You are currently planning the 30 June 20X7 audit of Forest Ltd, an Australian-owned company that produces and exports woodchips to Japan. Forest’s operations are located in Eden, on the far south coast of NSW. Timber is purchased from forests nearby, processed into woodchips and immediately stockpiled for export at the company’s shipyards at Twofold Bay. Forest contracts timber cutters to deliver set tonnages of logs to its mill throughout the year. Woodchips are transported to Japan on charter vessels, which make an average of one trip a month.
At a recent planning meeting with Forest Ltd’s senior staff, you obtained the following overview of this year’s operations:
A massive conveyor belt is used to transport the woodchips from the mill to the stockpile. The manufacturer of this belt was recently taken over by an overseas competitor of Forest Ltd, Chipper Ltd, which processes woodchips in several South-East Asian countries. Chipper Ltd has indicated that it is willing to sell equipment to its competitors, but at double the price it will sell to its other customers. It is doubtful whether any other companies in the world manufacture such specialised conveyor belts.
Based on current usage figures, it is expected that the existing conveyor belt will last until December 20X8. Sufficient spare parts are on hand to carry out routine maintenance work. However, should a replacement belt be required, it would take at least six months to have a replacement made and shipped to Australia, and a further four weeks to install and test it. It is unlikely that the company could survive a six months interruption to normal operations. Management are currently deciding whether they should order a replacement belt from Chipper Ltd despite the excessive cost, or continue to search for an alternate supplier.
Timber is purchased in 50 hectare lots from plantations and state forests. In the past, 70% of timber was sourced from plantations, however this has fallen to 50% in the current year. The corresponding increase in
timber sourced from state forests has angered environmental groups. Protests have been held in several forests, which has slowed production and frustrated the contractors, who are only paid once set tonnages of timber are delivered to the mill. In addition, several shipments of woodchips have been delayed, angering the Japanese customers who are threatening to deduct 20% from amounts owing as compensation for lost production time.
Last month, a protester suffered a broken leg, allegedly because he was hit by a timber truck. The protester was blocking the main access road to one of the state forests at the time of the accident. The protester is now suing Forest Ltd for damages, claiming the contractor was in fact an employee of Forest Ltd at the time of the accident, and was acting on Forest Ltd’s instructions. Forest Ltd is fighting the case and appears to have a reasonable chance of winning; however, the adverse publicity being generated is making the state government nervous about selling Forest Ltd any more of its timber resources.
One of Forest Ltd’s customers, Wood Ltd, is claiming that the latest batch of woodchips it received was contaminated with a microbe. This microbe affects the physical structure of the chips, reducing the pressure the chips can withstand when compressed. This has made the chips useless for heavy duty items such as desks and bookcases. Wood Ltd is refusing to pay its account, which is already five months overdue. Forest Ltd has launched an investigation into the allegations, but as yet has not been able to substantiate them.
In January, Forest Ltd upgraded its accounts payable system to a fully integrated package that automatically updates the general ledger when creditor entries are made. Some problems have been experienced with the creditors ledger, which is split into $US and $AUD amounts. In some cases, $US amounts have been recorded as $AUD, resulting in inaccurate creditor balances. Month-end rollovers have also proved problematic, with creditor balances being incorrectly re-set to zero at the first of every month. This has required each creditor’s history to be re-entered manually
each month, a time-consuming process that is taking accounting staff away from their normal duties.
During the period, the Australian dollar has remained steady against the Yen, although it fell by about 3% against the US dollar. Debtors are invoiced in $US at the time of shipment, and paid in $US one month after the shipment is received. It takes around six weeks for the charter vessels to travel from Twofold Bay to Japan. All plantations from which Forest Ltd sources timber are owned by US firms, which demand payment in $US prior to the timber being cut. A recent downturn in the Japanese economy is affecting forward orders, which have fallen by 15%.
(a) For each of the following items in Forest Ltd’s financial report, identify two (2) factors in the information provided that increase audit risk:
(i) Accounts payable;
(ii) Commitments and contingencies;
(iii) Inventory; and
(b) Discuss one (1) adjustment to be made to your audit plan in response to the audit risk associated with each of the factors identified in part (a).
(c) Outline six (6) factors that indicate Forest Ltd may encounter going concern problems over the next 12 months.
(Maximum 2,000 words)