HI6026 Audit, Assurance and Compliance

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). 2017DIPL 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 ‘e-books’ 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 2016, 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 2017 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, Bobby Fong, 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 2017, 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 2017. 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 2017, 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 Law, 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 2017, 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 first- in, 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).

Double Ink Printers Ltd Statement of Financial Position

 

 

 

 

 

Note

2015

2016

2017

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(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

 

Double Ink Printers Ltd

Income Statement

 

2015

2016

2017

 

 

 

 

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

 

 

 

2015

2016

2017

 

 

 

 

 

 

 

 

 

 

 

(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 part of your planning process, you are considering whether you will need to use the services of an expert in the audit of Double Ink Printers Ltd (DIPL).

Required:

Based on the background information contained in the case, explain whether it will be necessary to use the work of an expert in the audit of DIPL. (5 marks).

Question 2:

You are at the planning stage of the audit of Double Ink Printers Ltd (DIPL) for the year ended 30 June 2017 and have been asked by the audit manager to assists determine the materiality levels.

Required:

 

  • Referring to the background information contained in the case, identify five factors that would influence your determination of the preliminary figure for overall materiality for the 2017 audit of DIPL. (5 marks).

 

  • Explain why the factors identified in (a) above are relevant to your calculation of the preliminary figure for overall materiality. (5 marks).

 

  • Describe how the factors identified in (a) above will influence your preliminary figure for overall materiality in the audit planning process. (5 marks).

 

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