Biotech Limited

Financial year end 30 June 2020

You are an auditor in Smit & Chandra, a mid-tier audit firm. Your firm is the incumbent auditor on Biotech Ltd, a pharmaceutical company. Since the previous audit, the company has listed on the Australian Securities Exchange which means the company has to meet additional reporting regulations. Due to rapid growth, Biotech Ltd is financially stretched and its accounting systems are struggling to cope with the growth in the business. You recently read an article in the Australian Financial Review, which stated that Biotech Ltd is currently under investigation by the Australian Taxation Office (ATO) for alleged failure to pay the appropriate amount of Pay As You Go (PAYG) tax on their payroll.

Biotech Ltd is a pharmaceutical company, developing drugs to be licensed for use around the world. Products include medicines such as tablets, medical gels and creams. The market is very competitive, encouraging rapid product innovation. New products are continually in development and improvements are made to existing formulations. Drugs must meet very stringent regulatory requirements prior to being licensed for production and sale. You are aware that during the 2020 financial year, Biotech Ltd lost several customer contracts to overseas competitors.

Biotech Ltd approached its bank during the year to extend its borrowing facilities. An extension of $20 million was sought to its existing loan to support the on-going development of new drugs. The long-term borrowings are subject to debt covenants in which the company must maintain a current ratio of 3.5:1.

In addition, the company asked the bank to make cash of $5 million available if an existing court case against the company is successful. The court case is being brought by an individual who suffered severe side effects when participating in a clinical trial in 2016.

On 8 June 2020, the Company announced to the market it had been the victim of a cyber-security incident that resulted in supplier and customer details being disclosed on the dark web. The Company is assessing the costs of the incident and the subsequent reduction in revenue. The Company expects this to have a material impact on future earnings.

In December 2019, the internal audit department of Biotech Ltd performed a review of the operation of controls over processing of overtime payments in the Payroll department. It was found that the company’s specified internal control procedures in relation to the processing of overtime payments were not followed.

Below are some results of the analytical review procedures performed by the Senior Auditor (David) during the planning stage:

Sales                                                                                                            12.5% decrease since prior year

Net profit after tax                                                                                20% decrease since prior year

Accounts payable                                                                                   15% decrease since prior year

Cash at Bank                                                                                             16% increase since prior year

Accounts receivable                                                                              18% increase since prior year

Inventories                                                                                               6%   increase since prior year

Current ratio:                                                                                            3.6:1

Debt to Equity ratio:                                                                               0.6

Minutes from the Audit Planning meeting with Simon Jones (Finance Director of Biotech Ltd) held on 30^th April 2020:

Due to the current government restrictions, the planning meeting with Simon Jones was held via Zoom. In attendance at the meeting was the Audit Partner (Michael), the Audit Manager (Amanda) and the Audit Senior (David).

The following key items were discussed during the meeting:

• Mr Jones raised concerns about the conduct of the previous audit, stating numerous examples of when he and his staff had been interrupted when they were busy. He stated that he wanted guarantees that this year's audit will be more efficient, less intrusive and cheaper, otherwise he will seek an alternative auditor in future.
• Michael reminded Mr Jones that fees relating to the audit engagement from the previous year were still outstanding.
• Both Michael and Mr Jones also discussed the range of non-audit services provided to Biotech Ltd, which includes payroll preparation, tax computation and advice.
• Mr Jones gave the audit team an update on the court case pertaining to the individual who suffered severe side effects from a company trial (refer above). According to legal advice provided to Mr Jones by the company’s legal counsel, it is more likely than not that Biotech will lose the court case, which would result in a significant amount of cash having to be paid as a settlement.
• Amanda asked Mr Jones if he considered the decline in profitability as an indicator of a material uncertainty surrounding the going concern assumption. Mr Jones responded by saying, “Look, everything might seem dire, but we have it under control. We will be here this time next year, so keep that in mind”. Michael then looked at Amanda and David and said, “Make sure that you mention the conversation that we have just had with Mr Jones about the appropriateness of the going concern assumption in the audit working papers. This should be sufficient enough audit evidence for us.”
• Mr Jones also mentioned the following: “As you know, Biotech Ltd has a Goodwill asset on the balance sheet. This is an indefinite useful life intangible asset. In accordance with the Accounting Standards (AASB 138), we are required to test the asset for impairment every year. We usually prepare a Value in Use calculation based on discounted future cash flows that we expect to generate in the next five years. I have completed this year’s calculation by rolling forward the prior year’s calculation and have just updated the dates. There was no need to update the future cash flow figures.”

The Audit Team

The audit team consists of 4 people. The partner is Michael. He has been the audit partner on the Biotech Ltd audit for 6 years. The audit manager is Amanda. This is Amanda’s first time on the Biotech Ltd audit. David is the audit senior and is responsible for the initial audit planning. David has recently completed the Graduate Diploma of Chartered Accounting. David has just been offered a well-paying accountant position at Biotech but he has not yet decided whether to accept the position. The graduate on the audit is Audrey. Audrey’s friend is the receptionist at Biotech Ltd. The receptionist has no accounting knowledge and has no involvement with the recording or processing of accounting transactions.

Accounts Receivable / Sales Accounting Cycle and Internal Control System

At the end of each month, the sales manager determines the amount of products required to meet sales demand for the following month based on sales orders received. He reviews the sales orders received from customers and then prepares the pre-numbered inventory requisition forms, which he then sends to the warehouse managers so that they can prepare the goods for delivery. One copy of the sales order and inventory requisition form is sent to the warehouse, one copy is sent to the accounts receivable department and one copy is filed in the sales department.

The warehouse prepares the goods for delivery to the customers and generates the delivery document. When the goods have been delivered, the signed delivery document, which includes the delivery details, is forwarded to the accounts receivable department. The other copy is filed in the warehouse. The accounts receivable clerk matches the signed delivery document with the sales order and inventory requisition form. Once satisfied that all of the details agree, the clerk generates the sales invoice. Once generated, the clerk does another check to ensure that all details per the sales invoice agrees to the delivery document and sales order. Once satisfied, she writes “checked” on the sales invoice and sends it to the customer. At the end of every week, a different clerk in the Accounts Receivable team reviews the bank statements for receipt of payments from customers and performs a reconciliation against the sales invoices. Once a customer has paid the sales invoice, the clerk stamps “received” on the sales invoice and files that along with all the other documents in date order.

The walk-through of the accounts receivable/sales cycle confirmed that the accounting and internal control system was working as documented above.

Test of control:

As part of the audit, Audrey tested the controls over the accounts receivable system. She selected a sample of twenty sales transactions and tested the control that all details had been checked. Out of the 20 sales transactions that were selected for testing, 5 sales invoices in the sample did not have the word “checked” written on them. When documenting the results of the test performed, Audrey concluded that the internal control did not operate effectively and consistently throughout the year but that no further audit work is required.

Substantive test

In order to test the occurrence of the sales transactions, Audrey selected a sample of sales invoices and traced them to the General Ledger to test that they were properly recorded.

Subsequent events not previously mentioned

• One of Biotech Ltd’s major customers went into liquidation in July 2020. The balance due from the customer at 30 June 2020 was $564,000. This is a material amount. There has been no provision/allowance for doubtful debts raised for this debtor in the financial statements for the year ended 30 June 2020. Biotech Ltd’s legal adviser stated in a telephone call that that the probability of any funds being received from the debtor is remote.

• On 2 July 2020, Biotech Ltd declared a one-for-five rights issue of 100,000 shares at $2.20. These shares were payable in full on 31 July 2020.

Write about the internal control system and the assertion for the same?

For both this year and last year:

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For both this year and last year:

Starfax, Inc., manufactures a small part that is widely used in various electronic products such as home computers. Operating results for the first three years of activity were as follows (absorption costing basis):

In the latter part of Year 2, a competitor went out of business and in the process dumped a large number of units on the market. As a result, Starfax’s Sales dropped by 20% during Year 2 even though production increased during the year. Management had expected sales to remain constant at 50,000 units; the increased production was designed to provide the company with a buffer of protection against unexpected spurts in demand. By the start of Year 3, management could see that inventory was excessive and that spurts in demand were unlikely. To reduce the excessive inventories, Starfax cut back production during Year 3, as shown below:

Additional information about the company follows:

The company’s plant is highly automated. Variable manufacturing expenses (direct materials, direct labor, and variable manufacturing overhead) total only $6.00 per unit, and fixed manufacturing overhead expenses total $450,000 per year.  

Fixed manufacturing overhead costs are applied to units of product on the basis of each year’s production. That is, a new fixed manufacturing overhead rate is computed each year.

Variable selling and administrative expenses were $3 per unit sold in each year. Fixed selling and administrative expenses totaled $80,000 per year.

The company uses a FIFO inventory flow assumption.

Starfax’s management can’t understand why profits more than doubled during Year 2 when sales dropped by 20%, and why a loss was incurred during Year 3 when sales recovered to previous levels.

Required:

1. Prepare a contribution format variable costing income statement for each year.

2a. Compute the unit product cost in each year under absorption costing. (Round your answers to 2 decimal places.)

2b. Reconcile the variable costing and absorption costing net operating income (loss) figures for each year.

5b. If Lean Production had been used during Year 2 and Year 3 and the predetermined overhead rate is based on 50,000 units per year, what would the company's net operating income (loss) have been in each year under absorption costing? (Losses should be indicated by a minus sign.)

FORECASTING FINANCIAL STATEMENTS -

Company A reported an income statement and balance sheet as shown below:

Use the following assumptions to forecast pro-forma income statement and balance sheets for a 5-year period and a terminal year: (PLEASE SHOW FORMULAS USED TO SOLVE PROBLEM)

(a) Sales increase to $825 in the first year and then increase 20 percent the second year, 15 percent the third year, 10 percent in the fourth year, and 7 percent in the fifth year. Terminal year increases at the assumed growth rate of 4 percent.

(b) Cost of sales is 35 percent of sales.

(c) Sales, general, and administrative expenses are 15 percent of sales.

(d) Depreciation is 8 percent of gross end-of-year property, plant, and equipment.

(e) Interest expense is 5 percent of end-of-year notes payable.

(f) Tax expense is 35 percent of pretax income.

(g) Cash is equal to three month's cost of sales (use current year costs of sales divided by 4).

(h) Accounts receivable has a turnover ratio of 9.0.

(i) Inventory has a turnover ratio of 4.0

(j) Gross property, plant, and equipment gross at the same rate as sales.

(k) Accumulated depreciation increases in Years 1 through 5 by the amount of the current year depreciation. Accumulated depreciation in the terminal year is equal to $711.36

(l) Accounts payable has a turnover ratio of 6.0

(m) Other current liabilities are $35 in Year 1, increasing by $10 in each of Year 2 thorugh 5, and equal to $78.00 in the terminal year.

(n) Notes payable are $498.94 in Year 1, $521.48 in Year 2, $493,56 in Year 3, $401.47 in Year 4, $264.22 in Year 5, and $274.79 in the terminal year

(o) Common stock is remains at $100 in Years 1 through 5, increasing to $104 in the terminal year.

(p) Retained earnings increases by the current year net income less dividends of $125 in Year 1, $150.01 in Year 2, $174.99 in Year 3, $200.01 in Year 4, $224.99 in Year 5, and $339.19 in the terminal year.

q) The depreciation add back in the operating cash flow section of the statement of cash flows is equal to the change in accumulated depreciation for the year.

On January 1, Year 1, Hart Company issued bonds with a face value of $128,000, a stated rate of interest of 12 percent, and a five-year term to maturity. Interest is payable in cash on December 31 of each year. The effective rate of interest was 11 percent at the time the bonds were issued. The bonds sold for $132,731. Hart used the effective interest rate method to amortize the bond premium. (Round your intermediate calculations and final answers to the nearest whole number.)

Required
a. Prepare an amortization table.

b. What is the carrying value that would appear on the Year 4 balance sheet?
c. What is the interest expense that would appear on the Year 4 income statement?
d. What is the amount of cash outflow for interest that would appear in the operating activities section of the Year 4 statement of cash flows?

The following information was drawn from the annual report of Machine Imports Company (MIC).

*By definition, Infrequent items are not likely to recur in the future.

Required
a-1. Compute the percentage of growth in net income from Year 1 to Year 2.
a-2. Can stockholders expect a similar increase between Year 2 and Year 3?
c. Assuming that MIC experiences the same percentage of growth from Year 2 to Year 3 as it did from Year 1 to Year 2, determine the amount of income from continuing operations that the owners can expect to see on the Year 3 income statement.
d. During Year 3, MIC experienced a $59,000 loss due to storm damage. Liabilities and common stock were unchanged from Year 2 to Year 3. Use the information that you computed in Requirement c plus the additional information provided in the previous two sentences to prepare an income statement and balance sheet as of December 31, Year 3.
  

The City of Gurnee is preparing its Government-Wide financial statements for the year. Its accountant must prepare a number of journal entries to recognize assets and liabilities previously omitted from the Fund financial statements and to recognize revenues and expenses for the year under accrual accounting that were not recognized under the current financial resources measurement focus and the modified accrual basis of accounting used to prepare the Statement of Revenues, Expenditures, and Changes in Fund Balances for its Funds. The accountant identifies the following journal entries that must be made:

Recognize Capital Assets of $120,440 as of the beginning of the year.

Record Depreciation Expense of $6,850 for the year and reverse Expenditures of $7,360 for Capital Outlays during the year.

Recognize $21,000 of Bonds Payable as of the beginning of the year.

Reverse Other Financing Sources of $8,000 and Expenditures – Debt Payments of $3,100 relating to increases and decreases in the bond liability during the year.

Reverse Deferred Revenue of $10,340 as of the beginning of the year.

Reverse $1,430 of Deferred Revenue recognized during the year.

Recognize Compensated Absences of $1,980 as of the beginning of the year and an increase in that liability of $230 during the year.

Recognize $140 of Accrued Interest Payable as of the beginning of the year and an increase in that liability of $260 during the year.

Recognize a liability of $4,210 relating to the City’s landfill as of the beginning of the year. The estimate for this liability did not change during the year.

Required: Prepare journal entries for each of the items above.

The project will last for 8 years, beginning in 2011 (year 0) and ending in 2019 (year 8). Depreciation is straight line to zero, and taxation (at the time) is 35% in the United States. In any year with a negative EBIT, there is no tax. The capital investment for the fibre line project is $350,000,000 (invested in year 0), including costs of amplification sites, earthmoving equipment, easements etc. Working capital is expected to be $60,000,000, returned at the end of the project. A 24 hours a day, 7 days a week maintenance team is required to ensure 99.99% operational capacity, costing $60 million per year, and increasing at 3% per year. The project success hinges on access to the fibre ports in the exchanges, they know this and charge $50,000,000 per year (combined), declining by 5% p.a. as demand declines.      A team of surveyors and builders who inspected the 1400 km path cost $1.5 million. At the end of the project, the technology is obsolete for its purpose in investment banking, but it can be sold to a telecom provider (contributing to the revenue for year 8) for $127,000,000. Revenue is subscription based at $3,600,000 per year, per subscription. In year 1 there will be 200 subscriptions, year 2 is 150, year 3 is 100, year 4 is 50. In year 5, 6, 7, 8 only 20 subscriptions are taken in per year. The all-important discount rate is 14.5%.

Question: What is the NPV and IRR using excel?

Suppose that the Statistical Institute uses information about three goods to construct the basket to be used for construction of Consumer Price Index (CPI). The set of prices and the set of quantites describing the basket of goods at the year of t respectively is the following: Pt = {Pat , Pbt , Pct } ; Qt = {Qat , Qbt , Qct }
i) Please show the CPI for the year of t = 2 (2 years after base year- at the base year t=0) which would contain elements belong to sets of Pt and Qt. (Hint: The formulation should include summation over goods for t = 0 and t=2 ).   

ii)Suppose at the base year (t=0) all prices are doubled. Construct the CPI under the new setting for the year of t=2. (5 points)

iii) Suppose that a year after the base year (at t=1) all prices are freezed, was not allowed to change. Additionally, suppose that all price controls were lifted at the second year after the base year (at t=2). Pta increased by %150, Pbt increased by %100 and Pct increased by %200 at the year of t=2. Under these settings calculate the inflation from the year of t=0 to the year of t =1 and the inflation from the year of t=1 to the year of t =2. (Please solve (only) 1.iii) by assigning numbers to elements for the set of Pt and for the set of Qt ) (10 points)