Materiality base:

PBT = 5%
Question 1 TA = 1%-2%

You are the senior in charge of the external audit of Perkasa Berhad (Perkasa), a company
which assembles automobile spare-parts to customer specification. The draft financial
statements for the year ended 30 September 20X1 show profit before tax of RM1.2 million and
total assets of RM25 million.

The following issues were identified during the course of the audit of the financial statements
for the year ended 30 September 20X1.

(1) On 6 October 20X1, the company received an invoice for plant and equipment costing
RM3.5 million with an estimated useful life of five years which was installed and brought into
use on 1 September 20X1. The invoice was dated 5 October 20X1 and had been posted to
the ledger accounts as an October 20X1 transaction and as yet not included in the financial
statements for the year ended 30 September 20X1.

(2) On 12 November 20X1, a batch of automobile spare-parts which had been rejected by a
customer were sold to another customer for RM450,000. The automobile spare-parts are
currently included in work in progress in the financial statements for the year ended 30
September 20X1 at a cost of RM350,000. The automobile spare-parts were completed during
the first week of October 20X1 at a further cost of RM150,000.

(3) On 25 November 20X1, the company was advised by a tax specialist that because of the
complexity of the issues involved in the Inland Revenue Board of Malaysia enquiry into the
company's tax affairs, which was launched in September 20X1, it is not possible to forecast
the outcome of that enquiry. However, the specialist has advised that the possible range of
outcomes in respect of the additional tax liabilities ranges between RM0-RM10 million liability.
There is currently no reference to this matter in the draft financial statements.

Requirements:

For each of the issues outlined above:

- state, with reasons, the action you would take;

- discuss the implications for the auditor's opinion on the financial statements of Perkasa
and, where appropriate, describe any changes you would make to the auditor's report.

Suggested solutions:

(1) Plant and equipment

- Actions/reasons

Request the directors to amend the financial statements because the asset was received and
in use prior to the year end. The non-current assets, current liabilities and depreciation figures
should be amended. The amounts are material as the cost of the equipment of RM3.5 million 3.8M
is 14% of total assets and the depreciation of RM58,333 is 4.9% of profit before tax.
3.8M/25M * 100% = 15.2% 3.8M/5years = 760000/12mths = 63333/1.2M * 100% = 5.3%

- Report implications
If the directors agree to amend the financial statements, the opinion will be unmodified, and
no additional sections will be included in the report. However, if the directors refuse to amend
the financial statements, then the opinion will be modified on the grounds that the financial
statements are materially misstated. The opinion will be qualified (not adverse) as the
misstatement is material but not pervasive. An explanation should be given, in the 'Basis of
qualified opinion' section of the report, of the reason for the qualification and of the amounts
involved.

(2) Work in progress

- Actions/reasons

The amount should be noted on the schedule of individually immaterial misstatements and
the directors should be informed. The subsequent sale is an adjusting subsequent event
providing additional evidence of the value of the work in progress at the year end. As the NRV
is lower than the cost, the work in progress should be valued at NRV. However, the difference
between the cost and NRV is RM50,000 and is not material as it is only 4.2% of profit before
tax and 0.2% of total assets. NRV = Sales - completion cost - selling cost = 450K - 150K = 300K
Cost = 350K is reported in F.S
thus, WIP shd be recorded at 300K
- Report implications excess of 50K is material or not?

Even if the directors refuse to amend the financial statements, the auditor's opinion will not
be modified, and no additional sections will be included in the report. However, this issue
must be considered with other individually immaterial items, in case the issues become
material when aggregated together.

(3) Inland Revenue Board of Malaysia enquiry

- Actions/reasons

Request the directors to include a note describing the situation in the financial statements as
the circumstances give rise to a significant uncertainty which could have an impact on the
financial statements. The amount involved is potentially material as RM10 million is 40% of
total assets. However, a provision is not required as the outflow is possible rather than
probable. contingent liability = 10M/25M*100% = 40%

- Report implications

If the directors agree to include a note explaining the issue then the opinion will not be
modified, but the report will be amended. An emphasis of matter paragraph should be added
to the report in order to draw the user's attention to the note in the financial statements. This
paragraph is placed after the 'Basis for opinion' section. There should be a specific statement
that the opinion is not modified, and a brief description of the circumstances should be given.
If the directors refuse to include a note in the financial statements, or if the note is
inadequate, then the opinion should be qualified on the grounds of a material misstatement
of disclosure. The misstatement should be described in the 'Basis for qualified opinion' section
of the auditor's report, which is included directly below the 'Qualified opinion' section.

Question 2

Suggested solutions:
amended