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post-balance sheet eventsrelevant to Professional Scheme Paper 3.1 Candidates attempting Paper 3.1 should
following issues arising during the final audit find Question 3 relatively straightforward, as
By way of a case study, consider Question 3 of have been noted on a schedule of points for its style and standard have barely changed
the June 2005 exam. The requirement is ‘to (i) since the Pilot Paper in 2001. However, to
comment on the matters … and (ii) state the prepare for this question, candidates should
audit evidence that you should expect to find, read the article ‘Technique in auditing
in undertaking your review of audit working in Urvina from a supermarket to a ‘City questions’, student accountant, September
Metro’ in response to a significant decline 2001, and any relevant examiner’s feedback,
such as that published in student accountant
Question 3
shopping in the capital. The store will be in October 2005. This article provides
additional help, and considers post-balance
audit of Volcan, a long-established limited sheet events.
liability company. Volcan operates a national supermarket chain of 23 stores, five of which this store, together with two others, was are in the capital city, Urvina. All the stores bought from a national competitor. It is are managed in the same way with purchases Volcan’s policy to write off goodwill over being made through Volcan’s central buying department and product pricing, marketing, advertising and human resources policies ‘reward scheme’ for its customers. The being decided centrally. The draft financial include the awarding of a ‘store point’ to customers’ loyalty cards for every $1 – $282 million), profit before taxation of $9·5 spent, with extra points being given for the million (2004 – $7·3 million) and total assets purchase of each week’s special offers. of $178 million (2004 – $173 million). The 52 student accountant January 2006
convert their points into cash discounts many writing, in their answer to (a), ‘It is a PROVISION FOR SITE RESTORATION
against future purchases on the basis of post-balance sheet event.’ But what is ‘it’?: Now read part (c), sketch a timeline – see Figure 2 on page 55, identify the post-balance
sheet event(s) and which, if any, are adjusting. the development of a site in a valley of ‘outstanding natural beauty’ on which to going on, which of the following answer points build a retail ‘megastore’ and warehouse Sketching a timeline as part of an answer the provision for the relocation should not was received in April 2005, requires that establish a ‘picture’ of the situation. See is a non-adjusting post-balance sheet event three 100-year-old trees within the valley Figure 1 on page 55.
IAS 37 (FRS 12) prohibits provisions for relocations after the balance sheet date.
be restored in 2006. Additions to property, include $4·4 million for the estimated cost permission did not change the situation that of site restoration. This estimate includes a existed at the balance sheet date, namely that provision of $0·4 million for the relocation of the 100-year-old trees. In March 2005 These are all post-balance sheet events. provision for site restoration, etc should be Next question: are they ‘adjusting’ or made only if a liability exists at the balance for a car park. A fine of $20,000 per tree ‘non-adjusting’? Remember, adjusting events sheet date. This is the main issue – whether a provide additional evidence of condition(s) liability (legal or constructive) exists. It is true existing at the balance sheet date. Adjustments that IAS 37 (FRS 12) prohibits provisions for that affect the balance sheet can only be: staff relocations after the balance sheet date MATTERS TO CONSIDER
increases in liabilities (eg recognition of a following a business restructuring, but this is Most candidates understand that materiality needs to be assessed, and can, as a result, decreases in liabilities (eg derecognition gain up to six marks for dealing with this over of, or reduction in, a provision previously $0.4m of the provision was not suitable the three parts of this question. Note however, that assessing materiality does not mean increases in assets (eg reduction in an (see in Figure 2) and so could not
calculating all the ‘rules of thumb’ benchmarks (0.5% to 1% revenue, etc) nor does it require the ‘scattergun approach’ (ie calculating every number as a % of revenue, total assets and profit, and hoping something is correct). Marks In this case there can be no provisions, will be awarded to candidates who interpret for example, for redundancy payments (or who linked these points and stated that the materiality appropriately (ie only in relation to other costs) arising from the closure. There overprovision ($0.34m) should be written is no liability at the balance sheet date and Now consider Question 3. Don’t calculate a provision must meet the definition of a materiality for each of the three matters, but liability. Only if the announcement had been CONCLUDING REMARKS
identify which of the measures (ie revenue, made before the balance sheet date, so that a Misreading the facts, misunderstanding the profit before tax and/or total assets) is relevant ‘valid expectation’ had been created in those situation, and lack of accounting knowledge and indicate Y (relevant) or N (not relevant) affected, should provision be made for the contributed to many incorrect answer points in Table 1 on page 55. Please note, before
for this particular question. For example: reviewing the ‘solution’ in Table 2, that this
A credit, therefore, cannot be created as a ‘development of a site’ (as per the exercise does not seek to assess materiality, liability. But consider the alternative: creating question) could not be intangible (as in only the calculations that are relevant to a credit that is a reduction in the value of an asset, ie impairment. The decline in demand is the condition existing at the balance sheet was similarly irrelevant (Volcan was not a POST-BALANCE SHEET EVENTS
date which ‘triggers’ a store impairment review (including goodwill). The announcement and there were only three 100-year old trees, dealing with post-balance sheet event issues, closure provide evidence of the condition.
53 student accountant January 2006
capitalisation of restoration costs – on Total assets
Profit before tax
the contrary, it requires it where there is a liability to be recognised under IAS 37 (FRS 12).
See Table 2 below.
1 Historic cost ($5.5m) is no longer relevant.
Carrying value (ie the amount carried in the balance sheet) should most obviously be assessed in relation to total assets. In the case of assets (as here) the carrying value that might need to be written off to profit or non-recoverability etc) should also be assessed in relation to profit before tax.
2 Any charge to profit or loss is clearly relevant to profit before tax. Where the ‘other side of the entry’ is a balance sheet item (as here) it is also relevant to total assets. Note that this question was written pre-IFRS 3, Business Combinations. Now, the correct accounting treatment for goodwill is to test annually for impairment and not to amortise.
irrelevant to the exercise, but note that it is possible to put a ‘ceiling’ on the maximum potential discount, at 1% of revenue. The discounts on future purchases by customers constitute a reduction in sales revenue that accrues when the store points are earned, not when they are redeemed. The reduction in revenue (or, arguably, increase in cost of sales) clearly has a consequential effect on profit and the amount of the accrual/provision should be assessed in relation to the balance sheet (ie total assets).
not been expensed, but treated as a cost (of developing the megastore), it is not relevant to profit before tax. Such ‘decommissioning’ expenses are recognised in profit or loss through increased depreciation charges in future otal asse
Kim Smith is examiner for Paper 3.1
54 student accountant January 2006


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