VOLUME EIGHTEEN THE EXTERNAL AUDITS OF BENEFICIAL FINANCE CORPORATION LIMITED

CHAPTER 57
REVIEW OF THE 1988 EXTERNAL AUDIT OF BENEFICIAL FINANCE

CHAPTER 57 REVIEW OF THE 1988 EXTERNAL AUDIT OF BENEFICIAL FINANCE

CHAPTER 57
REVIEW OF THE 1988 EXTERNAL AUDIT OF BENEFICIAL FINANCE

57.1 PURPOSE OF CHAPTER

57.2 PLAN OF CHAPTER

57.3 BUSINESS OF BENEFICIAL FINANCE CORPORATION LIMITED

57.4 ACCOUNTS OF BENEFICIAL FINANCE CORPORATION LIMITED

57.5 INVESTIGATION OF THE AUDIT PROCESS

57.6 CONCLUSION

57.1 PURPOSE OF CHAPTER

57.2 PLAN OF CHAPTER

57.3 BUSINESS OF BENEFICIAL FINANCE CORPORATION LIMITED

57.4 ACCOUNTS OF BENEFICIAL FINANCE CORPORATION LIMITED

57.5 INVESTIGATION OF THE AUDIT PROCESS

57.6 CONCLUSION

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TABLE OF CONTENTS

57.1 PURPOSE OF CHAPTER

57.2 PLAN OF CHAPTER

57.3 BUSINESS OF BENEFICIAL FINANCE CORPORATION LIMITED
57.3.1 BENEFICIAL FINANCE CORPORATION LIMITED AND SUBSIDIARIES
57.3.2 OFF-BALANCE SHEET ENTITIES

57.4 ACCOUNTS OF BENEFICIAL FINANCE CORPORATION LIMITED

57.5 INVESTIGATION OF THE AUDIT PROCESS
57.5.1 PLANNING OF THE AUDIT PROCESS
57.5.1.1 Preamble
57.5.1.2 Matters Noted
57.5.1.3 Professional Standards and Practices
57.5.1.4 Opinion - Planning of the Audit
57.5.2 EXECUTION OF THE AUDIT PROCESS
57.5.2.1 Preamble
57.5.2.2 Matters Noted - Shockproofing
57.5.2.3 Matters Noted - Provision for Doubtful Debts
57.5.2.4 Opinion - Execution of the Audit
57.5.3 CONCLUDING PROCEDURES
57.5.3.1 Preamble
57.5.3.2 Matters Noted - Abnormal Items
57.5.3.3 Matters Noted - Shockproofing
57.5.3.4 Matters Noted - Disclosure of information pertaining to Off-balance sheet Entities
57.5.3.5 Matters Noted - Equity Accounting of Off-balance sheet Entities
57.5.3.6 Opinion - Concluding Procedures

57.6 CONCLUSION

Chapter 55 - "The External Audits of Beneficial Finance: Background Information" presented background information regarding the statutory obligations of Beneficial Finance and the auditors of Beneficial Finance in relation to the preparation and audit of the accounting records and annual accounts of Beneficial Finance. That Chapter also outlined, in general terms, the elements of an audit process that would characterise an appropriate and adequate audit, governed principally by standards and requirements of the Professional Accounting Bodies.

This Chapter provides some introductory comments concerning important events in the business operations of Beneficial Finance during 1987-1988, and significant features of the statutory accounts in respect of the 1987-1988 financial year. The Chapter then reports on matters arising from the assessment of the audit process applied by the External Auditor in the audit of the accounting records and accounts of Beneficial Finance for the year ended 30 June 1988. The Chapter also concludes as to the appropriateness and adequacy or otherwise of the audit process undertaken.

The Chapter comprises the following principal segments:

(a) Business of Beneficial Finance Corporation Limited;

(b) Accounts of Beneficial Finance and Beneficial Finance Group;

(i) Profit and Loss; and

(ii) Balance Sheet;

(i) Planning of the Audit Process;

(ii) Execution of the Audit Process; and

(iii) Concluding Procedures.

(d) Conclusion.

57.3.1 BENEFICIAL FINANCE CORPORATION LIMITED AND SUBSIDIARIES

The Beneficial Finance Group recorded for the 1987-88 financial year a significant growth in earnings and in the level of assets employed. The predominant growth areas of business conducted by Beneficial Finance were associated with the corporate and commercial sectors throughout Australia.

Consistent with the previous three financial years, the Beneficial Finance Group continued to operate under the requirements of the following Trust Deeds:

(a) the First Charge Debenture Stock Trust Deed (of 10 June 1960 and 1 June 1968);

(b) the Unsecured Deposit Note Trust Deed of 19 July 1974; and

Furthermore, the External Auditor, under the Trust Deeds, continued to provide to the Trustee certain certificates stating that various specific requirements of the Trust Deeds had been met. On a six monthly basis, the External Auditor was required, under the 1985 Trust Deed for Debenture Stock and Unsecured Notes, to report whether the company and its guarantors had observed, and complied in all respects with, the company's obligations under the Deed. Price Waterhouse signed unqualified six monthly reports in respect of the financial year ended 30 June 1988.

57.3.2 OFF-BALANCE SHEET ENTITIES

During the year the number of off-balance sheet entities and associated financing activity increased markedly. The activity was principally associated with the four off-balance sheet holding companies acquired in previous years (Kabani Pty Limited, Malary Pty Limited, Fortina Pty Limited, Lagan Pty Limited) and associated off-balance sheet entities.

In October 1987, the `Mindarie Keys' joint venture was established. A wholly-owned subsidiary of Kabani held a 50 per cent interest in the venture, which was to develop tourist resort and residential facilities north of Perth, Western Australia.

In the early part of 1988, subsidiary and associated entities of Kabani were utilised to purchase portfolios of receivables from Equiticorp companies located in Australia and New Zealand.

In May 1988 Beneficial Finance, with external participants, established a joint venture company to acquire 100 per cent ownership of the East End Market Company Limited, and to subsequently redevelop the East End Market site in Adelaide.

In June 1988, an off-balance sheet company, `Southstate Corporate Finance Limited', was incorporated in New Zealand to operate as the Beneficial Finance arm in that country. The shareholders were Beneficial Finance 49 per cent, Kabani 49 per cent, and Thomson Simmons Nominees Pty Ltd 2 per cent.

The `Mindarie Keys' joint venture property development, `Equiticorp Receivables' acquisitions and the `East End Market' joint venture redevelopment are examined in detail in Chapter 32 - "Case Study in Credit Management: Mindarie Keys", Chapter 38 - "Equiticorp Receivables" and Chapter 31 - "Case Study in Credit Management: East-End Market" respectively of this Report.

On 15 August 1988, an unqualified Audit Report was signed by Price Waterhouse in respect of the accounts of Beneficial Finance for the year ended 30 June 1988. The accounts presented comprised a Profit and Loss Statement, Balance Sheet, Source and Application of Funds Statement, and Notes to the Accounts, for both Beneficial Finance and the consolidated Beneficial Finance Group.

The following Table extracted from the audited accounts provides key information relative to the financial results of operations for the year to 30 June 1988 and the financial position of the Beneficial Finance Group at that date.

	Beneficial Finance Group
Profit and Loss Statement	1987 $M		1988 $M		Per Cent Increase

Revenue		185.6		235.8		27
Operating Profit

Pre Tax		16.3		21.4		31
After Extraordinary Item
and Tax		9.8		19.0		94

Balance Sheet
Assets
Receivables		1033.1		1476.8		43
Other		95.9		178.4		47
		1129.0		1655.2
Liabilities
Borrowings		980.6		1459.6		49
Other		64.4		68.6
		1045.0		1528.2		46
Net Assets		84.0		127.0		51
Shareholders Equity
Share Capital		50.0		85.0
Reserves		34.0		42.0
		84.0		127.0		51
Doubtful Debts
Expense for the Year		12.4		20.4		65
Provision at Balance Date		13.1		23.4		79

The 1987 comparative balances included in the 1988 audited accounts, include some re-classifications of figures appearing in the 1987 audited accounts.

New lending and portfolio acquisitions totalled $1.27B comprising $454.0M (mortgage lending), $318.0M (vehicle and equipment finance) and $495.0M (corporate/commercial).

57.5.1 PLANNING OF THE AUDIT PROCESS

57.5.1.1 Preamble

Adequate audit planning helps to ensure that appropriate attention is devoted to important areas of audit and that potential risk areas and problems are identified and adequately addressed. An integral part of the audit planning process, therefore, includes gaining an understanding of a company's business, its accounting systems, and its internal control environment, and an assessment of identified risks.

57.5.1.2 Matters Noted

(a) Risk Assessment

Consistent with previous audits, two planning documents were prepared by Price Waterhouse for the December 1987 and June 1988 audits:

(i) An audit planning memorandum was approved in January 1988 by Mr A H Giles (engagement partner), Mr A H Herald (second partner), Mr A W Hirst (tax partner), Mr D R Clark (manager), and Mrs T Anthon (senior). This is the planning document for the December 1987 audit.

(ii) A strategic plan was prepared for the June 1988 audit to reflect conditions then relevant. This document was signed by Mr Giles, Mr Clark, Mrs Anthon, Mr Hirst and Mr G Acutt (EDP manager). The document is undated.

The planning documentation contains a discussion of relevant planning issues including risk assessment, changes in Beneficial Finance's business activities, the business environment in which it operated, and the EDP control environment. It is evident from the planning documentation that Price Waterhouse viewed the audit as one of increasing risk.

Overall audit risk was increased from "intermediate" at December 1987 to "high" at June 1988. The factors identified by Price Waterhouse to support this reassessment were set out in the strategic plan and included:

(i) rapid growth in the receivables portfolio;

(ii) a continuation of the aggressive growth oriented approach to business in the finance industry with diversification into new products; and

(iii) general economic difficulties and adverse share market conditions.

It is further evident that Price Waterhouse considered key aspects of the audit to include:

(i) receivables and the recoverability of advances; and

(ii) accruals and the recognition of fee income - these being two specific areas which Price Waterhouse planned to review for evidence of "profit smoothing".

In this context, profit smoothing means deliberate actions taken by management to manipulate the reported results of an entity. For example, income earned in a particular accounting period may be deferred and spread over a number of accounting periods to even out an improving profit trend. This matter is considered further in the sections of this Chapter concerning execution and concluding procedures of the external audit, under the heading "shockproofing".

(b) Internal Audit

The planning documentation states that extensive reliance was to be placed on the work performed by the Internal Audit department of Beneficial Finance, particularly in relation to systems documentation, compliance testing, and loan initiation procedures. The strategic plan notes that:

"Our experience shows that the department is adequately staffed, internal auditors are competent and staff members well supervised. However, as mentioned earlier, the company is undergoing a period of rapid growth in the number and value of transactions, the number of staff employed and the types of products sold. In these circumstances, our assessment will be updated prior to placing reliance on the internal auditors' work."

It is evident from the audit working papers that this reassessment was carried out to the satisfaction of Price Waterhouse prior to finalising the June 1988 audit.

(c) Disclosure of information pertaining to Off-balance sheet Entities

The audit planning memorandum identifies a number of off-balance sheet entities which required consideration from an audit viewpoint. This memorandum states:

"... These were established during 1986 and serve two purposes. Firstly they `tie in' with Beneficial significant suppliers of business to the group thereby reducing the suppliers' ability to take business to other finance companies. Secondly by creating such business `off-balance sheet' the restrictive borrowing limits of the Trust Deed are circumvented.

We must continue to monitor the operations to ensure the accounting treatment continues to be appropriate. It is considered that if profits ever become material it would be necessary for them to be disclosed under the Equity Accounting Standard.

The company has assured us that the Trustees have been informed of the situation."

The strategic plan further states that:

"the joint ventures are used as vehicles for a variety of finance activities to allow Beneficial to grow quickly whilst still complying with the restrictions of the Trust Deeds ... The Trustees are however aware of all Beneficial's activities".

The planning documentation noted that these off-balance sheet entities would have to be equity accounted if profits ever became material.

57.5.1.3 Professional Standards and Practices

The statements of the Professional Accounting Bodies require auditors to identify risks, including the adequacy of internal control and the reliability of internal audit work, to assess their impact on the audit of the accounts, and to take them into account in developing the audit programmes.⁽⁾

57.5.1.4 Opinion - Planning of the Audit

Based on the evidence examined by this Investigation I have formed the opinion that the planning phase of the 1988 external audit of Beneficial Finance was appropriate and adequate.

57.5.2 EXECUTION OF THE AUDIT PROCESS

57.5.2.1 Preamble

During the execution phase of the audit, the auditor should obtain sufficient appropriate audit evidence through the performance of compliance and substantive procedures to enable him to draw reasonable conclusions therefrom on which to base his opinion on the financial statements.

57.5.2.2 Matters Noted - Shockproofing

(a) Introduction

"Shockproofing" was a term used by Beneficial Finance to describe a number of techniques employed by management which were, in substance, profit manipulation techniques. These include, but are not limited to:

(i) creating provisions for future expenses for which no liability existed at balance date (referred to as prudent accruals by Price Waterhouse); and

(ii) accelerating the amortisation of costs, which should otherwise have been spread over a number of accounting periods.

Shockproofing actions can have the effect of depressing reported profits in years when underlying profits are good and inflating reported profits in years when underlying profits are poor.

The audit working papers⁽⁾ provide evidence that Price Waterhouse:

(i) were aware of the intentions of Beneficial Finance to adopt shockproofing measures;

(ii) identified individual shockproofing measures adopted by Beneficial Finance, and had categorised them as shockproofing actions; and

(iii) considered the aggregate impact of shockproofing on the reported profits of Beneficial Finance.

The reported consolidated pre-tax profit for the year ended 30 June 1988 was $21.4M. The audit working papers⁽⁾ note that the following shockproofing actions were taken by management to reduce the underlying profit:

Item	$M		Per cent of Pre-tax Profit

Fee income not recognised	2.5		11.7
Accelerated depreciation of fixtures and fittings	2.0		9.3
Provision for Head Office refurbishment	1.0		4.7
Additional staff superannuation fund contributions	1.0		4.7
Equiticorp acquisition fee written off	1.3		6.1
Managing Director’s contingency fund	0.5		2.3
FRS development costs written off	1.0		4.7
Additional long service leave provisions	0.5		2.3
Sundry other prudent accruals	0.8		3.7
		10.6		49.5

For reasons set out below, I have formed the opinion that certain of the shockproofing actions, amounting to $2.6M, should not have been included as expenses in the accounts, and led to a deliberate understatement of profits for the year. Those items identified in bold in the above analysis, whilst having the effect of reducing profit, are in my opinion nonetheless in accordance with generally accepted accounting standards and practices in force at that time.

After deducting the opening prudent accrual of $0.8M, the net effect of shockproofing was to understate pre-tax profit by $1.8M. This represented 8.4 per cent of pre-tax profit. Price Waterhouse has submitted,⁽⁾ and I accept on balance, that shockproofing did not lead to a material understatement of profits for the year.

Price Waterhouse has submitted that the "Equiticorp acquisition fee" was properly written off.⁽⁾ For the reasons set out below, I am not satisfied that this was correct.

At 30 June 1987, Price Waterhouse determined that prudent accruals amounted to $0.8M.⁽⁾ This was the only evidence of shockproofing noted by this Investigation during the review of the 1987 external audit files.

Set out below is an explanation of each of the shockproofing items, including a discussion of the related audit procedures adopted by Price Waterhouse and relevant professional standards and practices. Each of these shockproofing actions was brought to the attention of Mr Giles. I comment below on the manner in which Mr Giles dealt with this matter.

(b) Fee Income Not Recognised - $2.5M

In the 1988 financial year, Beneficial Finance entered into a number of tax based structured finance deals. In addition to generating interest income on such deals, Beneficial Finance often received up front fee income. In their management letter, addressed to Mr J G Graham, General Manager, Finance and Operations, dealing with the outcome of the December 1987 audit, Price Waterhouse stated that:

"... Fee income largely related to Unit Trust Investment deals, of $2,841,000 was suspended at 31 December 1987. The income was for services rendered by the company as managers and in some cases, packagers, of the deals and it is reasonable to have deferred recognition of the income. The financial period to 31 December 1987 was the first in which this product was established and it is important that the company lay down a clearly defined accounting policy to ensure that income is recognised on a consistent basis."

Management's response, mentioned in that letter, was:

"... It is acknowledged that an agreed accounting policy should be formulated to deal with the situation described above. However the product of unit trusts is a relatively new and innovative mechanism of generating profits for the Group.

Management therefore considers that it would be prudent to adopt a highly conservative accounting approach in relation to the take up of fees which have been generated by this particular product.

This conservatism in the accounting approach is not a reflection on the professionalism of the skills of the team packaging such transactions but rather a management hedge against longer term tax issues that have not, as yet, been tested in practice".

At a Board Meeting, on 29 January 1988, the directors adopted the following policy in relation to fee income:⁽⁾

"...

(a) if the fee income is such that the interest component is reduced below the standard level, the fee is spread over 12 months

(b) if the fee is less than $10,000 it is taken to profit immediately

(c) in other cases, one third of the upfront fees are taken to profit when the business is written with the balance being spread over 12 months"

It is against this policy that Price Waterhouse calculated the prudent component of fee income in suspense. The audit working papers⁽⁾ state that, at 30 June 1988, total fee income in suspense was $6.0M. Price Waterhouse determined that, had the above policy been followed, additional fee income of approximately $2.5M would have been recognised as income at June 1988, rather than being held in suspense.⁽⁾

An undated file note, prepared by Mrs Anthon,⁽⁾ records the reasons put forward by management for deferring, rather than bringing to account, the $2.5M as follows:

"FEE INCOME SUSPENDED AT 30 JUNE 1988

Based on the Income Policy noted in the minutes of 29.2.88, PW calculated income of $2,515,782 should have been brought to account. Reasons given for not recognising this income are detailed as follows:

Account `A'

$533,333

This is a 15 year deal which is considerably longer than normal Unit Trust deals of approximately 5 years. At July 1988 the deal was still being negotiated as to the extent of the debt finance component and the effect of the reduced tax rate on the after tax yield. As a result, the total return was not certain at 30.6.88 and income was deferred.

Account `B'

$448,470

Although construction was complete and the building tenanted before year end, the fit out of the building has been changed and at 30.6.88 it was possible, and still is, that additional funding would be required to complete the exercise. There are also further legal costs anticipated which will have to be paid out of the management fee.

Account `C'

$311,111

Stage 1 is complete, however, stage 2 is still under construction and the costs are to be added into the tax effective structure of the deal. Of the total fee of $580K approximately 1/3 is estimated to apply to stage 2. The balance was applied to the account management required for 4 income distributions of which only 1 occurred before year end. ... (580 x 2/3) x 1/4 = $97K and $93K was recognised to 30.6.88.

Account `D'

$227,566

The management fee on this deal was negotiated to reduce a principal loss on a receivable account held in the name of the developer of the ... Shopping Centre. Beneficial accepted a low net fee which will remain after the payout of the Hall Account and payment of legal costs yet to be paid. The reduction of the receivable has been confirmed. As such most of the fee income has been deferred.

Account `E'

$494,107

The construction is divided into 2 stages, however, the fee received was not specifically allocated to each stage and no further fee has been agreed. Construction has not been completed and restructure of the deal is expected in mid to late 1989 with increased funding of $20.5 m due June 1989 by Beneficial. Once again, fees will be allocated according to account management work load which will increase once the hotel is complete and operating.

Account `F'

$351,140

The final structure of the deal is yet to be settled September 1988 which will involve the cross collaterisation of 2 more properties and an increase in funding of approximately $3.3 m. At the same time, legal costs which have to be paid out of the management fee have yet to be final billed to Beneficial. As such the client felt it would not be prudent to recognise fee income in the normal manner.

Total

__________

$2,365,727

_________"

This file note is annotated as having been provided to the auditors of the Bank.

Professional Standards and Practices

At the time that the audit of Beneficial Finance for the year ended 30 June 1988 was executed, it was generally accepted accounting practice to include those items, and only those items, of income and expenditure earned or incurred in an accounting period in the Profit and Loss Statement for that particular period.⁽⁾

Furthermore, at 30 June 1988 it was, and still is, generally accepted accounting practice for financial institutions to:

(i) recognise fee income which relates to establishing transactions in the period in which the transaction occurred; and

(ii) recognise the balance of fee income, as being yield related, over the life of the transaction.

Based on the evidence examined by this Investigation, and for the reasons set out above, I have formed the opinion that the evidence contained in the audit working papers supports the decision of Beneficial Finance to defer recognition of the full amount of fee income in suspense, and hence the amount was not a shockproofing item.

(c) Accelerated Depreciation of Fixtures and Fittings - $2.0M

The audit working papers⁽⁾ note that:

"... the substantial increase in depreciation is due to a change in accounting policy whereby all fixtures and fittings under $2,000 had the useful life decreased.

This had the effect of accelerating depreciation in the current period and is considered to have been done to "shockproof" Beneficial profits."

The amount written off was $2.0M.

This adjustment substantially arises from a change in accounting policy whereby fixtures and fittings with an original cost of $2,000 or less were no longer capitalised. In my opinion, it does not represent a reassessment of the useful lives of those assets.

Price Waterhouse submitted in relation to this item:⁽⁾

"The write off of assets under $2,000 each ... was agreed to the fixed asset retirement report (refer Schedule J19 in the audit working papers for 30 June 1988). The fixed asset retirement reports were considered to be reliable as a result of the audit testing performed on them. A sample of disposals was selected from each month's retirement report and calculations and supporting documentation (refer Schedule J13-15 in the audit working papers for 30 June 1988) ... The amount written off relating to the change in accounting policy for fixed assets was $1.2M ie 5.7 per cent of the profit before taxation. We are of the opinion that this amount is not sufficiently material to warrant a disclosure as an abnormal item ..."

I accept the submissions made by Price Waterhouse.

Professional Standards and Practices

At the time that the audit of Beneficial Finance for the year ended 30 June 1988 was executed, it was generally accepted practice for an auditor to obtain sufficient appropriate audit evidence to support his audit opinions.⁽⁾ Further, the applicable approved Accounting Standard ASRB1001 "Accounting Policies -Disclosure" requires:

"Where there is a change in accounting policy applied in preparing and presenting accounts or group accounts for the current financial year, which has a material effect on the accounts or group accounts, the summary of accounting policies shall disclose, or refer to a note disclosing -

(a) the nature of the change;

(b) the reason for the change;

(c) the financial effect of the change."

Based on the evidence examined by this Investigation, and having regard to applicable professional standards and practices, I have formed the opinion that Price Waterhouse obtained appropriate and adequate audit evidence to confirm the validity of the depreciation of fixtures and fittings amounting to $2.0M, and that

Price Waterhouse's decision to accept non-disclosure of the financial effect of the change in policy regarding accelerated depreciation was appropriate, hence the amount was not a shockproofing item.

(d) Provision for Head Office Refurbishment - $1.0M

The audit working papers⁽⁾ describe this item of expenditure as:

"... a provision for tearing down partitions, etc, for any loss on sale or disposal of these partitions, and for any work performed by contractors on head office refurbishment. This is an estimate only and is prudent.

As a result of Blossom Park profit of $8 million Beneficial feel they are now in a position to "shockproof" Beneficial profits, and therefore hold back profits for any future fall in growth. Head Office Refurbishment is one of the accounts that is set up for this purpose."

The audit files also contain an extract from the March 1988 monthly Board submission⁽⁾ which notes that:

"... the increase in the level of operating costs to $7,642K being $5,271K above budget was due to management taking the opportunity to shockproof the future operating results of the Group. Initiatives were taken to ... allocate $1.0M to a fund established to write off costs associated with the refurbishment of the Group's Head Office".

Price Waterhouse has submitted that the provision for head office refurbishment of $1.0M was established to cover the costs associated with the removal and scrapping of existing fixtures in Beneficial Finance's head office as part of a major renovation which had commenced prior to 30 June 1988 and had been observed by the audit team.⁽⁾ Price Waterhouse have submitted,⁽⁾ and I accept, that the establishment of such a provision was appropriate.

Professional Standards and Practices

Based on the evidence examined by this Investigation and having regard to applicable professional standards and practices, I have formed the opinion that the provision for Head Office refurbishment amounting to $1.0M, represented a provision for an expense that had been incurred at 30 June 1988, and hence the amount was not a shockproofing item.

(e) Additional Staff Superannuation Fund Contribution - $1.0M

The audit working papers⁽⁾ note that:

"$1 million was placed in this fund before the Economic Statement in May. This was done in order to "shockproof" Beneficial profits."

A similar statement is also made in the March 1988 monthly Board submission.⁽⁾

The Investigation found no evidence in the audit working papers that the contribution was made in accordance with an actuarial recommendation. The Investigation reviewed the external audit files of the Staff Superannuation Fund (a defined benefits fund) for the year ended 30 June 1988 (audited by Price Waterhouse), and has established that no such recommendation was made.

The Investigation has examined an independent actuarial valuation of the fund as at 1 April 1988, issued on 11 August 1988. The Investigation found that the total contribution to the fund by Beneficial for the year ended 30 June 1988 substantially exceeded that which would have been made in accordance with the recommendation of the actuary.

The additional contribution therefore had the effect of building up an asset off-balance sheet which had the potential to be used to reduce future contributions to the Fund, which would otherwise have been expended in the year of contribution.

Professional Standards and Practices

At 30 June 1988, there were no Australian Accounting Standards on issue dealing specifically with superannuation contributions. On general principles, a superannuation contribution would be incurred, and would be properly brought to account as an expense, if it was required in accordance with the trust deed or rules of the staff superannuation fund in order to fully fund benefits to be provided by the fund in respect of employees' service for periods ending on that date. To determine this matter at the end of each of year would require an actuary's determination, which ordinarily would only be obtained every several years, and then would be based upon assumptions as to future matters.

I understand, on the basis of expert evidence received by the Investigation, that the practice adopted by auditors in Australia at the time was to accept that any contribution to a superannuation fund determined by management to be appropriate should be treated as an expense of the current year, even if in excess of an actuary's recommendation. I understand it is thought that superannuation contributions which might appear to be excessive by reference to such recommendations should be disclosed if material.

Based on the evidence examined by this Investigation, and having regard to the absence of professional standards and practices issued by the Professional Accounting Bodies, I have formed the opinion, on balance, that it was appropriate for Price Waterhouse to accept management's treatment of the additional staff superannuation fund contribution of $1.0M as an expense of the current year, hence the amount was not a shockproofing item.

(f) Equiticorp Acquisition Fee Written Off - $1.3M

During the 1988 financial year, Beneficial Finance acquired receivables portfolios from Australian subsidiary companies of Equiticorp Holdings Ltd. The total value of the portfolio acquired was $167.0M, on which a premium of $1.3M was paid. The audit working papers suggest that the premium was expensed for shockproofing purposes only. For example:

(i) "... this write off is considered to be necessary by the client for "shockproofing" purposes only ..."⁽⁾

(ii) "as a means of taking advantage of record profits in Beneficial the premium was expended in total by 30 June 1988 ..."⁽⁾

Price Waterhouse submitted that, as was recorded in extracts from Beneficial Finance Board minutes in their working papers, at the time of the acquisition of the receivables portfolio from Equiticorp Holdings Ltd, the Board approved the payment of a premium of $1.3M to obtain Equiticorp's agreement to share the risk on certain of the receivables acquired.⁽⁾ Price Waterhouse further submitted that they were informed by Beneficial Finance's legal counsel during the course of the audit, which they noted in their working papers, that Equiticorp was contesting its liability under the risk participation agreement in respect of certain receivables where recoverability was in doubt.⁽⁾

Price Waterhouse submit that the fee of $1.3M was not part of the acquisition price of the receivables portfolio, and hence should not have been capitalised as part of the cost of acquiring the portfolio.⁽⁾

In evidence submitted to the Investigation Mr A Z Kane, Chief Manager, Risk Review, of Beneficial Finance advised as follows:

"... the premiums paid to Equiticorp on acquisition of the portfolio from 4 states were as follows:

Western Australia	500,000
South Australia	500,000
New South Wales	138,000
Victoria	112,000
	$1,250,000

(a) The payments were related to the cash flow returns from the various portfolios. In particular, the SA & WA portfolios were written by Equiticorp at a time when finance rates were relatively high, BFCL was acquiring the portfolio during a period [of] relatively low funding rates and therefore the margin to BFCL and any other potential buyer or financier was more than would have been available had the funds been utilised through other lending mechanisms.

Equiticorp was aware of the attractive margin difference and required an upfront share of that margin over and above the principal balance of the receivables being acquired. This upfront share of the margin has been generally referred to as the Equiticorp Acquisition Fee.

Officers of BFCL had reviewed the portfolios, arrears, loss history and cash flow relating to the SA Receivables being offered by Equiticorp and were capable of performing a similar review of the WA portfolio. The initial assessment of the portfolios indicated that the receivables in SA and WA were considered to be of a good quality and the upfront share of margin was considered reasonable.

In the case of the NSW and Victorian portfolios, the Equiticorp receivables in those states required a more intense review of the high volume, low value receivables. Instead of an intense review, the acquisition fee was effectively reduced in an effort to recognise that potential risk within the portfolio.

Similarly the lack of intense review of the NSW and Victoria [portfolios] prompted the need to include in the original documentation for the acquisition of the portfolios clauses and conditions surrounding credit risk and loss accounts.

(b) In the 1987/1988 Financial Year, profits from a number of large transactions were likely to occur. The most significant being the profit from the sale of one of BFCL's long term development projects - Blossom Park.

As a consequence of the anticipated influx in profit, the management of BFCL requested that all Divisions within the Group adopt a policy of "shockproofing". The payment of the "premium" to Equiticorp was considered to be an item which could be shockproofed.

As noted ... above, the acquisition fee was an up front payment of margin which was related to the difference in the funding rates which applied to the asset portfolio.

The up front fee could be defined as an additional specific funding cost which was incurred at the outset and recoverable over the life of the receivables. The shockproofing technique resulted in the fee being conservatively brought to account in 1988 financial year rather than being term matched over the balance of the receivables."⁽⁾

I am not satisfied that the fees were in respect of Equiticorp sharing the credit risk. In my opinion the fee appears to have been "margin related" and in substance represented an additional funding cost of acquiring the portfolios.

Professional Standards and Practices

At the time that the audit of Beneficial Finance for the year ended 30 June 1988 was executed, it was generally accepted accounting practice to record assets acquired at cost of acquisition.⁽⁾ For example, paragraph 24 of AAS21 states that:

"In accounting for all acquisitions of assets the cost method of accounting shall be used, whereby the assets acquired are initially recorded at the cost of acquisition, being the purchase consideration determined at the date of acquisition plus costs incidental to the acquisition."

Based on the evidence examined by this Investigation, and for the reasons set out above, I am not satisfied that the Equiticorp acquisition fee amounting to $1.3M should have been treated as an expense in the June 1988 accounts. I have formed the opinion, however, that the amount was not in any event material.

(g) Managing Director's Contingency Fund - $0.5M

The audit working papers⁽⁾ note that this provision represents:

"... a contingency for any future fall in profit below growth. This accrual is a prudent accrual."

Professional Standards and Practices

As noted above, in 1988 it was, and still is, generally accepted accounting practice to include those items, and only those items, of income and expenditure earned or incurred in an accounting period in the Profit and Loss Statement for that particular period.⁽⁾

Based on the evidence examined by this Investigation and having regard to the applicable professional standards and practices, I have formed the opinion that the Managing Director's contingency fund amounting to $0.5M, had not been incurred at 30 June 1988, and accordingly should not have been treated as an expense in the Profit and Loss Statement for that year.

(h) FRS Development Costs Written Off - $1.0M

The audit working papers⁽⁾ note that certain costs incurred in the development of the new receivables system (Financial Receivables System) were expensed as a shockproofing measure. The amount totalled $1.0M.

Professional Standards and Practices

When a company incurs expenditure on the development of computer systems for its own use, significant costs may be incurred, the benefit of which will not arise until future periods. It is often difficult to predict confidently the extent of benefit which may arise. I understand it is not uncommon for auditors in Australia to accept that expenditure on the development of computer software should be expensed as incurred.

Based on the evidence examined by this Investigation and having regard to applicable professional standards and practices, I have formed the opinion, on balance, that it was appropriate for Price Waterhouse to accept management's treatment of the Finance Receivables System development costs of $1.0M as an expense of the current year, hence the amount was not a shockproofing item.

(i) Additional Long Service Leave Provision - $0.5M

The long service leave provision was increased from $0.4M at 30 June 1987 to approximately $1.0M at 30 June 1988. The principal reason for the increase was the recognition of an additional $0.5M provision arising from a change in accounting method.

Previously, long service leave provisions were raised on a pro rata basis once an employee had completed seven years service. At 30 June 1988, this policy changed to include all employees, irrespective of length of service.

Although such a policy is not unusual, the audit working papers⁽⁾ record this was done as part of the 1988 shockproofing measures.

Based on the evidence examined by this Investigation and having regard to applicable professional standards and practices, I have formed the opinion that it was acceptable for Beneficial Finance to regard the additional long service leave provision of $0.5M as an expense of the current year, hence the amount was not a shockproofing item.

(j) Sundry Prudent Accruals - $0.8M

Prudent accruals were defined by Price Waterhouse in a report to Mr M G Hamilton, Director, dated 30 July 1990 as:

"... earned income which has nevertheless been deferred in the financial statements to be recorded as income in future periods".

In that same report Price Waterhouse went on to say:

"... Management maintained `prudent accruals' as a buffer to be released to profit if BFC suffered from unfavourable events in the future."

The audit working papers indicate that Price Waterhouse viewed the sundry balance of $0.8M, which comprises a number of immaterial prudent accruals, as provisions for expenses that had not been incurred at 30 June 1988.

Professional Standards and Practices

Based on the evidence examined by this Investigation and for the reasons set out above, I have formed the opinion that sundry prudent accruals amounting to $0.8M, represented provisions for expenses that had not been incurred at 30 June 1988, and accordingly should not have been recognised in the Profit and Loss Statement for that year.

57.5.2.3 Matters Noted - Provision for Doubtful Debts

The audited accounts of Beneficial Finance for the year ended 30 June 1988 disclose a provision for doubtful debts of $23.4M (1987 - $13.1M). The audit working papers⁽⁾ show that this provision comprises two elements, namely an allocated provision and an unallocated provision.

The balance of these provisions was:

The audited accounts at 30 June 1988 also state that doubtful debts expense for the year was $20.4M (1987 $12.4M) - up 65 per cent. New lending and portfolio acquisitions during the year ended 30 June 1988 totalled $1.27B comprising $454.0M (mortgage lending), $318.0M (vehicle and equipment finance) and $495.0M (corporate/commercial).

In accordance with Beneficial Finance's policy, allocated provisions represent provisions raised by management against specific accounts where full recovery is considered doubtful. Unallocated, or general provisions as they are more commonly referred to in the finance industry, are maintained to cover the risk of loss inherent in any loan portfolio which had not, at balance date, been specifically identified. Price Waterhouse determined that the unallocated provision expressed as a percentage of net receivables (including amounts due from off-balance sheet entities) for the four years ended 30 June 1988 was:

30 June 1988 1.09 per cent

30 June 1987 0.61 per cent

30 June 1986 0.61 per cent

30 June 1985 0.54 per cent

(a) Allocated Provision for Doubtful Debts

On a regular basis, Beneficial Finance prepared "Non-Performing Loans Review" reports which provided certain information in respect of non-performing loans. These reports were manually prepared, and used by Beneficial Finance as a basis for determining the level of allocated provisions for non performing loans, and included information such as:

(i) description of the security held by Beneficial Finance;

(ii) estimated value of the security and date of valuation;

(iii) amounts due to Beneficial Finance;

(iv) a commentary on the action proposed or being taken to maximise Beneficial Finance's recovery on the account; and

(v) recommended provision.

Price Waterhouse performed audit procedures to satisfy themselves as to the reliability of the Non-Performing Loans Review reports.

In my opinion, having regard to the evidence examined by this Investigation, the audit procedures carried out by Price Waterhouse on the allocated provision for doubtful debts in the year ended 30 June 1988 were appropriate and adequate.

(b) Unallocated Provision for Doubtful Debts

As previously discussed, the audit working papers⁽⁾ note that the total provision for doubtful debts included an unallocated provision of $16.8M (1987 - $6.8M). The unallocated provision represented 1.09 per cent of net receivables (including amounts due from off-balance sheet entities) at 30 June 1988 (1987 - 0.61 per cent).

In Chapter 56 - " Review of the 1985, 1986 and 1987 External Audits of Beneficial Finance", I reported that it was the intention of the Beneficial Financial Board to increase the unallocated provision to 1 per cent of net receivables. This was achieved by 30 June 1988.

The audit programme prepared by Price Waterhouse to evaluate the unallocated provision for doubtful debts included the following proposed tests:

(i) comparing the level of the unallocated provision with prior years, both in dollar terms and expressed as a percentage of net receivables; and

(ii) comparing the Beneficial Finance total provisions with those of similar financial institutions.

The Investigation could find no evidence in the audit working papers that the unallocated provision had been compared with those of similar financial institutions. Although this comparative analysis was not performed, I have formed the opinion that there was sufficient evidence in the audit working papers to support the conclusion reached by Price Waterhouse that the unallocated provision for doubtful debts was adequate.

57.5.2.4 Opinion - Execution of the Audit

Based on the evidence examined by this Investigation and having regard to the applicable professional standards and practices, I have formed the opinion that, except for my findings on the off-balance sheet entities set out below under Concluding Procedures, the execution of the audit was appropriate and adequate.

57.5.3 CONCLUDING PROCEDURES

57.5.3.1 Preamble

Concluding procedures are those procedures adopted by an auditor of an entity to identify, resolve and document his conclusions concerning significant aspects of his audit, including how exceptions and contentious or unusual matters, if any, are to be dealt with. It is vital that:

(a) These procedures ensure that all significant matters are identified and brought to the attention of the person responsible for signing the auditor's report.

(b) The resolution of each significant matter is given the necessary degree of attention to ensure that the accounts of the entity show a true and fair view in accordance with applicable law, and that other significant matters that do not affect the truth and fairness of the accounts are brought to the attention of the proper level of authority within the entity. In the case of some matters, this may involve the person responsible for signing the auditor's report consulting with some of his partners or peers.

In the following section of this Chapter, I comment upon the manner in which Mr Giles dealt with issues brought to his attention during the execution phase of the audit. In particular, I focus on:

(a) the consideration of abnormal items and disclosure thereof;

(b) the auditor's response to the shockproofing measures employed by Beneficial Finance;

(d) the equity accounting of off-balance sheet entities.

57.5.3.2 Matters Noted - Abnormal Items

The audited accounts of Beneficial Finance for the year ended 30 June 1988 disclosed, as an abnormal item, a provision for diminution in value of investments totalling $0.9M.

The Investigation's review of the audit working papers identified the following item which, in my opinion, should have been considered for possible disclosure as an abnormal item.

Item	$M	Per Cent of Pre-tax Profit

Revenue
Profit on Blossom Park project	8.3	38.8

Real estate development projects contributed $9.9M to the pre-tax group profit for the year (1987: $2.1M). Included in the $9.9M is a profit on the Blossom Park project of $8.3M, which was sold in March 1988. Blossom Park, a residential land development, had been owned by Beneficial Finance since 1983 following foreclosure on a debtor.

The audit working papers⁽⁾ contain a file note, prepared by Mr Clark, of a meeting held on 28 April 1988, and attended by Mr E P Reichert, Mr G L Martin, Mr Graham, Mr Kane (from Beneficial Finance) and Mr Giles and Mr Clark (from Price Waterhouse). The file note includes the following comment:

"AHG (Mr Giles) indicated that Blossom Park need not be disclosed as `abnormal because the profits had not been used to strike a profit of $16M after tax ..."

The treatment of the Blossom Park profit is also included on an agenda for a meeting held on 28 July 1988 between Mr J A Baker, Mr Kane, Mr Giles, Mr Clark, and Mrs Anthon. The minutes of that meeting, prepared by Mrs Anthon and signed by Mr Giles, make no reference to Blossom Park.⁽⁾

These are the only comments noted in the working papers which consider the identification and disclosure of the possible abnormal item.

Price Waterhouse have submitted that the profit on Blossom Park was not required to have been disclosed as an abnormal item:⁽⁾

"While prima facie the profits generated were from real estate project development, we consider that the income was in reality the recoupment of interest forgone on a non performing loan. BFCL assumed ownership of the Blossom Park project in 1982 as a solution to resolving a difficult loan exposure (Manel Southside). At that time, the non performing asset was transferred from the receivables classification to real estate developments. BFCL had previously ceased accruing interest on the asset. Over the succeeding years Blossom Park was subdivided and sold on a staged basis. A favourable rezoning of the 640 acre balance of Blossom Park land resulted in an increased sale price achieved in the year to 30 June 1988. Accordingly we consider that it is more appropriate to assess the significance of the Blossom Park transaction by expressing the $8.3M income as a percentage of gross interest income as follows:-

	$M
Gross interest received	229.1
Blossom Park income as a %	3.6

Blossom Park was not an isolated transaction whether considered as recoupment of the interest forgone, fee income or as profit from real estate development activities. Other transactions in 1988 were also significant when compared with the reported operating profit ... Any organisation with large revenue and expenditure figures is likely to have many individual transactions which when considered in terms of operating profit would be significant but would not be considered to be abnormal.

Consideration of AAS1 is not simply the application of a mathematical calculation, items are deemed to be abnormal by reason of `their size and effect on the operating result'; consequently an item is not abnormal simply because it is material. AAS1, therefore is concerned with the true and fair presentation of the profit or loss of a business for a specified period. In our opinion taking into account the matters raised in paragraphs 5.2 and 5.3 above, non specific disclosure of the Blossom Park income did not impair a reader's assessment of the results of BFCL nor was the truth and fairness of the financial statements impaired.

We note from our review of the 1988 annual report that the directors made various references in their review of operations to the impact this type of income had on the performance of BFCL during the year as follows:-

(a) "Construction and development finance is traditionally linked with Beneficial, whether for sub-divisions, residential units or commercial and industrial premises. Significant profit results were achieved from the development and sale of real estate in Victoria during 1987/8."

(b) "Gross revenue from operations increased by 26% to $235.8 million while interest costs on borrowings of $157.7 million only increased by 16%. This reflected the significant increase in non receivables based fee income and the benefit of improved margins as lower interest rates impacted more quickly on borrowing costs."

(c) "Beneficial Finance also made progressive changes in business direction to build on market opportunities which resulted in higher earnings from fee income products and services, particularly in real estate construction finance."

The Investigation found no evidence in the audit working papers, or, indeed, in the audited accounts, that, at 30 June 1988, the Blossom Park profit was treated by Beneficial Finance as anything other than a real estate development profit. In particular, I note that:

(a) the working papers describe it as a real estate development profit;

(b) the asset was disclosed in the annual accounts as a real estate development project, and not as a receivable;

(d) the published accounts, as noted in the Price Waterhouse submission, refer to significant profits having been achieved from the development and sale of real estate in Victoria during the year; and

(e) the written explanation provided by Price Waterhouse is inconsistent with the comment referred to above in the Clark file note that:

"AHG indicated that Blossom Park need not be disclosed as `abnormal because the profits had not been used to strike a profit of $16M after tax ..."

In the course of this Investigation, Mr Giles was examined on 24 July 1992, and Mr Clark was examined on 28 July 1992. Neither of them were able to explain Price Waterhouse's reasons for accepting the accounting treatment of the Blossom Park profit, nor were they able to explain what Mr Clark meant by the above file note. In my opinion, Price Waterhouse's answer does not satisfactorily explain their process of reasoning in 1988 as recorded in that file note.

Professional Standards and Practices

In my view it was generally accepted accounting practice to disclose, separately, in the financial statements, details of all abnormal items arising in a particular accounting period, affecting the operating profit/(loss). For example, paragraph 4(c) of AAS1 states that:

""Abnormal items" means items of revenue and expense, and other gains and losses, brought into account in the period, which although attributable to the ordinary operations of the business entity are considered abnormal by reason of their size and effect on the results for the period.";

Paragraph 22 of AAS1 states that:

"Where the operating profit (loss) has been affected by any abnormal item, such item should be shown either as a separate amount in the Profit and Loss Statement itself or in a note, but in any case in a way which clearly identifies it as forming part of the operating profit (loss). The income tax expense applicable to each abnormal item should also be disclosed so as to permit a proper assessment of the effect of the item on the operating profit (loss). Where an abnormal item relates directly to one or more prior periods, such periods should be specified".

Based on the evidence examined by the Investigation, including written submissions from Price Waterhouse, I have formed the opinion that the profit on Blossom Park should have been disclosed as an abnormal item in the accounts of Beneficial Finance for the year ended 30 June 1988, for the following reasons:

(a) it represented 38.8 per cent of pre-tax profit for the year;

(b) the profit earned was significantly greater than profits earned from this source in previous years; and

(c) the Investigation found no evidence that profits of this level, and from this source, were expected to be recurring.

It therefore follows that, in my opinion, the decision by Price Waterhouse to accept non-disclosure of that item in the accounts was inappropriate.

57.5.3.3 Matters Noted - Shockproofing

As discussed earlier in this Chapter, various shockproofing techniques were employed by Beneficial Finance apparently to deliberately reduce the underlying pre-tax profit for the year ended 30 June 1988 from $31.2M to $21.4M (a reduction of 31 per cent).

The audit working papers indicate that Price Waterhouse appeared to accept the situation on the grounds of prudence. For example:

(a) "the accounts are certainly much more prudent than in previous periods (as) part of the company's strategy "to shockproof" its position. PW have agreed these items during planning meetings over recent months ... Overall we can accept" ⁽⁾

(b) "1. ACCRUALS AND PROVISIONS

Our review of Accrual and Provision accounts and of the expenses incurred in the last 12 months revealed a high degree of conservatism at 30 June 1988. Our estimate of the prudent accruals and provisions totalled $807,000 at 30 June 1987, increased to $1,010,000 at 31 December 1987 and to $4,808,000 at 30 June 1988 ...

The effect on profit is to decrease the amount by $4,001,000 before tax ..."⁽⁾

As discussed earlier in this Chapter, I have formed the opinion that, of the total amount of shockproofing, the following items should not have been included as expenses in the June 1988 accounts:

	$M

Equiticorp acquisition fee written off	1.3
Managing Director’s contingency fund	0.5
Sundry Prudent Accruals	0.8
	2.6
less: Prudent Accruals at 30 June 1987	0.8
Net Increase in Prudent Accruals at 30 June 1988 (ie amount by which Pre-tax profit for year was under-stated).	1.8

These "expenses" (net of the opening prudent accrual) represent 8.4 per cent of reported operating profit for the year before tax .

Professional Standards and Practices

It was, and still is, common practice for management to adopt a conservative approach where subjective assessments are made which impact on a company's financial statements (eg in determining the level of provisions). From an auditors' viewpoint, this practice can, in my opinion, be accepted so long as:

(a) it does not give rise to a material mis-statement in the financial statements;

(b) policies are consistently applied from year to year; and

Nevertheless, it is, in my opinion, unacceptable for management to use such techniques to materially mis-state the reported results of a company. In such circumstances, the auditor should insist on changes to the accounts or, if management refuse, issue a qualified audit opinion.

I have commented in Chapter 55 - "The External Audits of Beneficial Finance: Background Information" on the applicable professional standards and practices concerning "materiality".

Guidance as to whether an item or event is material is provided in Australian Accounting Standard AAS5, "Materiality in Financial Statements", November 1986, issued by the Australian Accounting Profession.

Paragraph 12 of AAS5 states that:

"Guidelines which attempt to establish quantitative thresholds for determining the materiality of an item must, of necessity, be drawn at arbitrary levels. Whilst recognising this, the following percentage limits are proposed as useful benchmarks in considering the materiality of the amount of an item included in the comparisons referred to in sub-paragraphs 11(a), 11(b) and 11(c) of this Statement:

(a) an amount which is equal to or greater than 10 per cent of the appropriate base amount, ought to be presumed to be material unless there is evidence to the contrary;

(b) an amount which is equal to or less than 5 per cent of the appropriate base amount, ought to be presumed to be immaterial unless there is evidence, or convincing argument, to the contrary; and,

(c) no presumption ought to be made as to the materiality of an amount which lies between 5 per cent and 10 per cent of the appropriate base amount prior to consideration of the nature of the item.

In relation to profit and loss statement items, or other operating statement items, "an amount" as referred to in sub-paragraphs (a), (b) and (c) above, should be an amount after allowing for any income-tax effect where the "base amount" has itself been determined after allowing for any income tax effect."

As discussed above I have formed the opinion that the shockproofing identified above should not have been included as expenses in the accounts for the year ended 30 June 1988. These items collectively fall within the 5 per cent to 10 per cent band referred to in AAS5 on a pre-tax basis.

Based on the evidence examined by the Investigation and for the reasons set out above, I have formed the opinion that, while deliberate shockproofing actions taken by management had the effect of understating the pre-tax profit for the year ended 30 June 1988 by $1.8M, this amount was not material in relation to the accounts.

57.5.3.4 Matters Noted - Disclosure of information pertaining to Off-balance sheet Entities

The Investigation noted that information pertaining to the off-balance sheet entities was not disclosed in the group accounts for the year ended 30 June 1988.

(a) Companies Code - "True and Fair" Override

An auditor has a responsibility under Section 285 of the Code to express an opinion as to whether the accounts are properly drawn up so as to give a true and fair view of the state of affairs at the balance date and of the results for the period then ended, and whether the accounts are in accordance with Australian Accounting Standards and applicable approved accounting standards.

The term "true and fair" is not defined in the legislation, nor has it been defined by the Courts. Determination of what is true and fair is a matter of judgment to be exercised having regard to the objectives of financial reporting and to accounting standards.

In forming an opinion as to whether accounts are true and fair, an auditor must have regard to whether the view presented by the financial information as a whole is consistent with the auditor's knowledge of the business of the entity, and there is adequate disclosure of all material matters necessary to give a true and fair view.⁽⁾

Statement of Accounting Standards AAS6 "Accounting Policies: Determination, Application and Disclosure" identifies several important considerations in determining and applying accounting policies.

These include:⁽⁾

"Transactions and events should be accounted for and presented in accordance with their financial reality and not merely their legal form."

It is acknowledged that materiality must be considered in determining whether truth and fairness has been achieved. Paragraph 16 of AAS5 states that:

"... Information shall be deemed to be material if its omission, non-disclosure or mis-statement would cause the financial statements to mislead users of the statements when making evaluations or decisions."

In the light of the foregoing, it is my opinion that the test of truth and fairness is only met if the accounts are drawn up in conformity with accounting standards, portray a view that is in accordance with commercial reality, and are presented in a manner that is likely to provide useful information to users who may make decisions based upon them.

As noted above, in my opinion, the purpose of Section 269(3) of the Code is to truly and fairly represent the results and affairs of companies under the same control in their relations with outsiders. In my opinion, if it is accepted that the Kabani type structure has the legal effect Beneficial Finance contends, Beneficial Finance would have the power to elect whether or not to consolidate in the group accounts the results and affairs of business undertakings over which Beneficial Finance had control. It follows that it could be argued that disclosure of off-balance sheet arrangements would be required regardless of the amount of money involved. That is, because of the scope for manipulation of reported consolidated financial information, it could be argued that off-balance sheet arrangements ought to be treated as material by virtue of their nature.

The following is an extract from the Accounting and Reporting Manual of one of the Bank's joint auditors issued in February 1985:⁽⁾

"2. It is not yet considered appropriate for the Firm to come out strongly in either direction i.e. either to take a moral stance and insist that our clients consolidate such companies or alternatively actively to go out of our way to market such arrangements.

3. In essence the Firm does not condone the use of off-balance sheet arrangements purely and simply to enter into financing arrangements which would not be acceptable if they were in the company's own balance sheet ...

4. It is recommended that clients entering into ... off-balance sheet arrangements should clearly state in a note to their accounts that such an arrangement exists and where material the assets and liabilities of the off-balance sheet company should be disclosed as an abridged set of accounts within the note to the accounts ..."

While in my opinion it is arguable that the existence and affairs of the off-balance sheet entities ought to have been disclosed regardless of the amount of money involved, I have formed the opinion that the off-balance sheet entities by 30 June 1988 were material to Beneficial Finance and, if not otherwise required to be consolidated into the group accounts, should at least have been disclosed by way of note to the accounts of Beneficial Finance and the group accounts.

In the period under review, there was a divergence of views within the accounting profession on whether Section 269(3) of the Code permitted the consolidation of non-corporate entities where that might be considered necessary to enable the accounts to present a true and fair view. It appears that the National Companies and Securities Commission subsequently indicated informally that it would take a lenient view to consolidation of non-corporate entities where it was thought that consolidation would result in the presentation of a true and fair view, but in the absence of consolidation, the Commission's view appeared to be that the only requirement which could be legally enforced would be disclosure by way of note to the accounts.⁽⁾ Because of the divergence of opinion on the subject, I have not, for the purposes of this Report, pursued the possible view that the true and fair override could require in an appropriate case the consolidation of non-corporate entities. Mr Giles gave evidence that he did not believe that Price Waterhouse could pursue the issue of consolidation under the Companies Code as it stood, and that the most Price Waterhouse could insist upon was disclosure by way of note.⁽⁾

The audit working papers do not reveal whether Price Waterhouse gave any specific consideration to the materiality of the affairs of these entities when they carried out the audit for the year ended 30 June 1988.

Price Waterhouse made the following submission, in August 1992, regarding the consideration they gave in 1988 and 1989 to possible disclosures by way of note to the accounts which might have been required in order for the accounts to give a true and fair view of the affairs of Beneficial Finance and the Beneficial Finance Group:

"The Audit Opinion Clearance checklist, which was completed by the manager in charge of each BFCL audit and approved by the partner, required the manager to consider whether all matters necessary for the accounts to show a true and fair view had been disclosed.

The underlying assets of the Kabani type companies would have been predominantly receivables with some property and investment; the liabilities would have been funding by BFCL and third parties. In the context of the BFCL accounts for any of the periods under review we considered that for reasons set out [below] non disclosure of the underlying assets and liabilities did not affect the truth and fairness of BFCL's accounts.

BFCL's loans to off-balance sheet entities were fully disclosed in the accounts when they became significant. The disclosure on which we insisted, identified each individual loan and was more than required under prevailing accounting standards. Third party funding of off-balance entities was generally secured on the assets of the entities concerned; in certain cases they were also the subject of guarantees from BFCL and consequently included in BFCL's contingent liabilities. The full amount of BFCL's exposure to off-balance sheet entities was therefore included in BFCL's accounts.

With respect to the nature of the business activities being conducted through the Kabani type companies, they were predominantly of the nature encompassed by the principal activities description in the Directors' Report ie,

`The principal activities of the Beneficial Finance Group involve the provision of an extensive range of financial services to business, commercial and corporate sectors.'

Consequently no additional disclosure was considered necessary in order to give a true and fair view of the affairs of BFCL.

We would also refer to the fact that frequent mention was made of the activities of the off-balance sheet entities in BFCL's published accounts commencing 1986/87."⁽⁾

In subsequent submissions, however, Price Waterhouse argued that Section 269 of the Code does not contain any overriding requirement that, notwithstanding the absence of a holding company/subsidiary relationship, the group accounts, in order to provide a true and fair view, must include any disclosure relating to off-balance sheet entities.⁽⁾ They seem to argue that the true and fair override does not require disclosure of any information relating to off-balance sheet entities other than that required by Regulations 33 and 34 of Schedule 7.⁽⁾ In my opinion, this is incorrect, and the true and fair override is not limited by Schedule 7.

In my opinion, if such a review as that implied in the August 1992 submission had been undertaken, the failure to document it in the work papers would, having regard to the applicable Professional Standards and Practices,⁽⁾ constitute an inadequacy in the audit procedures.

I take the reference in the submission to "frequent mention" of the activities of the off-balance sheet entities to be references from time to time in the review of operations which accompanied the statutory accounts, but did not form part of them. This supports the view that these activities were considered by Beneficial Finance to be an important activity of the group, and therefore should have formed part of the financial information provided in the accounts.

Further, such mention of the activities of the off-balance sheet entities does not, in my opinion, make up for inappropriate and inadequate disclosure in the accounts. On the contrary, in my opinion, users of the accounts could have been misled by inappropriate mention of the activities of the off-balance sheet entities to believe that relevant financial information concerning these activities was included in the accounts.

The Beneficial Finance 1987-1988 Annual Report contained the following references to business undertakings that were in fact off-balance sheet undertakings, although that was not made clear in the Annual Report:

(i) The cover of the Annual Report featured two photographs which appear to be of the Mindarie Keys property development.

(ii) At page 8 of the Annual Report there was a full page photograph of the Mindarie Keys development with the following caption:

"Mindarie Keys, WA, a tourist, residential and marina development with Australia's largest man made in-shore harbour - a Beneficial joint venture project."

(iii) At page 9 of the Annual Report was a report on the activities of the Corporate Services division, which noted a move towards:

"... risk position taking in real estate developments.

Illustrative of transactions undertaken by Beneficial is the construction of the new IBM Centre and the residential/resort development of Mindarie Keys in Perth ..."

Beneficial Finance's only equity interest in the Mindarie Keys development was a 50 per cent interest in the joint venture held by a wholly owned subsidiary of Kabani.

In my opinion, a reader of the above statements could interpret them to mean that the Beneficial Finance Group had taken an equity position in a joint venture to develop the Mindarie Keys property, and that equity interest would be included in the accompanying accounts of the Beneficial Finance Group. Because the relevant interest was held through the off-balance sheet entities, and was not included in the consolidated accounts, in my opinion, the above representations, made in the Annual Report by the references to Mindarie Keys, could have been misleading.

My examination of the audit files of both Beneficial Finance and the material off-balance entities identified the following information, which was not separately disclosed in the audited consolidated accounts at 30 June 1988:

	$’M
Amounts receivable by Beneficial Finance from
associated companies	74.4
controlled off-balance sheets entities	2.7
Amounts payable by Beneficial Finance to
associated companies	11.2
controlled off-balance sheets entities	32.0
Equity investments in associated companies	7.2

Furthermore, the Investigation has prepared a proforma consolidated balance sheet and profit and loss statement of Beneficial Finance, its subsidiaries and off-balance sheet entities at 30 June 1988. This analysis was prepared by reference to the respective audited accounts of each relevant entity at 30 June 1988; and the figures have not been adjusted for the matters noted elsewhere in this Chapter.

	BFCL and Subsidiaries $’M		BFCL Group and Controlled Entities $’M		Difference $’M

Current Assets
Property developments		-		8.2		8.2
Other		1,093.7		1,211.6		117.9
		1,093.7		1,219.8		126.1
Non-Current Assets
Property developments		11.1		49.7		38.6
Property, plant & equipment		8.2		8.2		-
Investments		9.1		3.9		(5.2)
Other		533.1		527.7		(5.4)
		561.5		589.5		28.0
Total Assets		1,655.2		1,809.3		154.1

Current Liabilities		815.6		943.4		127.8
Non-Current Liabilities		712.6		735.1		22.5
Total Liabilities		1,528.2		1,678.5		150.3

Net Assets		127.0		130.8		3.8

Profit After-Tax and
Extraordinary Items		19.0		20.0		1.0

For the purposes of this analysis, "property developments" include equity participation in property developments either under construction or fully constructed and held for resale.

The above analysis shows that:

(i) amounts receivable by Beneficial Finance from associated companies at 30 June 1988, amounting to $74.4M, represented 4.8 per cent of total receivables;

(ii) the effect of consolidating the off-balance sheet entities at 30 June 1988 would have resulted in Beneficial Finance reporting that:

. consolidated assets of Beneficial Finance were approximately $154.1M (9.3 per cent) greater than those disclosed in the statutory accounts;

. consolidated liabilities of Beneficial Finance were approximately $150.3M (9.8 per cent) greater than those disclosed in the statutory accounts;

. Beneficial Finance's equity participation in property developments was approximately $46.8M or four times greater than that disclosed in the statutory accounts ($11.1M); and

. the consolidated after-tax profit (after extraordinary items) of Beneficial Finance and controlled entities was approximately $1.0M (5.3 per cent) greater than that disclosed in the statutory accounts.

In my opinion, the significance of the paragraph in bold above is greater than it would otherwise be in the light of the statement, at page 9 of the 1987-1988 Annual Report, that the Beneficial Finance Group had during the year moved towards "risk position taking in real estate developments". The user of the accounts would, in my view, be materially misled as to both the extent of the risk exposure of the Beneficial Finance Group to property development, and the extent of the move in that direction during the year ended 30 June 1988.

Price Waterhouse have submitted that the figure in the paragraph in bold above incorrectly includes an amount of $22.0M in respect of relevant interests in the Mindarie Keys Hotel and the IBM Centre, and that this amount should be re-classified as "property, plant and equipment" rather than property developments.⁽⁾ I do not accept this submission.

These assets were property development ventures. In my opinion, such assets could not be properly classified as "property, plant and equipment" of the Beneficial Finance Group. They might arguably be classified as property investments. In any event, in my opinion, the assets represent direct property exposures of the Beneficial Finance Group, whether they are classified as property developments or investments. In my opinion, it is the nature of this exposure which leads to the conclusion that the disclosure of the above information was material to the truth and fairness of the accounts.

In my opinion:

(i) For the reasons set out in Chapter 41 - "Management and Financial Information Reporting", Beneficial Finance controlled the affairs of the off-balance sheet entities, and had the benefit of the profits and assets, and substantially bore the risk of loss and liabilities, of the off-balance sheet entities; accordingly, information about the results and affairs of the off-balance sheet entities was relevant to users relying upon the accounts in making evaluations or decisions.

(ii) Price Waterhouse should have considered whether any disclosure of information, corresponding to that which would have been included in the accounts if the off-balance sheet entities had been regarded as subsidiaries, was necessary in order for the accounts to give a true and fair view of the results and affairs of the Beneficial Finance Group in respect of the year ended 30 June 1988, but Price Waterhouse failed to do so.

(iii) For the reasons set out above, the results and affairs of the off-balance sheet entities were material to the results and affairs of the Beneficial Finance Group in respect of the year ended 30 June 1988.

(iv) It was inappropriate for Price Waterhouse to accept management's treatment of the off-balance sheet entities which failed to make any disclosures in the notes to the accounts.

(v) In order for the accounts to give a true and fair view of the results and affairs of the Beneficial Finance Group in respect of the year ended 30 June 1988 there should have been disclosed, in the notes to the accounts, information corresponding to that which would have been included in the accounts if the off-balance sheet entities had been regarded as subsidiaries.

(b) Statutory Disclosure Requirements

Regulations 33 and 34 of Schedule 7 of the Companies Code first applied to Beneficial Finance in respect of the year ended 30 June 1988.⁽⁾

Regulation 33 of Schedule 7 to the Code requires disclosure of prescribed information concerning rights or interests in material business undertakings.

"Business undertaking" is defined in Regulation 1(1) as follows:

"... any financial or business undertaking or scheme that is carried on by means of or through an unincorporated association, a joint venture, partnership or trust whether or not that undertaking or scheme is carried on in the State or elsewhere;"

Regulation 33 provides in part:

"(1) Where at the end of a financial period a company has a right or interest in a business undertaking that is material to the company the accounts of that company, in respect of that period, shall include a note specifying -

(a) the nature of that right or interest;

(b) where that undertaking is carried on by means of or through an unincorporated association, joint venture, partnership or trust that has a name - that name;

(c) the principal activities carried on during that period in the course of that undertaking;

(d) the amount and the percentage of that right or interest in that undertaking;

(e) the method of accounting used to record that right or interest;

(f) the contribution of that undertaking to the profit or loss of the company; and

(g) the value of products or services or products and services directly received by the company from that undertaking after allowing for costs incurred by the company in receiving those products or services.

(2) Where at the end of a financial period a company has rights or interests in more than one business undertaking none of which rights or interests are material to the company individually but in aggregate are material to the company, the accounts of that company in respect of that period shall include a note specifying in summary form -

(a) the principal activities carried on during that financial period in the course of those undertakings;

(b) the methods of accounting used to record those rights or interests, and in respect of each of those methods, the amount at which those rights or interests are recorded in the books of the company;

(c) the aggregate contribution of those undertakings to the profit or loss of the company; and

(d) the aggregate value of products or services or products and services directly received by the company from those undertakings after allowing for costs incurred by the company in receiving those products or services."

Corresponding provision is made in sub-regulations (3) and (4) for disclosures in the case of group accounts.

Regulation 34 further requires disclosure of prescribed information⁽⁾ where a corporation has a material interest (whether by way of shares, convertible notes, loans, advances or otherwise)⁽⁾ in another corporation, not being a subsidiary of the first-mentioned corporation, that was material to the first-mentioned corporation.

The Investigation found no evidence in the audit working papers for the year ended 30 June 1988 that the disclosure requirements of Regulations 33 and 34 were considered by Price Waterhouse.

It may be inferred from the audit working papers that Price Waterhouse formed the view that these business undertakings were not material to Beneficial Finance; but the Investigation found no evidence in the working papers that the auditors had given adequate consideration to whether the loans to off-balance sheet entities included significant amounts which were, in substance, direct property or other investment exposures as opposed to credit risks of the kind undertaken by Beneficial Finance in the ordinary course of its business as disclosed in its accounts. Had the off-balance sheet entities been consolidated or otherwise disclosed, the true nature of the investment exposure would have been apparent to users of the accounts.

Price Waterhouse made the following submission in relation to the application of Regulations 33 and 34 in 1988 and 1989:⁽⁾

"The Audit Opinion Clearance checklist, which was completed by the manager in charge of each BFCL audit and approved by the partner, required the manager to consider whether all matters requiring disclosure under Schedule 7 to the Companies (South Australia) Code had been disclosed in the accounts.

It is considered that the disclosure requirements of Clauses 33 and 34 of Schedule 7 to the Companies (South Australia) Code in relation to the half yearly audits referred to above was not required on the grounds of materiality. Clause 33 applied to business undertakings; only a few off-balance sheet entities which were not significant could be classified as business undertakings, the majority being corporations and consequently governed by the disclosure requirements of Clause 34.

Clause 34 was referred to specifically in a Discussion Paper produced by a Price Waterhouse manager, P Francis, dated 15 March 1989. In this paper under the heading Seventh Schedule, referring to Clause 34, it is stated that:

`In the case of Beneficial, no amount is likely to be material. As a result this clause (Clause 34) of the Seventh Schedule does not add to the disclosure already required by the various standards.'

The `various standards' being referred to in the Discussion Paper were those on equity accounting and related party disclosure. Full disclosure as required under these accounting standards was made in the accounts of BFCL once loans to off-balance sheet entities became significant and, in doing so, the requirements of Clause 34 were complied with.

... we formed the view that the off-balance sheet entities were not material business undertakings of BFCL in 1988 and 1989 under Clause 33 or material corporations, not being subsidiaries, under Clause 34, for accounting periods prior to 30 June 1989.

In determining whether a business undertaking or corporation was material in relation to the disclosure requirements of Clauses 33 and 34 the following factors were taken into account:

. the investment by BFCL, if direct

. the amount of any loans advanced by BFCL

. the net assets of the entity

. the contribution made by the entity to BFCL's results for the period".

In my opinion, if such a review had been undertaken, the failure to document it in the work papers would, having regard to the applicable Professional Standards and Practices,⁽⁾ constitute an inadequacy in the audit procedures.

According to the above submission, Price Waterhouse failed to consider the nature of the underlying investment undertaken through the off-balance sheet entities. In my opinion, having regard to the applicable professional standards and practices, they should have considered that matter.⁽⁾

Price Waterhouse have submitted that the reference in Regulation 33 to an "interest in a business undertaking" does not refer to an interest in the underlying asset but, in this case, to the shares in the Kabani type companies.⁽⁾ This submission appears to be put on the basis that, if one disregards the share trusts, Beneficial Finance would have an interest in the shares in the Kabani type companies, which would not, at law, confer any interest in the assets or business of the Kabani type companies. In my opinion, this interpretation would place an unwarranted restriction upon the term "business undertaking" defined in Regulation 1(1) of Schedule 7. The definition is set out above. Whatever the scope of Regulation 33, there was no disclosure which could be said to have complied with it.

Price Waterhouse also submitted that Regulation 34 would only be triggered if Beneficial Finance had legal title to the shares in the Kabani type companies, which it did not because of the existence of the share trusts.⁽⁾ In my opinion, this overlooks the provisions of Regulation 34, which applies where a corporation has a material interest whether by way of shares, loans or otherwise in another corporation.

In my opinion, for the following reasons, Price Waterhouse in the above submissions have erred as to the interpretation of Regulations 33 and 34 of Schedule 7.

As noted in Chapter 41 - "Management and Financial Information Reporting" in my opinion Beneficial Finance had a vested equitable interest in the trusts through which the shares in the off-balance sheet entities were held. In my opinion, this means that each of the financial or business undertakings or schemes carried on by off-balance sheet entities which were subsidiaries of Kabani, Malary, Lagan or Fortina were "financial or business undertakings or schemes carried on by means of or through a trust" within the meaning of the definition of "business undertaking" in Regulation 1 (1) of Schedule 7. Regulation 33 (2) provides that all such business undertakings must be aggregated for the purpose of determining materiality.

In my opinion, for the purpose of determining the materiality of an interest in a corporation under Regulation 34, it is necessary to consider the consolidated financial information of the corporation and its subsidiaries. That is, the materiality of Beneficial Finance's interest in Kabani could only be considered by reference to consolidated financial information of Kabani and its subsidiaries. Regulation 34 defines "interest" to include loans and advances made to the relevant corporation. In my opinion, Price Waterhouse in the above submission have erred as to the interpretation of Regulation 34. In my opinion, if they had considered this matter, they should have determined that Kabani was material to Beneficial Finance.

I am not, however, satisfied that they did consider Regulations 33 and 34. There is nothing in the work papers to evidence such a consideration.

Based on the evidence examined by the Investigation, and for the reasons set out above, I have formed the opinion that Price Waterhouse did not perform adequate concluding procedures in that they failed to consider whether the accounts complied with Regulations 33 and 34 of Schedule 7 to the Code.

57.5.3.5 Matters Noted - Equity Accounting of Off-balance sheet Entities

Equity supplementary financial statements were not prepared at 30 June 1988. In the Audit Planning Memorandum for the year ended 30 June 1988, Price Waterhouse commented that, in relation to off-balance sheet entities:

"... It is considered that if profits ever become material it would be necessary for them to be disclosed under the Equity Accounting Standard".

A file note,⁽⁾ prepared by Mr Clark, of a meeting held on 28 April 1988, and attended by Mr Reichert, Mr Martin, Mr Graham, Mr Kane, and Mr Giles, recorded the following:

"... It was agreed that Beneficial should now draft pro-forma equity supplementary financial statements to reflect this transaction. [ie the sale of the Centrelease Group of companies from Kabani Pty Ltd to Asset Risk Management Ltd]. It was also agreed that if settlement conditions for ARM were deferred until July 1988, it would not be necessary to prepare Equity Statements as at 30 June 1988 on the grounds of materiality. Nevertheless, the cumulative effect of other transactions may still determine that equity statements are required."

The Minutes of the Beneficial Finance Board meeting held on 29 April 1988 record that the Board requested management to prepare a projected equity accounting balance sheet as at 30 June 1988, including off-balance sheet operations and a comparison projected standard set of accounts, both to be tabled at the May 1988 Board meeting. It appears that no such accounts were prepared or tabled.

The sale of the Centrelease Group of companies to Asset Risk Management Ltd was effected prior to 30 June 1988. The audited accounts of those two companies at 30 June 1988 (audited by Price Waterhouse) confirm this. Despite this, the Investigation found no evidence in the audit working papers to support the decision by Beneficial Finance not to prepare equity supplementary financial statements.

Price Waterhouse made the following submissions in relation to the application of AAS14:

"... notes of a meeting held between representatives of Price Waterhouse and BFCL on 28 April 1988, referred to materiality as being the deciding factor as to whether equity accounted supplementary financial statements would be prepared for the year ended 30 June 1988. This issue was considered in detail in a memorandum dated 24 March 1988 titled `ARM Ltd/Equity Accounting prepared for J A Baker by J G Graham and E P Reichert of BFCL'. This memorandum identified two investments which in the authors' opinion satisfied the definition of associated company and calculated that the effect of equity accounting for these investments would not be material. The agenda for a meeting between J A Baker and Price Waterhouse on 28 July 1988, filed in the 30 June 1988 working papers, shows equity accounts for period after 1 July 1988 being a matter for discussion at the meeting (Item 1(b) of the agenda). This evidences our consideration of the issue of equity accounting at the time of the 30 June 1988 audit."⁽⁾

The Investigation has examined the memorandum dated 24 March 1988, referred to in the Price Waterhouse submission; the memorandum does not treat the Kabani type off-balance sheet entities as being "associated companies" within the meaning of AAS14. The Investigation has calculated that, had the Kabani type off-balance sheet entities been regarded as associated companies, (based on the audited accounts of the relevant entities), Beneficial Finance's shares of associated company profits after-tax for the year ended 30 June 1988 would have been $1.8M. This represents, 9.5 per cent of the consolidated after-tax profit for the year, and having regard to the nature of the assets, in my opinion should have been material.

As noted above, I am not satisfied that Price Waterhouse carried out appropriate procedures in connection with the 1988 audit to determine the question of materiality in the context of equity supplementary financial statements.

Price Waterhouse submitted that compliance with AAS14 was not required by law, since it was not an approved accounting standard, but they acknowledged that generally accepted accounting practice would have required compliance with the standard.⁽⁾ I note that the Auditor's Report stated their opinion that the accounts complied with Australian Accounting Standards.

Professional Standards and Practices

Australian Accounting Standard AAS14 "Equity Method of Accounting" , November 1986, issued by the Professional Accounting Bodies required Beneficial Finance to present equity supplementary financial statements in its audited accounts if Beneficial Finance had a material investment in associated companies.

I refer to my finding, set out in more detail in Chapter 41 - "Management and Financial Information Reporting", that Beneficial Finance had a vested equitable interest in all the shares in the four off-balance sheet entities, Kabani Pty Ltd, Malary Pty Ltd, Fortina Pty Ltd, and Lagan Pty Ltd, under the terms of the relevant trusts.⁽⁾ This interest was subject to Beneficial Finance being divested in favour of other beneficiaries in exercise of the trustee's discretion upon termination of the trusts at any time. Nevertheless, it is clear that the trustee's discretion had not been exercised as at 30 June 1988.

Paragraph 2 of AAS14 sets out the following definitions:

"Associated company" means an "investee", not being a subsidiary of the "investor", over which the investor has "significant influence".

"Investor", means a company that holds an "ownership interest" in the share capital of another company ("the investee").

"Ownership interest", means the percentage of shares held in a company, whether such shares are held directly, or indirectly through a subsidiary(ies) and/or associated company(ies), or their respective nominees. The percentage of shares excludes shares which carry no right to participate beyond a specified amount in the distribution of the company's profits or in the ultimate distribution of its assets.

"Significant influence" means the capacity of an entity to affect substantially the financial and/or operating policies of another entity."

Based on the evidence examined by the Investigation and for the reasons set out above, I have formed the opinion that Price Waterhouse did not perform adequate concluding procedures in that they failed to adequately assess whether the audited accounts should have complied with AAS14.

57.5.3.6 Opinion - Concluding Procedures

Based on the evidence examined by the Investigation, and for the reasons set out above, I have formed the opinion that the manner in which Price Waterhouse dealt with certain issues arising on the audit was neither appropriate nor adequate, in the following respects:

(a) Price Waterhouse accepted non-disclosure of an abnormal profit of $8.3M on Blossom Park, which AAS1 required to be separately disclosed in the accounts. The decision of Price Waterhouse was therefore inappropriate.

(b) Price Waterhouse did not adequately deal with a number of matters relevant to the off-balance sheet entities, and in particular:

(i) whether the truth and fairness of the accounts was impaired in the absence of disclosure of adequate information pertaining to the off-balance sheet entities;

(ii) the disclosure requirements of Regulations 33 and 34 of Schedule 7 to the Code; and

(iii) whether equity supplementary financial statements should have been prepared, as required by AAS14.

(d) Consequently, no information pertaining to the off-balance sheet entities was disclosed in the accounts when, in my opinion, information and notes corresponding to that applicable to subsidiaries was required in order for the accounts to give a true and fair view of the results and affairs of the Beneficial Finance Group.

By reason of the foregoing, Price Waterhouse's conclusion that the accounts for the year ended 30 June 1988 complied with Section 269 of the Companies Code and gave a true and fair view was inappropriate.

In my opinion, the audit opinion expressed by Price Waterhouse on the accounts for the year ended 30 June 1988 was inappropriate, and the carrying out of the audit process leading to that opinion was inadequate, in the following respects:

(a) Price Waterhouse did not give appropriate or adequate consideration to the proper accounting treatment and disclosure of the results and affairs of the off-balance sheet entities.

(b) The accounts of Beneficial Finance and the Beneficial Finance Group did not give a true and fair view by reason of the failure to provide information in the notes to the accounts with respect to the off-balance sheet entities corresponding to the disclosure applicable to the results and affairs of subsidiaries, in particular, the nature and extent of Beneficial Finance's direct property exposures through the off-balance sheet entities.

(c) The Blossom Park profit of $8.3M should have been disclosed in the accounts as an abnormal item as required by AAS1, and the decision of Price Waterhouse to accept non-disclosure was inappropriate.

(d) The accounts of Beneficial Finance and the Beneficial Finance Group did not give a true and fair view by reason of the failure to disclose the Blossom Park profit as an abnormal item.

30 June 1998
$’M

30 June 1987
$’M

Allocated provisions

Unallocated provisions