(ii) Risks of material misstatement
General matters
HKSA 315 provides examples of conditions and events that may indicate risks of material misstatement. These include
changes to corporate structure such as large acquisitions, moving into new lines of business and the installation of
significant new IT systems related to financial reporting. The CS Group has been involved in all three of these during
the financial year, so the audit generally should be approached as high risk.
Goodwill
The client has determined goodwill arising on the acquisition of Canary Co to be $45 million, which is material to the
consolidated financial statements, representing 8·2% of total assets. The various components of goodwill have specific
risks attached. For the consideration, the contingent element of the consideration is inherently risky, as its measurement
involves a judgement as to the probability of the amount being paid.
Currently, the full amount of contingent consideration is recognised, indicating that the amount is certain to be paid.
HKFRS 3 (Revised) Business Combinations requires that contingent consideration is recognised at fair value at the time
of the business combination, meaning that the probability of payment should be used in measuring the amount of
consideration that is recognised at acquisition. This part of the consideration could therefore be overstated, if the
assessment of probability of payment is incorrect.
Another risk is that the contingent consideration does not appear to have been discounted to present value as required
by HKFRS 3, again indicating that it is overstated.
The same risk factors apply to the individual financial statements of Crow Co, in which the cost of investment is
recognised as a non-current asset.
The other component of the goodwill calculation is the value of identifiable assets acquired, which HKFRS 3 requires to
be measured at fair value at the date of acquisition. This again is inherently risky, as estimating fair value can involve
uncertainty. Possibly the risk is reduced somewhat as the fair values have been determined by an external firm.
Goodwill should be tested for impairment annually according to HKAS 36 Impairment of Assets, and a test should be
performed in the year of acquisition, regardless of whether indicators of impairment exist. There is therefore a risk that
goodwill may be overstated if management has not conducted an impairment test at the year end. If the impairment
review were to indicate that goodwill is overstated, there would be implications for the cost of investment recognised in
Crow Co’s financial statements, which may also be overstated.
Loan stock
Crow Co has issued loan stock for $100 million, representing 18·2% of total assets, therefore this is material to the
consolidated financial statements. The loan will be repaid at a significant premium of $20 million, which should be
recognised as finance cost over the period of the loan using the amortised cost measurement method according to
HKFRS 9 Financial Instruments. A risk of misstatement arises if the premium relating to this financial year has not been
included in finance costs.
In addition, finance costs could be understated if interest payable has not been accrued. The loan carries 5% interest
per annum, and six months should be accrued by the 31 July year end, amounting to $2·5 million. Financial liabilities
and finance costs will be understated if this has not been accrued.
There is also a risk of inadequate disclosure regarding the loan in the notes to the financial statements. HKFRS 7
Financial Instruments: Disclosures requires narrative and numerical disclosures relating to financial instruments that give
rise to risk exposure. Given the materiality of the loan, it is likely that disclosure would be required.
The risks described above are relevant to Crow Co’s individual financial statements as well as the consolidated financial
statements.15
