1

www.accaapc.com








ACCA P7 Advanced Audit & Assurance [INT]

Sample Study Note

For exams in June2014









2
www.accaapc.com




















Lesco Group Limited, April 2015
All rights reserved. No part of this publication may be reproduced, stored in a
retrieval system, or transmitted, in any form or by any means, electronic,
mechanical, photocopying, recording or otherwise, without the prior written
permission of Lesco Group Limited.

3
www.accaapc.com
Sample Note Content:

Main study note content [Total Pages: 235] ...................................................... 4
Product Summary .......................................................................................... 7
Live online note sample plan ........................................................................... 8
Live online course timetable: ........................................................................... 9
Chapter 1 Practise management .................................................................... 12
Practice questions relating to practise management in chapter1: ....................... 15
Stage 4 of audit flowchart [Substantive procedures] ......................................... 24








Please note:
This is just the sample study note extracted from the main study note in your tuition study
[This tuition study note is consistent in basic/super/gold package]. There would be more
chapters in the main study note covering the whole ACCA syllabus.
You can also take a look at the content within the main study note below:



4
www.accaapc.com
Main study note content [Total Pages: 235]


5
www.accaapc.com


6
www.accaapc.com


















7
www.accaapc.com
Product Summary

content Basic
package
Super
package
Gold
Package
Oxford Brookes BSc in Applied Accounting
ACCA HD quality super tuition videos

ACCA HD quality super revision videos


Last minute revision


ACCA Live online tuition(4sessions)


ACCA Live online revision(14hours)


ACCA Mock exams(with tutor mark)


ACCA Tutor support

ACCA Electronic study note


ACCA Student online forum

Pass Guarantee

ACCA Final revision mock exam paper


ACCA Super Live online session (20-
30hours)



ACCA Super Live online revision
(Super 3 days)



ACCA 1V1 Career Advice

ACCA Extra exam techniques
demonstration


Live online mentoring





8
www.accaapc.com
Live online note sample plan

Live online tuition note plan for June2014 P7 Exam
[Only for super / gold package (there would be a unique plan for gold package)]

Live sessions: [2 hours/session---live online + recorded after class]:

Live session1: Practice management knowledge +Questions go through
Live session2: Audit plan + Group issues+ P7 question1 go through
Live session3: Key Accounting issues (likely to be examined in June2014)
Live session4:Stage 5+ stage 6+ key non audit assignments + key current
issues[highly examinable in June2014]

Live revision note for June2014 P7 exam: [will be available since mid April 2014]:
Live revision1+2: [There would be a separate live revision note detailing all
past exam questions with answers to go through]










9
www.accaapc.com
Live online course timetable:
Live session/revision for F4-P7






10
www.accaapc.com




11
www.accaapc.com









*Please Note: This Timetable may be subjected to future changes.
Kindly check regularly for any possible updates.



12
www.accaapc.com
Chapter 1 Practise management




In this chapter we will be going through:

1. Advertisement issues
2. How to draft a tendering document
3. Professional appointment issues
4. Quality control issues
5. Regulatory issues

The best way to learn this chapter is to copy note from tuition video.








13
www.accaapc.com
These 2 pages are left blank intentionally in order for you to copy the note
from tutor:























14
www.accaapc.com

























15
www.accaapc.com
Practice questions relating to practise management in chapter1:

Chapter 1 Advertising: (DEC2010 Q4) Neeson&Co

An advertisement could be placed in national newspapers to attract new clients.
The draft advertisement has been given to you for review:

Neeson & Co is the largest and most professional accountancy and audit
provider in the country. We offer a range of services in addition to audit,
which are guaranteed to improve your business effi ciency and save you
tax.

If you are unhappy with your auditors, we can offer a second opinion on
the
report that has been given.

Introductory offer: for all new clients we offer a 25% discount when both
audit
and tax services are provided. Our rates are approved by ACCA.


Required:
Evaluate each of the suggestions made above, commenting on the ethical and
professional issues raised. 8marks





16
www.accaapc.com
Answer to Neeson&Co: [Tutors own answer]

Back up
Any comments made by the advertisement should be backed up with evidence. For
example it says Neeson&Co is the largest and most professional accountancy
provider in the country so sales revenue and number offices should be made to
back up this evidence.

Definitely clear
The advertisement should be definitely clear.The business efficiency can not be
guaranteed by the firm and this seems that its not honest by Neeson.

The second opinion offered by Neeson&Co may imply that the audit work done by
Neeson&Co is low and as a result client would not be happy with the first opinion
given and hence second opinion would be issued again. And this comment in the
advertisement is not professional.

Ensure to comply with laws and regulation
The advertisement should comply with laws and regulation.
The guarantee to save tax means maybe Neeson would use some tricks to help
client save time which may not comply with laws and regulation because not in
every circumstance that the tax can be saved.

Fundamental ethics
Neeson&Co cant quote rates are approved by ACCA because ACCA does not
approve any rates and this would be seen as unprofessional.


Legal obligation
17
www.accaapc.com
It seems that if taxes cant be saved and also business efficiency hasn't been
improved so that client may take potential legal action against Neeson&Co resulting
in further future cash outflow from Neeson&Co.

Low balling
The 25% of introductory fees is low balling and its not prohibited but Neeson&Co
should need to make sure by charging such a low amount of fees the quality of the
work should be maintained, ie, following ISAs to do the audit work.






Chapter 1 (June 2004)Hawk Assocaite


Displaying business cards alongside those of local tradesman and service providers
in supermarkets and libraries. The cards would read:

Hawk ACCA Associates
For PROFRSSIONAL Accountancy, Audit,
Business Consultancy and Taxation services
Competitive rates. Money back guarantees.

(4marks)

18
www.accaapc.com



Answer to June2004 Hawk Associate:

Advertisement in the super markets and libraries is not professional and they
should advertise their firm using eg, financial magazines.

Professional is in capital and this implies only their firm is professional while
others are not and firms shouldnt criticize others.

Competitive rate is vague and compare to whom? So this information is
misleading.

Money back guarantees may mean they can help company save tax and if not
they would give money back to them and this will:

Firstly involving some illegal techniques to help company save tax and hence
its a breach of laws and regulations.

Secondly it implies that the quality of services provided to the company may
not be good and hence give their money back.







19
www.accaapc.com
Chapter 1 tendering+Fees (June09 Q2)

The Dragon Group is a large group of companies operating in the furniture retail trade. The
group has expanded rapidly in the last three years, by acquiring several subsidiaries each
year. The management of the parent company, Dragon Co, a listed company, has decided
to put the audit of the group and all subsidiaries out to tender, as the current audit firm is
not seeking re-election. The financial year end of the Dragon Group is 30 September 2009.

You are a senior manager in Unicorn & Co, a global firm of Chartered Certified Accountants,
with offices in over 150 countries across the world. Unicorn & Co has been invited to tender
for the Dragon Group audit (including the audit of all subsidiaries). You manage a
department within the firm which specialises in the audit of retail companies, and you have
been assigned the task of drafting the tender document. You recently held a meeting with
Edmund Jalousie, the group finance director, in which you discussed the current group
structure, recent acquisitions, and the groups plans for future expansion.

Meeting notes Dragon Group
Group structure
The parent company owns 20 subsidiaries, all of which are wholly owned. Half of the
subsidiaries are located in the same country as the parent, and half overseas. Most of
the foreign subsidiaries report under the same financial reporting framework as Dragon
Co, but several prepare financial statements using local accounting rules.

Acquisitions during the year
Two companies were purchased in March 2009, both located in this country:
(i) Mermaid Co, a company which operates 20 furniture retail outlets. The audit opinion
expressed by the incumbent auditors on the financial statements for the year ended 30
September 2008 was qualified by a disagreement over the non-disclosure of a
contingent liability. The contingent liability relates to a court case which is still on-going.

(ii) Minotaur Co, a large company, whose operations are distribution and warehousing.
This represents a diversification away from retail, and it is hoped that the Dragon Group
will benefit from significant economies of scale as a result of the acquisition.

20
www.accaapc.com
Other matters
The acquisitive strategy of the group over the last few years has led to significant
growth. Group revenue has increased by 25% in the last three years, and is predicted to
increase by a further 35% in the next four years as the acquisition of more subsidiaries
is planned. The Dragon Group has raised finance for the acquisitions in the past by
becoming listed on the stock exchanges of three different countries. A new listing on a
foreign stock exchange is planned for January 2010. For this reason, management would
like the group audit completed by 31 December 2009.


Required:
(a)Recommend and describe the principal matters to be included in your firms
tender document to provide the audit service to the Dragon Group. (10 marks)


(b) Explain FOUR reasons why a firm of auditors may decide NOT to seek re-
election as auditor. (6 marks)

(c) Using the specific information provided, evaluate the matters that should be
considered before accepting the audit engagement, in the event of your firm
being successful in the tender. (7 marks)
Professional marks will be awarded in part (c) for the clarity and presentation of the
evaluation. (4 marks)







21
www.accaapc.com
Answer to June2009 Q2a-c:

(a)
Recourses
Detailed background of our firm should be included for example the expertise and
clients we serve.

Clients needs
Because Dragon group is going to go listed onto the stock exchange and so we can
provide non audit services such as corporate governance advice relating to the
listing.

We have offices in over 150 countries across the world so we can deal with audit
with your subsidiaries all around the world more effectively.

Way to do the audit
We should include how we perform the audit service to ensure appropriate quality
of work maintained such as following ISA to do the risk assessment.
Also we ensure quality during the audit by having appropriate quality control
procedures during the audit such as hot review on the audit work we have done.

Extra benefit
We can provide recommendation to address internal control weakness to
management in the management letter as an extra service for example.

Fees
Fees should be broken down into how its calculated by clearly laying out different
classes of staff involved, such as hourly rate for audit manager and partner.
22
www.accaapc.com
(b)
Overdue fees
Where a client hasn't paid their fees there has been outstanding for some time and
such overdue fees would be seen as loan to client which may cause a self interest
threat, ie, in order to keep the loan auditor may issue whatever opinion that client
wants so that a safeguard for this is not to seek re-election.

Resources
As the company expands the audit firm may not have enough resources to do the
audit any more. Such as the company is listing on a stock exchange and the audit
firm is a lack of relevant experts who know the regulation of the stock exchange
and so the firm may not seek re-election.

Integrity
When the management doesn't comply with specific accounting standards such as a
deliberate failure to provide a provision in the financial statements and this action
would be seen as a lack of integrity.
So in order for the audit firm to remain good reputation they should not seek re-
election.

Conflict of interest
Such as the existing company we are auditing is damaging the environment and
didn't disclose the fact.
Another company is waiting for out firms tendering but they are competitors and if
we audit both companies which would cause a conflict of interest so we should
resign the first company as by continuing to be an auditor for this would damage
our firms reputation.



23
www.accaapc.com
(c)

Evaluation of matters to be considered:
Recourses
As dragon group has expanded rapidly in the last three years so we must ensure we
have enough audit staff to audit those components.

Management integrity
As a qualified opinion issued by previous auditor over a deliberate non-disclosure of
contingent liability we should question managements integrity and if they not
integrate then we should not accept the engagement service because if after
conducting the service and we find information we obtained is fake then it will still
have an impact on our audit opinion.

Previous auditor
It would be necessary to contact previous auditor to gather information regarding
the non disclosure of contingent liability with clients permission of whether it
should be disclosed in the individual financial statements of Mermaid Co, and at
group level.

Experiences
Given Minotaur Co is involved in distribution and warehousing but this is not a very
complicated industry for Unicorn&Co because it has its offices over 150countries
and it should have relevant experience into auditing this eg, bringing in staff from a
different department more experienced in clients with distribution operations

Time
There will be only 3months for Unicorn&Co to complete the audit and Unicorn&Co
should consider whether to allocate more recourses to this engagement given this
client is large and it needs to spend more time into it.
24
www.accaapc.com
Stage 4 of audit flowchart [Substantive procedures]

This is the main content within your p7 study.
Your examiner expects you to have a solid understanding of accounting
standards and the related audit procedures to them and hence make sure
you are able to master all those accounting standards in your study note.




















25
www.accaapc.com
IAS 11 Construction Contracts

Accounting Issues:

1,When youre trying to build this tower it may take you more than 1 year to finish.
After finishing off this tower and you may try to sell off to the client.
So before finishing off this tower will you keep it as a inventory?(IAS2)
The answer is no! Remember inventory is current asset which is less than 1
accounting year.

2,Next question is because the contractor is building this tower so he may have to
pay for material, labor costs etc. So when is the cost being recognized?
The contractor can get the sales revenue only when after selling off this tower to
client. So before selling off this tower, the contractor gets no cash from the client.
So does the contractor recognize no revenue at all?
To answer this question:
According to Prudence concept, the sales revenue should be recognized after
this tower has been sold off to the client.
According to Accruals concept, the expenses relating to the building of the
tower should be matched with the revenue from the tower.
So one is contradict with another. But here in this case, Accruals concept wins.

3,But how much does the revenue and expenses should be recognized?
IAS 11 Construction Contract gives us the guidance.




26
www.accaapc.com

4,
Guidance by IAS 11 construction contract (Diagram)




yes
No



yes
No



yes

5, Stage of completion





Recognize based on stage of
completion
Outcome is certain?
Profit making contract?
Fixed Price or Mark up?
Revenue=costs(no profit/loss)
Recognize loss in full
Profit=price(cost+mark up)-
cost
Mark up
27
www.accaapc.com


Sales basis method (work certified method):

work certified to date
Contract price

Cost method:

Costs incurred to date
Total contract costs














28
www.accaapc.com
Audit question [june2011 Q2] IAS11:

Construction Contract(attachment1)
In the last week, two significant issues have arisen at Bill Co. The first issue concerns a
major contract involving the development of an old riverside warehouse into a conference
centre in Bridgetown. An architect working on the development has discovered that the
property will need significant additional structural improvements, the extra cost of which is
estimated to be $350,000. The contract was originally forecast to make a profit of $200,000.
The development is currently about one third complete, and will take a further 15 months to
finish, including this additional construction work. The customer has been told that the
completion of the contract will be delayed by around two months. However, the contract
price is fixed, and so the additional costs must be covered by Bill Co.

Forecast profit before tax is $25 million.

Hello
Thanks for taking on the role of audit manager for the forthcoming audit of Bill Co.
(i) I have just received some information on two significant issues that have arisen over the
last week, from Sam Compton, the companys finance director. This information is provided
in attachment 1. I am asking you to prepare briefing notes, for my use, in which you
explain the matters that should be considered in relation to the treatment of these two
issues in the financial statements, and also explain the risks of material misstatement
relating to them. I also want you to recommend the planned audit procedures that
should be performed in order to address those risks.
(8 marks)







29
www.accaapc.com
Answer to [june2011 Q2] IAS11
Matters to be considered
Materiality:
The loss on the contract of $150,000 represents 6% of the forecast profit before tax and is therefore
material to the statement of profit or loss.

Accounting treatment:
1. The $150,000 loss needs to be recognized immediately to the statement of profit and loss and other
comprehensive income.

2. the delay completion of contract would result in penalties and this should be accounted for under
IAS37 provision, contingent liabilities and contingent asset.

Risks of material misstatement:

There is a risk that loss of $150,000 has not been recognized in the statement of profit or loss and
hence overstate the profit figure by $150,000.

There is also a risk that a failure to provide for a provision or disclose contingent liability in the note of
the FS and this would result in understatement of liability and expense or under disclosure.

Audit procedures:
Inspect the customer-signed contract to verify the fixed price and any penalty clauses
relating to late completion.

Recalculate the budget for the Bridgetown development to verify the accuracy of the
schedule and confirm the expected loss of $150,000.

Inspect report made by the architect regarding the structural improvements to verify the
estimate of the additional costs.

Discuss the additional costs with contractors to assess if the estimate appears
reasonable.

30
www.accaapc.com
Review Bill Cos cash flow forecast to ensure adequate funds to cover the additional costs.
Chapter2 Q7: 8,IAS12 Income Taxes

Accounting issues:

In the statement of profit or loss and other comprehensive income:

$
Sale revenue 1,000
Cost of sales (300)
Gross profit 700
Expenses (100)
Profit before tax 600
Tax expense (@30%) (50)
Profit after tax 550

You can see although tax rate is 30% but we use 30%Xprofit before
tax which does not equal to 50, why?

The reason being within the tax expense there are 3 components:
(mnemonics: CPD)

Current tax payable (based on last year taxable profit)
Provision (under/(over))
Deferred tax movement
31
www.accaapc.com
Because of permanent and temporary difference which leads to the difference in taxable profit
calculation and accounting profit calculation.

Permanent differences are the amounts which represent income or expense for accounting purposes
but are not taxable/allowable for tax purposes. Example: client entertaining.

Temporary differences are amounts which represent income or expense for accounting purposes and
tax purposes but in difference periods. Example: depreciation and capital allowances.
Notice: The deferred tax transfer is not cash flow!!!

Before we look at deferred tax, why not start off by looking at current taxation? (this is what you have
already learnt in F3, just a recap.)



Current tax:
Companies have to pay tax on taxable profits. The tax charge is normally
ESTIMATED at the end of the financial year and charged to the statement of
comprehensive income, and paid in the following year.

The double entry for taxation would be:
DR Taxation expense (Statement of comprehensive income)
CR Taxation liability (Statement of financial position)

The double entry for when the tax is paid a few months later:
DR Taxation liability (Statement of financial position)
CR Bank (Statement of financial position)

32
www.accaapc.com
Since the amount paid is likely to differ from the estimated tax charge originally
recognized, a balance will be left on the taxation liability account being an under or
over provision of the tax charge.
Deferred tax:

What is deferred tax?

Illustrate with an example:
Imagine you have a building with a carrying value of $1000. During the year you
have revalued this building to $1,100 then you make a profit from it of $100 which
is not realized yet.

DR NCA 100
CR revaluation reserve 100

So for the tax mans perspective, because you will somehow in the future realized
this profit when sold so they may require you to provide for a future tax
obligation(deferred tax) of $100Xtax rate although you are not paying money now
but you will in the future.

Concept:
So we know that deferred tax is a future obligation to be settled by company
depending on the future tax law. So deferred tax does not necessarily fulfill the
liability definition (present obligation).

Deferred tax arises because of temporary differences (TD). Temporary difference is
the difference between CV and TB.
DT=TD* X CT%
*TD=CV - TB
33
www.accaapc.com
TD: Temporary difference between carrying value and tax base
CV: Carrying value of asset/liability.
TB: tax base in the tax mans book.(in real practice we will try to refer to
different tax regulations to calculate the tax base)
DT: Deferred tax liability/asset
CT%: Corporation tax rate


Deferred tax is a future liability recognized today. And deferred tax is based on
temporary difference (timing difference between accounting and tax law). So the
amount we owe to the tax authority will be finally paid back to them in the
subsequent years.

Typically, in P7, Deferred Tax Asset is most commonly tested.
The recoverability of Deferred Tax Asset will be limited depending on the forecast
profit company will make.




Audit Works: [Q11:DEC2008 Q1] Income taxes IAS 12
So we usually focus on the profit forecast, management accounts for the company
performance to estimate the company future profit making ability to establish if it
can utilize the deferred tax asset (unutilized losses) to set against the future profit.




34
www.accaapc.com
Audit question: [Q11:DEC2008 Q1] IAS 12

(b) Describe the principal audit procedures to be carried out in respect of the
following:
(ii) The recoverability of the deferred tax asset.
(4 marks)






Answer to [Q11:DEC2008 Q1] Income taxes IAS 12

(ii) Principal audit procedures recoverability of deferred tax asset

Agree figures in the current and deferred tax calculation to tax correspondence.

Inspect profitability forecast to agree there is enough forecast taxable profit to offset
against the loss.

Perform analytical procedure by evaluating assumptions used in the forecast to ensure
its in line with auditors business understanding.

Perform analytical procedure by assessing time taken to generate profit to recover tax
losses and if it takes many years to generate such profit and the recognition of deferred
tax asset would be restricted.

Inspect tax correspondence to verify theres no restriction for company to carry forward
and use losses against future taxable profits.



35
www.accaapc.com
Chapter2 Q7: 9,IAS16 Property, Plant and Equipment

Accounting Issues:
Initial measurement:
Capital expenditure
Capital expenditure is the costs of acquiring non-current assets.
According to IAS 16 the following costs may be capitalised in the statement of
financial position on acquisition of a non-current asset:
(Mnemonic: IIIID)
Initial cost (purchase price)
Import duty not refundable(if asset is bought from other country)
Installation costs
Intended use relating costs (lawyer, surveyor costs)
Delivery costs

Finance cost (IAS 23 see F7 & P2)

Revenue expenditure
Revenue expenditure is expenditure on maintaining the capacity of noncurrent
assets. Costs that are regarded as revenue expenditure should be expensed in the
statement of comprehensive income and may not be capitalised according to IAS 16
are:
(Mnemonic: RIM)
Repairs expenses
Insurance expenses
Maintenance expense

36
www.accaapc.com
After weve purchased the non current asset the accountant needs to record that
non current asset into the non- current asset register.
A non-current asset register is generally maintained in the finance department.
Companies can purchase specifically designed packages or a register can simply be
maintained on an Excel spreadsheet.
And this is used to reconcile the NCA in the NCA register to the individual asset in
place, ie, an example of control procedure by company.

Sample of Non-current asset register:
Asset
type
Date purchased Description Cost Depreciation Carrying
value
Disposal
proceeds
Disposal date
Machine
1 July 2013
Drink
machine
$7m

Year ended 31 DEC 2013
$700,000 $6.3m

Year ended 31 DEC 2014
$3m Jan-2014

Subsequent measurement

Cost model: cost-accumulated depreciation*=carrying value

Depreciation method should be reviewed each year to see whether or not it is
reasonable. A change in depreciation method should be treated as a change in
accounting estimate and prospective adjusting method according to IAS 8 should be
applied. Ie, disclose the depreciation method in the note of the financial statements.

Revaluation Model: revalued amount



37
www.accaapc.com
IAS 16 the test was whether the expenditure was Capital or Revenue e.g. an improvement
could be capitalised but maintenance or repair could not be capitalized.

The following circumstances should be capitalized:
(mnemonics: LOSE)

L: Life extension
O: major overhaul cost
S: separate component, eg, new enguine for an aircraft
E: energy saving, eg, improving production capacity


Basic idea:
1, economic benefits are excessed
2, component treated seperatly
3, major overhaul cost










38
www.accaapc.com

Revaluation
Basic Idea:
As time goes by initial costs of asset may be very different from their market value.

Eg, if a company purchased a property 35 years ago and therefore subsequently
charged depreciation for 35 years, it would be safe to assume that the carrying
value of the asset would be significantly different from todays market value.

If revaluation policy per IAS 16 may be adopted (i.e. the business has a choice),
and if so the following rules must be applied per the standard: (mnemonic: CRRR)

1, No Cherry picking(If a company chooses to revalue an asset they must revalue all assets in that category.)
2, Regular (Revaluations must be regular but IAS 16 doesn't specify how often)
3, Revalued amount(Subsequent depreciation must be based on the revalued amounts.)
4, Revaluation Reserve (Gains from revaluations are taken to revaluation reserve rather than retained earnings
unless they are sold)
Calculation:
$
Revalued amount X
CV of asset on revaluation date (X)
Revaluation gain/(loss) X/(X)


Journal
DR Asset cost (Statement of financial position)
DR Accumulated depreciation (Statement of financial position)
39
www.accaapc.com
CR Revaluation reserve (Statement of financial position)
Audit work:
IAS16 PP&E does not test it much, but if the asset involves finance cost and then
make sure its capitalized correctly.

Also, if it involves impairment issue ,then make sure an impairment test is properly
conducted by management. Also the discount rate used by management to
determine value in use of the asset should be verified for reasonableness.


















40
www.accaapc.com
Chapter2 Q7: 10,IAS17 Leases

Accounting issues:

Introduction
You want to have a photocopier and you have two choices:
1, you can buy it and then you become the owner of the photocopier;
2, you can lease it from the lessor and then you would become the lessee.
Long term-finance lease
Short term-operating lease

But the key to differentiate between them is not just the time length it takes but
rather substance over form.

IAS 17 leases describes two types (forms) of leases:
*Finance lease: lease that transfers the risks and rewards of the asset from the
lessor to the lessee.
*Operating lease: any leases other than finance lease.








41
www.accaapc.com
5 senarios
So the substance over form concept behind it can be summarized as follows:
IAS 17 prescribes there are 5 common scenarios that the lease is a finance lease.
(one of them fulfilled then its a finance lease and if none of them fulfills then its an
operating lease.)

1, ownership of asset has been transferred from lessor to lessee.
2, lessee has the option to purchase asset at a price which is sufficiently lower than
its FV.
3, lease term is almost the same as the major part of economic life of asset.
(IFRS doesn't specify the period but US GAAP has given us guidance of >75%.)
4, at the start of the lease, PV of minimum lease payment is close to FV of asset.
(again, IFRS doesn't specify the percentage but US GAAP has given us a guidance
of >90%.)
5, leased assets are specified nature and can only be used by lessee and they can
be used by others if any significant modification to assets occurs.











42
www.accaapc.com
Risks and rewards

But the idea behind it is when the majority risks and rewards has been transferred
from the lessor to lessee then its considered to be a finance lease.
So the typical risks and rewards may include:

Risks:
costs of repairing, maintaining and insuring the assets.
Risk of obsolescence
Risks of losses from idle capacity of the asset (if machine breaks down then lessee
bears the loss)

Rewards:
Use of assets for almost all of its useful life.
Use of the assets is not disrupted.











43
www.accaapc.com
Accounting Treatment:
Lessee

Lessor

Finance lease:
Initial measurement DR PPE
CR lease liability
DR lease receivable
CR lease asset
Subsequent measurement PPE:
DR I/S-depre expense
CR accumulated
depreciation

Lease liability:
DR lease liability
DR I/S-finance cost
CR cash






DR cash (from lessee)
CR lease receivable
CR I/S-interest income
Operating lease:
Expense the lease
payment on a straight
line basis

DR I/S
CR cash
Expense the lease revenue
received on a straight line basis
DR cash
CR I/S
Keep the assets in FS and
depreciates it.
DR I/S-depreciation expense
CR accumulated depreciation


44
www.accaapc.com
Sale and leaseback transaction:

Idea: any abnormal gain/loss would be deferred and released back as income over
the life of the lease.

Accounting question:

Q: Finco Ltd
Finco Ltd has 4 sale and leaseback transactions during the year which can be shown
as follows:

Description
Sale proceeds
$m
Fair value
$m
Book(carrying) value
$m
1, sale and finance lease back 50 50 32
2, sale at fair value operating lease back 80 80 55
3, sale at overvalue and operating lease
back
85 65 70
4, sale at undervalue and operating lease
back
65 85 60

Required:
Show how to deal with the above transactions.





45
www.accaapc.com
Audit work:

1The main piece of audit evidence is the lease agreement, as this will allow the
auditor to:
1Agree the length of the lease
2Agree the lease payments
3Assess how much of the rights and obligations of ownership have been
transferred.

2 For operating leases, any prepayment or accrual should be recalculated.

3 For finance leases, the present value of minimum lease payments should be
recalculated and the discount rate agreed as appropriate.


[June2009Q3] leases










46
www.accaapc.com

Audit question1: [June2009Q3] leases

Robster Co is a company which manufactures tractors and other machinery to be
used in the agricultural industry. You are the manager responsible for the audit of
Robster Co, and you are reviewing the audit working papers for the year ended 28
February 2009. The draft financial statements show revenue of $105 million, profit
before tax of $32 million, and total assets of $45 million.

Two matters have been brought to your attention by the audit senior, both of which
relate to assets recognised in the statement of financial position for the first time
this year:

Leases
In July 2008, Robster Co entered into five new finance leases of land and buildings.
The leases have been capitalized and the statement of financial position includes
leased assets presented as non-current assets at a value of $36 million, and a total
finance lease payable of $32 million presented as a non-current liability.

Required:
(a) In your review of the audit working papers, comment on the matters
you should consider, and state the audit evidence you should expect to find
in respect of:

(i) the leases (8 marks)





47
www.accaapc.com
Answer to audit question1 [June2009Q3] leases

Matters to consider
Materiality
The amount recognised in non-current assets accounts for 8% of total assets, and the total finance
lease payable accounts for 71% of total assets so they are material to statement of financial position.

Accounting treatment
Whether this is finance lease or operating lease and the key is to see whether risk and
reward of ownership of assets has been passed from lessor to lessee.

Indicators where risks and rewards have been transferred:

1. Robster Co is responsible for repairs and maintenance of the assets
2. Robster Co can obtain this asset at nominal value at the end of asset life.
3. The lease period is almost the same as useful life of the assets
4. The present value of the minimum lease payments is amounts to most of the fair value of the
asset.
Finance cost associated with leases would need to be expensed to statement of profit or
loss.

Leased asset should be depreciated over the shorter of lease term and economic useful
life of assets.

The finance lease payable recognised of $32 million should be split between current and
non-current liabilities in the statement of financial position.

Audit evidence
A review of the lease contract including consideration of the major clauses of the lease
which indicate whether risk and reward has passed to Robster Co.
A calculation of the present value of minimum lease payments and comparison with the
fair value of the assets obtained from lease contract at the start of the lease.
A recalculation of the finance charge expensed during the accounting period, and
agreement of the interest rate used in the lease contract.
Agreement to the cash book of amounts paid to the lessor.
A recalculation of the depreciation charged, and agreement that the period used in the
calculation is the shorter of the lease term and the useful life of the assets.
A recalculation and confirmation of the split of the total finance lease payable between current and
non-current liabilities.