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Introduction to Financial Statement Analysis: practice question

Financial Statement Analysis · Introduction to Financial Statement Analysis · Question ID fsa-s01b-2

Verano Foods: credit review before a bond purchase

Osric Havel is a credit analyst at Norlake Credit Partners, a bond fund that is considering buying bonds issued by Verano Foods, a listed grocery chain that reports under IFRS. Havel begins with Verano's annual report for the year ended 31 December 20X5, which contains the financial statements and notes, management's commentary on results, and the independent auditor's report.

The auditor, Quill & Harrow, was unable to obtain sufficient appropriate audit evidence about the inventories held by Verano's newly acquired overseas distribution subsidiary. Judging the possible effects to be material but not pervasive, the auditor issued a qualified opinion. During the year Verano also revalued a portfolio of retail properties upward by $34 million, and the resulting surplus is included in the movements shown in Exhibit 1.

Between annual reports, Havel tracks Verano's interim reports and press releases for developments that could affect creditworthiness. For the review itself, he plans to convert the reported statements of Verano and two peer companies into common-size statements and to compute leverage and coverage ratios before forming a view on the proposed bond purchase.

Exhibit 1: Verano Foods, extract from the statement of changes in equity, year ended 31 December 20X5 ($ millions)
ItemAmount
Equity, 1 January 20X5812
Net income96
Revaluation of retail properties (surplus)34
Dividends declared(40)
Proceeds from shares issued60

Quill & Harrow's opinion would most likely have been a disclaimer of opinion instead of a qualified opinion if:

  1. the possible effects of the unavailable evidence had been both material and pervasive
  2. the subsidiary's inventory balances had been confirmed as fairly stated
  3. the overseas subsidiary had represented an immaterial share of Verano's total assets
Show answer and explanation

Correct answer: A

Explanation: A disclaimer of opinion is issued when the auditor cannot obtain sufficient appropriate evidence and the possible effects are both material and pervasive; Verano's actual limitation was judged material but not pervasive, which is exactly why it produced a qualified opinion instead. If the inventories had been confirmed as fairly stated, the scope limitation would disappear and an unqualified opinion would be appropriate. If the subsidiary were immaterial, the uncertainty would not matter to the statements as a whole, so the opinion would likewise be unqualified.

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Original, unofficial practice material; not a CFA Institute question.