Auditing case study 2500words

Appendix A1

Background information You are the audit senior with Rogers & Brown and you have been approached to undertake the audit of Reliable Printers Ltd (RPL) for the year ended 30 June 2015, taking over from the small audit firm of Jones & Associates. RPL prints books, magazines and advertising material 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 print turnaround time for RPL is two business days for small orders and five to ten business days for large orders. In addition, four years ago, RPL further expanded its earnings base by having pub- lisher’s titles available as searchable ‘e-books’ that could be downloaded directly by readers from RPL’s web site.

Purchases and inventory RPL purchases 50 per cent of its inventory requirements of paper, ink and binding materials from Australian sources and 50 per cent from Asia. When inventory is received at RPL’s warehouse (whether it is purchased from Australia or Asia), the accounts payable clerk, Clare Kirby, records the arrival of the inventory and also its value and quantity in the accounts payable system. Inventory is paid for in the relevant currency of the coun- try 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 a proportion of manufacturing overheads based on nor- mal 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 a truck, ship or plane on its way to the customer, or it must already have arrived at the customer; it must no longer be in RPL’s warehouse).

‘Print on demand’ revenue and receivables Each time a publisher wants to add a book to RPL’s ‘digital library’ (a server storing all of the publisher’s books in digital format, ready to print), it emails the book to RPL 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 publisher can order copies to be printed as required.

When the publisher confirms the order, the accounting system automatically retrieves details of the pub- lisher’s credit record and stops any orders from publishers that have exceeded their credit terms and limits. A  printout of the transaction history of that publisher is generated and must be signed by both Amanda Payne, the head of publishing, and Jim Lane, the head of accounts at RPL, 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, Bob Watkins, prepares an invoice and dispatch docket and forwards them to the accounts receivable department. The accounts receivable clerk, Rebecca Chan, checks the prices and arithmetic accuracy of the invoices and signs the invoice as evidence of her check. Rebecca records the sale in both the accounts receivable subsidiary ledger and the general ledger and the books are shipped to the publisher’s nominated destination (or the publisher will

APPENDIX: Continuous case study

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A3 A2Appendix

arrange pick up at the warehouse if it 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 net of a 5 per cent commission. Proceeds are sent to publishers automatically upon download (the commission is withheld by RPL). Revenue from the commission is recognised when it is withheld from payment to the publisher.

RPL also charges publishers an annual ‘storage’ fee, payable 12 months in advance, for keeping the e-book on RPL’s website. Publishers are invoiced on the date the first download of a title occurs. As new books are down- loaded on an ongoing basis, the storage fees are invoiced at different times of the year. Revenue from the 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, RPL acquired Medical Books Ltd (MBL). The main rationale behind this lay in the value of the copyright MBL held over a large range of specialised medical textbooks. Although the potential print run for the textbooks was not large, each textbook had a high profit margin and had been used in universities across the world for many years. RPL acquired the business operations of MBL (not the shares), paying for 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 MBL’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 receivable are received by cheque through the mail, and the cashier, Carly Barnes, records these in an inwards remittance register when the mail is opened. She then banks the cheques and for- wards the payment advices to Rebecca for posting to the accounts receivable ledger. Most payments, however, are received by electronic funds transfer (EFT). Each day, Carly downloads the previous day’s receipts from online banking and provides a copy to Rebecca for posting. Carly then reconciles the total of the batch postings to accounts receivable to the amount banked for the day. The assistant accountant, Terry Graham, prepares a bank reconciliation at the end of each month.

Fixed assets Since RPL’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, RPL has entered into a $7.5 million loan from Trim Finance Ltd (Trim Finance). The loan has debt covenants requiring RPL to maintain a current ratio of at least 1.5 and a debt to equity ratio of less than 1.

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A3 Appendix Appendix

Failure to maintain these key financial ratios under the specified benchmarks would result in Trim Finance hav- ing the right to recall the loan.

Appointment of new CEO and internal audit William Jackson was appointed the new chief executive officer (CEO) of RPL 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 perfor- mance bonus based on RPL achieving an annual growth of 10 per cent in total revenue and 10 per cent 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, RPL decided to invest in a new IT system that would fully computerise 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 RPL managed to get the new accounting system installed in June, although the IT Manager, Andy Rogers, complained several times about how the instal- lation 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 reconciliations and testing before the new system went live prior to year end.

Andy’s preliminary testing showed that some transactions conducted around year end were not being allo- cated 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 At 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 material 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 unnecessary, as such a loss was unlikely. William also stated that based on his experience in the printing indus- try he believed that RPL’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 RPL 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. Further, it was resolved to change the depreciation of the company’s printing presses from 20 years to 30 years on a straight-line basis. In addition, following a review of the e-book facilities by internal audit, Cody recommended in a report to the board that RPL change the method it used to account for its revenue from e-book publications to ensure compliance with the applicable accounting standard. The board agreed that the revenue from e-books would be recognised in accordance with the stage of completion of each transaction (i.e. percentage of completion method).

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Appendix A4 Appendix

Financial information

Extracts from thE financial rEports of rpl for thE last thrEE yEars arE as follows:

statement of financial position

Note 2013 $

2014 $

2015 unaudited

$ current assets Cash 647 250 517 788 347 120 Accounts receivable 1 2 482 500 4 320 000 5 073 309 Inventories 2 2 256 188 2 671 362 4 180 500

5 385 938 7 509 150 9 600 929 non-current assets Property plant & equipment 3 7 544 062 8 394 750 15 572 062 Intangible assets – – 975 000

7 544 062 8 394 750 16 547 062 total assets 12 930 000 15 903 900 26 147 991 current liabilities Accounts payable 1 950 000 3 035 250 3 525 000 Deferred revenue – – 697 500 Interest-bearing liabilities 937 500 862 500 787 500 Provisions 810 000 1 125 000 1 267 500 Accruals 82 500 97 500 120 000

3 780 000 5 120 250 6 397 500 non-current liabilities Interest-bearing liabilities – – 7 500 000

– – 7 500 000 total liabilities 3 780 000 5 120 250 13 897 500 net assets 9 150 000 10 783 650 12 250 491 Equity Shareholders’ funds 2 250 000 2 250 000 2 250 000 Retained profits 6 900 000 8 533 650 10 000 491 total equity 9 150 000 10 783 650 12 250 491

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A5 Appendix Appendix

income statement

2013 $

2014 $

2015 unaudited

$ Revenue from operations 34 212 000 37 699 500 43 459 500 Cost of sales 28 207 500 31 620 000 36 855 000 Gross profit 6 004 500 6 079 500 6 604 500 Allowance for inventory obsolescence written back

– – 155 588

Commission income 108 000 123 000 130 500 E-book storage fees 667 500 1 027 500 1 417 500 Income from operating activities 6 780 000 7 230 000 8 308 088 Expenses Advertising 83 725 115 923 125 778 Audit fees 112 500 127 500 135 000 Bad debts 150 000 195 000 210 000 Depreciation 249 375 274 312 472 688 Discounts allowed 195 000 285 000 335 500 Legal fees 74 000 111 500 137 000 Foreign exchange loss 38 500 49 750 – Rates 98 500 106 000 113 500 Repairs and maintenance 224 000 276 500 306 500 Salaries 1 965 000 2 190 000 2 445 000 Telecommunication costs 134 750 141 478 159 785 Total expenses 3 325 350 3 872 963 4 440 751 Net income before inter- est and tax

3 454 650 3 357 037 3 867 337

Interest expense 84 379 83 663 808 038 Profit before tax 3 370 271 3 273 374 3 059 299 Income tax 1 011 081 982 012 871 116 Profit after tax 2 359 190 2 291 362 2 188 183

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Appendix A6Appendix

notes to the financial report

Note 2013 $

2014 $

2015 unaudited

$ 1 Accounts receivable 2 647 500 4 530 000 5 313 309

Allowance for doubtful debts (165 000) (210 000) (240 000) 2 482 500 4 320 000 5 073 309

2 Inventory 2 362 500 2 797 238 4 180 500 Allowance for obsolescence (106 312) (125 876) –

2 256 188 2 671 362 4 180 500

3 property plant & equipment Land 2 775 000 3 375 000 3 375 000 Plant & equipment 5 250 000 5 775 000 13 425 000 Accumulated depreciation (480 938) (755 250) (1 227 938)

7 544 062 8 394 750 15 572 062

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A7 Appendix Appendix

Reliable Printers Ltd 35 Cannon Street

Bankstown NSW 2200 Date: 14 September 2014

Invoice # 13236

TAX INVOICE To: Serenity Publishers Ltd

16 Gratton Street Robina Qld 4226

Quantity Description Unit Price Total Price 150 copies Sea Life $50 $7500

GST 750

$8250

Payment due: 14 October 2014 THANK YOU FOR YOUR BUSINESSPrices and arithmetic accuracy checked:

Signed: Rebecca Chan

Sales documents The following are some of the documents inspected by the auditor as part of the tests of controls for sales.

Date: 14 September 2014 DN # 13236

DISPATCH NOTE

Ship to: Serenity Publishers Ltd 16 Gratton Street Robina Qld 4226

I declare that all goods were received and no damage noted. Customer Signature: Amy Graham Date: 15 September 2014

Reliable Printers Ltd 35 Cannon Street

Bankstown NSW 2200

Description Quantity

Sea Life 150 copies

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Appendix A8Appendix

Reliable Printers Ltd 35 Cannon Street

Bankstown NSW 2200 Date: 5 December 2014

Invoice # 15326

TAX INVOICE To: Fictional Publishers Ltd

135 Ryan Street Melbourne Vic 3000

Quantity Description Unit Price Total Price 200 copies The Last Man Alive $55 $13 750 100 copies The Lost Astronaut $43 4 300 100 copies The Flash $45 4 500

2 155GST 21 550

$23 705

Payment due: 5 January 2015 THANK YOU FOR YOUR BUSINESSPrices and arithmetic accuracy checked:

Signed: Rebecca Chan

Date: 5 December 2014 DN # 15326

DISPATCH NOTE

Ship to: Fictional Publishers Ltd 135 Ryan Street Melbourne Vic 3000

I declare that all goods were received and no damage noted. Customer Signature: Bob �omas Date: 6 December 2014

Reliable Printers Ltd 35 Cannon Street

Bankstown NSW 2200

Description Quantity

The Last Man Alive 200 copies The Lost Astronaut 100 copies The Flash 100 copies

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A9 Appendix Appendix

Reliable Printers Ltd 35 Cannon Street

Bankstown NSW 2200 Date: 19 January 2015

Invoice # 15768

TAX INVOICE

Description Unit Price Total Price Star Monthly $10 $2500 Daily Magazine $8 2460 Celebrity Talk $7 3500

846GST 8460

$9306

To: Home Press Pty Ltd 16 Grace Street Artarmon NSW 2064

Quantity 250 copies 320 copies 500 copies

Payment due: 19 February 2015 THANK YOU FOR YOUR BUSINESS

Prices and arithmetic accuracy checked: Signed: Rebecca Chan

Date: 19 January 2015 DN # 15768

DISPATCH NOTE

Ship to: Home Press Pty Ltd 16 Grace Street Artarmon NSW 2064

I declare that all goods were received and no damage noted. Customer Signature: Ge� Ainsworth Date: 20 January 2015

Reliable Printers Ltd 35 Cannon Street

Bankstown NSW 2200

Description Quantity

Star Monthly 250 copies Daily Magazine 320 copies Celebrity Talk 500 copies

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Appendix A10Appendix

Reliable Printers Ltd 35 Cannon Street

Bankstown NSW 2200 Date: 25 March 2015

Invoice # 17524

TAX INVOICE To: Blockbuster Publishers Ltd

65 Albert Street Melbourne Vic 3000

Quantity Description Unit Price Total Price 500 copies The Greatest Battle $55 $27 500 100 copies Hero $50

3 250GST 32 500

$35 750

Payment due: 25 April 2015 THANK YOU FOR YOUR BUSINESS

5 000

Date: 25 March 2015 DN # 17524

DISPATCH NOTE

Ship to: Blockbuster Publishers Ltd 65 Albert Street Melbourne Vic 3000

I declare that all goods were received and no damage noted. Customer Signature: Sam Ronaldson Date: 26 March 2015

Reliable Printers Ltd 35 Cannon Street

Bankstown NSW 2200

The Greatest Battle 500 copies Hero 100 copies

Description Quantity

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A11 Appendix Appendix

Reliable Printers Ltd 35 Cannon Street

Bankstown NSW 2200 Date: 25 April 2015

Invoice # 18015

TAX INVOICE To: Nature Lovers Pty Ltd

160 James Street Richmond Vic 3121

Quantity Description Unit Price Total Price 500 copies The Gardening Magazine $12 $6000

600GST

$6600

Payment due: 25 May 2015 THANK YOU FOR YOUR BUSINESS

Prices and arithmetic accuracy checked: Signed: Rebecca Chan

Date: 25 April 2015 DN # 18015

DISPATCH NOTE

Ship to: Nature Lovers Pty Ltd 160 James Street Richmond Vic 3121

I declare that all goods were received and no damage noted. Customer Signature: Sally Black Date: 26 April 2015

Reliable Printers Ltd 35 Cannon Street

Bankstown NSW 2200

Description Quantity

The Gardening Magazine 500 copies

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Appendix A12Appendix

Reliable Printers Ltd Online Banking

EFT Deposits for 19 February 2015

Big Bank Ltd 10 Blade Street

Bankstown NSW 2200

Receipt Number Customer Amount $

EFT 324 Australia Wide Publishers Ltd 7 700 EFT 325 Glossy Magazines Ltd 6 050 EFT 326 Ace Publishing Pty Ltd 5 500

19 250

Cash documents The following are some of the documents inspected by the auditor as part of the tests of controls for cash.

Reliable Printers Ltd 35 Cannon Street

Bankstown NSW 2200

INWARDS REMITTANCE REGISTER 19 FEBRUARY 2015

Receipt Number Customer Amount $ CR 751 Home Press Pty Ltd 9306

Prepared by: Carly Barnes Date: 19 February 2015

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A13 Appendix

DAILY RECONCILIATION OF ACCOUNTS RECEIVABLE POSTING TO BANKING 19 FEBRUARY 2015

Total banking Bank statement

Prepared by: Carly Barnes Date: 20 February 2015

28 556

Reliable Printers Ltd 35 Cannon Street

Bankstown NSW 2200

Description Source Amount $

Cheques Inwards remittance register 9 306 EFT Online deposit report 19 250

Accounts receivable Sub-ledger 28 556

Balance as per general ledger

356 495

*Unreconciled difference is immaterial

BANK RECONCILATION AS AT 28 FEBRUARY 2015

Plus Unreconciled difference*

Prepared by: Te�y Graham Date: 5 March 2015

2 102

Reliable Printers Ltd 35 Cannon Street

Bankstown NSW 2200

Balance as per bank statement $407 430 56 107Less Unpresented cheques

351 323

Plus Deposits in transit 5 172

$358 597

Source: This case study was adapted from the Chartered Accountants Program of the Institute of Chartered Accountants in Australia—2012(3) Audit & Assurance module.

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