You are a newly qualified Chartered Accountant working for Master Partners Chartered Accountants

You are a newly qualified Chartered Accountant working for Master Partners Chartered Accountants (Master). You have been assigned to the audit of Hot Line Limited (Hot Line) for the year ended 30 June 2015 (FY 2015) and are in the planning stage of the final audit. Hot Line is a national surf wear retail chain with stores located throughout Australia. The major shareholders of Hot Line are the Spear siblings, Logan, Lily and Angela. The remaining minority shares are held by independent third parties. Both Angela and Logan Spear are employees of Hot Line. Logan is the chief executive officer (CEO), and is the only Spear sibling on the board. All of the other board members are independent. Hot Line specialises in expensive swimwear and summer resort wear. Hot Line designs its garments in Australia and manufactures them in China from Italian-sourced fabrics. The only exception is the material for Hot Line’s resort wear, which is purchased at commercial rates from George Spear, the fourth Spear sibling, through his company George’s Fabrics Pty Ltd (GF). The details of this arrangement are contained in a note in the financial statements. Hot Line has been struggling to meet its projected profit forecasts in recent years due to an influx of both local competitors and foreign imported products, increased competition from online shopping, the fluctuating dollar against the US dollar, and constant changes in consumer trends. Senior employees are entitled to an annual bonus which can be up to 20% of their base salary upon the achievement of their KPIs. Their bonus entitlement reduces to 5% of their base salary if profit forecasts are not met. During the audit you have identified the following matters: Matter 1 During the interim audit, Hot Line’s chief financial officer (CFO) confided that he suspected Hot Line was in breach of its bank loan covenants during the course of FY 2015. This would put his bonus in jeopardy, as maintaining covenants is one of his KPIs. A refinancing with Big Bank was due to occur on 31 July 2015. No refinancing documents had been provided by Big Bank as at 30 June 2015 and Hot Line had not attempted to secure financing from other financial institutions. 2 Matter 2 Since Master started auditing Hot Line four years ago, Hot Line has been plagued by poor internal controls over accounts payable operations. In past audits, Master has brought this issue to management’s attention. For example, Jamie Potts, one of the accounts payable clerks, is able to approve and pay invoices of up to $50,000 per transaction. You have learned he is currently having trouble paying his mortgage. Despite Master drawing these weaknesses to management’s attention, processes at Hot Line remain unchanged. Matter 3 Hot Line changed a key supplier of material in January 2015. A cheaper overseas supplier was sourced who happened to be an old friend of Lily Spear’s and was used to save costs. However, you notice that the number of product returns has significantly increased since March 2015. Initial discussions with management confirm the reason for the returns has been customer complaints over fabric quality. Cost savings have not been as much as expected. Matter 4 Hot Line owns 80% of its manufacturing operations in China, with the remaining 20% being owned by a Chinese company, Yi. Logan Spear’s wife is a clothing designer and has her fashion line manufactured in Hot Line’s Chinese plant at a reduced rate. To help support his wife’s business, Logan has asked for the manufacturing costs incurred by his wife to be written off as a bad debt. Yi is not aware of this arrangement. Matter 5 Angela Spear is in charge of purchases and in October 2014 she renegotiated Hot Line’s contract with GF. Angela and GF agreed that Hot Line would pay cash on delivery for all GF materials. Hot Line’s normal creditor terms are 45-day settlement. No one outside the purchasing department is aware of the renegotiation. GF advises Hot Line’s purchasing department of its intended deliveries three days in advance of any delivery to allow Hot Line time to withdraw cash to settle the deliveries. The value of the deliveries is material to Hot Line. This assignment has 3 parts 3 Required