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WZX has recently been engaged to provide audit and income tax services to UQ Retail Industries hereafter referred to as UQ Retail. The audit team selected has extensive experience in the diversified retail and property investment sectors.
UQ Retail Industries - Corporate Profile & Background
UQ Retail is an iconic integrated retail, franchise and property enterprise. UQ Retail Industries is listed on the Australian Stock Exchange (ASX). UQ Retail sells franchises trading under two trading names. These franchises sell electrical goods, furniture, computers, bedding and manchester direct to the public. The operations of UQ Retail also include property investment and the provision of consumer finance and other commercial advances (Morning Star DatAnalysis, Company Details;Corporate Profile).
UQ Retail has been trading for 10 years, and been listed for five years. The company has adopted a "growth & expansion" strategy during the last three years in order to increase its market share, achieve economies of scale and improve its competitiveness. UQ Retail currently has 250 franchised stores throughout Australia and New Zealand. UQ Retail also operates corporate (wholly owned) stores in Australia, New Zealand, Singapore and Malaysia.
The CEO, Mr John Smith, founded the company and is also the Executive Chairman. The CEO holds a 20% stake in the company with employees also owning a significant amount of the company's issued equity.
UQ Retail has a balance date of 30 June 2013. The audit is required to be completed no later than 20 July 2013. Consequently gaining a detailed understanding of the client, evaluating the internal control environment and interim testing must be completed by mid-May 2013 and presented to the audit and risk committee at their meeting scheduled for 20 May, 2013.
The timeline imposed by the client is very tight, however we have committed to achieving the dates outlined above. In order to avoid last minute 'surprises' and to ensure audit efficiency, the client has requested timely and clear communication regarding information required, audit timetabling, audit issues arising and potential adjustments to the financial statements. The client has also made it clear that the communication request extends to audit fees and potential overruns.
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An audit planning meeting has been scheduled for the week commencing 29 April 2013. To facilitate audit planning, the following documents are attached:
·€ ! detailed spread sheet detailing UQ Retail's audited financial information for the last three
financial years and the unaudited interim management accounts to 31 March 2013. The spread sheet has been prepared by the client. The spread sheet also includes analytical data and other supporting information;
! brief summary of the company's key accounting policies extracted from the 2012 audited
· Memorandums detailing discussions with:
o the predecessor auditor;
o the Board and the Audit and Risk Committee Chair; and o the CFO.
As you review each memo please identify any inherent risks that come to your attention, and be prepared to discuss the assertions that might be misstated and implications for the nature, timing or extent of audit procedures. After reviewing this information come to the planning meeting prepared to discuss a general audit plan for how to approach the UQ Retail audit. It is important that you come well prepared for this meeting as we need to utilise every minute to the fullest benefit. You should perform additional analytical procedures prior to the meeting to identify additional risks/concerns that I may have not noticed.
Specifically I expect to cover the following matters in this planning meeting:
1) Discuss the results of analytical procedures and the risk of material misstatement indicated
by this data. Identify additional analytical procedures that we should perform to assist in the planning process.
2) Identify the revenue recognition related accounting issues so that we can develop a
tailored audit program.
3) Identify what additional data and / or other documents, we should request from the client
in order to facilitate our audit planning process.
4) Have a 'fraud' discussion- i.e. discuss potential areas for fraud in the organisation and how
they might impact our audit program/plan.
5) Identify audit issues (and the general outline of our audit program) by each of the
a. Revenue - Generally & specific to Sale of Goods, Franchise Revenue and
Provisions of Consumer Finance
b. Other audit areas/concerns that have come to your attention.
At the conclusion of this meeting we will be required to document our preliminary assessment of risk as it relates to the revenue cycle as well as identify other risk factors. I would also expect that we would be able to draft a preliminary audit program, subject to changes and modifications as the result of further planning activities and controls testing.
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Accordingly, in addition to being prepared to discuss the general audit procedures with respect to the tests of controls you should be prepared to identify and discuss specific substantive audit procedures with respect to the audit issues you identified in (5) above.
If you would like to discuss any of this information (or other related matters) prior to the meeting, please do not hesitate to contact me. Thank you for being part of the audit team. It will be a lot of work over the next few months but it should be an incredible learning experience.
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14 March, 2013
UQ Retail Industries Planning Memo
Summary of Key Accounting Policies
The following is a summary of the key accounting policies with respect to revenue recognition and related matters included in the prior year's financial statements:
1) UQ Retail sells franchises to independent contractors who sell products to consumers
through retail outlets. UQ Retail also owns corporate stores which sell products directly to consumers. The franchises are located in Australia and New Zealand, with corporate stores located in Australia, New Zealand, Singapore and Malaysia. The Company owns investment property in Australia and Malaysia. The company also provides consumer finance and other commercial advances directly to customers and franchisees.
Sale of Goods:
Revenue (and related accounts receivable) is recorded when title passes, which is generally when goods are delivered. Lay by sales are recorded after the final payment is received from the customer.
The company has a 30 day return policy in which customer's may return faulty products. However, the company is considering whether to increase the return period in an effort to boost sales. The return rate has historically been around 1% of sales.
The Company provides for uncollectable amounts based on the Company's historical experience. The allowance for uncollectable or doubtful accounts historically runs at less than 1% of credit sales. An allowance for uncollectable accounts is not generated for consumer finance loans as the default rate has historically been deemed immaterial.
3) Franchisee Revenue:
Revenue attributable to franchise fees is brought to account only when the franchise fees have been earned, or where the franchise fees are unpaid but recovery is certain.
Revenue is recognised as the interest accrues (using the effective interest method, which is the rate that discounts estimated future cash receipts through the expected life of the financial instrument) to the net carrying amount of the financial asset.
Rental income arising on investment properties is accounted for on a straight-line basis over the lease term. Contingent rental income is recognised as income in the periods in which it is earned.
6) Inventory is recorded at the lower of cost or net realisable value. Inventory is recorded net of all volume rebates, marketing and business development contributes and settlement discounts. Costs are on a weighted average basis and include the acquisition cost, freight, duty and other goods inward charges. Inventory is located in Australia, Malaysia and New
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Zealand. Net realisable value is the estimated selling price in the ordinary course of business, less estimated costs necessary to make the sale.
7) Use of estimates - The preparation of financial statements in conformity with GAAP requires
the use of estimates in the preparation of the financial statements. The Company bases its estimates on historical experience and on various assumptions that are believed to be reasonable under the circumstances. Actual results could vary from those estimates.
The Company provides for an estimate of costs to be incurred under the Company's product warranty based on historical warranty claims.
8) The functional and presentation currency of UQ Retail is Australian dollars. Transactions in
foreign currency are initially recorded in the functional currency at exchange rates ruling at the date of the transactions. Monetary assets and liabilities denominated in foreign currencies are retranslated at the rate of exchange ruling at balance date. Gains or losses from foreign currency transactions are included in the income statement in the period they arise.
The functional currency of overseas subsidiaries is the currency commonly used in their respective countries. As at the reporting date the assets and liabilities of these overseas subsidiaries are translated into the presentation currency of UQ Retail at the rate of exchange ruling at the balance date and the income statements are translated at the weighted average exchange rates for the period. The exchange differences arising on the retranslation are taken directly to a separate component of equity called the foreign currency translation reserve (FCTR). On disposal of a foreign entity, the deferred cumulative amount recognised in equity relating to that particular foreign operation is recognised in the income statement.
9) Investment properties under construction are valued at fair value if fair value can be reliably
determined. The assessment of fair value may be based on an internal assessment approved by the Board, which may engage independent, qualified valuers to assist in the valuation process. The fair value of investment property under construction is calculated using the capitalisation method of valuation. Borrowing costs directly attributable to the acquisition, construction or production of qualifying assets, which are assets that necessarily take a substantial period of time to get ready for their intended use or sale, are added to the cost of those assets, until such time as the assets are substantially ready for their intended use of sale. The Company has investment properties under construction in Australia and Malaysia. Most of the Malaysian contracts are fixed price contracts and are quoted in Malaysian ringget.
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14 March 2013
UQ Retail Industries Planning Memo
Communication with predecessor auditor
On 24 March 2013 I met with Ms. Jane Smith, Partner with the accounting firm of Smith, Jones and White (SJW) who was the auditor for UQ Retail for the years ended 30 June 2009 - 2012. The communications were in accordance with the Code of Ethics for Professional Accountants (APES 210.11.1):
1) Ms. Smith was not aware of any significant issues with respect to the integrity of management
or any accounting personnel.
2) Ms. Smith indicated that there had been no significant disagreements with respect to
accounting principles, audit procedures or related matters.
3) Ms. Smith stated that there has been no communications with the audit committee, board of
directors or management with respect to fraud, illegal acts or weaknesses in internal controls.
4) Ms. Smith indicated that it was her understanding that UQ Retail was switching audit firms
because they believed they were getting too large for SJW to be able to serve the company's needs.
Upon further discussion Ms. Smith also volunteered the following information which she requested we keep confidential:
1) While the internal controls were adequate the Company had grown considerably due to its
aggressive expansion program and some of the personnel in key control positions were marginally qualified for their responsibilities.
2) The physical inventory counts were not always performed with the level of diligence and detail
that she would have preferred.
3) Ms Smith did indicate that they had some issues come up in last year's audit that the client was
not too happy about. They noted a few cut off errors that had to be followed up on.
4) The Company had a pretty liberal return policy, which results in approval of warranty claims
that do not always comply with the company's formal 'returns' policy.
5) They noted a couple of transactions toward the end of last year whereby the Company agreed
to include 'buy back provisions with deferred payment terms' in a few of the contracts with new franchisees. She said they only noticed this in a couple of the more recent contracts, however deemed the amounts to be immaterial and therefore did not really follow up on it much.
6) Having said all of this, she did state that the 'tone at the top' had always been fairly good. It
seems that top management and the Board of Directors generally are always saying that they want to do 'the right thing'. Ms Smith indicated that as the CEO was also the Executive Chairman and founder of the organisation, and has strong views with regard to the operation of the company.
We have made arrangements to review the prior year audit work papers on 7 April 2013 at 9:00 am.
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15 March, 2013
UQ Retail Industries Planning Memo
Communications with the audit committee and management during the scoping
The following is a summary of some of the communications that I had with the audit committee and management during our scoping meetings:
1) The Company has recently completed the acquisition of a smaller competitor ("Discount
Computer and Electrical") in order to increase it market share. The company is still in the process of integrating the acquired businesses and is experiencing teething problems and unexpected costs in this regard.
Occasionally customers request that the company hold onto some of the products after the
sale date and ship on request.
3) The company implemented a new customised inventory management software system in
the later part of 2012. The company had previously been using an off the shelf inventory management software system.
4) The Company has recently had some key personnel turnover. The corporate financial
controller was terminated early in the year and has only recently been replaced. The Company has in the past few weeks employed a new corporate financial controller. The financial accountant responsible for the Malaysian operations is also relatively new. In addition, a new division manager of the New Zealand operations was appointed about 9 months ago.
5) The Company's compensation system provides base pay at about the 50-55 percentile range
of industry averages but includes a generous incentive compensation plan that rewards managers for performance. The performance is based on a combination of sales and revenue growth and profitability. Performance is measured at both the local/division (Australia, New Zealand, and Malaysia) level as well as overall profitability. Key management personnel have the opportunity to more than double their base pay with the incentive compensation.
6) The Company has been economically hurt by the recent strengthening of the Australian
dollar and the slow down in the global economy and its impact on the retail sector.
7) There has been rumours circulating that a large US conglomerate may target the company
for a takeover. The rumours are believed to lack substance, however the company's share price has experienced volatility as a result of the rumours, and the overall depressed outlook regarding the global economy and local retail sector.
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14 March 2013
UQ Retail Industries Planning Memo
Communication Jim Jones, CFO
A summary of the key matters identified from my meeting with Jim are summarised below:
1) Jim informed me that they only do cycle counting at the New Zealand and Malaysia
operations. They have not done a complete 'wall to wall' inventory count at those locations for some time.
2) The acquisition of 'Discount Computer and Electrical' is the company's most substantial to
date and was funded by a mixture of bank debt and unsecured notes. The unsecured notes were offered to the public and are listed on the Australian Stock Exchange. Due to the increase in bank debt, the facility was restructured in late 2012.
3) He indicated that with a downturn in the global economy they were doing whatever was
necessary to increase revenue, often giving significant pricing and 'terms' concessions to new franchisees, but he did not see any accounting issues. In addition, aggressive revenue targets have been set for the year ending 30 June 2013.
4) 2012 was an incredibly challenging year, however he is confident that 2013 and future years
will see strong growth, particularly in regional areas as a result of the mining boom, and increased market share.
5) He also mentioned that they had a couple of large transactions with some key customers
whereby the Company sold significant quantities of products to the customers but were only shipping them as the customer requested the products. These transactions are recorded as sales prior to being shipped.
6) In relation to relevant industry factors, Jim noted:
· The industry is labour intensive. It is important that staff have strong product
knowledge and remain up to date regarding technology and consumer products.
· Demand is driven by the availability of disposable household income. · Competitive pressure is very high.
· Stock management is critical, ie ensuring do not carry excess amounts or obsolete
inventory lines and ensure pricing is competitive.
· Three major players account for 40% of the market.
· The industry as a whole expects to see a 4% increase in revenue growth and a 7%
increase in net profit before tax for the year ending 30.06.13.
7) He requested that we let him know as soon as possible which sites we would be observing
the physical inventory counts so that he could let 'his team' know and plan accordingly.
We will need to address these matters at our upcoming planning meeting.
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18 March 2013
UQ Retail Industries Planning Memo
Communication with Simon Black, Audit and Risk Committee Chairperson
I attended the same fundraising event last weekend as Simon Black who is Chairperson of the Audit and Risk Committee, and a long time member of the Board of Directors. Throughout the course of the evening Simon mentioned several relevant matters, in particular:
1) He is concerned with the operations in New Zealand. He does not believe the controller at that
location has an adequate understanding of accounting principles and IFRS.
2) He is very concerned that there might have been some unusual transactions with respect to
some of the contracts related to the Malaysian investment properties that are currently under construction. In particular, Simon is concerned about the possibility of bribery and corruption. He is aware of the significant adverse ramifications of increased penalties for bribery and fraud under !ustralia's Criminal Code Act 1995 and wants us to investigate this matter during our audit.
3) He also expressed concern with respect to the accuracy of the quarterly financial statements
that are distributed to the Board and the lending institutions.
4) And finally he expressed his appreciation that we were doing the audit this year. Simon has
heard great things about our Firm and several members of the audit team.
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