Background

Aeroluck Sdn Bhd (Aeroluck) is a semiconductor company located in Kuantan, Pahang.This company is part of the information and communication technology (ICT) industry and employs 150 staff with diverse backgrounds. The company is facing tough times due downturn in the industry and also the fierce competition in the market.

Misha has been a qualified accountant in Aeroluck for quite some time now and she has played a significant role in `healing' and `fixing' the company Aeroluck 's top management had appointed auditors from Excel Public Accounting Firm (Excell).Apparently, Misha had worked for Excell for five years before she joined Aeroluck. The top management of Aeroluck only happened to find out about this after the appointment of Excell as the company's auditor.However, it had been eight years since Misha left Excell and most of the colleagues she had known in Excell had already left Excell too.After much debate with Mr. Imran, Aeroluck 's CEO, the top management concluded that there were no independence issues that arose from the appointment.

Collectability of a major receivable

Both Misha and Mr. Imran are aware of the collectability of a material receivable (amounting to RM 1.2 million) from Syarikat Delima (Delima) which is one of Aeroluck's major customers.The receivable amount was established from a few huge transactions and the amount had been in the books for about three months.Delima has a big factory at Batu Kawan, Penang, and it had been business with Aeroluck for the past three years. During those three years, Delima's business was doing great and the collections of debt had been timely.

Just before the year-end, Misha was driving to work when she heard the terrible news through the radio.She barged into Mr. Imran's office frantically and said, `Big news! Big news! Delima has some real issues as it is having some cash flow problems and it had already announced that it will dismiss 20% of its employees.The word on the street is that it will not be able to last the year and may close the factory at Batu Kawan. We need to make adjustments for the provision of doubtful debt for Delima's receivables without any delay. We need to increase the percentage just in case something big occurs.'

Mr. Imran sighed and replied, `I heard about the news as well and has been giving me a headache.If we adjust the provision, our financial statements are not going to look good, and the auditors may have to mention our shaky financial position.If we don't get an unqualified opinion, the bank loan that we are applying for may not be approved, and we might be out of business too by this time next year.This loan is really important to us and we need it to improve our cash flows.If we can just weather this downturn, I know business will pick up and the economy will slowly improve to where it was. Maybe even better!'

After further discussions, Mr. Imran insisted on not adjusting the provision and he even reminded Misha that her appraisal had yet to be confirmed.It would depend on her performance on the provision that they had just discussed.

Back in her office, Misha pondered what she should do: follow her own instincts or Mr. Imran's opinion? If she followed Mr. Imran's instruction, her appraisal would not be affected, thus she may be promoted next year and working at Excell and was certain the auditors would check thoroughly on the low provision for a risky debt along with Delima's difficulties.She wanted to help Mr. Imran and the company but she was torn between the company's financial position and her career development.Misha's parents were both retired and leaving with her while her twin sons would be starting school next year.The bonus could really help her ease her burden, especially on the expenses for materials to prepare her children for school.

Audit findings

Sufi is a senior auditor at Excell, and he was assigned to lead the audit of Aeroluck together with another four-junior auditor.During the audit, in addition to the collectability of a major receivable issue, Sufi also found a material cut-off error in sales, thus causing Aeroluck's income to be significantly misstated as a greater figure compared to the actual figure.The titles of a great amount of goods were not passed to its customers as of year-end although the dates on the invoices were before year-end.Sufi was aware that Excell's policy clearly stated that the senior auditor must document any potential material adjustment in the working papers.The partner in-charge of the audit would then make the final decision of materiality. Sufi also knew that Aeroluck's did not want to make the year-end adjustments when he had discussed the issue with Misha.Although the materiality had yet to be decided by the partner, Sufi had make sure that the audit manager, Siva, was make aware of the cut-off issue and her suggested to Siva to post the adjustment in the working paper because the amount of misstatement was considered high enough from hisexperience throughout his audit career.

Before wrapping up the field work, Siva told Sufi, 'Let's not mention this adjustment in the working papers.'Since Aeroluck is not public listed company, this material adjustment has no tax implications, and Aeroluck doesn't want to make the adjustment as well.Plus, the partner has decided not to force an adjustment.Aeroluck is one of our largest clients, so we cannot afford to offend them.We need to get Aeroluck's working file up to the partner as soon as possible and set a signing date soon.'

Sufi was concerned and upset after the conversation with Siva because the failure to document such a material amount just did not seem right and he thought that the amount should be adjusted in the financial statement to provide a clear and unbiased view to the stakeholders.

From the above case, answer the following questions:

a.How do you perceive of the appointment of Excell as Aeroluck's auditor? Are they any independence issues involved?

(10 Marks)

b.Explain the meaning of 'cut-off issue' and what will be the implication arising from the cut-off issue on sales on the financial statement.

(10 Marks)

c.Explain the relationship between materiality and audit adjustments? Why is Siva so concerned about Aeroluck's response to the acceptance of the proposed audit adjustment?

(5 Marks)