HI6026 Audit, Assurance and Compliance TRIMESTER 2, 2017 INDIVIDUAL ASSIGNMENT 1
Assessment Value: 20%
Instructions:
• This assignment is to be submitted in accordance with assessment policy stated in the Subject Outline and Student Handbook.
• It is the responsibility of the student who is submitting the
work, to ensure that the work is in fact her/his own work. Incorporating
another’s work or ideas into one’s own work without appropriate
acknowledgement is an academic offence. Students should submit all
assignments for plagiarism checking on Blackboard before final
submission in the subject. For further details, please refer to the
Subject Outline and Student Handbook.
• Answer all questions.
• Maximum marks available: 20 marks.
• Due date of submission: Week 6, Friday at 5.00 p.m.
Case Study on Double Ink Printers Ltd (DIPL)
Background Information
You are a senior manager with Stewart and Kathy and you have been
approached to undertake the audit of Double Ink Printers Ltd (DIPL). For
the year ended 2015, taking over from the small audit firm of Jay and
Associates. DIPL print books, magazines and advertising materials for
the publishing, educational and advertising industries on a
print-on-demand basis. Printing on demand means that publishers can
print the exact quantities ordered by retail outlets, rather than
estimating in advance how many books are required and often printing too
few or too many. The average printing turnaround time for DIPL is two
business days for small orders and five to ten business days for large
orders. In addition, five years ago, DIPL further expanded its earnings
base by having publisher’s titles available as searchable ‘ebooks’ that
could be downloaded directly by readers from DIPL’s website.
Purchase and Inventory
DIPL purchases 50% of its inventory requirements of paper, ink and
binding materials from Australian sources and 50% from Asian countries.
When inventory received at DIPL’s warehouse (whether it is purchased
from Australia or Asia), the accounts payable clerk, Bill Jimmy, records
the arrival of the inventory and also its value and quantity in the
accounts payable system. Inventory is paid for the relevant currency of
the country from which it is purchased. Raw materials have been valued
at average cost and an allowance for inventory obsolescence has existed
in previous years to cover the estimated decline in value from the
effects of storage hazards. Work in progress is immaterial due to the
quick turn- around time of printing jobs. Any work in progress is
assessed at the cost of raw materials and labour and proportion of
manufacturing overheads based on normal capacity. At year end, the
warehouse is closed from 28 to 30 June for stocktake, so sales must be
invoiced in the system by close of business on 27 June. The stock must
have been sent to the customer (that is, it must either be on track,
ship or plane on its way to the customer, or it must already have
arrived at the customer; it must no longer be in DIPL’s warehouse).
‘Print on Demand’ revenue and receivables
Each time a publisher wants to add a book to DIPL’s ‘digital
library’ (a server storing all of the publisher’s books in a digital
format, ready to print), it emails the book to DIPL in PDF format. The
digital library is backed up at the close of business every day, with
the backup tapes kept off site. Once the book is stored in the digital
library, the publishers can order copies to be printed as required.
When the publishers confirm the order, the accounting system
automatically retrieves details of the publisher’s credit record and
stops any orders from publishers that have exceeded their credit terms
and limits. A printout of the transactions history of the publishers is
generated and must be signed by both Helena keng, the head of
publishing, and Jane Roger, the head of accounts at DIPL, before the
order can continue, after the transaction history has been signed and
dated, accounts receivable staff file it.
If there are no credit problems with the order, it is processed and
printed by casual staff in the relevant warehouse, who then load the
books onto pallets for shipping. When printing is finished, the sales
clerk, Brown Pall, prepares an invoice and dispatch docket and forwards
them to the accounts receivable department. The accounts receivable
clerk Gay Chan, checks the prices and arithmetic accuracy of the
invoices and signs the invoice as evidence of her check. Gay records the
sales both the accounts receivables subsidiary ledger and the general
ledger and books are shipped to the publisher’s nominated destination
(or the publisher will arrange pick up at the warehouse if has its own
distributors). The client accepts liability for the goods when they are
received in accordance with the purchase order, and signs the dispatch
docket as proof of delivery.
‘E-book’ Revenue
The proceeds from each e-book sale are paid to the publisher’s net of a 5% commission.
Proceeds are sent to publishers automatically upon download (the
commission is withheld by DIPL). Revenue from the commission is
recognised when is withheld from payment to the publishers.
DIPL also charge publishers an annual “storage fee” payable 12
months in advance, for keeping the e-book on DIPL’s website. Publishers
are invoiced on the date the first download of a title occurs. As new
books are downloaded on an ongoing basis, the storage fee is invoiced at
different times of the year. Revenue from storage fees has been
recognised in the month the fees are invoiced, notwithstanding the fact
that the fees are charged 12 months in advance.
In September 2014, DIPL acquired Nuclear Publishing Ltd (NPL). The
main rationale behind the lay in the value of the copyright NPL held
over a large range of specialised medical textbooks. Although the
potential print run for the textbook was not large, each textbook had a
high profit margin and had been used in universities across the world
for many years. DIPL acquired the business operation of NPL (not the
shares), paying net assets (including the right to the copyright).
However, in June 2015 an article was published in a medical journal
about a new theory that could result in NPL’s medical textbooks becoming
obsolete. If the new theory is valid, the textbooks are unlikely to be
reprinted or used as textbooks at universities in the future,
effectively making them unviable as e-books.
Cash Receipts
Some Payments from accounts receivables are received by cheque
through the mail, and the cashier, Judy Bones, record these in an
inwards remittance register when the mail is opened. She then banks the
cheques and forwards the payment advices to Gay Chan for posting ton the
accounts receivable ledger. Most payments, however, are received by
electronic funds transfer (EFT). Each day, Judy downloaded the previous
day’s receipts from online banking and provides a copy to Gary for
posting. Judy then reconciles the total of the batch postings to
accounts receivable to the amount banked for the day. The assistant
accountant, Boby Roger, prepares a bank reconciliation at the end of
each month.
Fixed Assets
Since DIPL’s incorporation, depreciation on assets has been
calculated using the straight-line method to allocate their cost over
their estimated useful lives, as follows:
• Printing presses up to 20 years
• Other production equipment up to 15 years • Other equipment up to 10 years
Finance
During 2015, DIPL has entered into a 7.5 million loan from BDO
Finance Ltd (BDO Finance). The loan has debt covenant’s requiring DIPL
to maintain a current ratio of at least 1.5 and a debt to equity ratio
of less than 1. Failure to maintain these key financial ratios under the
specified benchmarks would result in BDO Finance having the right to
recall the loan.
Appointment of New CEO and internal Audit
William Jackson was appointed the new chief executive officer (CEO)
of DIPL in January 2015. William has extensive experience in the
printing business. The previous CEO, Rebecca Styles, who is now semi-
retired, will remain on the board as a non-executive director. A
component of William’s remuneration package is a performance bonus based
DIPL achieving an annual growth of 10% in total revenue and 10% in net
profit after tax. Based on William’s recommendation, the board also
established a new internal audit department headed up by Cody Baines, an
ex-audit manager with a Big Four audit firm and two other recently
qualified chartered accountants. Cody reports directly to the board.
New IT System
During 2015, DIPL decided to invest in a new IT system that would
fully computerised and integrate all the current accounting processes
across the organisation, including integration into the general ledger
system.
Under extreme pressure from the board, the IT department at DIPL
managed to get the new accounting system installed in June, although IT
manager, Andy Rogers, complained several times about how the
installation was handled. Andy claimed that excess pressure had been
placed on staff to get the system installed and that there was simply
not enough staff to do the proper reconciliation’s and testing before
the new system went live prior to year-end.
Andy preliminary testing showed that some transactions conducted
around year-end were not being allocated to the correct period. The
problem appeared to be the interface between the new accounting system
and one of the existing software systems. A software ‘patch’ had to be
written to fix the problem.
Board year-end reporting discussions
As a board meeting held in June 2015, issues relating to the
forthcoming year end were discussed. William stated that he believed
that the valuation of raw materials inventories at average cost was no
longer appropriate as the current cost of paper was substantially above
the average cost. Further, he argued that the allowance for obsolescence
of inventory to cover the estimated decline in value from the effects
of storage hazards was necessary, as such a loss was unlikely. William
also stated that based on his experience in the printing industry he
believed that DIPL’s printing presses had a potential maximum life of 30
years, although he noted that another leading entity in the printing
industry adopted the policy of depreciating its printing presses over a
20-year period on a straight-line basis, similar to what DIPL had done
in the past. After much discussion, the board resolved that the
allowance for obsolescence of inventory be written back and that raw
materials be valued based on a firstin, first-out (FIFO) basis. In
addition, following a review of the e-book facilities by internal audit,
Cody recommended that in a report to the board that DIPL change the
method it used to account for its revenue from e-book publication to
ensure compliance with the applicable accounting standard. The board
agreed that the revenue from e-book would be recognised in accordance
with the stage of completion of each transaction (i.e. percentage of
completion method).
Statement of Financial Position
Note 2013 2014 2015
(Unadjusted)
Current Assets
Cash 647250 517788 347120
Accounts Receivables 1 2482500 4320000 5073309
Inventories 2 2256188 2671362 4180500
Total 5385938 7509150 9600929
Non-Current Assets
Property, Plant and
Equipment 3 7544062 8394750 15572062
Intangible Assets ------- ------- 975000
7544062 8394750 16547062
Total Assets 12930000 15903900 26147991
Current Liabilities
Accounts Payable 1950000 3035250 3525000
Deferred revenue ---- ---- 697500
Interest-bearing liabilities 937500 862500 787500
Provisions 810000 1125000 1267500
Accruals 82500 97500 120000
Total 3780000 5120250 6397500
Non-current Liabilities
Interest-bearing liabilities ---- ---- 7500000
Total Liabilities 3780000 5120250 13897500
Net Assets 9150000 10783650 12250491
Equity
Shareholders Fund 2250000 2250000 2250000
Retained Profits 6900000 8533650 10000491
Total Equity 9150000 10783650 12250491
Income Statement
2013 2014 2015
Revenues
Revenue from Operations 34212000 37699500 43459500
Cost of Sales 28207500 31620000 36855000
Gross Profit 6004500 6079500 6604500
Allowance for inventory obsolescence written back ------- ------- 155588
Commission Income 108000 123000 130500
E-book storage fees 667500 1027500 1417500
Income from operating activities 6780000 7230000 8308088
Expenses
Advertising 83725 115923 125778
Audit Fees 112500 127500 135000
Bad Debt 150000 195000 210000
Depreciation 249375 274312 472688
Discounts allowed 195000 285000 335500
Legal Fees 74000 111500 137000
Foreign Exchange loss 38500 49750 ----
Rates 98500 106000 113500
Repairs and maintenance 224000 276500 306500
Salaries 1965000 2190000 2445000
Telecommunication costs 134750 141478 159785
Total expenses 3325350 3872963 4440751
Net income before interest and tax 3454650 3357037 3867337
Interest expense 84379 83663 808038
Profit before tax 3370271 3273374 3059299
Income tax 1011081 982012 87116
Profit after tax 2359190 2291362 2972183
Notes to the Financial Report
2013 2014 2015
(Unadjusted)
Account Receivable 2647500 453000 5313309
1 Allowance for doubtful debts -165000 -210000 -240000
2482500 243000 5073309
Inventory 2362500 2797238 4180500
2 Allowance for obsolescence -106312 -125876 ------
2256188 2671362 4180500
3 Property, Plant & Equipment
Land 2775000 3375000 3375000
Plant and Equipment 5250000 5775000 13425000
Accumulated Depreciation -480938 -755250 -1227938
7544062 8394750 15572062
Required:
Question 1: As an auditor, you are conducting your preliminary
analytical procedures based on the background information for DIPL
contained in the case. Apply analytical procedures to the financial
report information of DIPL for the last three years. Explain how your
results influence your planning decisions for the audit for the year
ending 30 June 2015 (10 marks).
Question 2: You are conducting your risk assessment of DIPL, as part
of the planning for your audit for the year ended 30 June. Identify two
inherent risk factors that arise from the nature of DIPL’s business
operations. Explain why it is a risk and how it may affect the risk of
material misstatement in the financial report (5 marks).
Question 3: As part of your audit of DIPL for the year ended 30
June 2015, you are considering the risk that fraud may have occurred (a)
Based on the background information for DIPL contained in the case,
identify and explain two key fraud risk factors relating to
misstatements arising from fraudulent financial reporting to which DIPL
may be susceptible. (b) Explain how the risk factors identified in (a)
above would affect the conduct of the (a) audit. (5 marks).
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