Question

You are assigned to the audit of Computek Electronics Limited, a subsidiary company of Las Vegas Group Corporation (USA) Limited. Computek Electronics Ltd. is a wholly owned subsidiary of a US parent. The following information has been provided to you:

1.             The principal activities of Computek Electronics Ltd are the importation and distribution of modems and personal computers (PCs). It has offices in all capital cities in US and around Australia.

2.             All inventories are purchased either from its US parent or related companies in Hong Kong and Taiwan.

3.             Computek Electronics Ltd was incorporated in 1991 and had operated profitably until 1996 when significant losses were incurred, principally due to the downturn in the economy, competition from other manufacturers and the availability of cheaper clones.

4.             The company is well established in the modem market; however, it has not been doing well in the PC market for the reasons given above and has consequently decided to get out of the PC market and concentrate on enhancing its position in the modem market. This decision has been communicated to the public via computer journals and publications.

5.             The stock level of PCs, modems and spares as at 30 October 1998 was as follows:

                                                $’000

                Modems                 4426

                PCs                         3142

                Spares                    1563

9131

6.             Your manager has advised you that 2 of the largest debtors have gone into liquidation and the client has provided 50% of these debts as they are covered by credit insurance. There is no correspondence from the insurance company regarding whether or when the claim in respect of these debts will be settled. The insurance company has requested Computek to provide evidence that the company has fulfilled all the conditions of the insurance policy before it will settle. In view of previous experiences by the company with such insurance claims, it is unlikely that any notification on recovery will be received before year end. The financial controller has assured your manager that they have complied with all the conditions of the insurance agreement.

7.             The company maintains fully computerized accounting systems for sales/debtors, inventories and general ledger functions. Audit testing in prior years has shown that controls over these systems appear to be strong. The sales/debtors system matches cash receipts to outstanding items, and maintains back order details where customer orders cannot be filled immediately.

8.             Computek has a wholly owned subsidiary in New Zealand which has been making losses since its incorporation in 1995. As a result, the subsidiary has a large deficiency in shareholders’ funds. The New Zealand company figures have not been consolidated in the attached financial information.

9.             A large stock of PCs at a cost of $600,000 was ordered and is currently in transit from the overseas parent. These PCs are the latest machines which have been brought to Australia for the first time. However, since Computek has resolved to concentrate on the modem market, it has decided not to release the machines into Australia. The parent company from which these stocks were purchased will not accept them back, but the company’s directors are looking to on-sell them to another related company in Hong Kong.

10.          Initial discussions with management have revealed that the company has significant tax losses which management is keen to carry forward as an asset in the year end balance sheet.

11.          All modems and PCs sold by the company have a warranty of 12 months from the date of sale.

12.          One modem stock item (XP1000) which was released in early 1997 was found to have a factory fault. This defect only occurs in modems which are used excessively. Computek had established a provision of $480,000 for returns of this item, but only $80,000 of this provision had been utilized up to October 1998. The returns of this item have slowed down to only 1 per month. There are 100 units of this item still on hand.

Computek Electronics Limited

Statement of Financial Performance

	Unaudited 10 months 31/10/98 $’000	Audited 12 months 31/12/97 $’000
Operating revenue	47787	72007
Operating profit (loss)	(3652)	(5561)
Abnormal items	-	(1583)
Income tax expense	-	-
Operating loss after income tax	(3652)	(7144)
Retained profits/(losses) at beginning of financial year	(23816)	(16672)
Retained profits/(losses) at end of financial period	(27468)	(23816)
Statement of Financial Position
Current Assets
Cash	153	1107
Receivables	10353	14310
Inventories	7723	18073
Other	-	40
Total Current Assets	18229	33530
Non-current Assets
Investments	1	1
Property, Plant & Equipment	1800	2166
Total Non-current Assets	1801	2167
Total Assets	20030	35697
Current Liabilities
Creditors & Borrowings	16537	27177
Provisions	890	1672
Total Current Liabilities	17427	28849
Non-current Liabilities
Creditors & Borrowings	29034	29634
Provisions	37	30
Total Non-current Liabilities	29071	29664
Total Liabilities	46498	58513
Net Assets	(26468)	(22816)
Shareholders’ Equity
Share Capital	1000	1000
Retained profits/(losses)	(27468)	(23816)
Total Shareholders’ Equity	(26468)	(22816)

You are required to complete the following:

A).    i)    What are the key factors that indicate that the company may have a going concern

                problem?

ii)   What additional information would you obtain to evaluate this problem?

Answer 1

The key factors that indicate that the company may have a going concern problem are:

1. It's 2 of the largest debtor gone into liquidation. However the company has applied for recover of 50% of loss to insurance company. But in view with the previous records, it is unlikely that any notification will be received till the year end.

2. The company has a wholly owned subsidiary which is has a large deficiency in the shareholders fund. This might also act as a factor for going concern problem.

3. The company has a large stock of PC's costing to 6,00,000. However, since the company has decided to concentrate on mordem, it has decided not to release these PC's in Australia. This remains as stock in hand with the company. The directors have decided to sell it to another company. However, according to conservatism concept, we shall recognize the expected future loss but in notes to accounts. This shall also act as a factor to going concern problem.

4. Another factor is that the company has very less amount is cash in hand to cover its operation.

5. Company's current ratio is 1.046:1(current asset/current liability) which indicated that company's liquidity position is very low. A company must have 2:1 as it's current ratio.