(b) Explain the matters that should be considered when planning the nature and scope of the examination of

Cusiter Co’s forecast balance sheet and income statement as prepared for the bank. (7 marks)

3 The Stiletto Partnership consisted of three partners, Clint, Ben and Amy, who shared the profits of the business

equally. On 28 February 2007 the partners sold the business to Razor Ltd, in exchange for shares in Razor Ltd, with

each former partner owning one third of the new company.

The recent, tax adjusted, trading profits of the Stiletto Partnership have been as follows:

￡

Year ended 30 June 2006 92,124

1 July 2006 to 28 February 2007 81,795

Clint, who was 65 on 5 October 2006, retired when the business was sold to Razor Ltd. He is now suggesting that

if the sale of the partnership, and his retirement, had been delayed until 30 April 2007, his total tax liability would

have been reduced. Clint’s only other income is gross pension income of ￡6,100 per year, which he began receiving

in the tax year 2005/06. Clint did not receive any salary or dividends from Razor Ltd. It is estimated that the

partnership’s tax adjusted trading profits for the period from 1 March 2007 to 30 April 2007 would have been

￡20,760. Clint has overlap profits of ￡14,250 brought forward from when the partnership began trading.

Razor Ltd manufactures industrial cutting tools. On 1 July 2007, Razor Ltd will subscribe for the whole of the ordinary

share capital of Cutlass Inc, a company newly incorporated in the country of Sharpenia. It is intended that Cutlass

Inc will purchase partly finished tools from Razor Ltd and customise them in Sharpenia. It is anticipated that Cutlass

Inc’s annual profits chargeable to corporation tax will be approximately ￡120,000.

Ben and Amy will be the directors of Cutlass Inc, although Ben will not be involved in the company’s business on a

day-to-day basis. Amy intends to spend one or two weeks each month in the country of Sharpenia looking after the

company’s affairs. The remainder of her time will be spent in the UK. Amy has employment contracts with both Razor

Ltd and Cutlass Inc and her duties for Cutlass Inc will be carried out wholly in Sharpenia. Cutlass Inc will pay for

Amy’s flights to and from Sharpenia and for her husband and baby to visit her there twice a year. Amy is currently

UK resident and ordinarily resident.

The system of income tax and corporation tax in the country of Sharpenia is broadly similar to that in the UK although

the rate of corporation tax is 38% regardless of the level of profits. There is a double tax treaty between the UK and

Sharpenia based on the OECD model treaty. The clause in the treaty dealing with company residency states that a

company resident in both countries under domestic law will be regarded under the treaty as being resident only in the

country where it is effectively managed and controlled. Sharpenia is not a member of the European Union.

Required:

(a) (i) Calculate Clint’s taxable trading profits for the tax years 2006/07 and 2007/08 for both of the

alternative retirement dates (28 February 2007 and 30 April 2007). (3 marks)

6 Sergio and Gerard each inherited a half interest in a property, ‘Hilltop’, in October 2005. ‘Hilltop’ had a probate value

of ￡124,000, but in November 2005 it was badly damaged by fire. In January 2006 the insurance company made

a payment of ￡81,700 each to Sergio and Gerard. In February 2006 Sergio and Gerard each spent ￡55,500 of the

insurance proceeds on restoring the property. ‘Hilltop’ was worth ￡269,000 following the restoration work. In July

2006, Sergio and Gerard sold ‘Hilltop’ for ￡310,000.

Sergio is 69 years old and a widower with three adult children and seven grandchildren. His annual income consists

of a pension of ￡9,900 and interest of ￡300 on savings of ￡7,600 in a bank deposit account. Sergio owns his home

but no other significant assets. He plans to buy a domestic rental property with the proceeds from the sale of ‘Hilltop’,

such that on his death he will have a significant asset which can be sold and divided between the members of his

family.

Gerard is 34 years old. He is employed by Fizz plc on a salary of ￡66,500 per year together with a performance

related bonus. Gerard estimates that he will receive a bonus in December 2007 of ￡4,500, in line with previous

years, and that his taxable benefits in the tax year 2007/08 will amount to ￡7,140. He also expects to receive

dividends from UK companies of ￡1,935 and bank interest of ￡648 in the tax year 2007/08. Gerard intends to set

up a personal pension plan in August 2007. He has not made any pension contributions in the past and proposes to

use part of the proceeds from the sale of ‘Hilltop’ to make the maximum possible tax allowable contribution.

Fizz plc has announced that it intends to replace the performance related bonus scheme with a share incentive plan,

also linked to performance, with effect from 6 April 2008. Gerard estimates that Fizz plc will award him free shares

worth ￡2,100 each year. He will also purchase partnership shares worth ￡700 each year and, as a result, will be

awarded matching shares (further free shares) worth ￡1,400.

Required:

(a) Calculate the chargeable gains arising on the receipt of the insurance proceeds in January 2006 and the sale

of ‘Hilltop’ in July 2006. You should assume that any elections necessary to minimise the gain on the receipt

of the insurance proceeds have been submitted. (4 marks)

(c) Briefly discuss why the directors of HFL might choose contract D irrespective of whether or not contract D

would have been selected using expected values as per part (a). (2 marks)

(b) Wallace Co; and (5 marks)

(b) Assess the likely strategic impact of the new customer delivery system on Supaserve’s activities and its ability

to differentiate itself from its competitors. (10 marks)

1 Bailey’s is a large toy manufacturer based in a traditional industrial region. Established in the 1970s, it has faced many changes in the market and survived. This has been due in part to employing a largely unskilled low paid staff,and maintaining its main advantage, that of low production costs based on low pay. Most of the production involves repetitive and boring work with little challenge and opportunity for innovation. Although many of the employees have

been with the company for some time, there has been a high level of employee turnover.

However, an unhappy atmosphere has been apparent for some time. There has been a number of instances ofarguments between the staff, friction between different departments, disturbance, low morale, poor production and general unrest, made worse recently by a decline in business which may lead to staff reduction and redundancy. Poor pay is leading to family problems that are affecting the commitment and motivation of the employees.

The business was recently sold to the new owner, Rebecca Stonewall. She is concerned that the negative atmosphere she has found will harm the prospects of the business and is determined to address the issues that have become apparent.

She has therefore decided that it is time to take account of opinions and views of the employees in an attempt both to identify the problems and to resolve them. She has appointed external counsellors since she thinks that a programme of individual counselling might be appropriate and is also of the opinion that some form. of different or improved approach to motivation might be the answer to the problems at Bailey’s.

Required:

(a) Define the role that the external counsellor must fulfil at Bailey’s. (3 marks)

You are the audit manager of Chestnut & Co and are reviewing the key issues identified in the files of two audit clients.

Palm Industries Co (Palm)

Palm’s year end was 31 March 2015 and the draft financial statements show revenue of $28·2 million, receivables of $5·6 million and profit before tax of $4·8 million. The fieldwork stage for this audit has been completed.

A customer of Palm owed an amount of $350,000 at the year end. Testing of receivables in April highlighted that no amounts had been paid to Palm from this customer as they were disputing the quality of certain goods received from Palm. The finance director is confident the issue will be resolved and no allowance for receivables was made with regards to this balance.

Ash Trading Co (Ash)

Ash is a new client of Chestnut & Co, its year end was 31 January 2015 and the firm was only appointed auditors in February 2015, as the previous auditors were suddenly unable to undertake the audit. The fieldwork stage for this audit is currently ongoing.

The inventory count at Ash’s warehouse was undertaken on 31 January 2015 and was overseen by the company’s internal audit department. Neither Chestnut & Co nor the previous auditors attended the count. Detailed inventory records were maintained but it was not possible to undertake another full inventory count subsequent to the year end.

The draft financial statements show a profit before tax of $2·4 million, revenue of $10·1 million and inventory of $510,000.

Required:

For each of the two issues:

(i) Discuss the issue, including an assessment of whether it is material;

(ii) Recommend ONE procedure the audit team should undertake to try to resolve the issue; and

(iii) Describe the impact on the audit report if the issue remains UNRESOLVED.

Notes:

1 The total marks will be split equally between each of the two issues.

2 Audit report extracts are NOT required.

(iii) cheese. (4 marks)