(a)Analysis of events
Legal claim: The legal claim is within the scope of IAS 10, because it was received on 27 May 2011. This date is after
the reporting date (31 March 2011) but before the date that the financial statements will be authorised for issue. The legal
claim is an adjusting event because it provides evidence of conditions existing at the end of the reporting period. As at 31
March 2011, the claimant had purchased and used the product, and the damage to the claimant's skin had already
occurred.
The legal claim is material, because, if the claimant lived for, say, another 40 years, the company would owe him/her $4
million. This is 100% of the current year draft profit before taxation.
Therefore profit should be reduced and liabilities increased by the expected value of the claim.
Proposed dividend: The proposed dividend is within the scope of IAS 10, because it was proposed after the reporting
date (31 March 2011) but before the date that the financial statements will be authorised for issue. The proposed dividend
is a non-adjusting event because it is indicative of a condition that arose after the end of the reporting period. No liability
for the dividend can exist until the shareholders approve the dividend at the Annual General Meeting.
The proposed dividend is material because it constitutes 50% ($2m/$4m x 100) of the company's profit before tax.
Therefore the dividend should not be recognised in the financial statements for the year ended 31 March 2011. However,
the proposed dividend should be disclosed in a note to the financial statements.
(b)Audit procedures
Legal claim:
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Review legal correspondence in order to understand the likely outcome of the legal claim.
Review customer correspondence/legal files in order to identify other similar claims which could give rise to
additional liabilities.
Discuss with Production Director the likely cause of the burns (e.g. allergy in user or inadequate printed
instructions on product use) to determine the likelihood of any claim being successful in court.
Review trade/consumer press to identify whether the claim might damage Reallycool's reputation which could
impact future revenues or even create a going concern threat.
Propose adjustment of the financial statements to the directors.
Proposed dividend:
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Inspect Board Minutes in order to confirm the amount of the proposed dividend.
Propose an adjustment to the financial statements to remove the dividend from being recognised in the
Statement of Changes in Equity but ensure that the dividend proposal is disclosed within the notes.
(c)Impact on audit opinion.
The auditor must modify the audit opinion on the financial statements if the directors refuse to make the relevant
adjustments in the financial statements requested by the auditors.
Both the legal claim (which should have been recognised) and the proposed dividend (which should have been disclosed
rather than recognised) are materially misstated.
The auditor must express a qualified ('except for') opinion if they conclude that the misstatements are material, but not
pervasive, to the financial statements.
The auditor must express an adverse opinion if they conclude that misstatements are both material and pervasive to the
financial statements.
Given the size of the amounts involved, an adverse opinion may be appropriate in these circumstances.