Hammer Group SeptDec 2023

Briefing Note
To: Paula Sanders, Group Engagement Partner
From: Audit Manager
Subject: Audit planning of Hammer Group
Introduction
These briefing notes are prepared for the audit of Hammer Group for the year ended 30
September 20x5. The notes contain the evaluation of business risk, evaluation of risk of
material misstatement, principal audit procedure on store enhancement programme and
ethical issue as a result of service requested by Hammer Group for the firm to perform
(a) Business risks faced by the Group
Competitive Environment
Mallet Co is a wholly owned subsidiary and operates the Hammer stores. It
generates the majority of the Group income. Mallet Co owns 50 stores across the
country. Mallet Co have been involved in a price war with another national hardware
store during the year, by offering significant discount and heavily marketed the
Hammer Brand in an attempt to gain market share. High likely that the price war will
continue as long as the other national hardware store keeps reducing its prices. This
will be necessary to maintain the market share.
Impact will be the margin will continue to reduce. Currently the operating margin are
already reduced to 7.1 % (20x4: 7.5%). There will be lesser money to cover the fixed
costs. Impact is that there is no information on the cash balance, but the current ratio
has fallen by 21.4% from 1:4 to 1:1
Ladder – first overseas investment

The purpose of the acquisition was to expand the Group operation into a new
geographical market. This is the first time overseas investment made by the Hammer
Group. The 35% non-controlling interest in Ladder Co is owned by the government of
Farland due to a regulatory requirement that at least that proportion of company’s
share capital is government owned.
High likely that management may not be familiar with the law and regulation in
Farland. Also not familiar with the market condition. This the first time Hammer Group
is operating in Farland
Impact, Hammer may violate the Farland law and regulation. Huge penalties may be
imposed. Serious violation may even result in licenses being revoked. The
investment of 82 million may be lost. The 35% of non-controlling interest in Ladder
Co is owned by the government of Farland due to the regulatory requirement that at
least that proportion of company share capital is government owned. Hammer may
not have a experience on how the business operated and the rate of expansion may
be controlled by the government to ensure the local business do not suffer as a result
the expansion plan may not work as planned
Loan Variable
Ladder Co is an overseas subsidiary situated in Farland . The Group obtained a 65%
shareholding in October 20x4 for cash consideration of 82 million. The shares are
purchased financed partially using 32million loan from the bank under a variable
interest rate and partly for the Group reserves. The bank loan has a covenant
attached in relation to interest cover and gearing. High likely that the interest rate
might be increases by the bank. This is because the gearing has increased making
the company a riskier lender to the bank
Impact, current finance cost has increased by 60%. If the interest rate is increased,
Hammer may find it difficult to pay the finance cost. The gearing has worsened by
94.3% to 68% (20x4:35%). Interest rates could keep increasing. Interest cover also
worsen by 33.3%. It is now only 4 as compared to 6. There is no information as to the
specific covenant that need to be met. Breaching the covenant will mean that the
loan will be repayable immediately and Hammer may not have the sufficient fund to
pay.
Legal Case
In the last year, the financial services regulator has been investigating many banks
for charging excessive fees to customers in relation to loan, meaning the customers
can claim back the excessive fees they have been charged. Wrench Co has received
legal claim from more than 25,000 customers in respect of this and the Group
recognises a provision of 22million in its statement of financial position. High likely
the regulators will eventually investigate Hammer Bank. 25,000 customers have
already taken legal action against Wrench.
Impact charging customer excessive fees is unethical. This will impact the Hammer
brand seeing that the bank is name Hammer Bank. The Hammer brand is crucial to
the group success. Losing the Hammer reputation may cause the customers to shop
in other stores and lose the market share. Currently 25,000 customers have taken
legal action. Provision of 22 million been recognised in SOPL, which will increase the
expenses for the company
Liquidity
Hammer has used much of its cash resources to finance the acquisition (50m) and
store enhancement to make them destination stores (25stores x 5.75m =
143.75million). High likely, the stores will have closed for 2months while renovation is
going on.
Impact, Significant loss of revenue. The renovation carried out in 5 stores at a time
which will take 2months to complete. 25 stores will take 10 months to complete.
There will be more losses, if renovation take more that 2months. In the meantime.
which stores are renovated, customer may switch to another supplier and it will be
difficult to win them back
(b) Evaluate of risks of material misstatement
Materiality
For the purpose of this audit, materiality will be based on revenue as requested.
The benchmark is 0.5% - 1% of revenue = 2.25m – 4.5m. Hammer Group have
significant risks of material misstatement; hence the materiality will be set at the
lower range of 2.25m. 2.25m is only the starting point. Professional judgement must
be used during the audit
Management bias
The executive director each receive annual bonus which is based on annual increase
in the operating profit before exceptional item. The cost relating to the store
enhancement included in the statement of profit and loss which are projected to total
65 million by the financial year end. This will be separately disclosed as an
exceptional item in the Group statement of profit and loss.
This is considered as significant risk because management are in the position to
decide what item is exceptional and exclude the items from the profit to calculate the
bonus
Control on the new subsidiary

Ladder Co is a overseas subsidiary situated in the Farland. The company obtained a
65% shareholding in October 20x4 for the cash considerations of 82 million. The
purpose of the expansion is to expand the group operation into a new geographical
market. The 35% non-controlling interest in Ladder Co is owned by the government
of Farland. Due to regulatory requirement that at least that proposition of a company
share capital is government owned. This is a significant risk because the accounting
treatment of Ladder depends on very much of the ability of Farland government to
allow the Group to have control over the relevant activities and this is still unknown
Provision
Hammer bank has emerged in unlawful practice where they have excessively
charged fees to their customers taking loans. To date, 25,000 customer s have taken
legal action to recover the excessive fees and Group has made a provision of 22
million. The provision to date of $22 million is highly material (9.8 times of the overall
materiality
(c) Principal audit procedures

 Inspect the management progress report on which store have been completely
renovated, which is ongoing renovation and which have yet to be renovated to
confirm that only cost which are incurred have been recognised in the FS as
revenue or capital
 Inspect the management report on the cost incurred to date on individual stores
to see how cost are different from other as lower cost for some location may
mean cost have not yet been taken up
 Review the complete breakdown of cost of $120k (65 + 55) to ensure that
revenue expenditure has been expensed and only capital items have been
capitalised
 Obtain the breakdown of cost and recalculate to confirm the arithmetic accuracy.
 Obtain the supplier invoice in post year end, to confirm the amount is accrued for
the expenses incurred for year end
 Inspect architect drawing s for the individual cafe together with the cost to confirm
the nature of the expense whether it is revenue or capital.
 Physically inspect a sample of cafe location to confirm that the cafe is exist and it
is in accordance with the plan
 Inspect the purchase agreement for the acquisition of land to confirm accuracy of
the cost
 Inspect the contractor invoice to confirm cost of completing individual car park for
use
(d) Ethical issues
Self-interest threat
There is potential self-interest in that if the firm advise is acted upon and the advice
turns bad, the partner is unlikely to recommend any impairment adjustment on the
investment value. The threat is likely to be severe as the cost to acquire a company
may be material. Providing advice to selection of target company will amount to
making management decision threat. ACCA code of ethics prohibits the auditor to
make any decision on behalf of management. Management should be informed that
the firm will not provide this service and reason explained to them
Undue influence and threat to independence

Self-interest threat in that the firm is unlikely to qualify the audit should the need arise
for the fear of losing the client and subsequently lose the Non-Assurance Services.
The audit fee of plus 75% of audit fee might amount to substantial amount and result
in undue dependence on the client. ACCA Code of ethics states that there should not
be undue influence on one client. The firm to evaluate the level of dependence
before accepting the job and to consider to reduce the dependence by acquiring
more client.
Self-review threat
This will give rise to self-review threat in that the audit team is unlikely to be critical
over the accounting work carried by their colleagues in converting the FS using
Farland standard to the IFRS and the required consol adjustment. Threat is likely to
be severe seeing that Ladder is a material subsidiary that was purchased for $82
million. ACCA code of ethics states providing accounting services to an audit client is
allowed provided the accounting is routine is nature and does not involve
professional judgement. Converting FS using the Farland standards to the IFRS and
the consol adjustment is not a routine as in will involve much professional judgement.
As such client should be informed that the firm will not be able to provide this
services and reason explained to them

Hammer Group SeptDec 2023

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Briefing Note

To: Paula Sanders, Group Engagement Partner

From: Audit Manager

Subject: Audit planning of Hammer Group

(a) Business risks faced by the Group

Ladder – first overseas investment

(b) Evaluate of risks of material misstatement

Control on the new subsidiary

(c) Principal audit procedures

Undue influence and threat to independence

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