Auditing and Financial Statements of Gr8 Hols Ltd

Company History and Ownership

Gr8 Hols Ltd prepares annual financial statements to 30 September. It was established by John Cougar and his wife Mary in 1992 operating as the owner of a small single caravan and camping site based near the village of Taithness in Western Scotland. John and Mary retired from the company in January 2017 having overseen the number of sites grow to a total of seven all based in Scotland and the north of England. On their retirement from the company John and Mary sold  25 %  of the share  capital in the company   to friends  and distant  family members,  and the remaining  75%,   in equal  proportions to their  two sons, Reeves and  Jukka  and their daughter  Sabina - all three of whom were then appointed as the only directors of the company.  Whilst Sabina had always worked for the company at the Taithness site prior to obtaining her directorship, neither of the brothers had any experience of working in the camping or tourism sectors. Reeves, who tends to dominate his younger siblings, had previously been a full-time student and then university researcher and Jukka had worked as an area sales manager for a baby food manufacturer. However, all three are very entrepreneurial. This, combined with the fact that the company’s financial  director  is  an enthusiastic 24 year old, and  long - standing family  friend with a degree in Business Studies and Accounting,  gave John, Mary and the  other  shareholders confidence that the brothers and sister could take the company forward and expand its operations.

In 2017 the company commenced a five year controlled expansion program, as a result of which the company has established a further two sites based in England. Each and  every  year,  all of the company’s  sites  are open 7  days a week   for 35 weeks  throughout the year  for hires, and closed during the 17 weeks leading up to the end of April  for site repairs, renovations and improvements.

The company owns 1020 caravans and 1450 family tents, all of which remain static on its   sites, and are hired on a weekly basis to holidaymakers. A payment in advance (deposit), of 30% of the hire cost is payable at the time of booking and the balance at least ten   weeks before the letting period. Deposits are kept by the company if bookings are cancelled within eight weeks of the hire period. On average, caravans and tents are   booked four months in advance. Additionally, there are 300 caravan and 900 tent pitches for hire “on demand”.  Payment for these pitches is payable strictly by cash on arrival at each site and pitches are hired out at flat rates irrespective of the number of occupants. Chargeable facilities on all sites include washing and laundry rooms, child care facilities, a gym, a café and a social club with evening cabaret. The Taithness site also has a swimming pool and spa facilities. Customers pay by cash, or debit/credit card for the use of all these facilities.  On each site there are also amusement arcades and a mini-supermarket, all owned by the company.

Operations and Services

Your firm are  part  of the team auditing  the financial statements of Gr8 Hols Ltd, and having carried out the necessary audit procedures on the final day of the accounting period, staff are now preparing to carry out the detailed final audit for the year ended 30 September 2019. The audit manager in charge  has ascertained  the following information relevant to the audit:

(i) The company’s  reported gross sales from all revenue streams was £7.2 million with net profit before tax of £1.1  million. The company adopts   uniform accounting  systems and policies  for all sites and  the Taithness site is its  largest and most profitable site.  Materiality  levels  set  for the  audit  include amounts equivalent to 5 % of th company’s total   net profit before tax.

 (ii) Initial  conversations with the  directors have revealed that,  in general occupancy  rates of caravans at sites were lower than those for tents. This  seemed  to be as a consequence  of   families  having  less money  to spend  on holidays due to the current economic difficulties in the United Kingdom. The directors define occupancy” as  ‘the  actual  unit  nights  of hire , divided  by the  available  unit  nights of hire for the holiday season’.

 On  1^st February  2019 , following a  three month  period of parallel running  with  its  old accounting the company introduced a new  computer - based  accounting system. The new  system  is highl advanced,   designed  and  tailor - made for Gr8  Hols  Ltd by  a reputable  software design company.  When  discussing the  new system with your  firm's audit partner , Sabina  commented : the system's highly advanced and  a vast improvement  on the old system. It's so much quicker  in processing  transactions,   and  produces a vast range of  useful statistical reports  in addition  to  the  monthly financial accounts, which as  you know  we use  as a basis to prepare  the  annual accounts audited  by your firm .   It’s such a reliable system that  you won't need to  do any  detailed  checking of  the  company's accounting  transactions   processed since  1st  February, so we're expecting  aconsequent   in your  audit fees , as compared to  last year "      

 (iv)    The company has  followed a long -  established policy of employing  a   relatively small number of permanent staff on sites and in the centralised   administration,  booking  and accounts offices gearing up  with over  200 temporary workers for employment throughout the period May  December  only.   Whilst  site  employees are provided with caravan   accommodation  and fremeals on site, to enable them to properly carryout their employment duties; compared  to  employees working in other sectors - the employees of GR8 Hols Ltd have poor pay and working conditions. In arecent   email exchange   between  Sabina and  your firm's audit  partner, Sabina commented:As directors of the company  my brothers and I are aware of the various  risks to our business risks ),  and we  do take   regular account of these with a view to mitigating them,especially when exercising our recruitment policy.  I  have   to say that I'm really puzzled and  -given your hourly  charge out rates- concerned that you  seem to spend so much time finding out about all of the business risks we face.   What has business risk got to do with auditing?Please send me an email in which you provide a critical explanation addressing my concern. Also, given your own apparent  expertise  in the identification  and mitigation of   all  types of business risse include  commentary  on how  you would feel about  providing us with ongoing  business mitigation advice in addition to external audit services,  and  an estimate  of  how much you would charge for this additional service ".                      

Audit Findings and Concerns

(v)  During  May 2019, sewage waste from one of the company’s sites had  leaked into a local river causing water contamination, depletion of  fish  stocks and extensive damage to a nature reserve. The local rivers’   authority has indicated in correspondence  that it holds the company responsible  for the leakage and  in the absence of its agreement to pay full compensation for  thedepletion   and damage; it intends to  commence legal proceedings against the company for t recovery of the total consequential costs to be incurred of £120,000.   The  authorityhas provided written confirmation from an independent firm  of  experts on the   make up ofthe £120,000.

(vi)  It transpired that  the leakage  referred  to above had occurred as a consequence of  damage tothe main underground drainage pipes on the camp site. The directors of Gr8 Hols  Ltd  haveclaimed that the leakage could have been prevented if  the ( large national) firm  of drainagecontractors, employed by the company to carry  out an ongoing maintenance programme on the drainage systems had been more diligent in their work. The contractors have denied any culpability, the loss is not covered by insurance  and  the company’s own legal counsel hasprovided advice to its directors  advising that  in court the company would have at best  onlya 10% chance of recovering any of the loss   from the drainage contractors.In the circumstances.

The company’s directors instructed another independent firm of consultantsto assess the loss caused by the leakage. They agreed  with the sum of £120,000 and confirmedthis in a formal report to the directors. Given the  directors’ views on the issue and their intentionsto negotiate reimbursement from the drainage contractors, a net  provision of only  £20,000has been included    in the company’s financial statements in respect of the river authority's claim.   

REQUIRED

(a) Briefly  but critically,  evaluate  the  directors' reasoning  for  including  a provision of  £20,000 in the financial statements of GR8 Hols Limited for the year  ended  30 September  2019, in respect of the claim made by  the 
local rivers'  authority. Your  evaluation should   state,   with reasoning,   whether  the  provision for the  sum of 
£20,000 is reasonable and appropriate , or whether   an alternative amount should be provided for.

(b) Draft  the  content  of  an  explanatory  email  to  Sabrina in which you critically   address her concern  about your firm's interest  in business risk,   and respond  to  her request  for your firm to  provide ongoing  business risk  mitigation advice  in addition to the provision  of external audit services .  
 
( Note  if  you need  to  refer  to any  technical  " auditing " terms you  must explain these in your own words , such that a  competent  business executive would  understand  their meaning ). 

Sewage Leak and Legal Action

(c) Identify EIGHT inherent risks associated with the financial statements of Gr8 Hols Ltd, and explain the impact that each risk identified could have on information included in the company’s financial statements for the year ended 30 September 2019.

For  each risk identified  you  should set  out your answer in the following  format : 
Nature of  Risk

Area  of  Financial  Statement affected
Audit  Concern  - impact and effect  on the  financial  statements 

Carry out an analytical review of  the summary of financial information for the Taithness site included in  Appendix I (attached), and:

(i) explain any audit  concerns that  you may have with regard  to  the reported  income figures for  caravan hire, tent hire and pitch hire including occupancy rates.

(ii)  explain any other audit  concerns that you  any have with regard  to EIGHT other areas of the reported financial information.  

(d) State the effect that the introduction of the new system on 1st February 2019 should have had on your firm's approach to the audit of Gr8's financial statements, including  the procedures to be  carried out,    and explain the reasons for this.  Also, comment with justifying rationale, as to whether consider Sabrina's expectation   - of a reduction in the audit fee -  is reasonable. 
                                                                                                                                               

 Advise,  with justifying  rationale,   how your  firm should proceed with  regard  to  :       
               
(i)  assisting  Gr8 Hols  Ltd  in the possible purchase  of  the Campies  Ltd site, as requested                                           
(ii)  employing the site accountant currently engaged by Campies  Ltd ,  as suggested by Reeves ,and  

(iii ) carrying   out   future    end of year  non - current  assets and inventory counts  as requested by Reeves .  

The maximum  total mark achievable  for this assignment is  restricted to 100 % , and your mark  will count towards  the  total mark awarded for the  International Audit and Assurance  Module . The  maximum available  mark  shown against each part  ( a, b  c, d ,e  and f  ) above  will be awarded  only to  outstanding  answers  - demonstrating  exceptional   focus and   understanding  of  the  pertinent issues . You  MUST show  the total  word count for each part  at the end  of   your answer to each part  and the overall  total  word count at the  end of your submission. You must also  show  the  Turnitin originality % on the front  cover of your  submission.