Winterbourne Retail Ltd: five post-year-end events and a covenant to renew
Winterbourne Retail Ltd has a 31 December year end and its financial statements are approved on 18 March 20X6. Draft profit before tax is £1,250,000 and net assets £3,400,000. The company has a £2,000,000 bank facility repayable on demand, reviewed each April. Five matters arise during the audit. (a) On 6 February 20X6 a customer owing £260,000 went into liquidation with no expected recovery; £180,000 of the debt was 120 days overdue at 31 December 20X5 and the customer was then in restructuring talks. (b) On 2 March 20X6 fire destroyed the Bristol store; the loss is estimated at £1,100,000 and insurance will cover £700,000. (c) On 20 January 20X6 a court ordered Winterbourne to pay £310,000 on a claim that had been provided for at £200,000 at the year end. (d) On 1 March 20X6 the company agreed to buy a rival chain for £4,500,000. (e) The Bristol store generated £450,000 of the company's £1,250,000 profit.
1. Classify events (a), (b) and (c) as adjusting or non-adjusting, and state the accounting treatment.
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(a) Adjusting. The customer's financial difficulty existed at the reporting date - 120 days overdue and already in restructuring talks. IAS 10 treats the liquidation as providing additional evidence of a condition existing at the year end, and the additional evidence relates to the measurement of the receivable. Write the debt down to nil, a £260,000 charge against draft profit before tax. The whole balance goes, not just the overdue £180,000, because no recovery is expected on any of it.
(b) Non-adjusting. The fire occurred after the reporting date and no condition existed at 31 December 20X5. No adjustment to the 20X5 figures. Because the net loss of £400,000 (1,100,000 − 700,000) is material relative to profit before tax of £1,250,000, disclose the nature of the event and an estimate of its financial effect. The insurance recovery is not recognised as an asset at the year end.
(c) Adjusting. The court judgment provides evidence of the amount of the obligation that existed at the reporting date. Increase the provision from £200,000 to £310,000, charging £110,000 to the 20X5 statement of profit or loss. Settlement after the year end does not create a new obligation; it quantifies an existing one.
2. Deal with events (d) and (e): what is disclosed and how materiality should be judged.
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(d) Non-adjusting, requiring disclosure. An acquisition agreed after the year end does not change the 20X5 financial statements. But £4,500,000 against net assets of £3,400,000 is transformative - it more than doubles the size of the group - and a user would be misled by statements that mention it nowhere. Disclose the date of the agreement, the consideration, the funding, and the fact that the comparatives do not include the acquired business.
(e) Not an event in itself, but the quantification of (b). The £450,000 contribution, being 36% of group profit before tax, is exactly the kind of estimate the (b) disclosure needs: it tells the reader that the lost store was the group's profit engine, not a marginal site. Without it, the £400,000 net loss understates the forward impact.
Materiality reasoning. Judgements on (b) and (d) are not made by a fixed percentage. Consider size relative to profit, net assets and the facility; whether the item affects a key ratio; and whether it changes the direction of earnings. Here, the combination of a £400,000 uninsured loss, the loss of 36% of profits and a £4.5m acquisition dwarfs a simple 5% of profit test.
3. Advise the directors on the going concern assessment, showing how the figures change.
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Revised numbers. Starting from draft profit before tax: 1,250,000 − 260,000 (a) − 110,000 (c) = £880,000. The fire does not affect 20X5 profit, but it removes £450,000 of future profit and costs £400,000 net of insurance. Net assets fall from £3,400,000 to roughly £3,030,000 before the post-year-end fire impact.
The assessment. IAS 1 requires the directors to assess going concern over at least twelve months from the date of approval - here to March 20X7. The key vulnerability is not the loss itself but the £2,000,000 facility that is repayable on demand and reviewed in April, plus the £4.5m acquisition commitment. The directors must obtain the bank's position in writing before approving the accounts.
Three possible outcomes:
- Bank confirms renewal and the acquisition is funded: no material uncertainty; disclose the basis of the assessment and the facility terms.
- Renewal is uncertain but the directors judge the entity will continue: prepare on a going concern basis and disclose a material uncertainty prominently, in both the significant judgements note and the auditor's report.
- Facility will be withdrawn and no alternative funding exists: prepare on a break-up basis, which restates assets and liabilities at recoverable and settlement amounts.
The (b) fire is non-adjusting for measurement but is central to the going concern conclusion - the two judgements must be explained separately.