Explain the purpose of a ‘˜hot’ review and distinguish it from a ‘˜cold’
review
The audit of Bouncy Co is nearly complete and the financial statements and the audit
report are due to be signed next week. However, the following additional information
has just been presented to the auditor. The company’s year end was 30 September 2X11.
The springs in a new type of mattress have been found to be defective making the
mattress unsafe for use. There have been no sales of this mattress; it was due to be
marketed in the next few weeks. The company’s insurers estimate that inventory to the
value of £750,000 has been affected. The insurers also estimate that the mattresses are
now only worth £225,000. No claim can be made against the supplier of springs as
this company is in liquidation with no prospect of any amounts being paid to third
parties. The insurers will not pay Bouncy for the fall in value of the inventory as the
company was underinsured. All of this inventory was in the finished goods store at the
end of the year and no movements of inventory have been recorded post year-end.
What actions should the auditors take and what will be the effect on the accounts for the
year ended 30 September 2X11?
Give three examples of where auditors’ routine audit procedures involve periods after
the year end date, excluding consideration of post balance sheet events.
Sniffit & Coff plc is an established pharmaceutical company that has for many years
generated 90% of its revenue through the sale of two specific cold and flu remedies.
Sniffit & Coffl plc has lately seen a real growth in the level of competition that it faces
in its market
and demand for its products has significantly declined. To make matters worse, in the
past the company has not invested sufficiently in new product development and so has
been trying to remedy this by recruiting suitably trained scientific staff, but this has
proved more difficult than anticipated.
In addition to recruiting staff the company also needed to invest $2m in plant and
machinery. The company wanted to borrow this sum but was unable to agree suitable
terms with the bank; therefore it used its overdraft facility, which carried a higher
interest rate. Consequently, some of Sniffit & Coff’s suppliers have been paid much
later than usual and hence some of them have withdrawn credit terms meaning the
company must pay cash on delivery. As a result of the above the company’s overdraft
balance has grown substantially. The directors have produced a cash flow forecast and
this shows a significantly worsening position over the coming 12 months.
The directors have informed you that the bank overdraft facility is due for renewal next
month, but they are confident that it will be renewed. They also strongly believe that the
new products which are being developed will be ready to market soon and hence
trading levels will improve and therefore that the company is a going concern.
Therefore they do not intend to make any disclosures in the accounts regarding going
concern.
Identify any potential indicators that the company is not a going concern and outline the
procedures the auditors should carry out in this situation.