(iii) Audit procedures relating to goodwill
– Obtain the legal purchase agreement and confirm the date of the acquisition as being the date that control of
Canary Co passed to Crow Co.
– From the legal purchase agreement, confirm the consideration paid, and the details of the contingent consideration,
including its amount, date potentially payable, and the factors on which payment depends.
– Confirm that Canary Co is wholly owned by Crow Co through a review of its register of shareholders, and by
agreement to legal documentation or by a Companies House search.
– Agree the cash payment of $125 million to cash book and bank statements.
– Review the board minutes for discussion regarding, and approval of, the purchase of Canary Co.
– Obtain the due diligence report prepared by the external provider and confirm the estimated fair value of net assets
at acquisition.
– Discuss with management the reason for providing for the full amount of contingent consideration, and obtain
written representation concerning the accounting treatment.
– Ask management to recalculate the contingent consideration on a discounted basis, and confirm goodwill is
recognised on this basis in the consolidated financial statements.
Tutorial note: Procedures relating to impairment testing of the goodwill at the year end are not relevant to the
requirement, which asks for procedures relating to the goodwill initially recognised on acquisition.
(b) Ethical matters regarding the CS Group
Firstly, regarding the audit engagement partner attending board meetings, there is nothing to prohibit an auditor attending the
board meetings of an audit client. Indeed it is common practice for this to occur, and there may be times when the auditor
should attend in order to raise issues with management and/or those charged with governance pertaining to the audit.
However, the auditor attending the client’s board meeting must be careful that they take no part in any management decisions
made at the meeting. If matters not relevant to the audit are debated on which the auditor’s opinion is sought, the auditor
could be deemed to be involved with management decisions, or to be providing an additional service to the client which
potentially creates a threat to objectivity.
IFAC’s Code of Ethics for Professional Accountants and ACCA’s Code of Ethics and Conduct both advise that if an auditor
serves as a director or officer of an audit client, the self-review and self-interest threats created would be so significant that
no safeguards could reduce the threats to an acceptable level. Accordingly, no partner or employee shall serve as a director
or officer of an audit client. In summary, it is acceptable for the audit engagement partner to attend the board meetings, as
long as he is not involved with making management decisions, and if he is not appointed to the board.
The second matter relates to an audit manager being seconded to Starling Co in a role as finance director. IFAC’s Code refers
to this situation as a temporary staff assignment, and states that the lending of staff by a firm to an audit client may create a
self-review threat. Such assistance may be given, but only for a short period of time and the firm’s personnel shall not be
involved in providing non-assurance services or assuming management responsibilities.
It seems that in this case, the temporary staff assignment should not go ahead, as clearly the audit manager would be making
management decisions involving the preparation of Starling Co’s individual financial statements, and providing information
for the consolidated financial statements. It is not likely that any safeguard could reduce the self-review threat created to an
acceptable level.
Finally, our firm has been asked to help in the recruitment of a new finance director to Starling Co. IFAC’s Code states that
providing recruitment services to an audit client may create self-interest, familiarity or intimidation threats. The existence and
significance of any threat will depend on factors such as the nature of the requested assistance, and the role of the person to
be recruited.
The significance of any threat created shall be evaluated and safeguards applied when necessary to eliminate the threat or
reduce it to an acceptable level. In all cases, the firm shall not assume management responsibilities, including acting as a
negotiator on the client’s behalf, and the hiring decision shall be left to the client.
The firm may generally provide such services as reviewing the professional qualifications of a number of applicants and
providing advice on their suitability for the post. In addition, the firm may interview candidates and advise on a candidate’s
competence for financial accounting, administrative or control positions.
Therefore Magpie & Co may provide some assistance in the recruitment of the new finance director, but may wish to put
safeguards in place such as obtaining written acknowledgement from the client that the ultimate decision will be made by
them. 17
2 (a) (i) The terms of the engagement to review and report on Hawk Co’s business plan and forecast financial statements should
be agreed in an engagement letter, separate from the audit engagement letter. The following matters should be included
in the terms of agreement:
Management’s responsibilities
The terms of the engagement should set out management’s responsibilities for the preparation of the business plan and
forecast financial statements, including all assumptions used, and for providing the auditor with all relevant information
and source data used in developing the assumptions. This is to clarify the roles of management and of Lapwing & Co,
and reduce the scope for any misunderstanding.
The intended use of the business plan and report
It should be confirmed that the report will be provided to the bank and that it will not be distributed or made available
to other parties. This will establish the potential liability of Lapwing & Co to third parties, and help to determine the need
and extent of any liability disclaimer that may be considered necessary. Lapwing & Co should also establish that the
bank will use the report only in helping to reach a decision in respect of the additional finance being sought by
Hawk Co.
The elements of the business plan to be included in the review and report
The extent of the review should be agreed. Lapwing & Co need to determine whether they are being asked to report just
on the forecast financial statements, or on the whole business plan including any narrative descriptions or explanations
of Hawk Co’s intended future business activities. This will help to determine the scope of the work involved and its
complexity.
The period covered by the forecasts
This should be confirmed when agreeing the terms of the engagement, as assumptions become more speculative as the
length of the period covered increases, making it more difficult for Lapwing & Co to substantiate the acceptability of the
figures, and increasing the risk of the engagement. It should also be confirmed that a 12-month forecast period is
sufficient for the bank’s purposes.
The nature of the assumptions used in the business plan
It is crucial that Lapwing & Co determine the nature of assumptions, especially whether the assumptions are based on
best estimates or are hypothetical. This is important because ISAE 3400 The Examination of Prospective Financial
Information states that the auditor should not accept, or should withdraw from, an engagement when the assumptions
are clearly unrealistic or when the auditor believes that the prospective financial information will be inappropriate for its
intended use.
The planned contents of the assurance report
The engagement letter should confirm the planned elements of the report to be issued, to avoid any misunderstanding
with management. In particular, Lapwing & Co should clarify that their report will contain a statement of negative
assurance as to whether the assumptions provide a reasonable basis for the prospective financial information, and an
opinion as to whether the prospective financial information is properly prepared on the basis of the assumptions and is
presented in accordance with the relevant financial reporting framework. The bank may require the report to be in a
particular format and include specific wordings in order to make their lending decision.
Tutorial note: Credit will also be awarded for discussion of other matters relevant to agreeing the terms of the
engagement, such as confirming the fee and billing arrangements, and confirming the deadline for completion of the
engagement.
