Inventory NRV, Covenant Breach and Going Concern at a Yangon Solar Trader
Yangon solar-equipment trader Solar Link Co. has a 31 December 2024 year end. Draft current assets are MMK 9.20 billion and current liabilities are MMK 7.30 billion. Inventory includes slow-moving inverters costing MMK 900 million; expected selling price is MMK 620 million and expected selling costs are MMK 70 million, so net realisable value is MMK 550 million. Management refuses any write-down because the inverters are 'still under warranty' and it expects a government tender. The company's bank loan covenant requires a current ratio of at least 1.25; the loan of MMK 2.0 billion is due in June 2025. During the count, the auditor saw 200 sealed cartons not counted; management said they belonged to a customer but provided no agreement. Overall materiality is MMK 300 million. The auditor has not yet obtained the bank's covenant waiver or a signed shareholder support letter.
1. Evaluate the slow-moving inventory and calculate the effect of the required write-down on the current ratio and loan covenant.
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NRV = expected selling price - costs to sell = MMK 620m - MMK 70m = MMK 550m. Cost is MMK 900m, so the required write-down is MMK 350m. This exceeds overall materiality of MMK 300m, so it is material. Draft current ratio = MMK 9.20bn / MMK 7.30bn = 1.260. After write-down, current assets = MMK 9.20bn - MMK 0.35bn = MMK 8.85bn; current ratio = MMK 8.85bn / MMK 7.30bn = 1.212. That is below the 1.25 covenant. Management's warranty and expected tender do not justify carrying above NRV unless there is reliable evidence of a probable sale at the higher amount. The auditor should challenge the tender evidence and obtain a cash-flow forecast. If the write-down is required, the financial statements must show the covenant breach and the loan's consequences, and going concern may be a material uncertainty.
2. Outline the audit procedures for the 200 sealed cartons and for the going-concern assessment.
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Sealed cartons: inspect the cartons, look for ownership or customer markings, count them, inspect the count sheet and gate records, and vouch to purchase invoices, sales contracts or delivery documents. Confirm directly with the customer if management claims customer ownership. Review subsequent delivery or returns. If management cannot substantiate ownership, treat the exclusion from inventory as unsupported and consider a scope limitation or misstatement; communicate with those charged with governance and consider fraud risk. Going concern: obtain the loan agreement and covenant calculation, bank confirmation and any waiver; obtain the cash-flow forecast and test assumptions; check subsequent cash receipts and supplier terms; obtain signed shareholder support or refinancing evidence; review the June 2025 loan repayment and sensitivity analysis; assess whether disclosure of material uncertainty is adequate.
3. Assuming management refuses the write-down and going-concern disclosure is adequate, identify the appropriate opinion and audit report modifications.
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The inventory misstatement is MMK 350m, above materiality, but it is not pervasive to the financial statements as a whole, so a qualified opinion is appropriate: 'except for' the inventory overstatement and related effects. For going concern, if management discloses the material uncertainty adequately, the auditor includes a separate 'Material Uncertainty Related to Going Concern' section and does not modify the opinion for that matter. If disclosure is inadequate, the opinion becomes qualified or adverse depending on pervasiveness. For the sealed cartons, if the auditor cannot obtain sufficient evidence, a qualified opinion for a material scope limitation is appropriate unless the effect is pervasive, in which case a disclaimer is required. The report should clearly describe each matter and quantify the inventory effect where practicable.