Reference no: EM133014967

Question - DS Limited (DS) is an electrical retailer floated by a private equity company Harbour Pty td. (Harbour) on July 1st 2014. They were described as a national-electrical retail company offering a full range of electrical products and a number of products that were badged as a DS brand and sold at a discount to the public. Their strategy was to be customer-focused and dedicated to providing innovative, quality electronics at reduced prices.

In March 2012 Harbour had purchased DS from a large food and beverage retailer as a failing division for $20 million with a promise to pay a further $80 million in one year's time. Harbour made an immediate $60 million write down in DS inventories reducing the inventory to $300 million with total assets recorded at a fair value of $450 million and liabilities at $140 million. Harbour raised a further $80 million in bank debt through DS limited giving DS a debt to asset ratio of approximately 50%. While unlisted, the company made significant profits as it was able to sell it written down inventory at below or close to its original cost without competitors being able to match the prices they charged. By the 30th of June 2013 the inventory value had fallen to $170 million.

Harbour then floated DS for $520 million (as sizable profit on its original $10 million investment). At the time of the float, inventory had increased to $250 million funded primarily by accounts payable. The shares that floated at $2.20 rose to a peak of $5.00 before the year end but falling to 77c following a profit downgrade. Cashflow had reduced to negative $4 million at 2015 and the company was forced to borrow a further $71 million to fund working capital.

DS was struggling by September 2015 with stores much smaller than its competitors and no apparent competitive advantage. Internet sale had further damaged the profitability of DS. Significant lease costs of the small stores and the relatively large number of staff required to staff them (a store three times the size of the average DS store would only require 1.5 time more staff). A major issues faced by DS was that the company structure was not fully developed leading to ineffective communication. DS was highly centralized with the managers reluctant to challenge any of the decisions coming from head office. In addition, DS had low complexity as determined by having unclear job tasks and responsibilities. Sales staff had poor product knowledge. As there is no organizational chart, the relationship between the employees could not be determined and the job descriptions were ambiguous. There was no courses or procedures for training staff. DS recruited young inexperienced staff.

The auditors gave an unqualified audit report for the year ended 30 June 2015. Seven months later liquidators were appointed.

a) Outline any inherent and control risks you can see within the case study.

b) Which account(s) do you consider had the highest risk for the auditors when completing the 30 June 2015 accounts? What procedure should the auditors have undertaken to ensure the company was a going concern at the 30 June 2015? Does the subsequent liquidation of the company contribute to expectation gap between what auditors can provide and the public's desire to be protected from company liquidations? How might this gap be addressed in general?

c) Discuss the assertion about inventory and the procedures to test these assertions.