPs's first two contracts achieved a relatively low or even loss margin because management is willing sale of solar panels is relatively stable at around 50%, whilst the gross margin for installation service varies depending on the complexities of the installation. There is no market index in the industry that ISPS can make reference to as ISPs is at the start-up stage. ISPS purchases solar panels from two suppliers. When customer contracts are signed, ISPS places purchase orders to these suppliers and requests the suppliers to ship the solar panels to the customers' request IsPs to pay a 30% deposit when placing the purchase order, and the remaining balance is to be paid within 30 days after the goods are delivered. JSPs is going to prepare its first financial statements for the period from the date of its incorporation (1 April 2022) to 31 December 2022. According to its accounting policy, revenue from the sale of solar panels is recognised at the point in time when control of the asset is transferred to the customer, with the sale of solar panels to a customer. Revenue from the provision of installation service is also recognised at the point in time when service is rendered, when customer acknowledgement is obtained. Contracts for bundled sales of solar panels and installation services are comprised of two performance obligations because the promises to transfer the solar panels and provide installation services are capable of being distinct and separately identifiable. Accordingly, the transaction price (i.e., the contract sum) is allocated based on the relative stand-alone selling prices of the solar panels and installation services. The allocation of the sale of solar panels and installation services for IsPs's contracts is as follows: Allocated sale of Allocated Allocation% Allocation% Contract Total contract installation solar panels for sale of for installation number sum (HK$$) (HK$$) services (HK$$) solar panels services Allocated sale of Allocated Allocation% Allocation% Contract Total contract installation for sale of solarpanels forinstallation number sum (HK$$) (HK$$) services (HK$$) solar panels services C-001 180.000 600.000 420.000 70% 30% C-002 180.000 600.000 420.000 70% 30% 125.000 125.000 50% C-003 250.000 50% C-004 950.000 850.000 100.000 89% 11% Total: 2.400.000 1,815,000 585.000 The respective margin earned from the sale of solar panels and installation services income is detailed below: Sale of solar Installation Installation Sale of solar Sale of solar services Installation panels services Contract Gross panels panels Installation services Gross number Sale (HK$$) Cost (HK$$) profit/(loss) services Cost (HK$$) profit/(loss) (HK$$) (HK$$) (HK$$) C-001 420,000 455.000 (35.000) 195.000 180.000 (15.000) 420.000 C-002 270.000 150.000 180.000 110.000 70.000 62,500 62.500 125.000 125.000 C-003 62,500 62,500 C-004 625,000 225,000 850.000 225.000 100,000 (125,000) Total: 585.000 1.815.000 1.012.500 592.,500 ISPs has three operational departments: Engineering, Procurement and Finance. (1) The Engineering Department is responsible for submission of project plans and provision of workers the supplies of solar panels and other materials. (3) The Finance Department is responsible for financing, accounting, cash payments, and disbursement activities. ISPs has purchased an accounting software from an external vendor. As IsPS does not have the source code, any system changes raised by IsPs would require the external vendor to process. The accounting software records the transactions for sales, purchases, cash receipts, and disbursements. Management has implemented the following internal controls for its revenue recognition process as shown below: Information Manual Description of internal controls processing controls controls Sales are made to customers approved by IC#1 the Engineering Department. The Engineering Department allocates the sales of IC#2 solarpanelsand service incomeforeachcontract. Pre-numbered invoices are initiated by IC#3 the Engineering Department. Information Manual Description of internal controls processing controls controls The system records the revenue based on IC#4 the issued invoices. As extracted from the draft financial statements, the financial information relating to revenue and cost of sale and services for the period ended 31 December 2022 is as below: Notes HK$$ Revenue - Sale of solar panels 1,815,000 - Installation service income 125.000 1,940.000 Cost of sale and services - Sale of solar panels 1,012,500 -Installation service 62.500 1.075.000 Gross profit 865.000 Notes: 1. This relates to the sale of solar panels for contracts C-001 to C-004. The solar panels were delivered to customers within one month after the contracts were signed. customer's acknowledgment. HK$$125,000 is recognised as installation service income for the current period. CPA Limited has been engaged as IsPs's auditor to audit its first financial statements for the period ended 31 December 2022. You are the audit manager of this audit engagement team. The planning materiality is set at HK$80,000. 14 marks /24 min The audit team is now evaluating the effectiveness of internal controls IC#1 to IC#4 as set out in the case background in relation to IsPs's revenue recognition process and has considered that although certain controls are in place, internal controls to address the risk of material misstatements for different revenue-related assertions are still not adequate. Required: (a) List which assertions are addressed by IC#1 to IC#4. (2 marks) (b) Identify additional risk of "What could go wrong" possibilities in the occurrence, accuracy, completeness and cut-off assertions in IsPs's revenue recognition process. (4 marks)
SECTIONAICASEBACKGROUND ISPS Limited ("ISPs") is a start-up private company which ofers Innovative Solar Panel Solutions to its customers. It specialises in building mini-scale solar energy systems for small grid homes, schools, factories, and commercial buildings. IsPs provides sales of solar panels and installation services to its customers. Since incorporation, ISPs has successfully signed four contracts with its customers. The details of the contracts are set out below: Contract Contract Gross profit/ Total costs Expected time Date of contract sum Margin% qumber (HKS) (loss) (HK$$) of completion (HK$$) C-001 1 August 2022 600.000 650.000 (50.000) (8.3%) April 2023 C-002 600.000 380.000 220.000 36.7% 3 October 2022 May 2023 C-003 15 October 250.000 125.000 125.000 50.0% December 2022 2022 28 October C-004 950.000 450.000 500.000 52.6% July 2023 2022 2,400.000 Total: 1.605.000 iSPs's first two contracts achieved a relatively low or even loss margin because management is willing sale of solar panels is relatively stable at around 50%, whilst the gross margin for installation service varies depending on the complexities of the installation. There is no market index in the industry that ISPS can make reference to as ISPs is at the start-up stage. ISPS purchases solar panels from two suppliers. When customer contracts are signed, ISPS places purchase orders to these suppliers and requests the suppliers to ship the solar panels to the customers' request IsPs to pay a 30% deposit when placing the purchase order, and the remaining balance is to be paid within 30 days after the goods are delivered. JSPs is going to prepare its first financial statements for the period from the date of its incorporation (1 April 2022) to 31 December 2022. According to its accounting policy, revenue from the sale of solar panels is recognised at the point in time when control of the asset is transferred to the customer, with the sale of solar panels to a customer. Revenue from the provision of installation service is also recognised at the point in time when service is rendered, when customer acknowledgement is obtained. Contracts for bundled sales of solar panels and installation services are comprised of two performance obligations because the promises to transfer the solar panels and provide installation services are capable of being distinct and separately identifiable. Accordingly, the transaction price (i.e., the contract sum) is allocated based on the relative stand-alone selling prices of the solar panels and installation services. The allocation of the sale of solar panels and installation services for IsPs's contracts is as follows: Allocated sale of Allocated Allocation% Allocation% Contract Total contract installation solar panels for sale of for installation number sum (HK$$) (HK$$) services (HK$$) solar panels services Allocated sale of Allocated Allocation% Allocation% Contract Total contract installation for sale of solarpanels forinstallation number sum (HK$$) (HK$$) services (HK$$) solar panels services C-001 180.000 600.000 420.000 70% 30% C-002 180.000 600.000 420.000 70% 30% 125.000 125.000 50% C-003 250.000 50% C-004 950.000 850.000 100.000 89% 11% Total: 2.400.000 1,815,000 585.000 The respective margin earned from the sale of solar panels and installation services income is detailed below: Sale of solar Installation Installation Sale of solar Sale of solar services Installation panels services Contract Gross panels panels Installation services Gross number Sale (HK$$) Cost (HK$$) profit/(loss) services Cost (HK$$) profit/(loss) (HK$$) (HK$$) (HK$$) C-001 420,000 455.000 (35.000) 195.000 180.000 (15.000) 420.000 C-002 270.000 150.000 180.000 110.000 70.000 62,500 62.500 125.000 125.000 C-003 62,500 62,500 C-004 625,000 225,000 850.000 225.000 100,000 (125,000) Total: 585.000 1.815.000 1.012.500 592.,500 ISPs has three operational departments: Engineering, Procurement and Finance. (1) The Engineering Department is responsible for submission of project plans and provision of workers the supplies of solar panels and other materials. (3) The Finance Department is responsible for financing, accounting, cash payments, and disbursement activities. ISPs has purchased an accounting software from an external vendor. As IsPS does not have the source code, any system changes raised by IsPs would require the external vendor to process. The accounting software records the transactions for sales, purchases, cash receipts, and disbursements. Management has implemented the following internal controls for its revenue recognition process as shown below: Information Manual Description of internal controls processing controls controls Sales are made to customers approved by IC#1 the Engineering Department. The Engineering Department allocates the sales of IC#2 solarpanelsand service incomeforeachcontract. Pre-numbered invoices are initiated by IC#3 the Engineering Department. Information Manual Description of internal controls processing controls controls The system records the revenue based on IC#4 the issued invoices. As extracted from the draft financial statements, the financial information relating to revenue and cost of sale and services for the period ended 31 December 2022 is as below: Notes HK$$ Revenue - Sale of solar panels 1,815,000 - Installation service income 125.000 1,940.000 Cost of sale and services - Sale of solar panels 1,012,500 -Installation service 62.500 1.075.000 Gross profit 865.000 Notes: 1. This relates to the sale of solar panels for contracts C-001 to C-004. The solar panels were delivered to customers within one month after the contracts were signed. customer's acknowledgment. HK$$125,000 is recognised as installation service income for the current period. CPA Limited has been engaged as IsPs's auditor to audit its first financial statements for the period ended 31 December 2022. You are the audit manager of this audit engagement team. The planning materiality is set at HK$80,000. 12 marks / 22 min The audit team has evaluated the revenue recognition accounting policy applied by isPs and has concluded that it follows the relevant accounting standards. The audit team is satisfied that IsPs should recognise two revenue streams separately: (i) sale of solar panels, and (i) installation service income. However, the audit team has identified that the process relating to the allocation of the sale amounts of misstatement is high, and accordingly, it could impact the revenue recognised in the current period. Required: (a) Advise the factors and the situation applicable to Isps which supports the audit team's evaluation of the risk of inappropriate allocation of the sale amounts of solar panels and installation service income to be high. (8 marks) (b) Analyse which contract may have an inappropriate allocation of the sale amounts of solar panels and installation service income. Explain your answers. (4 marks)
SECTIONAICASEBACKGROUND ISPS Limited ("ISPs") is a start-up private company which ofers Innovative Solar Panel Solutions to its customers. It specialises in building mini-scale solar energy systems for small grid homes, schools, factories, and commercial buildings. IsPs provides sales of solar panels and installation services to its customers. Since incorporation, ISPs has successfully signed four contracts with its customers. The details of the contracts are set out below: Contract Contract Gross profit/ Total costs Expected time Date of contract sum Margin% qumber (HKS) (loss) (HK$$) of completion (HK$$) C-001 1 August 2022 600.000 650.000 (50.000) (8.3%) April 2023 C-002 600.000 380.000 220.000 36.7% 3 October 2022 May 2023 C-003 15 October 250.000 125.000 125.000 50.0% December 2022 2022 28 October C-004 950.000 450.000 500.000 52.6% July 2023 2022 2,400.000 Total: 1.605.000 iSPs's first two contracts achieved a relatively low or even loss margin because management is willing sale of solar panels is relatively stable at around 50%, whilst the gross margin for installation service varies depending on the complexities of the installation. There is no market index in the industry that ISPS can make reference to as ISPs is at the start-up stage. ISPS purchases solar panels from two suppliers. When customer contracts are signed, ISPS places purchase orders to these suppliers and requests the suppliers to ship the solar panels to the customers' request IsPs to pay a 30% deposit when placing the purchase order, and the remaining balance is to be paid within 30 days after the goods are delivered. JSPs is going to prepare its first financial statements for the period from the date of its incorporation (1 April 2022) to 31 December 2022. According to its accounting policy, revenue from the sale of solar panels is recognised at the point in time when control of the asset is transferred to the customer, with the sale of solar panels to a customer. Revenue from the provision of installation service is also recognised at the point in time when service is rendered, when customer acknowledgement is obtained. Contracts for bundled sales of solar panels and installation services are comprised of two performance obligations because the promises to transfer the solar panels and provide installation services are capable of being distinct and separately identifiable. Accordingly, the transaction price (i.e., the contract sum) is allocated based on the relative stand-alone selling prices of the solar panels and installation services. The allocation of the sale of solar panels and installation services for IsPs's contracts is as follows: Allocated sale of Allocated Allocation% Allocation% Contract Total contract installation solar panels for sale of for installation number sum (HK$$) (HK$$) services (HK$$) solar panels services Allocated sale of Allocated Allocation% Allocation% Contract Total contract installation for sale of solarpanels forinstallation number sum (HK$$) (HK$$) services (HK$$) solar panels services C-001 180.000 600.000 420.000 70% 30% C-002 180.000 600.000 420.000 70% 30% 125.000 125.000 50% C-003 250.000 50% C-004 950.000 850.000 100.000 89% 11% Total: 2.400.000 1,815,000 585.000 The respective margin earned from the sale of solar panels and installation services income is detailed below: Sale of solar Installation Installation Sale of solar Sale of solar services Installation panels services Contract Gross panels panels Installation services Gross number Sale (HK$$) Cost (HK$$) profit/(loss) services Cost (HK$$) profit/(loss) (HK$$) (HK$$) (HK$$) C-001 420,000 455.000 (35.000) 195.000 180.000 (15.000) 420.000 C-002 270.000 150.000 180.000 110.000 70.000 62,500 62.500 125.000 125.000 C-003 62,500 62,500 C-004 625,000 225,000 850.000 225.000 100,000 (125,000) Total: 585.000 1.815.000 1.012.500 592.,500 ISPs has three operational departments: Engineering, Procurement and Finance. (1) The Engineering Department is responsible for submission of project plans and provision of workers the supplies of solar panels and other materials. (3) The Finance Department is responsible for financing, accounting, cash payments, and disbursement activities. ISPs has purchased an accounting software from an external vendor. As IsPS does not have the source code, any system changes raised by IsPs would require the external vendor to process. The accounting software records the transactions for sales, purchases, cash receipts, and disbursements. Management has implemented the following internal controls for its revenue recognition process as shown below: Information Manual Description of internal controls processing controls controls Sales are made to customers approved by IC#1 the Engineering Department. The Engineering Department allocates the sales of IC#2 solarpanelsand service incomeforeachcontract. Pre-numbered invoices are initiated by IC#3 the Engineering Department. Information Manual Description of internal controls processing controls controls The system records the revenue based on IC#4 the issued invoices. As extracted from the draft financial statements, the financial information relating to revenue and cost of sale and services for the period ended 31 December 2022 is as below: Notes HK$$ Revenue - Sale of solar panels 1,815,000 - Installation service income 125.000 1,940.000 Cost of sale and services - Sale of solar panels 1,012,500 -Installation service 62.500 1.075.000 Gross profit 865.000 Notes: 1. This relates to the sale of solar panels for contracts C-001 to C-004. The solar panels were delivered to customers within one month after the contracts were signed. customer's acknowledgment. HK$$125,000 is recognised as installation service income for the current period. CPA Limited has been engaged as IsPs's auditor to audit its first financial statements for the period ended 31 December 2022. You are the audit manager of this audit engagement team. The planning materiality is set at HK$$80,000. As at 31 December 2022, ISPs recorded the following trade payables and deposits for purchases of solar panels with its two suppliers. HK$$ Deposits for purchases of solar panels Supplier A 150.000 Supplier B 153.750 303.750 Trade payables Supplier A 1,000,000 Supplier B 1.025.000 2.025.000 The audit team has analysed these balances and has considered that both the "Deposits for purchases of solar panels" and "Trade payables" may be materially misstated. Required: (a) Based on the facts provided in the case and the information above, analyse and identify the irregularities in the balances of "Deposit for purchases of solar panels" and "Trade payables" which require the audit team to perform further audit work. (8 marks)
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