Background

AeroluckSdnBhd(Aeroluck) is a semiconductor company located inKuantan, 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.

Mishahas been a qualified accountant inAeroluckforquitesome time now andshe has played a significant role in `healing' and `fixing' the company .Aeroluck's top management hadappointed auditors from ExcelPublic Accounting Firm (Excell).Apparently,Mishahad worked forExcellfor five years before she joinedAeroluck.The top management ofAeroluckonly happened to find out about this after the appointment ofExcellas the company's auditor.However, it had been eight years sinceMishaleftExcelland most of the colleagues she had known inExcellhad already leftExcelltoo.After much debate withMrImran,Aeroluck'sCEO, the top management concluded that there were no independence issues that arose from the appointment.

Collectability of a major receivable

BothMishaandMrImranare aware of the collectability of a material receivable (amounting to RM 1.2 million) from SyarikatDelima(Delima) which is one ofAeroluck'smajor customers.The receivable amount was established from a few huge transactions and the amount had been in the books for about three months.Delimahas abig factory atBatuKawan, Penang, and it had been business withAeroluckfor the past three years.Duringthose three years,Delima'sbusiness was doing great and the collections of debt had been timely.

Just before the year-end,Mishawas driving to work when she heard the terrible news through the radio.She barged intoMrImran's office frantically and said, `Big news! Big news!Delimahas 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 atBatuKawan. We need to make adjustments for the provision of doubtful debt forDelima'sreceivables without any delay .We need to increase the percentage just in case something big occurs.'

MrImransighed 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,MrImraninsisted on not adjusting the provision and he even remindedMishathat 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,Mishapondered what she should do: follow her own instincts orMrImran's opinion? If she followedMrImran's instruction, her appraisal would not be affected, thus she may be promoted next year and working atExcelland was certain the auditors would check thoroughly on the low provision for a risky debt along withDelima'sdifficulties.She wanted to helpMrImranand 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 atExcell, and he was assigned to lead the audit ofAerolucktogether 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 causingAeroluck'sincome 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 thatExcell'spolicy 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 thatAeroluck'sdid not want to make the year-end adjustments when he had discussed the issue withMisha.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.'SinceAeroluckis not public listed company, this material adjustment has no tax implications, andAeroluckdoesn't want to make the adjustment as well.Plus, the partner has decided not to force an adjustment.Aeroluckis one of our largest clients, so we cannot afford to offend them.We need to getAeroluck'sworking 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:

1. How do you perceive of the appointment ofExcellasAeroluck'sauditor? Are they any independence issues involved?

(10 Marks)

1. 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)

1. Explain the relationship between materiality and audit adjustments? Why is Siva so concerned aboutAeroluck'sresponse to the acceptance of the proposed audit adjustment?

(5 Marks)