Scenario
Gr8 Hols Ltd prepares annual financial statements to 30 September. It was established by John Cougar and his wife
Mary in 1992 operating as the owner of a small single caravan and camping site based near the village of Taithness in
Western Scotland. John and Mary retired from the company in January 2017 having overseen the number of sites
grow to a total of seven all based in Scotland and the north of England. On their retirement from the company John
and Mary sold 25 % of the share capital in the company to friends and distant family members, and the
remaining 75%, in equal proportions to their two sons, Reeves and Jukka and their daughter Sabina – all three of
whom were then appointed as the only directors of the company. Whilst Sabina had always worked for the company
at the Taithness site prior to obtaining her directorship, neither of the brothers had any experience of working in the
camping or tourism sectors. Reeves, who tends to dominate his younger siblings, had previously been a full- time
student and then university researcher and Jukka had worked as an area sales manager for a baby food manufacturer.
However, all three are very entrepreneurial. This, combined with the fact that the company’s financial director is an
enthusiastic 24 year old, and long – standing family friend with a degree in Business Studies and Accounting, gave
John, Mary and the other shareholders confidence that the brothers and sister could take the company forward and
expand its operations.
In 2017 the company commenced a five year controlled expansion program, as a result of which the company has
established a further two sites based in England. Each and every year, all of the company’s sites are open 7 days a
week for 35 weeks throughout the year for hires, and closed during the 17 weeks leading up to the end of April for
site repairs, renovations and improvements.
The company owns 1020 caravans and 1450 family tents, all of which remain static on its sites, and are hired on a
weekly basis to holidaymakers. A payment in advance (deposit), of 30% of the hire cost is payable at the time of
booking and the balance at least ten weeks before the letting period. Deposits are kept by the company if bookings
are cancelled within eight weeks of the hire period. On average, caravans and tents are booked four months in
advance. Additionally, there are 300 caravan and 900 tent pitches for hire “on demand”. Payment for these pitches is
payable strictly by cash on arrival at each site and pitches are hired out at flat rates irrespective of the number of
occupants. Chargeable facilities on all sites include washing and laundry rooms, child care facilities, a gym, a café and
a social club with evening cabaret. The Taithness site also has a swimming pool and spa facilities. Customers pay by
cash, or debit/credit card for the use of all these facilities. On each site there are also amusement arcades and a minisupermarket, all owned by the company.
Your firm are part of the team auditing the financial statements of Gr8 Hols Ltd, and having carried out the necessary
audit procedures on the final day of the accounting period, staff are now preparing to carry out the detailed final
audit for the year ended 30 September 2019. The audit manager in charge has ascertained the following information
relevant to the audit:
(i) The company’s reported gross sales from all revenue streams was £7.2 million with net profit before tax of
£1.1 million. The company adopts uniform accounting systems and policies for all sites and the Taithness site
is its largest and most profitable site. Materiality levels set for the audit include amounts equivalent to 5 % of
the company’s total net profit before tax.
(ii)Initial conversations with the directors have revealed that, in general occupancy rates of caravans at sites
were lower than those for tents. This seemed to be as a consequence of families having less money to
spend on holidays due to the current economic difficulties in the United Kingdom. The directors define
“ occupancy” as ‘the actual unit nights of hire , divided by the available unit nights of hire for the holiday
season’.
(iii) On 1st February 2019 , following a three month period of parallel running with its old accounting system,
the company introduced a new computer – based accounting system. The new system is highly advanced,
designed and tailor – made for Gr8 Hols Ltd by a reputable software design
company. When discussing the new system with your firm’s audit partner , Sabina commented :
” the system’s highly advanced and a vast improvement on the old system. It’s so much quicker in
processing transactions, and produces a vast range of useful statistical reports in addition to the
monthly financial accounts, which as you know we use as a basis to prepare the annual accounts
audited by your firm . It’s such a reliable system that you won’t need to do any detailed checking
of the company’s accounting transactions processed since 1st February, so we’re expecting a
consequent in your audit fees , as compared to last year ”
(iv) The company has followed a long – established policy of employing a relatively small number of
permanent staff on sites and in the centralised administration, booking and accounts offices
– gearing up with over 200 temporary workers for employment throughout the period May to
December only. Whilst site employees are provided with caravan accommodation and free
meals on site, to enable them to properly carryout their employment duties; compared to employees
working in other sectors – the employees of GR8 Hols Ltd have poor pay and working conditions. In a
recent email exchange between Sabina and your firm’s audit partner, Sabina commented:
“As directors of the company my brothers and I are aware of the various risks to our business
( business risks ), and we do take regular account of these with a view to mitigating them,
especially when exercising our recruitment policy. I have to say that I’m really puzzled and –
given your hourly charge out rates- concerned that you seem to spend so much time
finding out about all of the business risks we face. What has business risk got to do with auditing?
Please send me an email in which you provide a critical explanation addressing my concern. Also,
given your own apparent expertise in the identification and mitigation of all types of business risk,
please include commentary on how you would feel about providing us with ongoing business risk
mitigation advice in addition to external audit services, and an estimate of how much you would
charge for this additional service “.
(v) During May 2019, sewage waste from one of the company’s sites had leaked into a local
river causing water contamination, depletion of fish stocks and extensive damage to a nature
reserve. The local rivers’ authority has indicated in correspondence that it holds the company
responsible for the leakage and in the absence of its agreement to pay full compensation for the
depletion and damage; it intends to commence legal proceedings against the company for the
recovery of the total consequential costs to be incurred of £120,000. The authority
has provided written confirmation from an independent firm of experts on the make up of
the £120,000.
(vi) It transpired that the leakage referred to above had occurred as a consequence of damage to
the main underground drainage pipes on the camp site. The directors of Gr8 Hols Ltd have
claimed that the leakage could have been prevented if the ( large national) firm of drainage
contractors, employed by the company to carry out an ongoing maintenance programme on the
drainage systems had been more diligent in their work. The contractors have denied any
culpability, the loss is not covered by insurance and the company’s own legal counsel has
provided advice to its directors advising that in court the company would have at best only
a 10% chance of recovering any of the loss from the drainage contractors. In the circumstances
the company’s directors instructed another independent firm of consultants to assess the loss
caused by the leakage. They agreed with the sum of £120,000 and confirmed this in a formal
report to the directors. Given the directors’ views on the issue and their intentions to negotiate
reimbursement from the drainage contractors, a net provision of only £20,000 has been included
in the company’s financial statements in respect of the river authority’s claim. This is the maximum
provision the company is prepared to make for the claim, on the basis of the directors’ firm
belief that at worst the company is only one quarter culpable for the loss and – even if it is totally
culpable – there will be sufficient profits arising during the next financial year to absorb any
losses not recognised in the current financial year. Given their responsibilities as directors, and that they
own 75 % of the company’s shares , Reeves , Jukka and Sabina are firm in their conviction that they
should have the final say as to the content of the financial statements. They also believe that the
inclusion of any sum in excess of £20,000 is tantamount to the company accepting liability to that extent
and would therefore weaken the company’s position in any subsequent legal argument.
(vii) The company continued to upgrade both older tents and caravan stock during the year, replacing numerous
older units with new modern units. It enhanced its caravan fleet with twenty new caravans, each with a cost
of £25,500 – six of these being placed on the Taithness site. All caravans are depreciated to a scrap value of
£500 over a ten – year period in equal instalments, with a full year’s charge in the year of acquisition. As part
of its ongoing commitment to invest in site facilities, during the year the company enlarged and renovated one
of its mini-markets and also renovated amusement arcades at three of the company’s sites, including
Taithness, and it continued its ongoing policy of improving both the customer experience and efficiency of the
company by continually updating smaller items of camp site plant and equipment and disposing of the old.
The company also incurred costs of £66,000 in general upgrades to underground drainage.
(viii) In July 2019, Reeves, Jukka and Sabina were approached by the directors of Campies Ltd,
another camping and caravan site operator, and offered the opportunity to purchase one of their sites.
The reason given for Campies Ltd wishing to sell, is that the site in question does not fit into
that company’s future strategy for growth. The initial interest expressed in the site by the directors of
GR8 Hols Ltd, has since developed to the point where they have asked your firm to carry out a
valuation of the site, and then be part of the of Gr8’s team in subsequent negotiations to purchase the site.
In conversations between Reeves and the partner responsible for your firm’s audit of his company’s financial
statements, Reeves confirmed that the existing site accountant employed by Campies Ltd would be made
redundant if the purchase does proceed. However, he pointed out that the accountant may then be a useful
addition as a new employee to your audit firm given his previous audit experience, especially on
future audits of the financial statements of Gr8Hols Ltd. This is because the accountant has detailed knowledge
of the camp site on offer and of the holiday sector generally. Reeves also indicated that all shareholders are in
agreement that the purchase of the site should proceed, and it is likely that Gr8 Hols Ltd would make the
purchase in the summer months of 2020 and that the company would rely almost entirely on a bank loan to
finance the purchase. Finally he mentioned that as the company was trying to reduce
overhead expenses generally, with effect from next year’s audit he would like your firm to carry out the
company’s non – current assets and inventory counts at the Taithness site and absorb the cost of doing so
into the normal audit fee.
.
REQUIRED
(a) Briefly but critically, evaluate the directors’ reasoning for including a provision of £20,000 in the financial
statements of GR8 Hols Limited for the year ended 30 September 2019, in respect of the claim made by the
local rivers’ authority. Your evaluation should state, with reasoning, whether the provision for the sum of
£20,000 is reasonable and appropriate , or whether an alternative amount should be provided for.
( 8 marks) *
(
b
)
Draft the content of an explanatory email to Sabrina in which you critically address her concern
about your firm’s interest in business risk, and respond to her request for your firm to provide ongoing
business risk mitigation advice in addition to the provision of external audit services .
( Note if you need to refer to any technical ” auditing ” terms you must explain these in your own
words , such that a competent business executive would understand their meaning ).
(20 marks ) *
(
c
)
(
d
)
Identify EIGHT inherent risks associated with the financial statements of Gr8 Hols Ltd, and explain the
impact that each risk identified could have on information included in the company’s financial statements
for the year ended 30 September 2019.
For each risk identified you should set out your answer in the following format :
Nature of Risk
Area of Financial Statement affected
Audit Concern – impact and effect on the financial statements
(24 marks)*
Carry out an analytical review of the summary of financial information for the Taithness site included in
Appendix I (attached), and:
(i) explain any audit concerns that you may have with regard to the reported income figures for
caravan hire, tent hire and pitch hire including occupancy rates.
(9 marks )
(ii) explain any other audit concerns that you any have with regard to EIGHT other areas of
the reported financial information.
(16 marks )
Total (25 marks)*
(
e
)
State the effect that the introduction of the new system on 1st February 2019 should have had on your
firm’s approach to the audit of Gr8’s financial statements, including the procedures to be carried out,
and explain the reasons for this. Also, comment with justifying rationale, as to whether consider
Sabrina’s expectation – of a reduction in the audit fee – is reasonable.
(8 marks ) *
( f) Advise, with justifying rationale, how your firm should proceed with regard to : .
(i) assisting Gr8 Hols Ltd in the possible purchase of the Campies Ltd site, as requested ,
(ii) employing the site accountant currently engaged by Campies Ltd , as suggested by Reeves ,and
(iii ) carrying out future end of year non – current assets and inventory counts as requested by
Reeves .
(15 marks ) *
Total Available Marks ( 100 marks )
* The maximum total mark achievable for this assignment is restricted to 100 % of which half ( maximum 50 % )
will count towards the total mark awarded for the International Audit and Assurance Module . The maximum
available mark shown against each part ( a, b c, d ,e and f ) above will be awarded only to outstanding answers –
demonstrating exceptional focus and understanding of the pertinent issues . You MUST show the total word count
at the end of your submission.
Word count guide ( indicative maximums )
Part a Maximum 150 words
Part b Maximum 475 words
Part c Maximum 575 words
Part d Maximum 550 words (excluding numbers )
Part e Maximum 300 words
Part f Maximum 450 words
TOTAL 2,500 words
Max Extra if req’d 300 words
GRAND TOTAL 2,800 words