Instruction: please summarize this entire case study in three pages. (The Bill & Melinda Gates Foundation)

The Bill & Melinda Gates Foundation Growing up in Seattle, William H. Gates III was a slender, intense boy with a messy room and a dazzling mind. At age seven or eight he read the entire World Book Encyclopedia. At his family’s church the minister challenged young congregants to earn a free dinner by memorizing the Sermon on the Mount, a passage covering Chapters 5, 6, and 7 in the Book of Matthew. At age 11 young Bill became the only one, in 25 years of the minister’s experience, ever to recite every word perfectly, never stumbling, never erring. 1 Yet Christianity itself never attracted Gates. Years later he would remark, “There’s a lot more I could be doing on a Sunday morning,” an incongruous conviction for one who would become devoted to serving the poor. 2 His brilliance, however, was lasting. At private Lakeside prep school he was a prodigy, often challenging his teachers in class. Obsessed with computers in their then-primitive form, he stayed up all night writing code, a routine that would stay with him. He also read biographies of great historical figures to enter their minds and understand how they succeeded. After high school he attended Harvard University hoping to find an atmosphere of exciting erudition. Instead, he grew bored and left to pursue a fascination with computers. At age 19, Gates founded Microsoft Corporation with his Lakeside School friend Paul Allen. As its leader he was energetic, independent, and confrontational. He developed the reputation of a fanatical competitor willing to appropriate any technology and crush market rivals. He built a dominant business and by 1987, at age 31, he was a billionaire. Microsoft’s stock took flight, making more billions for Gates. However, even as he became the world’s richest man he remained absorbed in running the corporation.

References :1 James Wallace and Jim Erickson, Hard Drive: Bill Gates and the Making of the Microsoft Empire (New York: HarperBusiness, 1992), pp. 6–7. 2 Garrison Keillor, “Faith at the Speed of Light,” Time, July 14, 1999, p. 25.

He put little energy into charity, thinking it could wait until he grew old. But the world expected more. Requests for good deeds and contributions poured in. Gates responded with the help of his father, who worked in a home basement office handling his son’s donations. In 1994, Gates formalized his giving by creating the William H. Gates Foundation and endowing it with $94 million. His father agreed to manage it from the basement. Eventually, this arrangement evolved into the Bill & Melinda Gates Foundation, which included the name of his wife and was run by a professional staff from its new headquarters in Seattle. A foundation is essentially an organization with a pool of money for giving to nonprofit and charitable causes. It is not taxed if it gives out at least 5 percent of its funds each year. Bill Gates gave his foundation $16 billion in Microsoft stock in 2000. Since then he has given more. Today the Foundation is endowed with $37 billion, making it the world’s largest. It has two parts. One part decides what projects to fund. So far, more than $25 billion has been given out. The other part manages the endowment by investing the money to make it grow. The Gateses are deeply involved in the foundation’s work, which is based on a pair of “simple values” that inspire them. One is that “all lives—no matter where they are being led—have equal value,” and the other is that “to whom much is given, much is expected.” Giving is tightly focused on three areas—global health, poverty in developing nations, and U.S. public education. Because the foundation’s endowment is unprecedentedly large, more than the gross domestic products (GDPs) of 107 countries, its goals are ambitious. One is to correct market signals that cause modern medicine to neglect diseases of the poor, thus failing to value all lives equally. Pursuing this goal, the foundation has spent more than $3.8 billion on basic vaccinations for newborns in countries with low GDPs, preventing so far an estimated 3.4 million deaths. 3 It purchases such massive amounts of vaccines that prices fall, allowing doses for millions more children. It spends billions more to create new vaccines for tropical parasitic diseases and to fight a resurgence of polio in Africa. Bill Gates is characteristically intense, impatient, and direct in the quest to save lives. Learning that the global health staff was paying big travel grants for people to fly to meetings, he issued a curt memo about “rich people flying around to talk to other rich people.” He lectured the staff: “Our net effect should be to save years of life for well under $100, so, if we waste even $500,000, we are wasting 5,000 years of life.”

References: 4 Bill Gates at 31, already a billionaire. Source: © Ed Kashi/CORBIS. 3 Statement of Helen Evans, “State of the World’s Vaccines and Immunization Report 2009,” GAVI Alliance, October 31, 2009, at www.gavialliance.org. 4 Quoted in Andrew Jack, “Gates Foundation: Smaller Funds, Hard Decisions,” FT.com, September 30, 2009, at www.ft.com.

In 2006 Bill Gates’ friend Warren Buffett, chairman of Berkshire Hathaway and, at the time, the world’s second-richest man, decided to give most of his wealth away and made a bequest of 10 million shares of Berkshire Hathaway to the Gates Foundation. He believed Bill and Melinda Gates were doing such a superior job he could do no better and, rather than manage billions of dollars of giving on his own, he left his legacy in their hands. At the time, his gift was worth $31 billion, a sum that roughly doubled the Gates endowment. It arrives in annual installments of between $1 billion and $2 billion. The Gates Foundation confronts enormous social problems. Poverty and disease defy solution. Spending large sums in poor nations is a challenge. Corruption diverts funds. Agencies lack capacity. When infant lives are saved by vaccination, more people live to seek ordinary care. Some nations struggle to provide even the most basic care due to shortages of doctors and nurses. Thus, children are saved from diphtheria only to die in large numbers from common diarrhea. 5 Improving education is another nightmare. After spending $1 billion over six years to make small high schools better, an analysis showed that attendance, graduation rates, and test scores on basic subjects were lower than at similar schools not funded by the Gates Foundation. 6 Despite its magnificence, the Gates Foundation attracts critics. It is directed by only three trustees–Bill and Melinda Gates and Warren Buffet–putting its multibilliondollar expenditures in the hands of just two families. 7 It has been called an elitist, antidemocratic institution subsidized by taxpayers (through its tax exemptions) but having no accountability to society. 8 Suspicions are raised that its grants, being so big, shape the world’s health agenda and distort research priorities, for example, by overemphasizing vaccines for tropical diseases as opposed to other forms of treatment. 9 However, the Gateses and Warren Buffet want to extend the example set by their philanthropy. In 2009 they arranged a series of small, confidential dinners attended by fellow billionaires. Guests were asked to pledge the majority of their wealth to charity, either during their lifetime or at death, each one determining which causes to fund. Over the next year this initiative was formalized in a “Giving Pledge” joined by 40 billionaires. 10 Their pledges are moral commitments; they are not monitored or enforced as legal contracts. The Gateses and Buffet hope to spread the initiative to other nations. Their goal is to divert wealth from the very rich to enlarge the scope of global philanthropy for generations to come.

References :5 Laurie Garrett, “The Challenge of Global Health,” Foreign Affairs, January/February 2007. 6 The National Institutes of High School Transformation, Evaluation of the Bill & Melinda Gates Foundation’s High School Grants Initiative: 2001–2005 Final Report (Washington, DC: American Institutes for Research, 2006), pp. 9–10. 7 Pablo Eisenberg, “The Gates-Buffett Merger Isn’t Good for Philanthropy,” Chronicle of Philanthropy, July 20, 2006, p. 33. 8 “Philanthropic World Voices Mixed Reaction on Buffett’s Gift to Gates Fund,” Chronicle of Philanthropy, July 20, 2006, p. 12, comment of Rick Cohen. 9 David McCoy, et al., “The Bill & Melinda Gates Foundation’s Grant-Making Programme for Global Health,” The Lancet, May 9, 2009, p. 1652. 10 Carol J. Loomis, “The $600 Billion Challenge,” Fortune, July 5, 2010.

Philanthropy is one method for converting wealth to social value. Bill Gates and Warren Buffet follow a long tradition of rich capitalists who make fortunes, then later in life spend their wealth on works of kindness. In this chapter we will expand on the subject of philanthropy. First, however, we look at how managers implement social responsibility efforts within their firms. Social responsibility, like any other corporate goal, must be systematically planned, organized, and carried out. We will set forth a model of how this can be done

Flight Plan Consulting, Inc.

Cost of Capital and Firm Valuation Project

The Company background

Bill Gibson began Flight Plan Consulting, Inc. (FPC) in 1990. The company offered very specialized consulting services to corporate flight departments, i.e., to those companies that have their own planes for purposes of executive transportation. This consultancy focused on the cost versus benefit considerations of the acquisition and use of corporate aircraft. Bill Gibson was ideally suited for this line of work; he was both a commercial pilot and had held an adjunct position as a finance professor in a university near his home. His company had its first and only public offering of stock in 1995; at that time revenue had reached $5 million, and the employee headcount was up to ten. In the twelve years since the company's inception, sales, earnings and the company's fine reputation have increased steadily. The company's financial information, and selected capital market and industry data and information are provided in Table 1.

A major contributor to the company's good fortunes is a particular area of concern taking place in many corporate flight departments around the United States. This concern is known as “fractional ownership” versus full ownership of corporate aircraft. Gibson, while not a corporate pilot, understood well the costs, benefits, concerns and industry dynamics of corporate flight departments and the companies that supplied the aircraft. This knowledge and breadth of understanding formed the basis for his consulting company.

Fractional ownership, in its simplest terms, is when several companies, usually three or four, share the ownership of a corporate aircraft. For example, a company that wishes to buy fractional ownership will buy or lease a 1/5 interest in an airplane. Such an arrangement would allow for approximately 160 hours per year of usage. The total cost would depend upon the type of aircraft chosen. The fractional purchaser or lessee would also have access to aircraft crew, maintenance and everything else needed to complete the operation of a corporate aircraft.

The interest in fractional ownership has several origins, the most prominent of which is the corporate “downsizing” and “rightsizing” of the decade of the 1990's. The closing of a corporate flight department could possibly mean a significant reduction in total corporate overhead expenses. Moreover, fractional ownership may be more “flexible” in the manner in which the services are customized for each individual fractional owner. A rule of thumb among consultants was if the aircraft will be needed between 100 and 350 hours per year, fractional ownership would likely be the best option. [1]

Within that environment, FPC has become a major source of consulting services for firms that are moving from having an in-house flight department to fractional ownership, or are considering corporate aircraft acquisition for the first time. The operations of FPC involved Gibson or one of his five consultants working with the client to determine the most efficient manner in which to acquire the use of a corporate aircraft. The consulting relationships were always quite involved and of long duration. A consultant's reputation, however, depended upon the word-of-mouth goodwill of each client.

In the last year or so, Gibson had considered expanding by acquisition. There were several smaller consultancies in the same line of business as FPC. Gibson, after extensive discussions with his investment bank, had decided to focus upon two firms. Either one of those two would permit him immediately to acquire clients in Canada or Germany. The more pronounced international reach was exactly what FPC's strategic plan called for. While the company had done business in both Canada and parts of Western Europe for several years, the companies being considered for acquisition had very positive reputations in their respective locations.

Cost of Capital

Gibson believed that long-term capital from external sources would be needed to finance the acquisition. He believed FPC's common stock to be valued fairly at present. He also believed that the company's excellent bond rating would make a debt issue feasible.

Although the company’s board of directors was made up of successful and knowledgeable people from a variety of backgrounds, not all of them were intimately familiar with finance; it was, therefore, essential to answer any questions they had with authority. The firm’s investment in any asset, including other companies, was a result of the strategic plan, which the board had helped to develop and had certainly approved. The cost of capital issue was a very necessary tool in the implementation of that plan. The economic worth of any investment made by FPC would be measured against the firm’s cost of money, its opportunity cost, its cost of capital; terms that Gibson knew were interchangeable. At this crucial stage of the company’s development, he wanted his board to be “conversational” with those terms.

Gibson decided that he had better provide some specific and detailed information to his board concerning the company's cost of capital and its relation to the valuation process. In order to move the process along, Gibson decided to hand over the task of preparing a draft of “Cost of Capital and Acquisition Plans Memo”, as it had come to be called, to Kay Biddle. Biddle was a summer intern employed in FPC's controller's office. She was an MBA student and planned to graduate at the end of the fall semester with a concentration in finance. To construct her memo Biddle wondered how she, in relatively few words, could best show the interrelationship among the firm’s capital structure, the yield on the firm’s debt, and the rate of return on the firm’s equity. All of that information would be a starting point for her explanation.

Acquisition Plans

The board, Gibson believed, also needed to consider the effect of the impending acquisition upon the firm’s sales and net income after-tax. The purpose of the acquisition is to increase sales and income and to diversify the firm in terms of its geographic market. That is a key element in the long-term success of specialized consulting firms in FPC’s line of business.

FPC identified two possible target companies to acquire:

Maple Aviation, a fast-growing company with clients in major Canadian cities, such as Vancouver, Toronto, and Montreal.

Das Flugzeug, an established consulting company providing services to clients in Berlin, Frankfurt, and Munich.

Gibson asked Biddle to calculate the firm values of the above-mentioned targets and include the details in the memorandum. FPC's financial staff had spent considerable time analyzing the target companies’ current and historical financial statements. The analysis helped to determine the level of free cash flows after possible acquisition. The future expected free cash flows are the net cash flows available to the firm's investors after all investment in fixed assets and working capital have been made. The expected free cash flows from Maple Aviation and Das Flugzeug are listed in Table 2 and Table 3, respectively. All values are in US dollars. The last step of firm value calculation is to discount the cash flows at the weighted average cost of capital. The valuation process would help FPC justify the fair costs to acquire the target companies.

Table 1: Selected Firm, Industry, and Capital Market Data

Table 2: Free Cash Flows (Thousands of US Dollars) of Maple Aviation

Table 3: Free Cash Flows (Thousands of Euros) of Das Flugzeug

Your task:

Suppose you are Kay Biddle and you will prepare the memorandum. You have to structure your memorandum around the following items:

Describe the company's core business and the market it serves.

Discuss the role of a corporate board of directors. To whom is the board responsible?

Why are capital market data and information useful when a firm is considering its cost of capital?

Calculate and present FPC's weighted average cost of capital.

Calculate and present the valuation of the two target companies to acquire.

Quantitatively discuss the comparison of the two targets.

In general, describe the effect upon the cost of capital of changes in capital market conditions such as an increase in interest rates, or a decline in stock prices.

Discuss how various factors may affect the cash flow estimates and FPC's project evaluation.

Note:

The format of the report is memorandum addressing to the board of directors. The body of your memorandum must not exceed 6 single-sided letter-size pages of typed 12-point-font double-spaced characters. You may include tables and figures in an appendix and reference them in the body of the report. If you make any assumptions or use information from external sources, state or cite them clearly. Writing and analysis should be performed by each student individually.

[1] The other options are, for less than 100 hours per year, use a charter service; for usage over 350 hours per year, operate an in-house flight department.

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.

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.

Misstatements identified

What is the audit opinion for the above case study?

Answer the following hypothesis testing questions:

1. Determine if average prices of units “within 5KM of the CBD” exceed average prices of units “located within 5 to 10KM from the CBD”.

2. Determine if average prices for House within 5 to 10KM of the CBD exceeds the average price of Unit within 5KM of the CBD.

3. Determine if average prices for “Houses with three bed rooms within 5 to 10KM of the CBD” exceeds the average price of “Units within 5KM of the CBD”.

4. Test the difference between population means of houses of the following groups: prices for “One bedroom”, “Two bedrooms” and “Three bedrooms (or more)” properties.

5. Test the difference between population means of units of the following groups: prices for “One bathroom”, “Two bathrooms”, “Three bathrooms (or more)” properties.

Show your tested hypotheses for each questions, decision rules and then provide both statistical and managerial conclusions for each part. Then, provide an overall conclusion. Be clear in the conclusion that you draw from your analysis, and provide useful suggestions to the company’s CEO. Conclusions must be based on the findings of your analysis only.

Notes:

- Use critical value approach

- Use 0.05 level of significance in your analyses, and assume we have normal distributions and unequal variances of populations.

- Use Excel to conduct your analysis and hypothesis testing.

- Each question requires an Excel output. Simply copy your outputs from Excel sheets and paste them into the Word file of your Business Report.

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.

What is the independence of the audit team?

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.

Identify and Explain the inherent risk and business risk and their types for the above case study?

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?

ToyWorks Ltd. is a company that manufactures and sells a single product, which they call a Toodle. For planning and control purposes they utilize a monthly master budget, which is usually developed at least six months in advance of the budget year. Their fiscal year end is June 30.

During the summer of 2019, Chris Leigh, the ToyWorks controller, spent considerable time with Pat Frazer, the Manager of Marketing, putting together a sales forecast for the next budget year (July 2020 to June 2021). Unfortunately, their collaboration worked so well they eloped to Las Vegas, were married by an Elvis impersonator, and settled down somewhere in the desert. Prior to their departure they e-mailed letters of resignation and a cryptic sales forecast to the President of ToyWorks. Their sales forecast consisted of these few lines:

• For the year ended June 30, 2020: 475,000 units at $10.00 each*
• For the year ended June 30, 2021: 500,000 units at $10.00 each
• For the year ended June 30, 2022: 500,000 units at $10.00 each

*Expected sales for the year ended June 30, 2020 are based on actual sales to date and budgeted sales for the duration of the year.

ToyWorks’s President felt certain that the marriage wouldn’t last, and expected Chris would be back any day. But time is passing quickly, and there is still no word from the desert. The President, desperately needing the budget completed, has approached you on April 20, 2020, a management accounting student, for help in preparing the budget for the coming fiscal year. Your conversations with the President and your investigations of the company’s records have revealed the following information:

1. Peak months for sales correspond with gift-giving holidays. History shows that January, March, May and June are the slowest months with only 1% of sales for each month. Sales pick up over the summer with July, August and September each contributing 2% to the total. Valentines Day in February boosts sales to 5%, and Easter in April accounts for 10%. As Christmas shopping picks up momentum, winter sales start at 15% in October, move to 20% in November and then peak at 40% in December. This pattern of sales is not expected to change in the next two years.

1. Sales in May and June 2020 are budgeted to be 4,750 units and 5,100 units also at $10.00 each, respectively.  

1. Sales are on a cash and credit basis, with 75% collected during the month of the sale, 15% the following month, and 9.5% the month thereafter. 0.5% of sales are considered uncollectible.

1. From previous experience, management has determined that an ending inventory equal to 30% of the next month’s sales is required to fit the buyer’s demands.  

1. There is only one type of raw material used in the production of toodles. Space-age acrylic (SAA) is a very compact material that is purchased in powder form. Each toodle requires 10 kilograms of SAA, at a cost of $0.25 per kilogram. The supplier of SAA tends to be somewhat erratic so ToyWorks finds it necessary to maintain an inventory balance equal to 50% of the following month’s production needs as a precaution against stock-outs.  

1. ToyWorks pays for 30% of a month’s purchases in the month of purchase, 35% in the following month and the remaining 35% two months after the month of purchase. There is no early payment discount.

1. ToyWorks’s manufacturing process is highly automated, so their direct labour cost is low. Employees are paid on a per unit basis. Their total pay each month is, therefore, dependent on production volumes and averages $12.00 per hour. This rate already includes the employer’s portion of employee benefits. All payroll costs are paid in the period in which they are incurred. Each unit spends a total of 15 minutes in production.

1. Due to the similarity of the equipment in each of the production stages and the company’s concentration on a single product, manufacturing overhead is allocated based on volume (i.e. the units produced). The unit variable overhead manufacturing rate is $1.50, consisting of: Utilities--$0.60; Indirect Materials--$0.10; Plant maintenance--$0.50; environmental fee--$0.14; and Other--$0.16.

1. The fixed manufacturing overhead costs for the entire year are as follows:

Training and development                  $   43,200

Property and business taxes 39,000

Supervisor’s salary 149,400

Amortization on equipment 178,800

Insurance premium 24,000

Other      75,600

$ 510,000

• The property and business taxes and insurance premium as shown above have been prepaid in the previous year. You should treat these two prepaid items as follows:
  • Spread the prepaid costs evenly over each month in the determination of total fixed manufacturing overhead costs in each month.
  • These items should be treated as “non-cash” for the budgeted year (i.e. you should deduct the prepaid items to arrive at “cash disbursements” in the manufacturing overhead budget). This is obvious because the amounts have already been prepaid and have not actually been incurred in the corresponding month of the budgeted year.
• All other fixed manufacturing overhead costs are incurred evenly over the year and paid as incurred.  
• ToyWorks uses the straight line method of amortization.

1. Selling and administrative expenses are known to be a mixed cost; however, there is a lot of uncertainty about the portion that is fixed. Previous year’s experience has provided the following information:

Lowest level of sales:     375,000 units     Total S & A Expenses: $596,100

Highest level of sales:    750,000 units     Total S & A Expenses: $858,600

The High-Low method is used to determine the variable and fixed component of selling and administrative expense. It is estimated that both components of selling and administrative expenses for the budget year will be about 10% greater than the previous average. These costs are paid in the month in which they occur, with the exception of the only non-cash item: a monthly amortization of office equipment in the amount of $800. Not included in the above expenses is bad debt expense which should be considered. Bad debt expense in each month is equal to all sales that are considered uncollectible.

1. Another component of selling and administrative expenses for ToyWorks is warehouse rental. Because sales are seasonal, ToyWorks must rent an additional storage facility from September to December to house the additional inventory on hand. The only related cost is a flat $5,000 per month, payable at the beginning of the month.

1. During the fiscal year ended June 30, 2021 ToyWorks will be required to make monthly income tax installment payments of $3,000. Moreover, outstanding income taxes from the year ended June 30, 2020 must be paid in October 2020 which is equal to $21,500. These payments are made in cash.

1. Note that property and business taxes and insurance that are part of fixed manufacturing overhead are prepaid. The property and business taxes are paid on December 31 of each year, and the expected payment for next year is $39,600. The annual insurance premium is paid at the beginning of March each year. There should be no change in the premium from last year, so the expected payment is $24,000. These payments are also made in cash.

1. Prior to the busy season, ToyWorks is planning to upgrade its manufacturing equipment for which they will need to pay cash. The bid that was accepted totaled $212,000 of which 40% is to be paid in August 2020 and 50% in September 2020. The 10% holdback will be paid in January 2021, assuming everything goes as planned.

1. ToyWorks Ltd. has a policy of paying cash dividends at the end of each quarter. The President tells you that the board of directors is planning on continuing their policy of declaring cash dividends of $25,000 per quarter.

1. ToyWorks Ltd. has an internal policy to maintain a cash balance of at least $20,000 before considering its financing activity.

1. An arrangement has been made with the local bank that they will be given a line of credit at a preferred rate of 6% per year. All borrowing is considered to happen on the first day of the month, repayments are on the last day of the month. All borrowings and repayments from the bank should be in multiples of $1,000 and interest must be paid at the end of each month. Interest is calculated on the balance at the beginning of the month, which includes any amounts borrowed that month.   

1. A listing of the estimated balances in the company’s ledger accounts as of June 30, 2020 is given below:

Required:

You MUST follow the instructions below:

• Use the excel file “Problem 4_MasterBudget_Template” uploaded on Quercus under Assignment → Problem 4 to answer questions a) and b) below. This is a template the company historically used, and you would just have to populate the right numbers in the yellow cells. (Note that using equations and excel’s “drag” function can significantly reduce your time in completing this task.)
• Save the excel file as “P4_LastName_FirstName_StudentNumber”
• Submit the excel file on Quercus under Assignment → Problem 4

1. Prepare a monthly master budget for ToyWorks for the year ended June 30, 2021, including the following schedules:

Sales Budget & Schedule of Cash Receipts (3.5 points)

Production Budget (2 points)

Direct Materials Budget & Schedule of Cash Disbursements (5.5 points)

Direct Labour Budget (1 point)

Manufacturing Overhead Budget (3 points)

Ending Finished Goods Inventory Budget (3 points)

Selling and Administrative Expense Budget (4 points)

Cash Budget (7 points)

1. Prepare a budgeted income statement for the year ended June 30, 2021 using absorption costing. (1 point)

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.

What are the strengths and weaknesses in the payroll cycle?

What misstatements this control should prevent? State the control test that one could undertake to the test the control is operating as expected?

The Person Class

• Uses encapsulation

1. Attributes
   • private String name
   • private Address address

1. Constructors
   • one constructor with no input parameters
     • since it doesn't receive any input values, you need to use the default values below:
       • name - "John Doe"
       • address - use the default constructor of Address
   • one constructor with all (two) parameters
     • one input parameter for each attribute
2. Methods
   • public String toString()
     • returns this object as a String, i.e., make each attribute a String, concatenate all strings and return as one String.
     • toString() is a special method, you will learn more about it in the next lessons
       • it needs to be public
       • it needs to have @override notation (on the line above the method itself). Netbeans will suggest you do it.
   • Get and Set methods
     • public int getName()
     • public void setName(String name)
     • public Address getAddress()
     • public void setAddress(Address address)

The Player Class (with updates from the last lab)

• Player is a Person with some extra attributes
• Uses encapsulation
• Player now is an abstract class because it has an abstract method
  • public double getRatings( );
    • an abstract method is an incomplete method that has to be implemented by the subclasses.

1. Attributes
   • private int number
   • private String sports
   • private gamesPlayed

1. Constructors
   • one constructor with no input parameters
     • since it doesn't receive any input values, you need to use the default values below:
       • number - 0
       • sports - "none"
       • gamesPlayed - 0
   • one constructor with all (three) parameters
     • one input parameter for each attribute
2. Methods
   • public String toString()
     • returns this object as a String, i.e., make each attribute a String, concatenate all strings and return as one String.
     • toString() is a special method, you will learn more about it in the next lessons
       • it needs to be public
       • it needs to have @override notation (on the line above the method itself). Netbeans will suggest you do it.
   • Get and Set methods
     • public int getNumber()
     • public void setNumber(int number)
     • public String getSports()
     • public void setSports(String sports)
     • public int getGamesPlayed()
     • public void setGamesPlayed(int gamesPlayed)
   • public abstract getRatings();

The SoccerPlayer Class

• SoccerPlayer is a Player with some extra attributes
• Uses encapsulation
• SoccerPlayer will implement the method getRatings (an abstract method from the superclass Player)
• toString has to include the result of getRatings() too

1. Attributes
   • private int goals
   • private int yellowCards

1. Constructors
   • one constructor with no input parameters
     • since it doesn't receive any input values, you need to use the default values below:
       • goals - 0
       • yellowCards - 0
   • one constructor with all (two) parameters
     • one input parameter for each attribute
2. Methods
   • public String toString()
     • returns this object as a String, i.e., make each attribute a String, concatenate all strings and return as one String.
     • toString() is a special method, you will learn more about it in the next lessons
       • it needs to be public
       • it needs to have @override notation (on the line above the method itself). Netbeans will suggest you do it.
       • should also include the value of getRatings() in the string
   • Get and Set methods
     • public int getGoals()
     • public void setGoals(int goals)
     • public int getYellowCards()
     • public void setYellowCards(int yellowCards)
   • public double getRatings()
     • calculate and return the rates using this formula:
       • (double) (goals - yellowCards)/gamesPlayed
         • the (double) is called casting, forcing the expression that comes afterwards to become a double.
         • it is necessary to avoid getting 0 as a result because of the precision loss in the division by integers
         • if goals or gamesPlayed is 0, return 0 (you need to do this test to avoid the application crashing in case one of them is 0)

The FootballPlayer Class

• FootballPlayer is a Player with some extra attributes
• Uses encapsulation
• FootballPlayer will implement the method getRatings (an abstract method from the superclass Player)
• toString has to include the result of getRatings() too

1. Attributes
   • private int yards
   • private int minutesPlayed

1. Constructors
   • one constructor with no input parameters
     • since it doesn't receive any input values, you need to use the default values below:
       • yards - 0
       • minutesPlayed - 0
   • one constructor with all (two) parameters
     • one input parameter for each attribute
2. Methods
   • public String toString()
     • returns this object as a String, i.e., make each attribute a String, concatenate all strings and return as one String.
     • toString() is a special method, you will learn more about it in the next lessons
       • it needs to be public
       • it needs to have @override notation (on the line above the method itself). Netbeans will suggest you do it.
       • should also include the value of getRatings() in the string
   • Get and Set methods
     • public int getYards()
     • public void getYards(int yards)
     • public int getMinutesPlayed()
     • public void setMinutesPlayed(int minutesPlayed)
   • public double getRatings()
     • calculate and return the rates using this formula:
       • (double) ( (yards - minutesPlayed/10.0) ) /gamesPlayed
         • be careful with the parenthesis to avoid getting 0 as a result
         • the (double) is called casting, forcing the expression that comes afterwards to become a double.
           • it is necessary to avoid getting 0 as a result because of the precision loss in the division by integers
         • use 10.0 instead of 10 to force Java to use more precision in the calculation
         • if yards or gamesPlayed is 0, return 0 (you need to do this test to avoid the application crashing in case one of them is 0)

The Address Class

• Uses encapsulation

1. Attributes
   • private int number
   • private String name
   • private String type
   • private ZipCode zip
   • private String state

1. Constructors
   • one constructor with no input parameters
     • since it doesn't receive any input values, you need to use the default values below:
       • number - 0
       • name - "N/A"
       • type - "Unknown"
       • zip - use the default constructor of ZipCode
       • state - " " (two spaces)
   • one constructor with all (five) parameters
     • one input parameter for each attribute
2. Methods
   • public String toString()
     • returns this object as a String, i.e., make each attribute a String, concatenate all strings and return as one String.
     • toString() is a special method, you will learn more about it in the next lessons
       • it needs to be public
       • it needs to have @override notation (on the line above the method itself). Netbeans will suggest you do it.
   • Get and Set methods
     • public int getNumber()
     • public void setNumber(int number)
     • public String getName()
     • public void setName(String name)
       • this method will receive an input parameter name and will correct if necessary to make its first letter upper case and the remaining part of the word lower case (correcting MAIN to Main, for instance)
       • it will work for at least 2 words (correcting north atherton to North Atherton, for instance)
       • the attribute name will be updated with the corrected value
     • public String getType()
       • this method will return a corrected value depending on the value of the attribute type.
       • it will return "Dr." if the attribute type is "Drive"
       • it will return "Ave." if the attribute type is "Avenue"
       • it will return "St." if the attribute type is "Street"
       • it will return the value of the attribute type for any other cases
     • public void setType(String type)
     • public ZipCode getZip()
     • public void setZip(ZipCode zip)
     • public String getState()
     • public void setState(String state)

The ZipCode Class (updated to include encapsulation)

• Uses encapsulation

1. Attributes
   • private String fiveDigit
   • private String plus4
2. Constructors
   • one constructor with no input parameters
     • since it doesn't receive any input values, you need to use the default values below:
       • private fiveDigit - "00000"
       • private plus4 - "0000"
   • one constructor with one parameter
     • one input parameter for fiveDigit
     • use the default value from the no-parameter constructor to initialize plus4
   • one constructor with all (two) parameters
     • one input parameter for each attribute
3. Methods (updated to include Get and Set methods)
   • public String toString()
     • returns this object as a String, i.e., make each attribute a String, concatenate all strings and return as one String.
     • toString() is a special method, you will learn more about it in the next lessons
       • it needs to be public
       • it needs to have @override notation (on the line above the method itself). Netbeans will suggest you do it.
     • the toString method will have a similar functionality as App had in the first lab.
       • it returns all the data from each object as a String
         • if the second attribute, plus4, is blank, display only the first attribute fivedigit, for instance, 16801
         • if the second attribute, plus4, is not blank, display only the first attribute fivedigit followed by a "-" and then the plus4 attribute, for instance, 16802-1503
   • Get and Set methods for each of the two attributes
   • display()
     • this method gets the "toString()" value (whatever is returned by toString() ) and uses "System.out.println" to display it.
     • you need to decide what is the type of this method
   • displayPrefix(int p)
     • this method receives an input parameter, an int number p
     • based on p's value
       • if p's value is 1
         • uses "System.out.println" to display the zipcode's prefix, i.e., its 3 first digits.
         • if the fiveDigit is "10022", displays "100"
       • if p's value is2
         • uses "System.out.println" to display the zipcode's area, i.e., its fourth and fifth digits.
         • if the fiveDigit is "10022", displays "22"
       • for any other value of p, it should not display anything

The App class

1. create a SoccerPlayer object sp0 using the no-parameter constructor
2. create a SoccerPlayer object sp1 using the all-parameter constructor with the value
   • name "Julia Dohle"
   • address
     • number - 10
     • name - Old Main
     • type - Street
     • zip
       • fiveDigit - 16802
       • plus4 - 0001
     • state - PA
   • number - 7
   • sports - "Soccer"
   • gamesPlayed - 10
   • goals - 5
   • yellowCards - 1
3. create a FootballPlayer object fp0 using the no-parameter constructor
4. create a FootballPlayer object fp1 using the all-parameter constructor with the value
   • name "Saquon Barkley"
   • address
     • number - 10
     • name - Old Main
     • type - Street
     • zip
       • fiveDigit - 16802
       • plus4 - 0001
     • state - PA
   • number - 26
   • sports - "Football"
   • gamesPlayed - 10
   • yards - 80
   • minutesPlayed - 220
5. display all the data from each object using the method toString()