Question

Background information

From: Billy Wallace (procurement department)

Sent: Wednesday 16 September 20X8 To: Paul Yan (finance department) Subject: FW: Ottoman Cycles

Paul,

I’ve just received the email (below) from John Doe. Billy

From: John Doe (safety manager)

Sent: Tuesday 9 September 20X8

To: Billy Wallace (procurement department)

Subject: Ottoman Cycles Greetings,

Thanks for the great Induction to Myer and my new role as Myer safety manager. There isn’t much I don’t know about the average factory, but I do take your point: it is quite different being on this side of the fence. As you know, I’ve certainly seen quite a few manufacturers in my time

… after all, lots of time on the factory floor is what you’d expect from someone with my union background. So, I’m confident that this role is made for me.

I visited Ottoman Cycles yesterday. The local management team have been busy over the last few months. The factory expansion has been completed with new and second-hand machinery purchased and installed. The factory is now fully operational and deliveries are recommencing.

I did notice that one of the machines was a MAJOP1, which makes sense as it’s $100,000 cheaper than the PCJB. The MAJOP1 was widely used in Australia up until a couple of years ago but

the union pushed hard to get rid of them – the MAJOP1s were involved in quite a few serious injuries and a couple of deaths. I’m told that the machine has been in operation at Ottoman Cycles for over a year. I’ve checked the accident register at Ottoman Cycles and there aren’t any serious incidents recorded. Mr Khan is pretty confident that there won’t be any problems and isn’t interested in getting rid of the MAJOP1.

To be honest, it’s very clear that there’s no way Ottoman can fund the replacement as it’s very clear that they don’t have spare cash or any ability to raise a loan. Both what to do and funding it will be an issue for Myer as a major shareholder. This is an ethical issue for Myer.

Everyone here is getting ready for the upcoming stocktake and seem pretty confident that inventory records are accurate. Yesterday the warehouse manager showed me around and was able to point out the areas where parts have been borrowed for urgent machine repairs – they’ll be replaced before the count so it’s all looking good.

I’m heading off to Vietnam next, and will catch up with you again after that. Cheers,

John

End of background information

Required
The board is querying the decision to invest in Ottoman Cycles. The board wants greater oversight of the Ottoman Cycles investment.
(a) (i) Identify the governance issues that the board should be concerned about in relation to its investment in Ottoman Cycles
(ii) Based on the above concerns, discuss measures that the board could request to ensure it has sufficient oversight over Ottoman Cycles
(b) The board is particularly concerned about inventory. You have been asked to accompany the internal auditors at the Ottoman Cycles stocktake. Kim has heard rumours that there have been no formal inventory stocktake in the past. In preparation for the stocktake you have arranged a meeting with John Doe as he has recently visited the factory. Identify potential inventory issues. Discuss why these issues are important and how these issues could, if at all, impact the reported results for Myer.

Answer 1

(a)(i)Governance issues:

John Doe, the safety manager pointed out that usage of MAJOP1 caused several serious injuries and a couple of deaths in Australia which finally resulted in removing the machines due to pressure from the union. As stated, Ottoman Cycles factory has been using MAJOP1 machinery over a period of one year and no serious incidents are mentioned in the register.

Further, it is apparent that Ottoman Cycles is not in a position to replace MAJOP1 machine with a safer machine like PCJB since it requires an additional $100,000 and Ottoman Cycles is neither have spare cash nor can avail a loan from outside parties.

Hence, there is a possibility that Ottoman Cycles might use unsafe machinery due to their financial constraints by exposing its workers to an unsafe working environment. In the worst case scenario, there might be some serious incidents with MAJOP1 machinery and local management might ignore the same while updating the accident register to continue the usage of MAJOP1 machinery, which leads to huge governance issue for Ottoman Cycles and it’s a major shareholder, Myer.

  

1. (ii)Governance measures:

The board should request the procurement team to provide a brief on purchase process of MAJOP1 machinery which should include whether Ottoman Cycles considered the possible incident risks associated with machinery and measures taken to eliminate the same. Further, the board should also direct inter audit team to look into Ottoman Cycles on matters like compliance of internal frameworks, accuracy in the register maintained at factory site including accident register, measures taken by local management in creating the safe working factory environment etc. Upon reviewing the report from the internal audit team and comparing the findings with the procurement team briefings, the board should take appropriate decisions to tackle the situation if it finds any lapses in the governance process.

(b)Inventory accounting:

Inventory is one of the major current assets of any manufacturing company and a smooth flow of production depends on the proper maintenance of inventory. Kim suspected that there might be no formal inventory stocktake in the past. Hence, it might be the first formal inventory stocktake at Ottoman Cycles. Hence, it possible that we might face issues like mismatch of physical stock with inventory records, keeping spoilage [i.e. expired stock which needs to be written off] in records, maintaining the dead stock/non-moving stock [out of style, out of season, or the products become otherwise irrelevant] value at purchase cost instead of net realisable value etc.

As per the generally accepted accounting principles, the inventories should be recorded at lower of purchase cost or net realisable value. Keeping the lost stock and spoilage in the books at purchase cost will result in a misrepresentation of factory assets which needs to write off on a priority basis. In the case of non-moving stock, management should check it’s net realisable value [NRV] and restate it’s inventory wherever NRV is lower than the purchase cost.