Texts: Question 2: Loan and Goodwill June 2017 Q1
Pluto Co (P) is planning to acquire 80% of the issued share capital of PT Satia (S), a company listed in Indonesia. S will issue new shares to P if the acquisition goes ahead. P has engaged your firm, DEKP LLP (DEKP), to perform a limited review on the unaudited financial statements of S for the financial year ended on 31 March 20x7. This would be the first time S has prepared its financial statements using Singapore.
P engaged an independent valuer who determined the bond's fair value to be US$40 million at acquisition. As the regulations in Indonesia require the acquisition to be paid in cash, P paid S US$250 million as cash consideration, issued the bond with a US$50 face value, and received US$50 million cash from the seller on the acquisition date. P accounted for goodwill on acquisition of US$10 million and recognized a gain on the bond issue of US$10 million.
P has secured, with the agreement of S and S's auditor, BGR LLP (BGR), for your firm to review the audit working papers of BGR for the year ended 31 March 20x6.
Required:
(a) Suggest THREE reasons why it is important to report Issue 1 to the management of Pluto Co. (6 marks)
The Audit Senior has highlighted the following issues for the engagement manager's attention:
(b) As an auditor, explain how professional skepticism should be applied in relation to Issue 2. (6 marks)
Issue 1 - Guarantee: The bank confirmation performed by BGR identified two outstanding guarantees (amounting to a total of US$20 million) that S gave to Conway Bank in favor of a_Suss Co. The financial statements of 20x6 did not disclose the existence of any guarantee, and the bank made a mistake in its confirmation reply. However, S's management did not highlight the error to Conway Bank.
(c) With reference to appropriate Singapore Financial Reporting Standards, assess the risk of material misstatement in relation to the classification of the loan payable to Conway Bank (Issue 3). Include in your discussion whether the risk of misstatement is due to fraud or error. (6 marks)
(d) Explain the misstatement in Goodwill on Acquisition of PT Satiam.
(e) Outline whether the acquisition and the related goodwill should be included as Key Audit Matters in the audit report. (3 marks)
Issue 2 - Investment: The 20x6 statement of financial position included investments in financial assets, at a cost of US$20 million, classified as current assets. The note disclosed these as investments in quoted perpetual bonds acquired in 20x3. BGR's working papers documented that the market price of these bonds at 31 March 20x6 were US$15 million but there was no need to write down to fair value as the accounting policy was to state investment at cost.
The 20x7 statement of financial position did not include the US$20 million investment in bonds. S's management explained that the bonds were sold to Suss,Co on 3 April 20x6 for US$20 million and the sale proceeds were collected.
Issue 3 - Loan payable: There is an unsecured loan of US$30 million payable to Conway Bank, classified as non-current loan payable in both the 20x6 and 20x7 statements of financial position. The bank confirmation in BGR's working papers shows that the loan was due for repayment on 30 April 20x7. S's management explained that the bank agreed on 29 April 20x7 to extend the loan repayment date until 30 September 20x9.
There is another loan of US$40 million from LOL Bank, secured on the head office building of S. The audit working papers of BGR showed that the loan would be repayable on 30 June 20x9. There is a loan covenant that requires S to maintain a current ratio of at least 2.0. The 20x7 statement of financial position showed current assets of US$100 million and current liabilities of US$50 million.
P subsequently proceeded with the acquisition of S for the following consideration terms: Cash payable of US$200 million; and Five-year unconvertible bond payable with a face value of US$50 million.
