Question 1
As a newly promoted audit manager, you are assigned to the audit of Life Long Learning Pte Ltd (LLL) for the year ending 31 December 2022. LLL is a leading enrichment centres that has developed a customised learning program, X’plore, to help primary and secondary students develop curiosity in learning.
Part I
Based on the prior audit files, you noted that LLL had successfully moved its in-person classroom learning to online learning during the COVID-19 pandemic without any significant
loss in quality as shown by many of its students still achieving their desired school results at end of 2021. Boosted by the success of its online learning program, LLL launched its X’plore online learning program (XO’plore) in January 2022, with the introduction of the following new terms for the XO’plore program:
1. A one-time non-refundable registration fee of S$2,700 per child for the registration and setup of the student’s learning profile in the XO’plore system.
2. Parents can opt for interest-free deferred payment of the registration fee payable within 12 months.
3. Monthly fees are based on a 20% discount off the rates for the X’plore program.
4. Money-back guarantee if a child does not achieve a higher grade after attending the program each year, subject to certain minimum attendance requirements.
XO’plore proves to be a success and LLL managed to sign up 50% more students as compared to its in-person classes. Management estimates its fair value to be S$5m. During your planning discussion with the founder, Mr Shawn Smart, you understand the following new terms for the XO’plore program:
1. As the registration fee is non-refundable, it is recognised as revenue upon the registration of the student.
2. As the deferred payment period is for 12 months or less, the interest element is not considered significant and hence it is not separately allocated.
3. The 20% discount is an estimated amount based on savings from the rental and overheads of the physical classroom.
4. From their past 20 years’ track record, less than 5% of students on average did not achieve a higher grade at the end of each program year. The refunds will be recorded when incurred.
Required:
(a) For each of the four (4) new terms for the XO’plore program, evaluate whether there is a risk of material misstatement in the revenue recognition.
(b) For two (2) new terms above with the highest level of risk of material misstatement, describe the appropriate audit procedures to evaluate the extent of each of the risks of material misstatement. Assume that you have verified and are satisfied that the contract terms are as described above.
Part II
On 1 July 2022. LLL signed a S$9 million contract with a leading preschool learning group, USKids Inc (USK) in the USA, to help USK develop a similar online learning system like XO’plore, with relevant customisations to migrate USK’s existing classroom learning materials into the new system.
The key terms of the USK contract are as follows:
1. USK will make a monthly payment of S$150,000 starting from 1 July 2022 and upon final payment in 1 May 2027, LLL will transfer the legal title of the learning system to USK.
2. The system development and material conversion project are expected to take 10 months to complete, thereafter LLL will be responsible for the maintenance and upkeep of the online learning system for the next 50 months, i.e., till 1 May 2027.
3. To ensure the timely completion of the conversion project, LLL will commit at least 50 staff to the USK project for 10 months.
Based on your discussion with Mr Shawn Smart, you noted that given the following the long financing period provided to USK, revenue from USK will be recognised by LLL as lease income on a straight-line monthly basis, i.e., S$900,000 by 31 December 2022.
After the discussion with Mr Shawn Smart, you performed additional independent verification work and arrived at the following conclusion:
1. The USK contractual terms are as described above.
2. Given the knowledge and experience of LLL, the risk of system development and material conversion project for the USK contract not being completed on time is assessed as low.
3. The maintenance and upkeep of the new online learning system for the USK contract are simple and require only two skilled staff.
Required:
(c) Evaluate whether there is a risk of material misstatement in the revenue recognition of the contract with USK and describe the appropriate audit procedures to address the risk of material misstatement.
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