technical
post-balance sheet events
relevant to Professional Scheme Paper 3.1
after the event?
Candidates attempting Paper 3.1 should
find Question 3 relatively straightforward, as
its style and standard have barely changed
since the Pilot Paper in 2001. However, to
prepare for this question, candidates should
read the article ‘Technique in auditing
questions’, student accountant, September
2001, and any relevant examiner’s feedback,
such as that published in student accountant
in October 2005. This article provides
additional help, and considers post-balance
sheet events.
52 student accountant January 2006
CASE STUDY
By way of a case study, consider Question 3 of
the June 2005 exam. The requirement is ‘to (i)
comment on the matters … and (ii) state the
audit evidence that you should expect to find,
in undertaking your review of audit working
papers…’.
Question 3
You are the manager responsible for the
audit of Volcan, a long-established limited
liability company. Volcan operates a national
supermarket chain of 23 stores, five of which
are in the capital city, Urvina. All the stores
are managed in the same way with purchases
being made through Volcan’s central buying
department and product pricing, marketing,
advertising and human resources policies
being decided centrally. The draft financial
statements for the year ended 31 March
2005 show revenue of $303 million (2004
– $282 million), profit before taxation of $9·5
million (2004 – $7·3 million) and total assets
of $178 million (2004 – $173 million). The
following issues arising during the final audit
have been noted on a schedule of points for
your attention:
a On 1 May 2005, Volcan announced its
intention to downsize one of the stores
in Urvina from a supermarket to a ‘City
Metro’ in response to a significant decline
in the demand for supermarket-style
shopping in the capital. The store will be
closed throughout June, re-opening on
1 July 2005. Goodwill of $5·5 million
was recognised three years ago when
this store, together with two others, was
bought from a national competitor. It is
Volcan’s policy to write off goodwill over
five years. (7 marks)
b On 1 April 2004 Volcan introduced a
‘reward scheme’ for its customers. The
main elements of the reward scheme
include the awarding of a ‘store point’
to customers’ loyalty cards for every $1
spent, with extra points being given for the
purchase of each week’s special offers.
Customers who hold a loyalty card can
technical
convert their points into cash discounts
against future purchases on the basis of
$1 per 100 points. (6 marks)
c In October 2004, Volcan commenced
the development of a site in a valley of
‘outstanding natural beauty’ on which to
build a retail ‘megastore’ and warehouse
in late 2005. Local government planning
permission for the development, which
was received in April 2005, requires that
three 100-year-old trees within the valley
be preserved and the surrounding valley
be restored in 2006. Additions to property,
plant and equipment during the year
include $4·4 million for the estimated cost
of site restoration. This estimate includes a
provision of $0·4 million for the relocation
of the 100-year-old trees. In March 2005
the trees were chopped down to make way
for a car park. A fine of $20,000 per tree
was paid to the local government in May
2005. (7 marks)
MATTERS TO CONSIDER
Most candidates understand that materiality
needs to be assessed, and can, as a result,
gain up to six marks for dealing with this over
the three parts of this question. Note however,
that assessing materiality does not mean
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
will be awarded to candidates who interpret
materiality appropriately (ie only in relation to
relevant amounts).
Now consider Question 3. Don’t calculate
materiality for each of the three matters, but
identify which of the measures (ie revenue,
profit before tax and/or total assets) is relevant
and indicate Y (relevant) or N (not relevant)
in Table 1 on page 55. Please note, before
reviewing the ‘solution’ in Table 2, that this
exercise does not seek to assess materiality,
only the calculations that are relevant to
assessing materiality.
POST-BALANCE SHEET EVENTS
Many candidates appear uncertain when
dealing with post-balance sheet event issues,
53 student accountant January 2006
many writing, in their answer to (a), ‘It is a
post-balance sheet event.’ But what is ‘it’?:
the announcement?
the closure?
the re-opening?
the decline in demand?
Sketching a timeline as part of an answer
plan can be very constructive and can
establish a ‘picture’ of the situation. See
Figure 1 on page 55.
So:
the announcement? yes … 1 May
the closure? yes … June
the re-opening? yes … 1 July
These are all post-balance sheet events.
Next question: are they ‘adjusting’ or
‘non-adjusting’? Remember, adjusting events
provide additional evidence of condition(s)
existing at the balance sheet date. Adjustments
that affect the balance sheet can only be:
increases in liabilities (eg recognition of a
provision not previously recognised)
decreases in liabilities (eg derecognition
of, or reduction in, a provision previously
recognised)
increases in assets (eg reduction in an
allowance previously recognised)
decreases in assets (eg due to
impairment).
In this case there can be no provisions,
for example, for redundancy payments (or
other costs) arising from the closure. There
is no liability at the balance sheet date and
a provision must meet the definition of a
liability. Only if the announcement had been
made before the balance sheet date, so that a
‘valid expectation’ had been created in those
affected, should provision be made for the
constructive obligation arising.
A credit, therefore, cannot be created as a
liability. But consider the alternative: creating
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
date which ‘triggers’ a store impairment review
(including goodwill). The announcement and
closure provide evidence of the condition.
PROVISION FOR SITE RESTORATION
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.
Having had time to think about what is
going on, which of the following answer points
would earn marks?:
the provision for the relocation should not
be made because the planning permission
is a non-adjusting post-balance sheet event
IAS 37 (FRS 12) prohibits provisions for
relocations after the balance sheet date.
Answer – neither. Obtaining planning
permission did not change the situation that
existed at the balance sheet date, namely that
the development had commenced and that
provision for site restoration, etc should be
made only if a liability exists at the balance
sheet date. This is the main issue – whether a
liability (legal or constructive) exists. It is true
that IAS 37 (FRS 12) prohibits provisions for
staff relocations after the balance sheet date
following a business restructuring, but this is
irrelevant.
What should be clear is that:
$0.4m of the provision was not suitable
because the trees had been chopped down
(see in Figure 2) and so could not
be relocated
the fine, though immaterial, should be
provided.
There was an easy mark for candidates
who linked these points and stated that the
overprovision ($0.34m) should be written
back.
CONCLUDING REMARKS
Misreading the facts, misunderstanding the
situation, and lack of accounting knowledge
contributed to many incorrect answer points
for this particular question. For example:
‘development of a site’ (as per the
question) could not be intangible (as in
‘research and development’)
accounting for construction contracts
was similarly irrelevant (Volcan was not a
building contractor)
there were only three 100-year old trees,
not 100 three-year old trees
technical

IAS 16 (FRS 15) does not prohibit TABLE 1

capitalisation of restoration costs – on Total assets Profit before tax Revenue
the contrary, it requires it where there is a Goodwill carrying value $3.3m
a liability to be recognised under IAS 37
(FRS 12). a Goodwill amortisation/expense $1.1m

SOLUTION b Discount (amount unspecified)

See Table 2 below.
c Provision for restoration $4.4m
Notes
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 FIGURE 1
that might need to be written off to profit or Announcement Closure
loss (in the event of impairment/ Y/e 31/3/05
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 Re-opening
‘other side of the entry’ is a balance sheet Decline in demand
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.
3 That the amount is not specified is FIGURE 2
irrelevant to the exercise, but note that it is Y/e 31/3/05 $4.4m Fine paid $60k Restoration (2006)
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, October 2004 Planning permission Build megastore
not when they are redeemed. The reduction Development
in revenue (or, arguably, increase in cost commences
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).
4 As the provision for restoration has N N Y 4 c Provision for restoration $4.4m
not been expensed, but treated as a
cost (of developing the megastore), Y Y Y 3 b Discount (amount unspecified)
it is not relevant to profit before tax.
Such ‘decommissioning’ expenses are N Y Y 2 a Goodwill amortisation/expense $1.1m
recognised in profit or loss through
increased depreciation charges in future N Y Y 1 a Goodwill carrying value $3.3m
years. Revenue Profit before tax Total assets Note
TABLE 2
Kim Smith is examiner for Paper 3.1

54 student accountant January 2006