This question ties together several topics covered so far in this course.Read the following article and answer the questions below.

Lessons from the Freedom Foods fess-up

https://www.bankingday.com/lessons-from-freedom-foods-fess-up

Banking Day, 8 December 2020

There is nothing like a major accounting whodunnit to get people's imaginations whirring and so it was last week with the Freedom Foods Group Limited annual report and associated company announcement.

News broke on November 30 via the Australian Securities Exchange that the company had fessed up to a series of accounting hiccups resulting in approximately $590 million in adjustments over several reporting periods.

The net loss after tax is A$174.5 million for the 2019-20 financial year. That loss is greater than the preceding financial year, which was adjusted to $145.8 million.

These write-downs - or 'losses' as some media folks described them - occurred across a range of areas. It is clear from reading the financial statements and the report from the audit firm, Deloitte, that the company had been optimistic in keeping certain carrying amounts on balance sheet.

A key to understanding what went on with Freedom Foods Group Limited lies in part in the company's market release on its 2019-20 financial statements.

It also discloses that the regulator is looking carefully at the circumstances and that the company is cooperating with ASIC's investigation on the issues given the regulator has made a request under Section 30.

Section 30 of the ASIC Act 2001 gives ASIC power to request an entity or an individual from an entity to produce documents related to a business.

This will be material that goes beyond the usual public disclosures and involves internal accounting information and other documents that may explain the circumstances. It also means that there will be things parties outside of the company and the regulator will not be able to know given the usual investigation protocols.

The company had its auditors look at a series of issues and commissioned a forensic investigation from PricewaterhouseCoopers. The work done by both these accounting firms raised accounting issues needing the company's consideration.

Capitalising expenses as assets was one of the issues pointed to by the accounting firms. The company used the figures as previously calculated to make business decisions. The company's disclosures underscore the need to get the right numbers the first time around.

Capitalising certain expenses will have made certain ratios look more attractive because stuff that needed to be off a balance sheet in in the income statement as an expense was still hanging about recognised as an asset.

"The reviews determined that most of the costs capitalised during the commission phase of the Group's capital investment program should be more appropriately treated as expenses," the company told the market in its results release.

"These accounting treatments contributed to decisions on new products and expansions that were based on unrealistic assessments of market opportunities and margin assumption that were not realised."

Adjustments over multiple years impacting the company's results include: $372.8 million written off asset values related to capitalisation of capital works; $75.9 million in write-downs of goodwill and grants; $60.1 million in write-downs of out of date, unsaleable and obsolete inventory; and $38.9 million as a result of a change in accounting practices related to capitalised new product costs.

These are not small numbers. ASIC issues media releases detailed company changes to financial statements as a result of financial reporting surveillance. None of the recent changes in accounting policy, practices or write-downs in relation to carry amounts on balance sheet match the issues that Freedom Foods has confronted.

The company also bit its bottom lip in March of this year and kicked off an investigation looking into the equity incentive plan.

Deloitte's audit report also points to litany of key audit matters that required consideration during the most recent financial year. That report is also a qualified opinion given the firm has said that it could not get sufficient appropriate audit evidence related to the changes in comparatives across several years. In other words, the firm tells users of the accounts not to place reliance on the restated comparative figures.

There is also a section on going concern, and a whole slew of key audit matters that have caused auditors a headache. A close reading of the key audit matter related to possible management overriding of internal controls is encouraged if you want to better understand what the audit firm was dealing with during its audit of Freedom's financials for the year just gone. The audit firm tells a conscientious reader of this part of the audit report that it needed to undertake a deeper dive to work through some issues related to internal control.

For those who view the disclosure with cynicism, this is not the audit firm saying it just wants to do more work to increase hours and fees. Auditors are obliged to assess internal controls and if they have any concerns then they are obliged to determine whether more detailed work is required. Deloitte said that it means that the firm had determined that the internal controls cannot be sufficiently relied upon so more work must be done to kick the tyres.

There are red flags auditors give active readers of accounts in key audit matters and these must be read very carefully so that shareholders, other stakeholders and, yes, even journalists who think it is ripe for some satire get more threads for inquiry from these parts of annual reports.

It is important that people look closely at the detail in the financial statements and related audit report to better understand some of the issues involved in Freedom's operations in recent years.

This does not mean we will understand everything. ASIC is taking a deep dive into the company's documents. It will be interesting to see what transpires once the ASIC investigations and other matters have concluded.

Required:

Answer the following questions:

1)Do you think that management's behaviour at Freedom foods is more consistent with the efficiency perspective or the opportunistic perspective of Positive Accounting Theory? Explain your answer, citing evidence from the article to support your argument.

2)Drawing on the semi-strong form of the efficient market hypothesis and capital markets research, how would you expect the capital markets to respond to this article? Are there any factors indicated in the article that would likely result in a stronger (compounding) or weaker (mitigating) market reaction?