AUDITING & ASSURANCE SERVICES PAPER

AdoreU Children Fashion Ltd Mini Audit Project

QUESTIONS

Part A: Professional Ethics and Audit Planning

BACKGROUND INFORMATION

Wallace & Davey Partners, Chartered Accountants is a medium size accounting firm located in Auckland with four audit partners, seven business advisory partners and four tax partners. The firm has been appointed to audit AdoreU Children Fashion Ltd for the year ended 31 December 2018. The former auditor has been rotated off the client. The engagement partner is Patrick Wallace, and you are the audit manager assigned to this client. Your firm does not have experience in the children fashion industry, but Wallace thinks it is a good opportunity to learn about the industry. The fee for the financial audit of AdoreU is $150,000, which is about 16% of total audit fees your firm generates. The company would also require advice on taxation and treasury. Since this is a first time audit, you accompanied Wallace to meet the senior management of the client. The following is a summary of your notes from the interviews with senior management of AdoreU Children Fashion.

NOTES FROM CLIENT INTERVIEW

The company profile

AdoreU Children Fashion is an Auckland company incorporated in 1990. It was founded by Sally Hall, a former childrenswear buyer, and a mum. Hall spotted a gap in the market for quality and fashionable childrenswear and started the brand with a mail order catalogue. Halls mail order catalogue was very popular and soon after she opened the first AdoreU retail store. By 1994, AdoreU headed into Australia as a mail order catalogue, opening its first Australian store three years later. AdoreUs rise seemed unstoppable in the early 2000s. It secured its first US wholesale partner Nordstrom in 2002, and in 2003 added Australian department store David Jones as a distribution channel. In 2004 it listed on the New Zealand stock exchange and opened franchise partner stores across the Middle East. Retail stores in the US, franchises in Singapore, Malaysia, Indonesia, South Africa and Pakistan followed, along with the companys first ecommerce website in 2006. Around that time, the founder Hall stepped down from the Board, leaving the Directors to find a new managing director. Since then, the company has changed three Managing Directors. The fast expansion of AdoreU was heavily financed through debts, which contributed to a highly geared financial position. It created pressure for the company in serving the high level of debts. The companys expansion ceased in 2007 and its shares price peaked in January 2007 at $4.95 per share. By November 2018, the share price dropped by 60% to $1.98. As of 2015, the company closed its stores in nearly all international markets, with just 92 stores remaining across Australia, New Zealand and Ireland. Market commentators believe that the deterioration of AdoreU financial performance was largely because of its inability to sustain the rapid global expansion.

Despite the highly competitive retail market, the core retail businesses in New Zealand and Australia have performed well in the current financial period and progress has been made to improve stock efficiency. Despite the difficulties in performance, the new Managing Director Neil Jenkins, who was appointed in June 2017, is confident that the company can be turned around because the brand is still strong and well recognised. The company also has reduced net banking debt by $20 million, and its banking facilities are secured until the end of 2018. Before he was appointed as the managing director, Jenkins was an experienced director and was the CFO of a large retailing chain in NZ. At the meeting, you discovered that Jenkins daughter works for your firm as an audit graduate.

The new Managing Director Neil Jenkins is changing its business strategy, which aimed at repositioning itself in the market. The new MD has a turnaround plan. He says that AdoreUs must redirect its focus to customers, the style of clothes parents desire to buy for their kids and enhance customers experience in the stores. To achieve this, an investment will be required in the new design of products, marketing channels and various customer communication mediums.

Competition in the market

In recent years, clothing retailers in Australia and New Zealand have struggled. Although AdoreU is the biggest player in the Australasian market, it claims to have 12% of the children fashion market. It competes with brands carried by department stores as well as small boutiques such as Seed, H&M and Cotton On Kids etc.

Financial situation

AdoreU delivered a $9,079,000 after-tax loss for the year ended 31 December 2018, an improvement compared to the prior year loss of $11,495,000. Jenkins said "the financial position of the company has improved significantly over the last year in particular and we have formed a very strong working relationship with the bank. Over the last 12 months, we have made significant progress in reducing inventory level. Our debts (interest bearing liabilities) also have dropped from over $60 million last year to around $40 million this year. In our view, this is material and has created the platform for us to move forward."

The structure of the Board of Directors

The Board of Directors consists of five members: the Managing Director and four independent directors at the end of 2018 financial year. Three of the four independent directors are also members of the Audit Committee. The Company has a formal Code of Conduct and Ethics Policy. This policy provides guidance to all Directors, managers, employees and contractors of AdoreU Limited expected conduct when undertaking business on behalf of the company.

Communication with the prior auditor

With the clients approval, the predecessor auditor shared their audit file for the last financial year. You noted in the audit file, a concern regarding the valuation of inventory. The predecessor auditor believed that one of the inventory range called Comfort maternity wear had a long turnover time and should be written off. The value of this particular label was 10% of the total inventory. However, management believed that it can still be sold at cost. Eventually, no write-off was made for this inventory range in the last financial statements. The previous auditor also noted that they questioned about the companys risk of breaching its bank covenant because the turnover was disappointing. The management argued that the company is in a transition period and the poor performance was partially contributed by the failure of two suppliers because of major flooding in a key supply region in China. They had to find other reputable suppliers which caused delays in production.

Part A Audit Planning and Professional Ethics

Required:

1. Referring to the case facts, identify and explain three potential threats to professional ethics. Discuss possible safeguard to address each threat. (10 marks)

2. Following the above meeting, the engagement partner asks you to review the unaudited financial statements for the year 31 December 2018 (attached as a separate Excel document) and to produce the audit planning workpaper discussing the potential risks of material misstatement that the firm may encounter in this audit. (30 marks)

Your audit planning workpaper must cover the following:

a) Identify ten risks factors (conditions) that the financial statements maybe misstated.

b) Explain the potential impact of each of the identified risk factor on the assertions of the financial statements or the audit.

c) Determine the audit strategies or procedures that should address each identified risk.

Use the following format to present your answer.

Identify the risks (facts) (a)

The potential impact on the assertions of financial statements or the audit. (b)

Audit strategies or procedures to address the risks (c)

Adore Children Fashion Ltd STATEMENTS OF COMPREHENSIVE INCOME For the year ended 31 Dec 2018 Notes Unaudited 31-Dec-18 $'000 238,537 -115,901 122,636 231 100.0% -48.6% 51.4% 31-Dec-17 $'000 240,902 -120,120 120,782 100.0% -49.9% - 50.1% 2.20 - 2.07 Inventory turnover 173 3 -45.4% -1.7% -7.6% 0.85 3.23 Interests coverage ratio -108,223 -4,011 -18,056 -7,423 -1,656 -9,079 -45.3% -1.4% -9.5% -5.9% -3.1% Revenue Cost of goods sold Gross profit Other operating income Expenses Selling expenses Finance expenses Administrative and general expenses Loss from continuing operations before income tax Income tax (expense)/credit Net loss from continuing operations Profit from discontinuing operations (net of tax) Loss for the year Other comprehensive loss Items that may be reclassified subsequently to loss: Exchange differences on translation of foreign operations Net movement on cash flow hedges Income tax relating to components of other comprehensive income Other comprehensive income/(loss) for the year Total comprehensive loss for the year, net of tax Total comprehensive loss for the year is attributable to equity holders -109,016 -3,352 -22,778 -14,191 2,579 -11,612 -117 -11,495 -9,079 2,093 1,818 -59 -4,128 -509 3,402 -5,677 1,157 -3030 -14,525 -5,677 -14,525 BALANCE SHEETS As at 31 December 2018 12/31/2018 Notes $'000 12/31/2017 $'000 12/31/2016 $'000 ASSETS Current assets 0.21328 0.58460 0.32539 Quick ratio Cash and cash equivalents Trade and other receivables Derivative financial instruments Inventories Current tax receivables Total current assets Non-current assets 1,870 13,458 5,808 41,230 1,016 63,382 1,077 16,845 1,009 64,318 3,679 14,957 8,348 51,957 83,249 78,941 0.881922 2.715497 1.378328 Current ratio 11 28,420 2,803 3,567 Property, plant and equipment Intangible assets Non-current tax receivables Derivative financial instruments Deferred tax assets Total non-current assets 32,436 5,756 3,475 278 7,932 49,877 133,126 40,113 9,690 2,958 614 3,563 56,938 135,879 5,550 40,340 103,722 Total assets 27,305 25,451 41,000 1,210 2,968 1,239 71,868 356 1,112 1,884 30,657 24,608 25,000 662 5,509 1,494 57,273 27,000 LIABILITIES Current liabilities Trade and other payables Interest bearing liabilities Lease Provisions Derivative financial instruments Other Provisions Total current liabilities Non-current liabilities Interest bearing liabilities Lease Provisions Deferred landlord contributions Derivative financial instruments Total non-current liabilities Total liabilities Net assets EQUITY Share capital Reserves Retained earnings / (deficit) Total equity 512 2,971 66,000 488 2,102 74 68,664 99,321 33,805 518 2,105 1,054 3,677 75,545 28,177 57 30,540 87,813 48,066 1.273023 1.674015 Debt/equity 59,343 3,006 - 34,172 - 28,177 59,331 433 25,093 - 33,805 59,147 3,734 14,815 48,066 STATEMENTS OF CHANGES IN EQUITY For the year ended 31 December 2018 ATTRIBUTABLE TO EQUITY HOLDERS OF THE COMPANY Share capital Treasury Retained Total Reserves stock deficit equity S'000 $'000 $'000 $'000 3,734 - 268 - 14,815 48,066 - - 11,495 - 11,495 59,415 - - - - 3,030 3,030 - 11,495 - - 184 3,030 14,525 184 15 80 Balance at 1 January 2017 Note Comprehensive income Loss for the year Other comprehensive loss Total comprehensive income Movement in treasury stock Movement in share based payment reserve Balance at 31 December 2017 Balance at 1 January 2018 Comprehensive income Loss for the year Other comprehensive income Total comprehensive income Movement in treasury stock Movement in share based payment reserve Balance at 31 December 2018 59,415 - 59,415 - 1,137 433 433 - - 84 - 84 - 1,217 25,093 25,093 33,805 33,805 9,079 - 3,402 3,402 9,079 - 9,079 3,402 5,677 12 37 28,177 15 12 37 3,006 59,415 - 72 - 34,172 Note 2 SEGMENT INFORMATION An operating segment is a component of an entity that engages in business activities which earns revenue and incurs expenses on which the chief operating decision maker reviews the operating results on a regular basis and makes decisions on resource allocation. The Company is organised into operating segments, depicting the three geographical regions the Company operates in and the centralised support function based in New Zealand. Management has determined the operating segments based on the business activities of the Company together with the information and the manner in which decisions regarding performance and resource allocation are made by the Senior Management Team. The "Chief Operating Decision Maker" is considered to be the Senior Management Team who consider the business from a geographic and support function perspective, being New Zealand, Australia and other International markets while the performance of the centralised support function is assessed separately. The International segment includes the results of continuing operations in markets located outside New Zealand and Australia. The following is an analysis of the Company's revenue and results by operating segment. Revenue reported below represents revenue from the sale of children's clothing products to external customers. Revenue is allocated based on the country where the sale is generated. There were no inter-segment sales in the year (2015: nil). Geographic segment profit represents the profit earned by each segment without allocation of central administration costs, finance costs, income tax, store impairment and lease provisions. These costs are recorded in the centralised support segment Australia New International Centralised Total Zealand Support 2018 $'000 $'000 $'000 $'000 $'000 Revenue 151,923 46,833 39,781 - 238,537 Expenses 135,734 - 38,611 - 37,857 - 33,758 - 245,960 Segment result before income tax 16,189 8,222 1,924 - 33,758 - 7,423 Income tax - 1,656 Loss for the year 9,079 Segment total assets (other than deferred tax) 39,844 18,745 18,653 20,930 98,172 Segment non-current assets (other than deferred tax) 18,910 4,869 90 10,921 34,790 Acquisitions of property, plant and equipment, intangibles 3,028 188 - 649 3,865 and other non-current segment assets Depreciation and amortisation expense 3,438 - 1,275 - 97 - 4,117 - 8,927 Finance expense - 4,011 - 4,011 2017 Revenue Expenses Segment result before income tax Income tax - Income tax - Profit from discontinuing operations (net of tax) 149,914 47,971 - 130,993 - 39,527 - 18,921 8,444 43,017 38,845 - 4,172 - - Loss for the year Segment total assets (other than deferred tax) Segment non-current assets (other than deferred tax) Acquisitions of property, plant and equipment, intangibles Depreciation and amortisation expense Finance expense - 240,902 45,728 - 255,093 45,728 - 14.191 - 2,579 117 - 2,696 -- 11495 16,935 125,194 14,696 41,945 3,542 8,567 5,077 - 11,010 3,352 - 3,352 51,217 20,139 4,045 4,471 - 25,410 6,639 757 1,335 - 31,632 471 223 127 - - - - (1) The Company's liabilities are not analysed on a segmental basis and therefore have not been reported. (ii) Revenue comprises the fair value for the sale of goods and services, net of sales tax and discounts and after eliminating sales within the Company. - Sales of goods - retail Sales of goods are recognised when a Company entity sells a product to the customer. Retail sales are usually in cash or by credit card either in store or online. Sales of goods-wholesale Wholesale sales are recognised in accordance with the terms of sales when the title has transferred and the benefits of ownership and risk pass to the customer. This is dependent on customer specific terms of trade. - Interest income Interest income is recognised using the effective interest method. 31-Dec-18 31-Dec-17 - Other income - Interest received 941 830 P&L Balance Sheet Equity Note 2 Notes 3,7,8 Note 10 Notes 11,12,13 Note 15 oth ... + Note 3 EXPENSES 12/31/2018 $'000 12/31/2017 '000 5,720 - 1,167 - Loss before income tax includes the following specific expenses: Depreciation of property, plant & equipment Impairment of store assets Gain/(loss) on disposal of assets Amortisation of intangibles Impairment of intangibles Lease provision expense 3,207 - 7,169 5,905 43 3,841 3,074 397 20,429 1,471 - 11,532 - Employee benefit expense Salaries & wages Share based payments Employee related reorganisation costs 57,549 - 37 - 859 58,445 - 58,449 80 2,034 60,563 Rental expense relating to operating leases Rental and operating lease expenses 48,889 - 49,875 Finance costs Interest expense 4,011 - 3,352 34 71% Sundry expenses Bad debts written off Director's fees Donations Doubtful debts expense 58 - 418 - 40 - 2,090 2,606 - 24 417 150 - 156 Remuneration of auditors (based on the amount agreed upon engagement) Audit of financial statements - Statutory audit Other services - Treasury advice - Taxation advice Total fees paid to auditor 25 - 14 189 - 176 37 Note 7 TRADE RECEIVABLES, PREPAYMENTS AND OTHER ASSETS 38 Accounting Policy 39 Trade receivables are recognised initially at fair value and subsequently at amortised cost less provision for doubtful debts. Collectibility of trade receivables is reviewed on an ongoing basis. Debts which are known to be uncollectible are written off. A provision for doubtful receivables is established when there is objective evidence that the Company will not be able to collect all amounts due according to the original terms of receivables. The amount of the provision is the difference between the asset's carrying amount and the present value of estimated future cash flows. The amount of the provision is recognised in the Income Statement. Significant financial difficulties of the debtor, probability that the debtor will enter bankruptcy or financial reorganisation, and default or delinquency in payments are considered indicators that the trade receivable is impaired. 31 Dec 31 Dec 2018 2017 $'000 $'000 42 Trade receivables 6,531 12,704 43 Prepayments 5,454 2,739 Other receivables 1,473 1,402 13,458 16,845 46 The carrying amounts of the Company's trade and other receivables are denominated in the following currencies: 47 NZD 2,974 3,357 48 USD 6,219 12,479 49 AUD 3,728 70 50 GBP 251 588 51 EUR 286 351 13,458 16,845 The Company has assessed total trade receivables as being impaired and has recognised a doubtful debt provision of $2.1m based on additional information in relation to economic developments so subsequent to year end. All other remaining balances at 31 Dec 2018 are considered current and within terms. 52 54 55 Note 8 INVENTORIES 56 Accounting Policy Finished goods are stated at the lower of cost and net realisable value. Costs are assigned to individual items of inventory on the basis of weighted average costs, and include expenditure incurred in acquiring the assets and bringing them to their existing location and condition. Net realisable value is the estimated selling price in the ordinary course of business. The Company annually reviews the carrying value of inventory to ensure it remains valued at lower of cost or net realisable value. An inventory provision is created to reflect instances where the 58 forecast selling value is lower than cost. 31 Dec 2018 31 Dec 2017 $'000 $'000 50 Finished Goods 41,230 64,318 51 Inventory provisions of $1,093,000 (2017: $1,566,000) have been included in the Income Statement to reflect the recoverable value of the company;s aged stock provision. Note 10 PROPERTY, PLANT AND EQUIPMENT Accounting Policy All property, plant and equipment is stated at historical cost less depreciation and impairment. Historical cost includes expenditure that is directly attributable to the acquisition of the items. Subsequent costs are included in the asset's carrying amount or recognised as a separate asset, as appropriate, only when it is probable that future economic benefits associated with the item will flow to the Group and the cost of the item can be measured reliably. All repairs and maintenance are charged to the Income Statement during the financial period in which they are incurred. Land is not depreciated. Depreciation on other assets is calculated using the straight line method to allocate their costs, net of their residual values, over their estimated useful lives, as follows: -Shop fitout 5 - 10 years - Office equipment (including furniture and fittings (F&F) 5 - 10 years - Computer equipment (including point of sale equipment (POS) 3-5 years 3 - Plant and machinery 3 - 7 years The assets' residual values and useful lives are reviewed, and adjusted if appropriate, at each balance date. O An asset's carrying amount is written down immediately to its recoverable amount if the asset's carrying amount is greater than its estimated recoverable amount. 1 Gains and losses on disposals are determined by comparing proceeds with carrying amount. These are included in the Income Statement. Computer Office equipment and equipment and Plant and 2 Year ended 31 December 2018 fitout POS F&F machinery Land Total $'000 $'000 $'000 $'000 $'000 $'000 Shop 902 2,504 17,219 18 - 2,848 1 - - 2,648 14 - 314 7- 5 Opening net book amount 6 Exchange differences 7 Additions 8 Disposals 9 Impairment charge recognised in income sta- Depreciation charge 1 Closing net book amount 9,163 43 385 48 - 32,436 74 3,611 64 210 401 666 1,167 - 3,384 15,288 - - 574 - 2,367 1,714 - 7,743 48 - 518 1,167 5,720 28,420 2,504 3 At 31 December 2018 4 Cost 92,868 13,666 25,126 6,263 2,504 140,427 5 Accumulated depreciation 77,580 - 11,299 - 17,383 - 5,745 - - 112,007 6 Net book amount 15,288 2,367 7.743 518 2,504 28,420 The performance of all Adore stores is reviewed throughout the year to ascertain whether any indicators of impairment exist in relation to the carrying value of store assets. During the year such a review highlighted that the carrying value of shop fitout of a number of stores in the retail network did not reflect their current and forecast trading performance. As a result a charge of $1,167,000 (2017: $5,905,000) has been recorded in the administrative and general expenses account in the financial statements for the year ending 31 December 2018, which reflects the full impairment of the shop fitout of the stores identified. The recoverable amount of the assets has been determined based on a value-in-use calculation. The assumption used to determine the recoverable amount is a 8 key accounting estimate Note 11 INTANGIBLE ASSETS Accounting Policy (i) Trademarks Trademarks have a finite useful life and are carried at cost less accumulated amortisation and impairment losses. Amortisation is calculated using the straight line method to allocate the cost of trademarks and licences over their estimated useful lives (three to five years). (ii) Software costs Acquired computer software licences are capitalised on the basis of the costs incurred to acquire and bring to use the specific software. These costs are amortised over their estimated useful lives (three to five years). Costs associated with maintaining computer software programmes are recognised as an expense as incurred. Costs that are directly associated with the production of identifiable and unique software products controlled by the Company, and that will probably generate economic benefits exceeding costs beyond one year, are recognised as intangible assets. Direct costs include the software development employee costs. Computer software costs recognised as assets are amortised over their estimated useful lives (three to five years). Trademarks Software Total $'000 $'000 $'000 Year ended 31 Dec 2017 1 Opening net book amount 472 5,284 5,756 Additions 254 3 Disposals 4 Imparirment expenses - - 5 Amortisation expenses 165 - 3,042 - 3,207 5 Closing net book amount 366 2,437 2,803 7 At 31 Dec 2017 3 Cost 2,296 29,011 31,307 Accumulated amortisation 1,930 - 26,574 - 28,504 Net book amount 366 2,437 2,803 The carrying value of software assets have been assessed to determine whether any indicators of impairment exist. No indicators were identified and accordingly no impairment charge was recorded in 1 the year ending 31 Dec 2018 (2017: $3,074,000). 59 195 23 Note 12 TRADE AND OTHER PAYABLES 24 Accounting Policy 25 Trade and other payables are initially recognised at fair value and subsequently at amortised cost. These amounts represent liabilities for goods and services provided to the Company prior to the end of financial year which are unpaid. Trade Payable amounts are unsecured and are usually 26 paid within 30 days of recognition. 31 Dec 31 Dec 2018 2017 28 Trade payables 11,414 12,021 29 Sundry Accruals 10,025 11,206 30 Sales tax payable 826 1,004 31 Employee Benefits 3,186 3,074 25,451 27,305 34 The carrying amounts of Company's trade and other payables are denominated in the 35 following currencies: 36 NZD 6,265 6,574 37 USD 9,890 12,573 38 AUD 7,984 7,059 39 GBP 437 402 40 EUR 875 697 25,451 27,305 43 Note 13 LEASE PROVISIONS 44 Accounting Policy 45 Provisions are recognised when the Company has a present legal or constructive obligation as a result of past events, it is probable that an outflow of resources will be required to settle the 31 Dec 31 Dec 2018 2017 47 Current Provisions 1,210 356 48 Lease provision 1,210 356 49 Non-Current Provisions 518 488 50 Lease provision 518 488 51 Onerous Lease and Make Good Provision 52 The Company recognised a lease provision for onerous contracts and make good under existing lease agreements as follows: The provision for onerous lease represents the lesser of the discounted future lease payments or the estimated costs to exit the lease. The leases are deemed to be onerous on the basis that the forecast future profit of the relevant stores is not sufficient to cover the contracted costs of leasing the store. The provision for make good represents the obligation to restore certain leasehold sites to their original condition upon store closure or relocation. This provision represents the present value of the expected future make good commitment. At 31 Dec 2018 the provision relating to leases of stores identified being onerous and make good provisions totalled $1,728,000 (2017: $844,000). 54 Movement in provisions Lease provision 31 Dec 31 Dec 2018 2017 56 Opening provision 844 1,174 57 Utilised during the year 587 - 727 58 Lease provision expense 1,471 397 59 Closing provision 1,728 844 P&L Balance Sheet Equity Note 2 Notes 3,7,8 Note 10 Notes 11,12,13 Note 5 Oth ... : Note 15 SHARE CAPITAL Accounting Policy Ordinary shares are classified as capital. Incremental costs directly attributable to the issue of new shares or instruments are shown in equity as a deduction, net of tax, from the proceeds. Where any Group company purchases or controls the Company's equity share capital (treasury stock), the consideration paid, including any directly attributable incremental costs (net of income taxes), is deducted from equity attributable to the Group's equity holders until the shares are cancelled or reissued. Where such shares are subsequently reissued, any consideration received (net of any directly attributable incremental transaction costs and the related income tax effects) is included in equity attributable to the Group's equity holders. 72 31 Dec 2018 31 Dec 2017 $'000 $'000 Opening balance of issued and paid up capital 59,415 59,415 3 Issues of ordinary shares during the year e Shares held as Treasury stock 84 Closing balance of issued and paid up capital 59,343 59,331 1 (a) Ordinary shares As at 31 Dec 2018 there were 169,078,908 ordinary shares on issue (2017: 169,078,908). 169,078,908 ordinary shares include treasury shares. All ordinary shares are fully paid and rank 2 equally with one vote attaching to each share. 3 (b) Treasury stock As at 31 Dec 2018 there were 1,096,974 shares (2017: 1,097,754) which have been issued under the DF7 (Income Tax Act 1994) Scheme and other employee schemes but at balance date have not been allocated to employees. The shares are held in trust by Cool & Cute Children Fashion Limited. 5 (c) Earnings per share Basic earnings per share is calculated by dividing the loss attributable to the equity holders of the company by the weighted average number of ordinary shares on issue during the year, 169,078,908 shares (2017: 169,078,908 shares). Diluted earnings per shares is calculated by dividing the loss by the weighted average number of ordinary shares on issue during the year adjusted to assume conversion of dilutive potential of ordinary shares as a result of the issue of share options, 169,078,908 shares (2017: 169,078,908 shares). Where the market price is lower than the exercise price of the option, there is no effect on diluted earnings per share. Others LLO of stores 25 Inventory rage Nature of the range Label Age Infants Cuties 0-2 Young children Cool monkeys 2-5 School-aged children Fun kids 5-12 Maternity wear Comfort Adults Total Closing balance of inventory 1 Provision for inventory write-offs Value $000 8,431 18,654 10,765 4,473 42,323 41,230 1,093 Retailing Stores Location New Zealand Australia Ireland Total TO UI UI - Adore Children Fashion Ltd STATEMENTS OF COMPREHENSIVE INCOME For the year ended 31 Dec 2018 Notes Unaudited 31-Dec-18 $'000 238,537 -115,901 122,636 231 100.0% -48.6% 51.4% 31-Dec-17 $'000 240,902 -120,120 120,782 100.0% -49.9% - 50.1% 2.20 - 2.07 Inventory turnover 173 3 -45.4% -1.7% -7.6% 0.85 3.23 Interests coverage ratio -108,223 -4,011 -18,056 -7,423 -1,656 -9,079 -45.3% -1.4% -9.5% -5.9% -3.1% Revenue Cost of goods sold Gross profit Other operating income Expenses Selling expenses Finance expenses Administrative and general expenses Loss from continuing operations before income tax Income tax (expense)/credit Net loss from continuing operations Profit from discontinuing operations (net of tax) Loss for the year Other comprehensive loss Items that may be reclassified subsequently to loss: Exchange differences on translation of foreign operations Net movement on cash flow hedges Income tax relating to components of other comprehensive income Other comprehensive income/(loss) for the year Total comprehensive loss for the year, net of tax Total comprehensive loss for the year is attributable to equity holders -109,016 -3,352 -22,778 -14,191 2,579 -11,612 -117 -11,495 -9,079 2,093 1,818 -59 -4,128 -509 3,402 -5,677 1,157 -3030 -14,525 -5,677 -14,525 BALANCE SHEETS As at 31 December 2018 12/31/2018 Notes $'000 12/31/2017 $'000 12/31/2016 $'000 ASSETS Current assets 0.21328 0.58460 0.32539 Quick ratio Cash and cash equivalents Trade and other receivables Derivative financial instruments Inventories Current tax receivables Total current assets Non-current assets 1,870 13,458 5,808 41,230 1,016 63,382 1,077 16,845 1,009 64,318 3,679 14,957 8,348 51,957 83,249 78,941 0.881922 2.715497 1.378328 Current ratio 11 28,420 2,803 3,567 Property, plant and equipment Intangible assets Non-current tax receivables Derivative financial instruments Deferred tax assets Total non-current assets 32,436 5,756 3,475 278 7,932 49,877 133,126 40,113 9,690 2,958 614 3,563 56,938 135,879 5,550 40,340 103,722 Total assets 27,305 25,451 41,000 1,210 2,968 1,239 71,868 356 1,112 1,884 30,657 24,608 25,000 662 5,509 1,494 57,273 27,000 LIABILITIES Current liabilities Trade and other payables Interest bearing liabilities Lease Provisions Derivative financial instruments Other Provisions Total current liabilities Non-current liabilities Interest bearing liabilities Lease Provisions Deferred landlord contributions Derivative financial instruments Total non-current liabilities Total liabilities Net assets EQUITY Share capital Reserves Retained earnings / (deficit) Total equity 512 2,971 66,000 488 2,102 74 68,664 99,321 33,805 518 2,105 1,054 3,677 75,545 28,177 57 30,540 87,813 48,066 1.273023 1.674015 Debt/equity 59,343 3,006 - 34,172 - 28,177 59,331 433 25,093 - 33,805 59,147 3,734 14,815 48,066 STATEMENTS OF CHANGES IN EQUITY For the year ended 31 December 2018 ATTRIBUTABLE TO EQUITY HOLDERS OF THE COMPANY Share capital Treasury Retained Total Reserves stock deficit equity S'000 $'000 $'000 $'000 3,734 - 268 - 14,815 48,066 - - 11,495 - 11,495 59,415 - - - - 3,030 3,030 - 11,495 - - 184 3,030 14,525 184 15 80 Balance at 1 January 2017 Note Comprehensive income Loss for the year Other comprehensive loss Total comprehensive income Movement in treasury stock Movement in share based payment reserve Balance at 31 December 2017 Balance at 1 January 2018 Comprehensive income Loss for the year Other comprehensive income Total comprehensive income Movement in treasury stock Movement in share based payment reserve Balance at 31 December 2018 59,415 - 59,415 - 1,137 433 433 - - 84 - 84 - 1,217 25,093 25,093 33,805 33,805 9,079 - 3,402 3,402 9,079 - 9,079 3,402 5,677 12 37 28,177 15 12 37 3,006 59,415 - 72 - 34,172 Note 2 SEGMENT INFORMATION An operating segment is a component of an entity that engages in business activities which earns revenue and incurs expenses on which the chief operating decision maker reviews the operating results on a regular basis and makes decisions on resource allocation. The Company is organised into operating segments, depicting the three geographical regions the Company operates in and the centralised support function based in New Zealand. Management has determined the operating segments based on the business activities of the Company together with the information and the manner in which decisions regarding performance and resource allocation are made by the Senior Management Team. The "Chief Operating Decision Maker" is considered to be the Senior Management Team who consider the business from a geographic and support function perspective, being New Zealand, Australia and other International markets while the performance of the centralised support function is assessed separately. The International segment includes the results of continuing operations in markets located outside New Zealand and Australia. The following is an analysis of the Company's revenue and results by operating segment. Revenue reported below represents revenue from the sale of children's clothing products to external customers. Revenue is allocated based on the country where the sale is generated. There were no inter-segment sales in the year (2015: nil). Geographic segment profit represents the profit earned by each segment without allocation of central administration costs, finance costs, income tax, store impairment and lease provisions. These costs are recorded in the centralised support segment Australia New International Centralised Total Zealand Support 2018 $'000 $'000 $'000 $'000 $'000 Revenue 151,923 46,833 39,781 - 238,537 Expenses 135,734 - 38,611 - 37,857 - 33,758 - 245,960 Segment result before income tax 16,189 8,222 1,924 - 33,758 - 7,423 Income tax - 1,656 Loss for the year 9,079 Segment total assets (other than deferred tax) 39,844 18,745 18,653 20,930 98,172 Segment non-current assets (other than deferred tax) 18,910 4,869 90 10,921 34,790 Acquisitions of property, plant and equipment, intangibles 3,028 188 - 649 3,865 and other non-current segment assets Depreciation and amortisation expense 3,438 - 1,275 - 97 - 4,117 - 8,927 Finance expense - 4,011 - 4,011 2017 Revenue Expenses Segment result before income tax Income tax - Income tax - Profit from discontinuing operations (net of tax) 149,914 47,971 - 130,993 - 39,527 - 18,921 8,444 43,017 38,845 - 4,172 - - Loss for the year Segment total assets (other than deferred tax) Segment non-current assets (other than deferred tax) Acquisitions of property, plant and equipment, intangibles Depreciation and amortisation expense Finance expense - 240,902 45,728 - 255,093 45,728 - 14.191 - 2,579 117 - 2,696 -- 11495 16,935 125,194 14,696 41,945 3,542 8,567 5,077 - 11,010 3,352 - 3,352 51,217 20,139 4,045 4,471 - 25,410 6,639 757 1,335 - 31,632 471 223 127 - - - - (1) The Company's liabilities are not analysed on a segmental basis and therefore have not been reported. (ii) Revenue comprises the fair value for the sale of goods and services, net of sales tax and discounts and after eliminating sales within the Company. - Sales of goods - retail Sales of goods are recognised when a Company entity sells a product to the customer. Retail sales are usually in cash or by credit card either in store or online. Sales of goods-wholesale Wholesale sales are recognised in accordance with the terms of sales when the title has transferred and the benefits of ownership and risk pass to the customer. This is dependent on customer specific terms of trade. - Interest income Interest income is recognised using the effective interest method. 31-Dec-18 31-Dec-17 - Other income - Interest received 941 830 P&L Balance Sheet Equity Note 2 Notes 3,7,8 Note 10 Notes 11,12,13 Note 15 oth ... + Note 3 EXPENSES 12/31/2018 $'000 12/31/2017 '000 5,720 - 1,167 - Loss before income tax includes the following specific expenses: Depreciation of property, plant & equipment Impairment of store assets Gain/(loss) on disposal of assets Amortisation of intangibles Impairment of intangibles Lease provision expense 3,207 - 7,169 5,905 43 3,841 3,074 397 20,429 1,471 - 11,532 - Employee benefit expense Salaries & wages Share based payments Employee related reorganisation costs 57,549 - 37 - 859 58,445 - 58,449 80 2,034 60,563 Rental expense relating to operating leases Rental and operating lease expenses 48,889 - 49,875 Finance costs Interest expense 4,011 - 3,352 34 71% Sundry expenses Bad debts written off Director's fees Donations Doubtful debts expense 58 - 418 - 40 - 2,090 2,606 - 24 417 150 - 156 Remuneration of auditors (based on the amount agreed upon engagement) Audit of financial statements - Statutory audit Other services - Treasury advice - Taxation advice Total fees paid to auditor 25 - 14 189 - 176 37 Note 7 TRADE RECEIVABLES, PREPAYMENTS AND OTHER ASSETS 38 Accounting Policy 39 Trade receivables are recognised initially at fair value and subsequently at amortised cost less provision for doubtful debts. Collectibility of trade receivables is reviewed on an ongoing basis. Debts which are known to be uncollectible are written off. A provision for doubtful receivables is established when there is objective evidence that the Company will not be able to collect all amounts due according to the original terms of receivables. The amount of the provision is the difference between the asset's carrying amount and the present value of estimated future cash flows. The amount of the provision is recognised in the Income Statement. Significant financial difficulties of the debtor, probability that the debtor will enter bankruptcy or financial reorganisation, and default or delinquency in payments are considered indicators that the trade receivable is impaired. 31 Dec 31 Dec 2018 2017 $'000 $'000 42 Trade receivables 6,531 12,704 43 Prepayments 5,454 2,739 Other receivables 1,473 1,402 13,458 16,845 46 The carrying amounts of the Company's trade and other receivables are denominated in the following currencies: 47 NZD 2,974 3,357 48 USD 6,219 12,479 49 AUD 3,728 70 50 GBP 251 588 51 EUR 286 351 13,458 16,845 The Company has assessed total trade receivables as being impaired and has recognised a doubtful debt provision of $2.1m based on additional information in relation to economic developments so subsequent to year end. All other remaining balances at 31 Dec 2018 are considered current and within terms. 52 54 55 Note 8 INVENTORIES 56 Accounting Policy Finished goods are stated at the lower of cost and net realisable value. Costs are assigned to individual items of inventory on the basis of weighted average costs, and include expenditure incurred in acquiring the assets and bringing them to their existing location and condition. Net realisable value is the estimated selling price in the ordinary course of business. The Company annually reviews the carrying value of inventory to ensure it remains valued at lower of cost or net realisable value. An inventory provision is created to reflect instances where the 58 forecast selling value is lower than cost. 31 Dec 2018 31 Dec 2017 $'000 $'000 50 Finished Goods 41,230 64,318 51 Inventory provisions of $1,093,000 (2017: $1,566,000) have been included in the Income Statement to reflect the recoverable value of the company;s aged stock provision. Note 10 PROPERTY, PLANT AND EQUIPMENT Accounting Policy All property, plant and equipment is stated at historical cost less depreciation and impairment. Historical cost includes expenditure that is directly attributable to the acquisition of the items. Subsequent costs are included in the asset's carrying amount or recognised as a separate asset, as appropriate, only when it is probable that future economic benefits associated with the item will flow to the Group and the cost of the item can be measured reliably. All repairs and maintenance are charged to the Income Statement during the financial period in which they are incurred. Land is not depreciated. Depreciation on other assets is calculated using the straight line method to allocate their costs, net of their residual values, over their estimated useful lives, as follows: -Shop fitout 5 - 10 years - Office equipment (including furniture and fittings (F&F) 5 - 10 years - Computer equipment (including point of sale equipment (POS) 3-5 years 3 - Plant and machinery 3 - 7 years The assets' residual values and useful lives are reviewed, and adjusted if appropriate, at each balance date. O An asset's carrying amount is written down immediately to its recoverable amount if the asset's carrying amount is greater than its estimated recoverable amount. 1 Gains and losses on disposals are determined by comparing proceeds with carrying amount. These are included in the Income Statement. Computer Office equipment and equipment and Plant and 2 Year ended 31 December 2018 fitout POS F&F machinery Land Total $'000 $'000 $'000 $'000 $'000 $'000 Shop 902 2,504 17,219 18 - 2,848 1 - - 2,648 14 - 314 7- 5 Opening net book amount 6 Exchange differences 7 Additions 8 Disposals 9 Impairment charge recognised in income sta- Depreciation charge 1 Closing net book amount 9,163 43 385 48 - 32,436 74 3,611 64 210 401 666 1,167 - 3,384 15,288 - - 574 - 2,367 1,714 - 7,743 48 - 518 1,167 5,720 28,420 2,504 3 At 31 December 2018 4 Cost 92,868 13,666 25,126 6,263 2,504 140,427 5 Accumulated depreciation 77,580 - 11,299 - 17,383 - 5,745 - - 112,007 6 Net book amount 15,288 2,367 7.743 518 2,504 28,420 The performance of all Adore stores is reviewed throughout the year to ascertain whether any indicators of impairment exist in relation to the carrying value of store assets. During the year such a review highlighted that the carrying value of shop fitout of a number of stores in the retail network did not reflect their current and forecast trading performance. As a result a charge of $1,167,000 (2017: $5,905,000) has been recorded in the administrative and general expenses account in the financial statements for the year ending 31 December 2018, which reflects the full impairment of the shop fitout of the stores identified. The recoverable amount of the assets has been determined based on a value-in-use calculation. The assumption used to determine the recoverable amount is a 8 key accounting estimate Note 11 INTANGIBLE ASSETS Accounting Policy (i) Trademarks Trademarks have a finite useful life and are carried at cost less accumulated amortisation and impairment losses. Amortisation is calculated using the straight line method to allocate the cost of trademarks and licences over their estimated useful lives (three to five years). (ii) Software costs Acquired computer software licences are capitalised on the basis of the costs incurred to acquire and bring to use the specific software. These costs are amortised over their estimated useful lives (three to five years). Costs associated with maintaining computer software programmes are recognised as an expense as incurred. Costs that are directly associated with the production of identifiable and unique software products controlled by the Company, and that will probably generate economic benefits exceeding costs beyond one year, are recognised as intangible assets. Direct costs include the software development employee costs. Computer software costs recognised as assets are amortised over their estimated useful lives (three to five years). Trademarks Software Total $'000 $'000 $'000 Year ended 31 Dec 2017 1 Opening net book amount 472 5,284 5,756 Additions 254 3 Disposals 4 Imparirment expenses - - 5 Amortisation expenses 165 - 3,042 - 3,207 5 Closing net book amount 366 2,437 2,803 7 At 31 Dec 2017 3 Cost 2,296 29,011 31,307 Accumulated amortisation 1,930 - 26,574 - 28,504 Net book amount 366 2,437 2,803 The carrying value of software assets have been assessed to determine whether any indicators of impairment exist. No indicators were identified and accordingly no impairment charge was recorded in 1 the year ending 31 Dec 2018 (2017: $3,074,000). 59 195 23 Note 12 TRADE AND OTHER PAYABLES 24 Accounting Policy 25 Trade and other payables are initially recognised at fair value and subsequently at amortised cost. These amounts represent liabilities for goods and services provided to the Company prior to the end of financial year which are unpaid. Trade Payable amounts are unsecured and are usually 26 paid within 30 days of recognition. 31 Dec 31 Dec 2018 2017 28 Trade payables 11,414 12,021 29 Sundry Accruals 10,025 11,206 30 Sales tax payable 826 1,004 31 Employee Benefits 3,186 3,074 25,451 27,305 34 The carrying amounts of Company's trade and other payables are denominated in the 35 following currencies: 36 NZD 6,265 6,574 37 USD 9,890 12,573 38 AUD 7,984 7,059 39 GBP 437 402 40 EUR 875 697 25,451 27,305 43 Note 13 LEASE PROVISIONS 44 Accounting Policy 45 Provisions are recognised when the Company has a present legal or constructive obligation as a result of past events, it is probable that an outflow of resources will be required to settle the 31 Dec 31 Dec 2018 2017 47 Current Provisions 1,210 356 48 Lease provision 1,210 356 49 Non-Current Provisions 518 488 50 Lease provision 518 488 51 Onerous Lease and Make Good Provision 52 The Company recognised a lease provision for onerous contracts and make good under existing lease agreements as follows: The provision for onerous lease represents the lesser of the discounted future lease payments or the estimated costs to exit the lease. The leases are deemed to be onerous on the basis that the forecast future profit of the relevant stores is not sufficient to cover the contracted costs of leasing the store. The provision for make good represents the obligation to restore certain leasehold sites to their original condition upon store closure or relocation. This provision represents the present value of the expected future make good commitment. At 31 Dec 2018 the provision relating to leases of stores identified being onerous and make good provisions totalled $1,728,000 (2017: $844,000). 54 Movement in provisions Lease provision 31 Dec 31 Dec 2018 2017 56 Opening provision 844 1,174 57 Utilised during the year 587 - 727 58 Lease provision expense 1,471 397 59 Closing provision 1,728 844 P&L Balance Sheet Equity Note 2 Notes 3,7,8 Note 10 Notes 11,12,13 Note 5 Oth ... : Note 15 SHARE CAPITAL Accounting Policy Ordinary shares are classified as capital. Incremental costs directly attributable to the issue of new shares or instruments are shown in equity as a deduction, net of tax, from the proceeds. Where any Group company purchases or controls the Company's equity share capital (treasury stock), the consideration paid, including any directly attributable incremental costs (net of income taxes), is deducted from equity attributable to the Group's equity holders until the shares are cancelled or reissued. Where such shares are subsequently reissued, any consideration received (net of any directly attributable incremental transaction costs and the related income tax effects) is included in equity attributable to the Group's equity holders. 72 31 Dec 2018 31 Dec 2017 $'000 $'000 Opening balance of issued and paid up capital 59,415 59,415 3 Issues of ordinary shares during the year e Shares held as Treasury stock 84 Closing balance of issued and paid up capital 59,343 59,331 1 (a) Ordinary shares As at 31 Dec 2018 there were 169,078,908 ordinary shares on issue (2017: 169,078,908). 169,078,908 ordinary shares include treasury shares. All ordinary shares are fully paid and rank 2 equally with one vote attaching to each share. 3 (b) Treasury stock As at 31 Dec 2018 there were 1,096,974 shares (2017: 1,097,754) which have been issued under the DF7 (Income Tax Act 1994) Scheme and other employee schemes but at balance date have not been allocated to employees. The shares are held in trust by Cool & Cute Children Fashion Limited. 5 (c) Earnings per share Basic earnings per share is calculated by dividing the loss attributable to the equity holders of the company by the weighted average number of ordinary shares on issue during the year, 169,078,908 shares (2017: 169,078,908 shares). Diluted earnings per shares is calculated by dividing the loss by the weighted average number of ordinary shares on issue during the year adjusted to assume conversion of dilutive potential of ordinary shares as a result of the issue of share options, 169,078,908 shares (2017: 169,078,908 shares). Where the market price is lower than the exercise price of the option, there is no effect on diluted earnings per share. Others LLO of stores 25 Inventory rage Nature of the range Label Age Infants Cuties 0-2 Young children Cool monkeys 2-5 School-aged children Fun kids 5-12 Maternity wear Comfort Adults Total Closing balance of inventory 1 Provision for inventory write-offs Value $000 8,431 18,654 10,765 4,473 42,323 41,230 1,093 Retailing Stores Location New Zealand Australia Ireland Total TO UI UI