Question 2: (15 marks) Pellegrino Pty Ltd is a company involved in the manufacture and retail distribution of farm machinery, and is a wholly owned subsidiary of Potter House Ltd. Pellegrino has two subsidiaries of its own, Pippin Pty Ltd, which is wholly owned, and Merryn Pty Ltd, which is 67 per cent owned by Pellegrino and 33 per cent owned by well-known entrepreneur, Kevin Wingnut.

Pellegrino has been suffering liquidity problems for the past two years due to losses incurred by its two subsidiaries. However, this has been countered by the non-repayment of the intercompany debt owed to the parent company. The parent company is expected to convert Pellegrino's debt to equity by 31 December 2021. It has also given verbal assurances to Pellegrino's management that no payments to Potter House will be required within the next 12 months, and that Potter House will continue to support the operations of Pellegrino.

There has been a great deal of pressure on Pellegrino's staff and computer systems. As the turnover of staff has been very high, temporary staff are often used in the accounting department to ensure that regular processing continues. New inventory, accounts receivable and accounts payable software was installed during the year but is yet to be integrated with the general ledger system. Reconciliations between the subsidiary ledgers and the general ledger control accounts are being performed monthly. Last month's unreconciled difference for accounts receivable was $134,200.

Pellegrino invested considerable funds in the research and development of a new high-precision computer-controlled harvester. They believe they have designed a machine that is more accurate and much cheaper than others already available on the market. All development costs associated with this work have been capitalised. In March 2021, the new harvester was completed and released to the market. Initial sales have been disappointing, with the market preferring to continue with the established products already available, but management have revised their market strategy and believe that this initial market reluctance will be reversed during the next 12 months.

The following extracts are from financial information in respect of the Pellegrino group for the year ended 30 June 2021: 2021 2020 2019 $'000 $'000 $'000 Accounts Receivable 129,480 108,000 103,700 Less Provision for Doubtful Debts (9,200) (9,700) (9,700) 120,280 98,300 94,000 Inventory 126,700 115,700 97,200 Sales July-September 80,111 97,998 105,222 October-December 75,890 100,920 111,580 January-March 74,580 112,640 105,720 April-June 220,990 157,430 138,060 Total sales 451,571 468,988 460,582 Cost of sales 312,500 295,848 290,177 Gross profit 139,001 173,140 170,405