18 Which of the following statements about accounting ratios and their interpretation are correct?

1 A low-geared company is more able to survive a downturn in profit than a highly-geared company.

2 If a company has a high price earnings ratio, this will often indicate that the market expects its profits to rise.

3 All companies should try to achieve a current ratio (current assets/current liabilities) of 2:1.

A 2 and 3 only

B 1 and 3 only

C 1 and 2 only

D All three statements are correct

(b) Using the TARA framework, construct four possible strategies for managing the risk presented by Product 2.

Your answer should describe each strategy and explain how each might be applied in the case.

(10 marks)

4 (a) The purpose of ISA 510 ‘Initial Engagements – Opening Balances’ is to establish standards and provide guidance

regarding opening balances when the financial statements are audited for the first time or when the financial

statements for the prior period were audited by another auditor.

Required:

Explain the auditor’s reporting responsibilities that are specific to initial engagements. (5 marks)

(ii) how effective delegation might be achieved; (6 marks)

(b) When a director retires, amounts become payable to the director as a form. of retirement benefit as an annuity.

These amounts are not based on salaries paid to the director under an employment contract. Sirus has

contractual or constructive obligations to make payments to former directors as at 30 April 2008 as follows:

(i) certain former directors are paid a fixed annual amount for a fixed term beginning on the first anniversary of

the director’s retirement. If the director dies, an amount representing the present value of the future payment

is paid to the director’s estate.

(ii) in the case of other former directors, they are paid a fixed annual amount which ceases on death.

The rights to the annuities are determined by the length of service of the former directors and are set out in the

former directors’ service contracts. (6 marks)

Required:

Draft a report to the directors of Sirus which discusses the principles and nature of the accounting treatment of

the above elements under International Financial Reporting Standards in the financial statements for the year

ended 30 April 2008.

3 You are the manager responsible for the audit of Seymour Co. The company offers information, proprietary foods and

medical innovations designed to improve the quality of life. (Proprietary foods are marketed under and protected by

registered names.) The draft consolidated financial statements for the year ended 30 September 2006 show revenue

of $74·4 million (2005 – $69·2 million), profit before taxation of $13·2 million (2005 – $15·8 million) and total

assets of $53·3 million (2005 – $40·5 million).

The following issues arising during the final audit have been noted on a schedule of points for your attention:

(a) In 2001, Seymour had been awarded a 20-year patent on a new drug, Tournose, that was also approved for

food use. The drug had been developed at a cost of $4 million which is being amortised over the life of the

patent. The patent cost $11,600. In September 2006 a competitor announced the successful completion of

preliminary trials on an alternative drug with the same beneficial properties as Tournose. The alternative drug is

expected to be readily available in two years time. (7 marks)

Required:

For each of the above issues:

(i) comment on the matters that you should consider; and

(ii) state the audit evidence that you should expect to find,

in undertaking your review of the audit working papers and financial statements of Seymour Co for the year ended

30 September 2006.

NOTE: The mark allocation is shown against each of the three issues.

(c) Describe the audit procedures you should perform. to determine the validity of the amortisation rate of five

years being applied to development costs in relation to Plummet. (5 marks)

3 Mark Howe, Managing Director of Auto Direct, is a victim of his own success. Mark has created an innovative way

of selling cars to the public which takes advantage of the greater freedom given to independent car distributors to

market cars more aggressively within the European Union. This reduces the traditional control and interference of the

automobile manufacturers, some of whom own their distributors. He has opened a number of showrooms in the

London region and by 2004 Auto Direct had 20 outlets in and around London. The concept is deceptively simple;

Mark buys cars from wherever he can source them most cheaply and has access to all of the leading volume car

models. He then concentrates on selling the cars to the public, leaving servicing and repair work to other specialist

garages. He offers a classic high volume/low margin business model.

Mark now wants to develop this business model onto a national and eventually an international basis. His immediate

plans are to grow the number of outlets by 50% each year for the next three years. Such growth will place

considerable strain on the existing organisation and staff. Each showroom has its own management team, sales

personnel and administration. Currently the 20 showrooms are grouped into a Northern and Southern Sales Division

with a small head office team for each division. Auto Direct now employs 250 people.

Mark now needs to communicate the next three-year phase of the company’s ambitious growth plans to staff and is

anxious to get an understanding of staff attitudes towards the company and its growth plans. He is aware that you

are a consultant used to advising firms on the changes associated with rapid growth and the way to generate positive

staff attitudes to change.

Required:

(a) Using appropriate strategies for managing change provide Mark with a brief report on how he can best create

a positive staff response to the proposed growth plans. (12 marks)