The following background relates to Southern Lights Holdings Pty Limited (SLH), who have engaged you as an independent consultant ahead of what they anticipate will be the successful raising of capital, the completion of two major projects, and ultimately, the listing of the company on the Australian Stock Exchange. 

 

BACKGROUND

1. A BRIEF HISTORY

During the 1960s, Harbhajan Ashwin, an accomplished engineer, commenced business in partnership with Rory McGuiness, a master builder, and Nazar Al Sharaf, a prominent architect. Initially trading as Lakeside Residential and Commercial (LRC), the business achieved considerable success in designing and building several apartment blocks and suburban shopping precincts throughout the southern suburbs of Melbourne, Victoria. Following continued growth, the partners employed and eventually passed the ownership and management of LRC to their family members. Subsequently, the proprietary company Southern Lights Holdings Pty Limited (SLH) was incorporated in 1995 and has continued to complete construction contracts of increasing size and scope. Shares have remained equally held by members of the Ashwin, McGuiness and Al Sharaf families and related entities.

 

1. CURRENT OWNERSHIP AND CONTROL

Shares in SLH are currently held as follows: 

Shelton Ashwin (grandson of Harbhajan) 100,000 ordinary shares of $10 each 

Melissa Parker is Chief Financial Officer (daughter of Shelton Ashwin) 100,000 ordinary shares of $10 each, 500,000 B class shares of $1 each

Daisy O'Toole is Chief Operating Officer (granddaughter of Rory McGuiness) no shares

McGuiness Family Trust 200,000 ordinary shares of $10, 500,000 B class shares of $1 each

Yasin Chau is Chief Executive Officer (grandson of Nazar Al Sharaf) 50,000 ordinary shares of $10 each, 500,000 B class shares of $1 each

Anat Chau (wife of Yasin Chau) 50,000 ordinary shares of $10 each 

Al Sharaf Holdings Pty Limited 100,000 ordinary shares of $10 each

Note - All B Class shares have been issued as bonus shares from reserves to the currently serving executive of SLH.

 

1. MANAGEMENT AND EXECUTIVE REMUNERATION

SLH has reported the following remuneration of its executives: 

Melissa Parker - Chief Financial Officer $250,000 (Salary) $27,500 (Superannuation)

Daisy O'Toole - Chief Operating Officer $50,000 (Salary) $6,000 (Superannuation)

Yasin Chau - Chief Executive Officer $250,000 (Salary) $27,500 (Superannuation) 

Sarah Di Marchi - Chief People Officer $140,000 (Salary) $15,000 (Superannuation)

 

Your initial discussions and investigations have determined that the following arrangements are also in place: a. Al Sharaf Holdings (ASH) are the exclusive supplier of air-conditioning, kitchen and bathroom fittings for all SLH projects. This has resulted in a profit of $200,000 per year for ASH in each of the past 3 years as a result of markups. 

b. Daisy O'Toole's 3 adult children have each been granted parcels of land worth $400,000 each from projects undertaken by SLH. 

c. 5 separate apartments built by SLH have been retained by the company and have been provided to Melissa Parker's parents and each of her 4 adult children. The apartments have been provided rent free where the market rate would otherwise have totalled $200,000 per year. 

d. In 2022, Melissa, Daisy and Yasin were each issued $500,000 of bonus shares from reserves. Daisy's shares were issued directly to the McGuiness Family Trust (of which she is Trustee). 

e. The above arrangements have been agreed to ensure parity between the total benefits flowing to each family.

 

1. FINANCIAL PERFORMANCE AND POSITION

The following is a summary drawn from SLH financial reports from each of the past 3 years: 

2020

Current assets 1,890,000 

Property held as an investment 12,560,000

Property held for resale 8,260,000

Current liabilities 2,350,000 

Net profit 73,000 

Other comprehensive income 650,000

 

2021

Current assets 2,155,000

Property held as an investment 14,010,000

Property held for resale 4,230,000

Current liabilities 1,764,000 

Net profit 487,000 

Other comprehensive income 318,000

 

2022

Current assets 1,694,000

Property held as an investment 14,436,000

Property held for resale 3,995,000

Current liabilities 2,077,000 

Net profit 289,000 

Other comprehensive income 426,000

 

1. ACCOUNTING ESTIMATES AND PRACTICES

Discussions with Melissa (the CFO) have determined that SLH have exercised the following accounting practices: 

• SLH sells many of its developments 'off the plan' requiring a 15% deposit from investors. While this does not currently apply as SLH is yet to commence either of its upcoming projects, SLH has previously recognized these deposits as revenue as it has always carefully vetted its buyers. 

• SLH has typically not recognised leave entitlements (including executives) as the company has rarely had employees eligible for long service leave and cease operations for 4 weeks each summer. Where executives have become due for leave, they have generally accepted company assets in settlement. 

• SLH has retained units from several of its developments (some held for resale, some leased to tenants). As these are typically in high value areas of Melbourne, SLH annually revalues units held. All revaluations are performed by directors as they have the clearest understand of the value of each development. 

• SLH recognises work in progress (WIP) from the commencement of each development. Although there is not any current WIP, SLH generally includes the capitalisation of a portion of executive salaries and head office overheads in determining these amounts.

 

1. OTHER ISSUES

Daisy is currently separated from her husband Keith. Current divorce proceedings have not been amicable and Daisy has intentionally structured her remuneration and bonus shares in a manner that makes it difficult for Keith to successfully seek a divorce settlement against her interest in SLH. SLH has a debt covenant with their principal finance provider Bendigo Bank. The covenant specifies that the current ratio must not fall below 0.7:1 and the debt to equity ratio must not exceed 2:1. Although the company is not in danger of breaching these requirements, the SLH executive is aware that meeting the future financial needs under the same covenant terms will be difficult. This has influenced some of the accounting practices noted above.

 

QUESTION

SLH executive had requested that you summarize and address the following concerns: 

1. Are there any issues with their current accounting practices and earning management? Outline changes that may need to be made in the event of accepting capital from the general public. 

2. How does SLH's reporting of executive remuneration compare with ASX listed companies? Select an ASX listed company and briefly compare and contrast the reporting of key management personnel with that of SLH. 3. Briefly summaries any other ethical issues and concerns that should be brought to the attention of SLH owners

 

Create a slide deck that supports a brief in-class presentation addressing the needs of your client

A suggested format is outlined below: 

Slide 1: Cover slide 

Slide 2: Issues to be addressed (3 brief points) 

Slide 3: Current accounting practices of SLH - overview 

Slide 4: Issues arising from current accounting practices 

Slide 5: Suggested changes to future accounting practice 

Slide 6: Current remuneration reporting of SLH 

Slide 7: Remuneration reporting of selected listed company 

Slide 8: Suggested changes to future remuneration reporting 

Slide 9: Ethical issues and concerns facing SLH 

Slide 10: Summary (points only)