Faculty of Business & Enterprise Higher Education Division HBC225/HBC 225N Assignment ADELPHI...

Faculty of Business
& Enterprise

Higher Education Division

HBC225/HBC 225N

Assignment

ADELPHI HEALTH CARE LTD:

CONTINUOUS CASE STUDY IN AUDITING
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(Week 5 â€“ Week 11)

Semester 1, 2012

Â© Swinburne University
of Technology, 2012
Except
as provided in the Copyright Act 1968, this document may not be reproduced in
any form without the written permission of the University.

ADELPHI HEALTH
CARE LTD:

CONTINUOUS CASE STUDY IN AUDITING

You need to start work on this online
based continuous case study from W/B 26th
March. You need to work in pairs (can choose member from other tutorials) and
must participate (individually) in online discuss board (please check
Blackboard discussion page).

You
should be able to answer each weekâ€™s requirements after you attended lecture,
tutorial and read relevant chapters. Need to put together your case study
answers and submit them as your final assignment (ONE pdf or word file) by due
date, Monday 14th May, 2012 5pm (donâ€™t submit on a weekly basis!).

Part 1: Week 5
(Chapter 6)
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Adelphi Health Care Ltd listed on the Australian
Securities Exchange in 2004. Prior to listing, it was a privately held company
managing medical centers in New South Wales. The founders of Adelphi are John
Simpson and Eddie Gallagher who are both medical practitioners by profession.
At the time of going public, John held the position of Chief Executive Officer
(CEO) and Eddie was the Chief Operating Officer (COO). The company raised $50
million and moved into research and development of the flu vaccine.

The companyâ€™s main product Fluvacs was
commercialized in 2007 and it is now sold across Australia. Since 2009, this
vaccine is also being distributed in Singapore, Malaysia and the Philippines.
The marketing director Anne Tanner has been instrumental in putting in place
the local and overseas distribution agreements. Adelphi has agreements with one
distributor in each Australian state and one distributor in each of its
offshore locations.

In January 2010, John Simpson resigned as CEO and
took on the role of Board Chairman. He was replaced as CEO by Ray Wilson who
was the CEO of a listed mining group prior to joining Adelphi. Ray has a proven
track record of expanding into new projects and markets but has no experience
in the health care industry. Eddie Gallagher continues in his COO role but
spends more time on the golf course these days. The company has retained the
same Chief Financial Officer, Jenny Maxwell. Jenny was offered a 30% increase
in salary and a lucrative bonus in the current year as part of the Boardâ€™s plan
to retain her. Jenny has been with Adelphi since its listing and has put into
place extensive processes and controls over the past seven years. She is a
perfectionist and prefers to handle important matters on her own, seldom
delegating to her finance team.

Since taking over Ray Wilson has decided that the
companyâ€™s future lies in developing a vaccine for avian (bird) flu. He is of
the view that the company is well placed to market the product in Asia with its
existing distributor base. A dedicated research team has been hired to work on
this vaccine. Management has indicated that initial lab results are promising
and are

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ADELPHI HEALTH
CARE LTD:

CONTINUOUS CASE STUDY IN AUDITING

confident
that clinical trials can be commenced within the next 12 months. As a result, a
significant proportion of research and development costs have been capitalized
in the current financial year.

In late 2008, the company bought a piece of land in
Sydneyâ€™s inner west and constructed a purpose built building with offices and
research labs. Prior to this, the company was renting premises. The land cost
$6.5 million and the building cost $3.5 million. Jenny recently asked a friend
who is a real estate agent for an informal valuation and was advised that the
property market has lost its momentum and the companyâ€™s land and buildings were
currently worth about $9 million. Jenny did not mention this to any of the
company directors.

You are the audit manager in charge of the audit of
Adelphi Health Care Ltd. Your firm has been the auditor for the past three
years. Adelphi has been provided with an unqualified opinion since your firm
has been the company auditor. You are currently carrying out the audit planning
for the financial year end audit.

The client has provided you with the following draft
financial information in respect of the year ended 30 June 2011.

Adelphi Healthcare Ltd

Draft Statement of Comprehensive
Income

for
the year ended 30 June, 2011

2011

2010

$’000

Revenue

28,715

37,280

Cost of sales

10,880

12,640

Gross profit

17,835

24,640

Operating expenses

Research & development

2,930

11,210

Advertising

1,180

925

Distribution

1,010

1,370

Shipping and handling

465

550

Salaries and wages

7,985

4,840

Depreciation

795

675

Interest

825

725

Other expenses

1,325

180

Profit before income tax

1,320

4,165

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ADELPHI HEALTH
CARE LTD:

CONTINUOUS CASE STUDY IN AUDITING

Income tax expense

395

1,250

Profit after income tax

925

2,915

Draft Statement of Financial
Position

as at 30 June, 2011

Notes

2011

2010

$’000

CURRENT ASSETS

Cash and cash equivalents

1,040

11,500

Receivables

8,615

5,880

Inventories

3,560

1,335

Other current assets

440

565

Total current assets

13,655

19,280

NON-CURRENT ASSETS

Intangibles

6,570

–

Property, plant and equipment

10,280

10,475

Total non-current assets

16,850

10,475

TOTAL ASSETS

30,505

29,755

CURRENT LIABILITIES

Accounts payable

1,845

2,390

Provisions

1,015

775

Total current liabilities

2,860

3,165

NON-CURRENT LIABILITIES

Borrowings

10,000

Provisions

365

235

Total non-current liabilities

10,365

10,235

TOTAL LIABILITIES

13,225

13,400

NET ASSETS

17,280

16,355

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CARE LTD:

CONTINUOUS CASE STUDY IN AUDITING

EQUITY

Contributed equity

50,000

General Reserve

10,000

Accumulated losses

(42,720)

(43,645)

TOTAL EQUITY

17,280

16,355

Notes to the financial statements

Note 1 Summary of significant accounting policies

Receivables

Trade receivables are carried at
original invoice value less any provision for doubtful debts. Debts, which are
known to be uncollectible, are written off. A provision for doubtful debts is
recognized when collection of the full amount is no longer probable.

Inventories

Inventories are measured at the
lower of cost and net realizable value. Costs incurred in bringing the product
to its present location and condition, are accounted for as follows:

–
Raw
materials â€“ purchase cost on a first in first out basis; and

–
Finished
goods and work-in-progress â€“ cost of direct material, direct labour and a
proportion of manufacturing overhead based on normal operating capacity

Property, plant and equipment

Cost and valuation

All
property, plant and equipment are brought to account at cost.

Depreciation

Depreciation is calculated on a
straight line basis to write off the depreciable amount of each item of
property, plant and equipment (excluding land) over its expected useful life to
the company.

Depreciation
periods are:

Buildings 20 years

Plant
and equipment 2.5 â€“ 10 years

Intangible assets

Research and development

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Costs
incurred on research and development projects are expensed as incurred, unless
future recoverability is assured beyond a reasonable doubt, to exceed those costs.
Where research and development costs are capitalized, such costs are amortised
over future periods on a basis related to expected benefits. Unamortised costs
are reviewed at each reporting date to determine the amount (if any) that is no
longer recoverable and any amount identified is written off.

2011

2010

$’000

Note 2

Receivables

Accounts receivable

9,015

6,235

less Provision for doubtful debts

(400)

(355)

8,615

5,880

Note 3

Intangibles

Research and development

6,570

–

Note 4 Property, plant and equipment

Freehold Land

6,500

Buildings

3,500

Accumulated depreciation

(700)

(525)

2,800

2,975

Plant and equipment – at cost

2,600

2,000

Accumulated depreciation

(1,620)

(1,000)

980

1,000

Total property, plant and equipment

10,280

10,475

Note 5

Provisions

Current

Provision for annual leave

1,015

775

Non-current

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CARE LTD:

CONTINUOUS CASE STUDY IN AUDITING

Provision for long service
leave

365

235

Note 6
Borrowings

Secured bank loan

10,000

Required

Carry out preliminary analytical procedures
based on the draft financial information provided and discuss the impact of
your findings on the audit plan.

Part 2:Week 6 (Chapter
7)
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This is a continuation of
question in Chapter 6, relating to Adelphi Health Care Ltd. However, it may be completed
independently of that question. Refer to the background information contained
there.

Required

(a)
Outline
the factors that would affect your assessment of inherent risk associated with
the audit of Adelphi Health Care Ltd.

(b) For each of the inherent risk
factors you outlined in (a) above, indicate:

(i) whether it increases or decreases
audit risk; and

(ii) its effect on your audit
procedures.

(c)
Your
audit partner has asked you to set a preliminary materiality level for the
audit of Adelphi Health Care Ltd to be discussed at the planning meeting. The
audit partner has asked you to consider and justify the base you think is
appropriate in setting planning materiality. You should take into account your
assessment of the inherent risk factors in determining planning materiality.
Outline how the materiality level will influence the nature and extent of audit
procedures planned.

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ADELPHI HEALTH
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CONTINUOUS CASE STUDY IN AUDITING

Part 3:Week 7 (Chapter
8)
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This
is a continuation of questions in Chapter 6 and Chapter 7, relating to Adelphi
Health Care Ltd. However, it may be completed independently of those questions.

You
are currently planning the audit of Adelphi Health Care Ltd, a listed company
involved in the manufacture and sale of the flu vaccine. The company has a
balance date of 30 June. The following notes were drafted as part of the audit
plan two years ago and describe the procedures performed by the employees of
the company in relation to the purchases cycle. Control risk around purchases
was assessed as low during the audit two years ago. The audit plan this year
includes testing controls around purchases.

Audit file note: Understanding
the purchases cycle and control procedures implemented by management:
The
head of the manufacturing department has the authority to approve purchases up
to $50,000. The computerized inventory management system generates requisition
orders when inventory levels fall below re-order levels. All purchase
requisitions are processed through the centralized purchasing department. The
role of the purchasing department is to ensure that purchase requisitions are
duly approved, approved suppliers are used and where there are no pre-approved
suppliers for a particular item, competitive quotes are sought if the cost
exceeds $5,000 per item. The purchasing department then prepares a purchase
order which is sent to the relevant supplier.
All
goods are delivered to the central warehouse. The warehouse supervisor is
responsible for checking that the goods received are in good order and that the
quantities received and description of items matches the purchase order. The
warehouse clerk then updates the inventory management system to reflect the
receipt of the goods. If an order is only partially filled, a note is made on
the purchase order and the purchasing department follows up with the supplier.

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CONTINUOUS CASE STUDY IN AUDITING

Supplier
invoices are received by the accounts payable clerk who checks the invoices for
mathematical accuracy and also agrees the details and quantities on the
invoices to the goods received report and purchase order. Once these checks are
done, the accounts payable clerk signs off on the invoice and sends it to the
financial accountant for final approval. A register is maintained of all
invoices received so as to avoid paying duplicate invoices. Once the accountant
approves the invoices, they are batched and sent back to the accounts payable
clerk for posting to the accounting system.

At
each month end, the accounting system generates a payment report along with a
remittance advice providing a break-down of the balances owing. The financial
accountant reconciles the totals to each weekly batch summary. Once the
balances are reconciled, the accountant approves the payment. The system then
initiates electronic transfer of funds to all suppliers and sends either an
email copy or hard copy of the remittance advice.

Conclusion:Control risk around purchases is assessed as LOW.

Required

(a) List the control procedures
implemented by Adelphi over the purchases cycle.

(b) Discuss the appropriateness of
using the audit notes from two years ago and the associated control risk
assessment.
(c) Outline further work that would
be required to assess control risk in the current audit.

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ADELPHI HEALTH
CARE LTD:

CONTINUOUS CASE STUDY IN AUDITING

Part 3: Week 7
(Chapter 9)
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This
is a continuation of question in Chapter 8. However, it may be completed
independently of that question.

You
are currently involved in the audit of Adelphi Health Care Ltd, a listed
company involved in the manufacture and sale of the flu vaccine. The company
has a balance date of 30 June. One of the key audit risks identified in the
audit plan relates to credit sales and the collectability of trade receivables.
The reliance on single distributors in each local and overseas jurisdiction as
well as their geographical spread heightens the risk in this area.

An
initial evaluation of control risk in the planning stage indicates that
management has sound controls around approving the distributors, recording
sales accurately and diligently following up outstanding accounts.
The following are the control objectives identified
in the audit plan:

1.
Ensure
that Adelphi evaluates each potential distributorâ€™s credit history prior to
approving them as an authorized distributor.

2. Ensure there is adequate
segregation of duties between authorizing sales, delivering the finished
product and recording sales.
3.
Ensure
there are adequate controls to ensure sales are recorded in the correct
financial period.

4. Ensure there are adequate controls
around the estimation of provision for doubtful debts.

Required

Identify appropriate tests of controls for each of
the above control objectives.

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Part 4:Week 8 (Chapter
10)
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This is a continuation of
question in Chapter 9, with additional background information from question in
Chapter 6. However, it may be completed independently of those questions.

The
audit senior noted that research and development expenses had decreased
significantly during the year. Adelphi expensed more than $11 million in
research and development costs while in the current year they have only
expensed close to $3 million. It was brought to the attention of the audit
senior that the CFO in discussions with the Board decided to capitalize about
$6.5 million in research and development costs in the current year. The CFO
advised the audit senior that â€œwhile we are still in the early stages of
developing the avian flu vaccine, initial testing is showing some promising
results and we believe that the current research program will contribute
significantly to the commercial outcomes of our new productâ€.

2. Land and
buildings

While
reading the minutes of the Board meetings, the audit senior came across an item
discussing the valuation of land and buildings. Board members were concerned
with the recent slowdown in the property market and what impact that may have
on the valuation of land and buildings. The CFO was asked to follow up on this
matter and to arrange an independent valuation of land and buildings. There was
no evidence of a follow up in the subsequent minutes.

3. Accounts
payable

In
reviewing liabilities, the audit senior noticed that trade and other payables
had decreased compared to the prior year. This did not appear reasonable given
the level of spending on operating costs and research and development
activities. The audit senior approached the

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financial
accountant to seek clarification. â€œWe have made a concerted effort this year to
make prompt payments to all suppliers. We have ensured that trade payables have
been reconciled to all supplier invoices and to the payment summaryâ€, reassured
the financial accountant.

Required

(a)
Identify
the key financial report assertions relevant to the audit of the above account
balances.

(b) For each of the assertions
identified in (a) above, describe two procedures that could be used to gather
sufficient and appropriate audit evidence.

Part 5:Week 9 (Chapter
11)
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This
is a continuation of question in Chapter 10. However, it may be completed
independently of that question.

You
are reviewing your audit assistantâ€™s work for Adelphi Health Care Ltd for the
year ended 30 June 2011, and note the following issues.

(a) Your audit assistantâ€™s work
papers on the trade payables testing conclude the following:

â€œIn testing trade payables,
twenty balances were randomly selected and vouched to suppliersâ€™ invoices and
receiving reports. The sample selected amounted to $832,000. Total trade
payables is $1,760,000.Results of the testing revealed two invoices with a
total of $24,900 had been incorrectly recorded on the trade payables ledger, as
the goods were only received in July 2011.The error found relates to 3 per cent
of trade payables tested. This results in a total error of $52,673 of the total
trade payables balance. As total error is only 3 per cent of trade payables, it
is not considered material and, therefore, no further work has been performed.
I conclude that the trade payables balance of Adelphi Health Care Ltd is not
materially misstated.â€

(b) The audit assistant performed
tests of controls on 30 purchases transactions. This testing resulted in the
discovery of three errors. A tolerable error of 5 per cent had been set during
the audit planning. The audit assistant concluded that the controls were
reliable on the basis that none of the errors found were considered to be
material.

Required

Do you consider your audit
assistantâ€™s conclusions in each of the above situations appropriate? Justify
your response.

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LTD:

CONTINUOUS CASE STUDY IN AUDITING

Part 6:Week 11 (Chapter
12)
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This
is a continuation of question in Chapter 11, and the background information
provided in question in Chapter 6. However, it may be completed independently
of those questions.

You
are the audit senior currently involved in the audit of Adelphi Health Care
Ltd, a listed company involved in the manufacture and sale of the flu vaccine.
The audit is drawing to a close and the timeline below applies. The following matters
come to your attention.

Â§ Balance date: 30 June 2011

Â§ Directorsâ€™ declaration and audit
report signed: 22 August 2011

Â§ Financial report and audit report
mailed to shareholders: 29 August 2011

Â§ Annual general meeting of
shareholders: 17 October 2011

(i)
The
Board of Directors were growing increasingly concerned with recent media
reports about falling property values in Australia and in June 2011, the Board
commissioned an independent property consultant to prepare a valuation report
on the land and buildings. On 18 July 2011, the property valuation report was
received by the Board. The land and buildings collectively were valued at $8.5
million.

(ii)
In
May 2011, Adelphi received correspondence from SHC Distributors Pte Ltd (SHC),
its distributor in Singapore advising that it was having difficulty paying its
monthly invoices. As at 30 June, 2011 SHC owed Adelphi $1.2 million. As at
balance date, the financial accountant had posted a provision for doubtful
debts of $300,000 against the balance owing by SHC. On 15 August, Adelphi
received correspondence from company administrators advising that SHC is under
voluntary liquidation. Initial estimates are that creditors are likely to
receive 15 cents in the dollar once SHC is liquidated.

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(iii)
In
early August 2011, Adelphi received reports from its distributor in the
Philippines that a few patients administered with the flu vaccine had
complained of serious side effects. An investigation by the distributor
revealed that these complaints were attributed to a batch of the flu vaccine
that was shipped out in early July 2011. The distributor has recalled the
affected batch and is seeking compensation from Adelphi for the cost of the
recall. On 18 August 2011, Adelphi received correspondence from a legal firm
representing a patient whose health has deteriorated significantly since
receiving the flu vaccine. Compensation of $2 million is being sought.

(iv)
On
4 July 2011, there was some isolated flooding in Adelphiâ€™s warehouse caused by
a damaged water pipe. Most of the inventory stored was unaffected but after the
warehouse has been cleaned up, warehouse staff determined that about $350,000
worth of inventory was damaged in the flooding and had to be destroyed as it
was unfit for sale.

Consider each of these independent
issues to be material when determining your response to the following
requirements.

Required

(a)
For
each of the events (i) to (iv) select the appropriate advise you would give
your client from the actions listed below, and justify your choice:

(1) Adjust the 30 June 2011 financial
report.

(2) Disclose the information in a
note to the 30 June 2011 financial report.

(3) Request the client to recall the
30 June 2011 financial report for revision.

(4) No further action required.

(b)
What
additional audit evidence would you obtain in relation to each of the events
(i) to (iv) to ensure a sound basis for forming the audit opinion?

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CONTINUOUS CASE STUDY IN AUDITING

Part 7:Week 11 (Chapter
13)
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This
is a continuation of question in Chapter 12, and of the background information
contained in question in Chapter 6. However, it may be completed independently
of those questions.

The
audit of Adelphi Health Care Ltd is now complete, and as the audit manager on
the engagement you have been tasked with drafting the audit report. The Board
of directors has accepted the advice of the audit partner and has updated the
financial report to appropriately reflect the impact of all the subsequent
events identified in question 12.xx. You receive a phone call from the CEO just
as you are about to finalize the audit report.

â€œWeâ€™ve
got some fantastic news! I have been discussing our new vaccine with a private
equity firm and they are really excited about its prospects and have verbally
assured us that they would be willing to invest up to $20 million over the next
two years given how promising the preliminary results have been. This will help
tremendously with our cash flow and get us back on track given the recent
issues we have had. Based on this news, I think we can sign off the accounts on
a going concern basis and look forward to an unqualified opinion from your
firmâ€

You
assured the CEO that you would consider this information along with the audit
evidence gathered thus far in arriving at the appropriate audit opinion.

Required

(a)
Do
you think Adelphi Health Care Ltd is a going concern risk? Identify the
relevant factors in forming and justifying your conclusion. Also identify any
mitigating factors you may have considered.

(b) If you conclude that there is a
going concern risk and management decide not to include a

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disclosure note detailing the
going concern issue, identify the type of audit opinion you would issue and
explain the basis of your decision.

Continuous case
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Faculty of Business & Enterprise Higher Education Division HBC225/HBC 225N Assignment ADELPHI…

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