Question

Warmset Clothing Berhad

Warmset Clothing Berhad is a supplier of winter clothing that has acquired a significant portion of the winter clothing market by producing finest quality products and services. This has contributed favourably to their brand name. The company is contemplating broadening their markets by obtaining a certification from the International Standards Organisation (ISO). The board of directors (BODs) is made up of nine members that hold roughly 26% of the company’s common stock. The members are:

The BODs have good knowledge of the industry and the international distribution market. The board meets thrice a year to discuss important matters pertaining to the business. The following are selected excerpts from the minutes of the BOD meetings in 2019.

1 Jan 2019	Halim Osman recommended that Warmset is to purchase a yacht for the purpose of tax saving. If the company buy the yacht from Yacht-ing Incorporated, he will guarantee a handsome discount since he is the managing director of the company. The recommendation was supported by Ananda Balakrishnan. The board has agreed to the recommendation and will be purchase the yacht in the following month.
	Dorian Wong presented highlights, trends, and issues from the balance sheet, income statement, and cash flow statement for the year ended 30 November 2018. Based on the performance, Dorian Wong recommended a bonus pay of two months to all directors and vice directors, and one month pay to all employees who are without disciplinary issue. Due to the increased performance in 2018, compared to 2017, the board has agreed to the recommendation. Eric Hwang commented on the high account receivables and requested that the company need to improve its debt collection methods. Dorian Wong agreed to the request.
	Dorian Wong presented Warmset’s strategic plan for the year 2019. Janice Jungsoon wanted the company to come up with more new designs and requested Warmset to attend the fashion festival in Paris.
1 July 2019	Dorian Wong reported Warmset’s half year’s financial report is not ready and will be circulated to all members by August 2019. Dorian Wong reported that the purchase of the yacht at a price of RM2.3 million has been completed. Board members are welcome to book the yacht for their use beginning 15 July 2019.
	Jamal Abdullah presented the need for an internal audit department within Warmset Clothing. Dorian Wong indicated that he trusts all his employees and such department is not necessary. Ananda Balakrishnan supported Jamal Abdullah proposal and said that internal audit is not about finding people’s fault and is a good tool to ensure performance. The board has agreed to the formation of the internal audit department.
	Janice Jungsoon raised the issue of poor financial reporting due to the weaknesses in the existing system. She recommended the purchase of a new Enterprise Resource Planning (ERP) system to replace the current system that was developed in-house. The board agreed to the recommendation and the purchase is to be funded by a public offering of Warmset’s corporate bonds. The board also agreed that Morrison and Associates is to be appointed as the consultant for the system implementation.
1 December 2019	Janice Jung Soon reported that she was extremely satisfied with the design and implementation of the ERP system and recommended that someone from Morrison and Associates should be appointed as the company’s CFO. Dorian Wong supported the idea and said that the appointment would ensure vigilant watch over company’s operations and ensuring the accuracy and completeness of all financial reports. Other members of the board also happy with the system implementation and agreed to the recommendation.
	Halim Osman reminded the board of the planned retreat in January 2020.
	The board has unanimously agreed to reappoint Morrison and Associates as the company’s external auditor due to the firm’s commitment to Warmset as its prized client.

ERP system implementation

The implementation of the system was done by Morrison and Associates, the appointed consultants and system developers. The ERP system would enable online real-time transaction processing, which is a significant upgrade from the previous batch-processing system. In order to speed up the implementation process, the system analysts and programmers of Morrison and Associates 24-hour access to the current system.

Upon installation of the system, the programmers entered transactions from December 2019. Various reports generated from both new and old systems were then compared as a test of accuracy. Other than differences due to data entry errors on the old system, both systems have produced similar reports and no differences could be detected. All controls used in the old system was verified and implemented in the new system. The development manager was proud to report the speedy implementation of the system.

Warmset’s IT Department was fully restructured following the new system implementation whereby the programming functions was blended with transaction processing functions. Morrison and Associates recommended the restructuring as a cost-cutting measure. Morrison and Associates also provides round the clock help desk which provides access to anyone requesting to use the system, as well as onsite data library. Data processing efficiency was significantly increased by allowing data processing team to detect and rectify data entry errors made in other departments, including the sales, purchases and production departments. Consequently, closing the accounts took only two days, compared to two weeks on the old system.

The appointment of the Chief Financial Officer

Ms. Nisha Pillai has been appointed as the company’s new controller and CFO. Ms. Nisha was a partner in Morrison and Associates and was recommended by the firm as she possessed talents that are suitable for the Warmset Clothing.

The internal audit department

For the past five years, the internal audit function was outsourced to Morrison and Associates. Dorian Wong has always been contented with the functional integration of the services contracted with Morrison and Associates and was very pleased with the cost-savings. So, he was quite uneasy with the board’s decision to establish the internal audit department.

The newly established internal audit department is led by Adam Ahmad, the director. He has eight years of experience in the finance sector before he continued his study at a local university. Less than three years ago, he graduated with a bachelor degree in accounting. Adam Ahmad is quite well known at Warmset Clothing because his father is the director of finance at Warmset. Adam Ahmad reports directly to Nisha Pillai.

The human capital department

The department has also been restructured based on the recommendation by Morrison and Associates, in the effort to cut costs. The previously autonomous IT department is now part of the human capital department. The restructuring was done to enable better integration between human resources and the information resources, while reducing the bureaucratic decision-making. The previous director, Susanah Chin, has resigned from the position following her dissatisfaction with the restructuring. Hasnina Manaf was then appointed as the new director of human capital. A graduate with a bachelor degree in sports science, Hasnina Manaf was quickly oriented into her roles. To accelerate her grasp of the system, she was allowed access to Susanah Chin’s system access

Financial results

During the board meeting on 1 January 2020, Nisha Pillai presented the financial performance of the company. Among the notable achievement of the company include:

1. The earnings per share of Warmset have been steadier over the years and were marginally higher than the industry average.
2. Warmset’s revenue recognition strategy has proven to be effective in stabilising earnings. The strategy involved recognising revenues at the point of sale and the goods are delivered at a later date.
3. The operating expenses include gains from the sale of old machinery. The decision to sell the machinery has proven to be wise because the new machines has cut the labour hours by half and the gains from the sale has somewhat eased the operating expenses.
4. The company has managed to increase the collection of accounts receivable, resulting in higher debt-to-equity ratio, compared to the industry average.

REQUIREMENTS

1. Assess the risks associated with the industry within which Warmset Clothing Berhad operates.

2. Appraise the potential impact of public offering of Warmset’s bonds as a way to fund the purchase of the new ERP system.

3. Assess the revenue recognition strategy adopted by Warmset Clothing.

4. Identify Warmset Clothing’s internal control weaknesses over financial reporting and corporate governance. Classify the weaknesses as either control deficiencies, significant deficiencies, or material weaknesses. Justify your answer.

Answer 1