Case Study on Double Ink Printers Ltd (DIPL)

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Case Study on Double Ink Printers Ltd (DIPL)
Background Information
You are a senior manager with Stewart and Kathy and you have been approached to
undertake the audit of Double Ink Printers Ltd (DIPL). For the year ended 2015, taking over
from the small audit firm of Jay and Associates. DIPL print books, magazines and advertising
materials for the publishing, educational and advertising industries on a print-on-demand
basis. Printing on demand means that publishers can print the exact quantities ordered by
retail outlets, rather than estimating in advance how many books are required and often
printing too few or too many. The average printing turnaround time for DIPL is two business
days for small orders and five to ten business days for large orders. In addition, five years ago,
DIPL further expanded its earnings base by having publisher’s titles available as searchable ‘ebooks’
that could be downloaded directly by readers from DIPL’s website.
Purchase and Inventory
DIPL purchases 50% of its inventory requirements of paper, ink and binding materials from
Australian sources and 50% from Asian countries. When inventory received at DIPL’s
warehouse (whether it is purchased from Australia or Asia), the accounts payable clerk, Bill
Jimmy, records the arrival of the inventory and also its value and quantity in the accounts
payable system. Inventory is paid for the relevant currency of the country from which it is
purchased. Raw materials have been valued at average cost and an allowance for inventory
obsolescence has existed in previous years to cover the estimated decline in value from the
effects of storage hazards. Work in progress is immaterial due to the quick turn- around time
of printing jobs. Any work in progress is assessed at the cost of raw materials and labour and
proportion of manufacturing overheads based on normal capacity. At year end, the
warehouse is closed from 28 to 30 June for stocktake, so sales must be invoiced in the system
by close of business on 27 June. The stock must have been sent to the customer (that is, it
must either be on track, ship or plane on its way to the customer, or it must already have
arrived at the customer; it must no longer be in DIPL’s warehouse).
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‘Print on Demand’ revenue and receivables
Each time a publisher wants to add a book to DIPL’s ‘digital library’ (a server storing all of the
publisher’s books in a digital format, ready to print), it emails the book to DIPL in PDF format.
The digital library is backed up at the close of business every day, with the backup tapes kept
off site. Once the book is stored in the digital library, the publishers can order copies to be
printed as required.
When the publishers confirm the order, the accounting system automatically retrieves details
of the publisher’s credit record and stops any orders from publishers that have exceeded their
credit terms and limits. A printout of the transactions history of the publishers is generated
and must be signed by both Helena keng, the head of publishing, and Jane Roger, the head of
accounts at DIPL, before the order can continue, after the transaction history has been signed
and dated, accounts receivable staff file it.
If there are no credit problems with the order, it is processed and printed by casual staff in
the relevant warehouse, who then load the books onto pallets for shipping. When printing is
finished, the sales clerk, Brown Pall, prepares an invoice and dispatch docket and forwards
them to the accounts receivable department. The accounts receivable clerk Gay Chan, checks
the prices and arithmetic accuracy of the invoices and signs the invoice as evidence of her
check. Gay records the sales both the accounts receivables subsidiary ledger and the general
ledger and books are shipped to the publisher’s nominated destination (or the publisher will
arrange pick up at the warehouse if has its own distributors). The client accepts liability for
the goods when they are received in accordance with the purchase order, and signs the
dispatch docket as proof of delivery.
‘E-book’ Revenue
The proceeds from each e-book sale are paid to the publisher’s net of a 5% commission.
Proceeds are sent to publishers automatically upon download (the commission is withheld by
DIPL). Revenue from the commission is recognised when is withheld from payment to the
publishers.
DIPL also charge publishers an annual “storage fee” payable 12 months in advance, for
keeping the e-book on DIPL’s website. Publishers are invoiced on the date the first download
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of a title occurs. As new books are downloaded on an ongoing basis, the storage fee is invoiced
at different times of the year. Revenue from storage fees has been recognised in the month
the fees are invoiced, notwithstanding the fact that the fees are charged 12 months in
advance.
In September 2014, DIPL acquired Nuclear Publishing Ltd (NPL). The main rationale behind
the lay in the value of the copyright NPL held over a large range of specialised medical
textbooks. Although the potential print run for the textbook was not large, each textbook had
a high profit margin and had been used in universities across the world for many years. DIPL
acquired the business operation of NPL (not the shares), paying net assets (including the right
to the copyright). However, in June 2015 an article was published in a medical journal about
a new theory that could result in NPL’s medical textbooks becoming obsolete. If the new
theory is valid, the textbooks are unlikely to be reprinted or used as textbooks at universities
in the future, effectively making them unviable as e-books.
Cash Receipts
Some Payments from accounts receivables are received by cheque through the mail, and the
cashier, Judy Bones, record these in an inwards remittance register when the mail is opened.
She then banks the cheques and forwards the payment advices to Gay Chan for posting ton
the accounts receivable ledger. Most payments, however, are received by electronic funds
transfer (EFT). Each day, Judy downloaded the previous day’s receipts from online banking
and provides a copy to Gary for posting. Judy then reconciles the total of the batch postings
to accounts receivable to the amount banked for the day. The assistant accountant, Boby
Roger, prepares a bank reconciliation at the end of each month.
Fixed Assets
Since DIPL’s incorporation, depreciation on assets has been calculated using the straight-line
method to allocate their cost over their estimated useful lives, as follows:
• Printing presses up to 20 years
• Other production equipment up to 15 years
• Other equipment up to 10 years
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Finance
During 2015, DIPL has entered into a 7.5 million loan from BDO Finance Ltd (BDO Finance).
The loan has debt covenant’s requiring DIPL to maintain a current ratio of at least 1.5 and a
debt to equity ratio of less than 1. Failure to maintain these key financial ratios under the
specified benchmarks would result in BDO Finance having the right to recall the loan.
Appointment of New CEO and internal Audit
William Jackson was appointed the new chief executive officer (CEO) of DIPL in January 2015.
William has extensive experience in the printing business. The previous CEO, Rebecca Styles,
who is now semi- retired, will remain on the board as a non-executive director. A component
of William’s remuneration package is a performance bonus based DIPL achieving an annual
growth of 10% in total revenue and 10% in net profit after tax. Based on William’s
recommendation, the board also established a new internal audit department headed up by
Cody Baines, an ex-audit manager with a Big Four audit firm and two other recently qualified
chartered accountants. Cody reports directly to the board.
New IT System
During 2015, DIPL decided to invest in a new IT system that would fully computerised and
integrate all the current accounting processes across the organisation, including integration
into the general ledger system.
Under extreme pressure from the board, the IT department at DIPL managed to get the new
accounting system installed in June, although IT manager, Andy Rogers, complained several
times about how the installation was handled. Andy claimed that excess pressure had been
placed on staff to get the system installed and that there was simply not enough staff to do
the proper reconciliation’s and testing before the new system went live prior to year-end.
Andy preliminary testing showed that some transactions conducted around year-end were
not being allocated to the correct period. The problem appeared to be the interface between
the new accounting system and one of the existing software systems. A software ‘patch’ had
to be written to fix the problem.
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Board year-end reporting discussions
As a board meeting held in June 2015, issues relating to the forthcoming year end were
discussed. William stated that he believed that the valuation of raw materials inventories at
average cost was no longer appropriate as the current cost of paper was substantially above
the average cost. Further, he argued that the allowance for obsolescence of inventory to
cover the estimated decline in value from the effects of storage hazards was necessary, as
such a loss was unlikely. William also stated that based on his experience in the printing
industry he believed that DIPL’s printing presses had a potential maximum life of 30 years,
although he noted that another leading entity in the printing industry adopted the policy of
depreciating its printing presses over a 20-year period on a straight-line basis, similar to what
DIPL had done in the past. After much discussion, the board resolved that the allowance for
obsolescence of inventory be written back and that raw materials be valued based on a firstin,
first-out (FIFO) basis. In addition, following a review of the e-book facilities by internal
audit, Cody recommended that in a report to the board that DIPL change the method it used
to account for its revenue from e-book publication to ensure compliance with the applicable
accounting standard. The board agreed that the revenue from e-book would be recognised in
accordance with the stage of completion of each transaction (i.e. percentage of completion
method).
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Statement of Financial Position
Note 2013 2014 2015
(Unadjusted)
Current Assets
Cash
647250 517788 347120
Accounts Receivables 1 2482500 4320000 5073309
Inventories 2 2256188 2671362 4180500
Total
5385938 7509150 9600929
Non-Current Assets
Property, Plant and
Equipment 3 7544062 8394750 15572062
Intangible Assets
——- ——- 975000
7544062 8394750 16547062
Total Assets
12930000 15903900 26147991
Current Liabilities
Accounts Payable
1950000 3035250 3525000
Deferred revenue
—- —- 697500
Interest-bearing liabilities
937500 862500 787500
Provisions
810000 1125000 1267500
Accruals
82500 97500 120000
Total
3780000 5120250 6397500
Non-current Liabilities
Interest-bearing liabilities
—- —- 7500000
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Total Liabilities
3780000 5120250 13897500
Net Assets
9150000 10783650 12250491
Equity
Shareholders Fund
2250000 2250000 2250000
Retained Profits
6900000 8533650 10000491
Total Equity
9150000 10783650 12250491
Income Statement
2013 2014 2015
Revenues
Revenue from Operations 34212000 37699500 43459500
Cost of Sales 28207500 31620000 36855000
Gross Profit 6004500 6079500 6604500
Allowance for inventory obsolescence written
back ——- ——- 155588
Commission Income 108000 123000 130500
E-book storage fees 667500 1027500 1417500
Income from operating activities 6780000 7230000 8308088
Expenses
Advertising 83725 115923 125778
Audit Fees 112500 127500 135000
Bad Debt 150000 195000 210000
Depreciation 249375 274312 472688
Discounts allowed 195000 285000 335500
Legal Fees 74000 111500 137000
Foreign Exchange loss 38500 49750 —-
Rates 98500 106000 113500
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Repairs and maintenance 224000 276500 306500
Salaries 1965000 2190000 2445000
Telecommunication costs 134750 141478 159785
Total expenses 3325350 3872963 4440751
Net income before interest and tax 3454650 3357037 3867337
Interest expense 84379 83663 808038
Profit before tax 3370271 3273374 3059299
Income tax 1011081 982012 87116
Profit after tax 2359190 2291362 2972183
Notes to the Financial Report
2013 2014 2015
(Unadjusted)
Account Receivable 2647500 453000 5313309
1 Allowance for doubtful debts -165000 -210000 -240000
2482500 243000 5073309
Inventory 2362500 2797238 4180500
2 Allowance for obsolescence -106312 -125876 ——
2256188 2671362 4180500
3 Property, Plant & Equipment
Land 2775000 3375000 3375000
Plant and Equipment 5250000 5775000 13425000
Accumulated Depreciation -480938 -755250 -1227938
7544062 8394750 15572062
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Required:
Question 1: As an auditor, you are conducting your preliminary analytical procedures
based on the background information for DIPL contained in the case. Apply analytical
procedures to the financial report information of DIPL for the last three years. Explain
how your results influence your planning decisions for the audit for the year ending
30 June 2015 (10 marks).
Question 2: You are conducting your risk assessment of DIPL, as part of the planning
for your audit for the year ended 30 June. Identify two inherent risk factors that arise
from the nature of DIPL’s business operations. Explain why it is a risk and how it may
affect the risk of material misstatement in the financial report (5 marks).
Question 3: As part of your audit of DIPL for the year ended 30 June 2015, you are
considering the risk that fraud may have occurred (a) Based on the background
information for DIPL contained in the case, identify and explain two key fraud risk
factors relating to misstatements arising from fraudulent financial reporting to which
DIPL may be susceptible. (b) Explain how the risk factors identified in (a) above would
affect the conduct of the (a) audit. (5 marks).

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