Soft Touch Limited (STL) is an Australian public company. The company is not listed. It manufactures high-quality toilet paper and tissues in two states, Victoria and Western Australia using Australian wood chips. STL commenced operations in 1992 and maintained slow but steady growth over the years. Its major customers are the large supermarkets: Coles, Woolworths, IGA and Aldi. It also sells to smaller outlets, such as pharmacy stores.

STL has had a tumultuous 2020. The bushfires throughout Australia in January and February led to a shortage of woodchips from its usual suppliers, reducing STL's ability to maintain its manufacturing processes. Fortunately, by the end of February, STL was able to source additional supplies of woodchips, albeit at a significantly higher cost. In March toilet paper and tissue sales increased exponentially due to toilet paper and tissue stockpiling associated with COVID-19. This made access to sufficient woodchips even more difficult.

The company initially responded to its increased orders by extending its manufacturing hours by 2 hours a day and offering overtime to its fulltime staff and additional hours to its casual staff. However, this was not sufficient to meet demand, and the company doubled its normal employee numbers by hiring more casual staff and operating its manufacturing processes 24 hours, 7 days a week for 6 weeks from the middle of March to the end of April. Manufacturing was then decreased to 24 hours for 5 days a week. Unlike the normal 2 week induction period for new staff that the company had previously offered, the new workers hired at this time were provided with a one-day induction and then went straight on to the production line.

The company has two delivery drivers who normally deliver to the supermarkets' large central warehouses and pharmacies. The drivers worked extensive overtime during this period. However, due to the inability to meet demand, STL ceased deliveries to small pharmacies, forcing them to find other suppliers.

As a result of the huge surge in demand for toilet paper and tissues, other companies have entered this market. To establish themselves these companies have offered their products at a discounted rate. They have become the preferred suppliers to the pharmacies where STL ceased deliveries.

By the end of June, demand for toilet paper had fallen to pre-COVID-19 levels and the company held a large inventory of both toilet paper and tissues in its warehouses.

The company is audited by Contessotto, Perera and Chandra (CPC), a mid-tier audit firm located in Melbourne. CPC has audited STL since its incorporation.

The Audit Team

The audit team consists of 4 people. The partner is Kellie. She has been involved in the STL audit for over 20 years and partner on the engagement for the last 15 years. The audit manager is Tim. This is Tim's first time on the STL audit. Nisa is the audit senior and is responsible for the initial audit planning. Nisa has recently completed the Graduate Diploma of Chartered Accounting. The graduate on the audit is MingYan. While a student, MingYan worked part-time in the accounting department at STL undertaking basic processing tasks. MingYan's friend is the receptionist at STL. The receptionist has no accounting knowledge and has no involvement with the recording or processing of accounting transactions

The audit team commenced planning the audit on STL in the middle of March 2020. The auditors were delighted to be able to buy toilet paper and tissues from the STL warehouse under the same pricing arrangement available to STL's staff. The interim work on STL was undertaken at the end of March and early April and the final work in early September 2020.

Corporate Governance and the accounting department

The company's Board of Directors consists of 5 directors. Due to the small size of the board, there is no separate audit committee. STL also does not have an internal audit division. The Board of Directors consists of an independent and non-executive Chairman, the CEO who has been with the company for 2 years, a CFO who has been with the company for 3 years, and an independent lawyer and another independent non-executive director. Up until December 2019, the CFO previously worked as an auditor with CPC and was involved on the audit of STL. The CFO is great mates with Tim (the audit manager) and prior to the current season often went to the AFL games each Saturday to support Essendon.

Shareholders are expecting to see a large increase in profit this year as they are aware of the significant increase in toilet paper and tissue sales.

The accounting department is of a reasonable size and has the ability to segregate duties, although this is not something the company focuses on. The increased manufacturing has placed the current accounting staff under extreme stress as the number of staff on the payroll has increased significantly and there has been a large increase in the numbers of suppliers' invoices received and associated goods received notes. In addition, the number of sales orders have doubled. The company chose not to increase the number of accounting staff despite the large increase in manufacturing.

Subsequent events:

In early July 2020, the Australian Taxation Office (ATO) commenced a tax audit of STL's income tax returns for the three income tax years 2017 to 2019. After the conclusion of the tax audit, the ATO sent written advice on the 15 August that, in their view, STL had incorrectly calculated the effective life of its depreciable fixed assets and, therefore, had claimed excessive depreciation allowances as deductions. The ATO issued amended assessments for the relevant tax years which were due for payment on 31 August 2020.The amounts were material. STL sought advice from an independent tax expert and has been advised to appeal the revised tax assessments, despite there being significant doubt regarding the likely success of an appeal.

In late July the sales agreement with Coles expired. Coles chose not to renew the agreement.

Extracts of CPC Working Papers for the year ended 30 June 2020.

Planning Materiality was set at $115,000

Payroll Accounting and Internal Control System

There have been no significant changes in the payroll processing cycle since the previous audit. The company usually employs approximately 50 employees but from March to the end of June, this number increased to 80. The additional staff were casual workers. There are two staff members in the payroll department who add new employees to the payroll with no further authorisation required.and who process the payroll.

Staff recruitment

When staff are hired, all their details are entered on the computerised payroll system by the staff in the payroll department. All staff are paid award wages as per the relevant award. All award rates are in the payroll master file and do not need to be entered for each employee. The entering of staff details is not checked or authorised by a supervisor.

Processing of pays

Employees are paid fortnightly. Hourly employees earn pay at the ordinary time for the first 37.5 hours each week, time and a half for the next 10 hours in a pay period, and double time for any hours exceeding 50 hours in a pay period. The split between ordinary, time and a half and double time calculation is performed by the payroll system. The payroll system interfaces with the general ledger system.

All staff working in the production and warehouse areas are required to clock-on using time-cards. They are forbidden to clock-on for their colleagues. All timecards are authorised by the production manager who signs the cards as evidence. The time-cards are then sent to the payroll office. Payroll staff enter the hours from the timesheets into the payroll system. While there is no double-checking of data entry, the system has data entry checks to ensure that hours over 60 hours cannot be entered and that only numeric data has been entered.

Whilst performing the payroll walk-through and in particular observing the clock-on procedures of factory staff on four mornings, the audit team noted that two workers were clocking on more than one time-card at a time. The foreman was queried about this and he told MingYan that the workers do sometimes clock-on for their friends if they know they are going to be late for work. The foreman thanked us for bringing the matter to his attention and said that he will remind workers of the rules about not clocking-on for others.

Accounts Payable Accounting and Internal Control System

At the end of each month, the production manager determines the amount of woodchips required to meet production requirements for the following month. He determines the amount of woodchips on hand and then prepares four part purchase orders for woodchips to meet production demands and a minimum inventory level for the end of the following month. Copy 1 of each purchase order is sent to the supplier, copies 2 and 3 are forwarded to the receiving department, and copy 4 is filed in the purchasing department.

The woodchips are delivered progressively over the month. When goods are received, the receiving department prepares a goods received note and documents each delivery on the relevant purchase order. When each order is complete, the purchase order, which includes the delivery details, is forwarded to the accounts department. The other copy is filed in the receiving department. When the supplier's invoice is received, the accounts payable clerk matches it with the purchase order and good received notes and then approves it for payment. The accounts payable clerk checks the calculations on the invoice and then writes "checked" on the invoice. The accounts payable clerk prepares a payment voucher, attaches the invoice, purchase order and good received notes and gives it to the accountant for approval. The accountant signs the payment voucher but does not check any of the supporting documentation. The accountant then makes the payment by bank transfer to the supplier and returns the supporting documents to the accounts payable department for filing in numeric order.

The walk-through of the accounts payable cycle confirmed that the accounting and internal control system was working as documented above.

Test of control:

As part of the audit, Nisa tested the controls over the accounts payable system. She selected a sample of twenty payments and tested the control that all invoice calculations had been checked. All invoices in the samples had "checked" written on the invoice, indicating that the accounts payable clerk had carried out the control. Nisa also checked the calculations herself to verify the effectiveness of the control. While three invoices had calculation errors, they were less than $10 in total and not considered to be material. Nisa has therefore determined that the internal control operated effectively and consistently throughout the year.

a) MingYan believes an adverse opinion is appropriate based on the audit findings. Explain whether this is the appropriate opinion.

b) Identify four (4) factors which indicate that STL meets the going concern assumption.