Session 4

[Acid]

Q : You are an auditor of Sheraton hotel and Express food company.
Express food is the food supplier to Sheraton . Recently few guests became ill after eating at a party in the hotel.

Guest sued Sheraton and Sheraton sued Express food companies. Sheraton is making out of court settlements with guests and express food is trying to make one as well with the hotel.

The lawyers are also only making some informal remarks about the progress of case .


You are required to tell me the application of IAS 37 and what problems will the company face while obtaining the the audit evidence on which to base the audit opinion ?

[Vivienne]

IAS 37 Provisions,contingent liabilities and assets.
before this standard came into effect,a lot of companies were doing what is called creative accounting.that is they were 'massaging' the accounts.for example if they anticipated future losses or maybe they were going to have heavy repairs,they would in this year make a provision so that profits are reduced and then release it in subsequent years to the income statement in order to enhance their profits.

the key aim of IAS 37 was to define what a provision is and what should be stated in the financial statements as such.

according to ias 37, a provision is defined as a present obligation that is probable and there is a likelyhood of transferring economic benefits when it is settled and that it should be estimated reliably( probable means that more than 50% likely)

a liability is defined as a present obligation arising form past transactions of
which an entity may transfer economic benefits.

from the above definitions and the requiremnts of ias 37 we can deduce that a provision can only be made if it meets the above citeria.if we look at these two companies sheraton and express food company we can conclude that this case meets the said criteria ie
1)it is arising fiom past transactions
2)it can be reliably estimated
3)it is more than 50% likely that there would be a transfer of economic benefit as can be seen from the company making out of court settlements

Audit evidence is the information that auditors gather about an entity that helps them to form an opinion.this information has to be sufficient,reliable and appropriate.
in the situation that we are faced with the auditors would face a number of problems in obtaining this evidence

1)the independence of the auditor is questionable here as he is said to be auditing both companies sheraton and express food company that have sued each other.there may also be an element of conflict of interest as the auditor may end up getting conflicting views because he has a common interest in both clients.

2)the lawyers have not come out to make formal remarks or issue an official statement on the progress of the case.this may mean that these two companies may not even be sure whether to make a provision or just to do disclosure notes in the financial statements as required by ias 37 in the case of a contingent liability.

3)the out of court settlements may make it difficult in the event that the complainants loose the case.its difficult because the two companies are making out of court settlements at the same time waiting for the outcome of the case in court..the best thing that they would do is to either withdraw the case and settle outside court or go aheard with the court case and wait for the outcome in the mean time stopping the out of court settlements.

As long as these evidence related issues are not taken care of then placing reliability on them by the auditors is highly questionable.


the end

[Annie]

Customer sues Sheraton Hotel and Sheraton Hotel sues Express Foods

Here due the past event of supplying food a present obligation has risen. There fore there is a probability of economic outflow of benefits. This has to be shown as contingent liability according to IAS 37. Therefore Sheraton Hotel will show the probable amount in its books and Express foods will show the probable amounts in its books as contingent liability according to the estimate of their respective lawyers. Being an auditor of both the entity's you can find out whether they contradict each other and what is the true status of the case and whether according to that the amounts shown in the contingent liability is right.

If it becomes certain that there would be a outflow of economic benefits due to the court case then both the entities should make a provision for that effect. The auditor can easily check on the amount.

Sheraton Hotel would show a contingent liability for the amount payable to the customer and on being certain would provide for it. It will also show a contingent asset in its disclosures or notes to accounts for the amount receivable from express foods.

The auditor should check that the amount shown as contingent liability in express foods is approximately the same that appears as contingent asset in Sheraton Hotel. It there is a huge difference he should investigate and find out the actuals.

Is this right

Annie

[Acid]

Hey Annie!

You also had to talk about the difficulties in obtaining the audit evidence and therefore less evidence in forming audit opinion!

You only discussed the Application of IAS37!

Acid.

[Annie]

Hi Vivienne,

Even if the matter is settled out of the court it is documented as the solicitors of entities meet and settle the case by way of a MOU and the case is closed. Therefore it is reliable and the auditor can form an opinion on the basis of these documents.

And in case of the independence of the auditor, then the auditor can ask any other accountant to check his work or it can be checked by the audit committee or internal auditor. In case you are the internal auditor it would be checked by the statutory auditor. But if both come to terms then you can take help of the ACCA advisory cell.

Annie

[Annie]

Hi Acid,

Well here the auditor should take a management letter for all the contingent liabilities it has and through this letter the auditor would come to know that there are some litigation cases against the entity or it has sued some other entity, then he would go through the minutes of the meetings of the board and the litigation papers of the lawyers and form his opinion. If he thinks that his independence would be hampered then he would take an external help of the audit committee or an expert or the ACCA advisory cell.

The auditor ideally should form his opinion on all the evidences available to him.

From the evidences available if he feels that for the hotel the outflow is certain and still it has shown it as a contingent liability then he should ask the managemnet for a reason and if not satisfied to ask them to provide for it.

And if he also finds that hotel will loose its case against express foods and would not be receiving anything then he would not approve it to be shown as contingent asset in the disclosures.



Annie

[Acid]

Auditor must exercise professional judgement in such a case.

The first step should be :


To manage conflict of interest , as stated by ACCAs Rule of Professional Conduct.
The Clients may objet auditor working for other client eg. Auditor may be acting on behalf of hotel since a long time so supplier may object thinking that auditor may be biased.
The Auditor should resign if he is being accused of being biased
Auditor should appoint different teams of staff , and different engagement partners
Auditor must make sure that he dont transfer confedential internal information which may be harmful for either of the client.
Problems in obtaining sufficient appropriate evidence.


Auditors may find it difficult to determine which amount should be provided in the FS due to the presense of contingent assets/liabilities.
Lawyers are only making informal comments which may not be true but just be said infront of press to prevent a bad publicity in front of the press.
Lawyers maynot provide any formal remarks about case progression
The auditor can give a qualified opinion with a "except for" paragraph explaining significant matters i.e. difficulties in determining the appropriate amount of liabilities etc.
The IAS 37 Definition and application is well explained in Annies and Vivies answers above.


If you need to ask anything regarding my answer then please dont hesistate.

Cheers

Acid