Question 1

SECTION B: ADVISORY REPORT

It is 10 November 20X6. You are a manager in the advisory department of K&P Associates. Your firm has been the external auditor for AquaStream Utilities Co (AquaStream), a listed public water treatment company, for the past five years.

AquaStream is looking to expand its capabilities and is currently in negotiations to acquire 100% of the share capital of DesalInnovate, a private technology startup. DesalInnovate has developed a patented, highly efficient water desalination process. However, the startup has only been trading for two years and is currently loss-making.

The Board of Directors of AquaStream has approached K&P Associates to perform a financial due diligence review on DesalInnovate prior to finalizing the acquisition. Specifically, AquaStream wants your team to:
1. Assess the overall financial health and unrecorded liabilities of the target.
2. Review and provide assurance on DesalInnovate's 5-year prospective financial information (PFI), which forecasts a return to profitability by Year 3 based on aggressive licensing of their patent.

Requirements:

(a) Evaluate the ethical and professional issues K&P Associates should consider before accepting the engagement to perform the financial due diligence and PFI review for AquaStream. (8 marks)
(b) Recommend the key areas of focus for the financial due diligence review of DesalInnovate, explaining why each area is critical to AquaStream's acquisition decision. (10 marks)
(c) Describe the specific examination procedures you would perform to review DesalInnovate's 5-year prospective financial information (PFI). (7 marks)

Accepted Answer

Step 1: For ethics, identify the specific threats (Self-review is the biggest one here since it's an audit client). Propose practical safeguards. Step 2: For due diligence, think commercially. What does a buyer of a loss-making tech startup care about? (Cash, patents, hidden debts, key staff). Step 3: For PFI procedures, use ISAE 3400 principles. Check the math, check the starting data, challenge the assumptions, and do sensitivity analysis.

Question 2

What mistakes do candidates make on this ACCA question?

Accepted Answer

In part (a), candidates often list generic ethical threats without applying them to the specific scenario (e.g., failing to mention that the patent valuation will eventually be audited by K&P). In part (b), candidates sometimes list standard audit procedures instead of due diligence focus areas. DD is about commercial reality and valuation, not just verifying historical numbers.

How to approach this question

Full Answer

Common mistakes

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