Inventory NRV, a covenant breach and a post-year-end refinancing
Ashraf & Co. is auditing Delta Food Industries S.A.E. for the year ended 31 December 2025. Materiality is EGP 5,000,000. Three matters remain unresolved. First, finished goods costing EGP 20,000,000 are close to expiry. The price list still shows a selling price of EGP 22,000,000, but the goods need rework costing EGP 1,000,000 and selling costs will be EGP 3,000,000. Management refuses any write-down, arguing that the price list has not changed. Second, an EGP 60,000,000 bank loan is classified as non-current although the current ratio covenant was breached at 31 December 2025, making the loan payable on demand. A three-year refinancing term sheet was signed with another bank on 15 February 2026; the audit report is dated 20 March 2026. Management says the refinancing proves non-current classification. Third, a customer owing EGP 4,000,000 was placed in liquidation on 10 February 2026 because of losses that existed throughout 2025; no provision has been made. Management refuses all adjustments. The finance director says the total effect is below materiality.
1. Evaluate each of the three matters against the applicable accounting standards and ISA requirements, and quantify the effect on the financial statements.
Read the worked answer
Inventory: IAS 2/EAS require measurement at the lower of cost and net realisable value. NRV = estimated selling price 22,000,000 less rework 1,000,000 less selling costs 3,000,000 = 18,000,000. Cost is 20,000,000, so write down 2,000,000. The unchanged price list is irrelevant if the goods are near expiry and require rework; the estimate must reflect the condition of the inventory at the reporting date.
Loan: under IAS 1, a breach at the reporting date that makes the loan payable on demand results in current classification unless the lender had agreed, before the end of the reporting period, to provide a right to defer settlement for at least twelve months. A term sheet signed on 15 February 2026 is after the reporting date and does not change the right at 31 December 2025. The loan should be reclassified from non-current to current, an increase in current liabilities of 60,000,000. It is also evidence for the going concern assessment, because the company may not be able to settle on demand.
Receivable: the customer losses existed throughout 2025, so the liquidation is additional evidence of a condition at the reporting date. Under IAS 10 this is an adjusting event; provide 4,000,000. Total profit misstatement is 2,000,000 + 4,000,000 = 6,000,000, which exceeds materiality of 5,000,000. The finance director is wrong to look only at the total; the loan classification is also material to the balance sheet and to the going concern disclosure.
2. Determine the audit opinion and the structure of the auditor report. Explain the going concern implications and whether an adverse opinion is required.
Read the worked answer
A qualified opinion is appropriate on the financial statements as a whole if the effects are material but not pervasive. The inventory and receivable misstatements are confined to specific account balances, and the loan is a classification matter, so an except-for conclusion is defensible: the financial statements do not give a true and fair view of inventory, trade receivables and current liabilities. The basis for qualified opinion should quantify each matter and state that management refused to adjust.
Going concern: the loan is payable on demand and the breach existed at year-end. If management prepares the statements on a going concern basis and discloses the material uncertainty, the auditor includes a separate Material Uncertainty Related to Going Concern section and still expresses the qualified opinion. If management does not disclose the material uncertainty, the financial statements are materially misstated; the auditor considers a qualified or adverse opinion depending on how pervasive the going concern effects are. Here, because the refinancing was agreed before the report date but after the year-end, the auditor may conclude that the entity can continue, but the classification and disclosure remain wrong. The report should also include the key audit matters section if Delta is listed, and the auditor should not use an Emphasis of Matter as a substitute for a modified opinion.
3. What communications and documentation should be completed before the report is signed?
Read the worked answer
The auditor should communicate the uncorrected misstatements to those charged with governance, itemising each matter and its effect, and request correction. A written representation should be obtained covering the inventory valuation, the loan covenant and refinancing, the receivable, and the going concern assumptions. The engagement quality control reviewer should review the judgements because of the going concern and modification issues.
The auditor should document the audit strategy for going concern, the cash-flow forecasts and sensitivity analysis, the terms of the refinancing term sheet, and the conclusion on classification. The communications with the audit committee should record that the finance director was informed of the materiality breach. If management and those charged with governance continue to refuse adjustments, the auditor documents the reasons, considers whether withdrawal is appropriate, and evaluates any statutory or regulatory reporting obligations. The auditor should also consider whether the matter affects other information in the annual report and whether the report should be issued at all before the disagreements are resolved.