CHAPTER 58
REVIEW OF THE 1989 EXTERNAL AUDIT
OF BENEFICIAL FINANCE
TABLE OF CONTENTS
58.1 PURPOSE OF CHAPTER
58.2 PLAN OF CHAPTER
58.3 BUSINESS OF BENEFICIAL FINANCE CORPORATION LIMITED
58.3.1 BENEFICIAL FINANCE CORPORATION LIMITED AND SUBSIDIARIES
58.3.2 OFF-BALANCE SHEET ENTITIES
58.4 ACCOUNTS OF BENEFICIAL FINANCE CORPORATION LIMITED
58.5 INVESTIGATION OF THE AUDIT PROCESS
58.5.1 PLANNING OF THE AUDIT PROCESS
58.5.1.1 Preamble
58.5.1.2 Matters Noted
58.5.1.3 Professional Standards and Practices
58.5.1.4 Opinion - Planning of the Audit
58.5.2 EXECUTION OF THE AUDIT PROCESS
58.5.2.1 Preamble
58.5.2.2 Matters Noted - Shockproofing
58.5.2.3 Matters Noted - Provision for Doubtful Debts
58.5.2.4 Opinion - Execution of the Audit
58.5.3 CONCLUDING PROCEDURES
58.5.3.1 Preamble
58.5.3.2 Matters Noted - Shockproofing
58.5.3.3 Matters Noted - Disclosure of information pertaining to Off-balance Sheet Entities
58.5.3.4 Opinion - Concluding Procedures
58.6 CONCLUSION
58.1 PURPOSE OF CHAPTER
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 1988-1989, and significant features of the statutory accounts in respect of the 1988-1989 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 1989. The Chapter also concludes as to the appropriateness and adequacy or otherwise of the audit process undertaken.
58.2 PLAN OF CHAPTER
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;
(c) Investigation of the Audit Process;
(i) Planning of the Audit Process;
(ii) Execution of the Audit Process; and
(iii) Concluding Procedures;
(d) Conclusion.
58.3 BUSINESS OF BENEFICIAL FINANCE CORPORATION LIMITED
58.3.1 BENEFICIAL FINANCE CORPORATION LIMITED AND SUBSIDIARIES
The 1988-89 financial year again saw Beneficial Finance record a marked growth in profitability and in the level of assets held. As in the past year, a major segment of business involvement related to the provision of finance to the corporate and commercial business sectors throughout Australia, associated with residential, commercial, and leisure/tourist property developments.
Consistent with the previous 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
(c) the 1985 Trust Deed for Debenture Stock and Unsecured Notes.
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 1989.
58.3.2 OFF-BALANCE SHEET ENTITIES
The Beneficial Finance off-balance sheet network of entities and activities, which expanded considerably in the previous financial year, was again extended in 1988-89.
In October 1988, the Investment Bank known as Campbell Capital Limited was acquired by Kabani Pty Limited (51 per cent ownership) and Beneficial Finance (49 per cent ownership).
58.4 ACCOUNTS OF BENEFICIAL FINANCE CORPORATION LIMITED
On 11 August 1989, an unqualified Audit Report was signed by Price Waterhouse in respect of the accounts of Beneficial Finance Corporation Limited for the year ended 30 June 1989. 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 1989 and the financial position of the Beneficial Finance Group at that date.
|
Beneficial Finance Group |
|||||||||||||
|
|
1987 |
1988 |
Per Cent Increase |
||||||||||
|
Revenue |
238.9 |
329.1 |
38 |
||||||||||
|
Operating Profit |
|||||||||||||
|
Pre Tax |
21.4 |
36.0 |
68 |
||||||||||
|
After Extraordinary Item |
|||||||||||||
|
and Tax |
19.0 |
30.0 |
58 |
||||||||||
|
Balance Sheet |
|||||||||||||
|
Assets |
|||||||||||||
|
Receivables |
1546.4 |
2091.0 |
35 |
||||||||||
|
Other |
108.8 |
159.4 |
|||||||||||
|
1655.2 |
2250.4 |
36 |
|||||||||||
|
Liabilities |
|||||||||||||
|
Borrowings |
1459.6 |
1954.5 |
34 |
||||||||||
|
Other |
68.6 |
128.1 |
|||||||||||
|
1528.2 |
2082.6 |
36 |
|||||||||||
|
Net Assets |
127.0 |
167.8 |
32 |
||||||||||
|
Shareholders Equity |
|||||||||||||
|
Share Capital |
85.0 |
125.0 |
|||||||||||
|
Reserves |
42.0 |
42.8 |
|||||||||||
|
127.0 |
167.8 |
32 |
|||||||||||
|
Doubtful Debts |
|||||||||||||
|
Expense for the Year |
20.4 |
16.5 |
(18) |
||||||||||
|
Provision at Balance Date |
23.4 |
31.1 |
33 |
||||||||||
The 1988 comparative balances included in the 1989 audited accounts include some re-classifications of figures appearing in the 1988 audited accounts.
58.5 INVESTIGATION OF THE AUDIT PROCESS
58.5.1 PLANNING OF THE AUDIT PROCESS
58.5.1.1 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 dealt with. An integral part of the audit planning process, therefore, includes gaining an understanding of a company's business, its accounting systems, its internal control environment, and an assessment of identified risks.
58.5.1.2 Matters Noted
(a) Risk Assessment
Consistent with previous audits, two planning documents were prepared by Price Waterhouse for the December 1988 and June 1989 audits:
(i) A strategic plan was prepared for the December 1988 audit and approved by Mr A H Giles (engagement partner), Mr D R Clark (second partner), Mr A W Hirst (tax partner), Mr G Acutt (EDP manager), and Mrs T Anthon (senior). This document is undated.
(ii) A strategic plan was prepared for the June 1989 audit to reflect conditions then relevant. This document was signed by Mr Giles, Mr Clark, Mr Hirst, Mr Acutt, and Mrs Anthon (assistant manager), in July 1989.
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.
The strategic plan notes that Price Waterhouse were cognisant of the organisational restructure which took place during the year under review, and that this was considered in their assessment of business, inherent, and overall audit risk.
It is evident from the planning documentation that Price Waterhouse viewed the audit as one of high risk. Overall audit risk was assessed as high. The factors identified by Price Waterhouse to support this assessment were set out in the June 1989 strategic plan and included:
(i) the increase in interest rates and the long term pessimism about the economy;
(ii) rapid growth in the receivables portfolio;
(iii) a continuation of the aggressive growth oriented approach to business in the finance industry, with diversification into new products;
(iv) decentralisation of the collections system; and
(v) continuing teething difficulties with the new receivables system.
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, to even out an improving profit trend, income earned in a particular accounting period may be deferred, and spread over a number of accounting periods. 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 declares 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 states that:
"The internal audit function which has a high degree of independence contributes strongly to the Group's system of internal controls. This year, as in previous years, our fee proposal was prepared and accepted by the company on the understanding that internal audit would conduct a substantial amount of systems testing of the branches. Staff from PW Adelaide will continue to accompany the internal audit team with two branch visits each year. This enables us to maintain a working knowledge of branch operations and also to review the performance of the internal auditors in the field.
The internal audit work programmes have been drawn up with the agreement of PW. We must continue to monitor their work to ensure sample sizes and basis of selection are adequate and we must consider the implications of their reports on the company. Our contact with Internal Audit indicates that the department is not adequately staffed at present, although internal auditors are competent and staff members well supervised. 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 internal auditors' work.
The chief GM - Finance, Credit and Personnel considers the internal audit team numbers to be adequate and an analysis of internal audits performed in the last twelve months will be done to ensure that adequate coverage has been obtained."
It is evident from the audit working papers that Price Waterhouse acted accordingly, and did sufficient work to satisfy themselves that reliance could be placed on the work performed by Internal Audit.
(c) Disclosure of information pertaining to Off-balance Sheet Entities
The June 1989 strategic plan identifies a number of off-balance sheet entities which required consideration from an audit viewpoint:
"In addition to the audit of the Beneficial Group, we are also engaged to audit the accounts of various off balance sheet joint ventures. The audits will be performed by separate audit teams immediately after the main audit each 6 months for seven of the larger joint ventures, namely:
. Asset Risks Management Group (ARM) comprising 5 entities
. Beneficial Equipment Rentals - rental business
. Centrelease Equipment Finance - finance leases
. Centrelease Equipment Rental - rental business winding down
. Centrelease Finance Corporation - to utilise tax losses
. Centrelease Brokerage - holding company
. Allied Westralian Finance Ltd - WA retail finance
. Pegasus Securities Leasing Joint Venture - bloodstock finance
. First Pacific Mortgage Ltd - mortgage banking
. Equus - Timeshare finance
. South State Finance Ltd - NZ retail finance
. First Pacific Insurance Ltd (formerly Dynock) - insurance brokers ...
The joint ventures are used as vehicles for a variety of finance activities and allow Beneficial to grow quickly whilst still complying with the restrictions of the Trust Deeds. They also "tie-in" significant suppliers of business to Beneficial. The Trustees are, we understand, aware of all Beneficial's activities.
A significant exercise has been carried out in the last three months to assess the effect of consolidating all Beneficial managed entities and to ascertain which entities should be equity accounted ..."
58.5.1.3 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, in order to assess their impact on the audit of the accounts, and to take them into account in developing the audit programme.()
58.5.1.4 Opinion - Planning of the Audit
Based on the evidence examined by the Investigation, I have formed the opinion that the planning phase of the 1989 external audit of Beneficial Finance was appropriate and adequate.
58.5.2 EXECUTION OF THE AUDIT PROCESS
58.5.2.1 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.
58.5.2.2 Matters Noted - Shockproofing
(a) Introduction
As discussed in Chapter 57 - "Review of the 1988 External Audit of Beneficial Finance" 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 categorised them as shockproofing actions; and
(iii) considered the aggregate impact of shockproofing on the reported profits of Beneficial Finance.
The reported pre tax profit for the year ended 30 June 1989 was $36.0M. In their audit management letter, dated 30 October 1989, addressed to Mr M Chakravarti, Price Waterhouse reported that the net effect of shockproofing on the 1989 accounts was to increase the reported pre tax profit by approximately $0.7M. In my opinion, the net effect was not material.
Details of the Price Waterhouse estimates of shockproofing as set out in the audit management letter dated 30 October 1989, are summarised as follows:
|
Item |
$M |
$M |
|
|
Fee income not recognised |
5.5 |
||
|
Managing Director’s contingency fund |
1.0 |
||
|
Provision for Head Office refurbishment |
0.7 |
||
|
Immediate write-off of goodwill |
0.5 |
||
|
Sundry other prudent accruals |
1.2 |
||
|
8.9 |
|||
|
less: |
|||
|
Provision for loss on Equiticorp |
3.1 |
||
|
Effect of change in long service |
0.5 |
||
|
Sundry provisions not recognised |
1.2 |
||
|
4.8 |
|||
|
Price Waterhouse estimate of prudent accruals |
4.1 |
||
|
Price Waterhouse estimate of prudent accruals |
4.8 |
||
|
Net increase in Pre-tax profit for the year |
0.7 |
Set out below is an explanation of the significant shockproofing actions, including a discussion of the related audit procedures adopted by Price Waterhouse and relevant professional standards and practices. The Investigation observed that each of these shockproofing actions was brought to the attention of Mr Giles. I comment below upon the manner in which Mr Giles dealt with this issue. The preceding Chapter contains a discussion of "prudent accruals" at 30 June 1988.
(b) Fee Income in Suspense - $5.5M
As discussed in Chapter 57 - "Review of the 1988 External Audit of Beneficial Finance", 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"
Nevertheless, as noted in the Beneficial Finance Board Minutes of 24 February 1989,() the accounting policy for recognition of fee income was amended during the 1989 financial year:
"...
(c) Fee Income It was reported that the policy was to take up fee income when earned for amounts less than $10,000 and to take up over the life of the asset amounts in excess of $10,000 if yield related on large transactions, or otherwise over 12 months."
The audit working papers indicate that Price Waterhouse calculated the prudent component of fee income in suspense by reference to the policy adopted in January 1988, and not the policy adopted in February 1989. The audit working papers() show that, at 30 June 1989, total fee income in suspense was $7.8M (1988 - $6.0M). Price Waterhouse determined that, had the January 1988 policy been followed, additional fee income of approximately $5.5M (1988 $2.5M) would have been recognised as income at June 1989 rather than being held in suspense.() This represents an increase of $3.0M during the 1989 financial year.
The Investigation found no evidence in the audit working papers that Price Waterhouse determined whether fee income had been recognised in accordance with the amended policy of February 1989.
The audit working papers,() however, indicate that the prudent component of fee income in suspense largely relates to Unit Trust deals. The working papers further note that:
"1. Unit Trusts
In tax ruling IT 2512 relating to the financing of Unit Trusts, the Tax Commissioner indicated that each trust would be reviewed in isolation and a decision made on its own merits. As such there is still some doubt that the deals will be tax effective and Beneficial may not earn the management fee. The commercial reality of an unfavourable ruling would be that Beneficial and the client would have to renegotiate the deal at higher rates or refinance the development. In either case the uncertainty of the change would make the prudence of not recognising income appropriate." ()
Professional Standards and Practices
At the time that the audit of Beneficial Finance for the year ended 30 June 1989 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 1989, 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 the 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) Provision for Head Office Refurbishment - $0.7M
As discussed in Chapter 57 - "Review of the 1988 External Audit of Beneficial Finance", a provision for Head Office refurbishment of $1.0M was included in the accounts of Beneficial Finance for the year ended 30 June 1988, which in my opinion was proper. The audit working papers() record that this provision was reversed during the year and had the effect of reducing the charge for repairs and maintenance by $1.0M. A similar provision of $0.7M was raised at 30 June 1989. The audit working papers() state that this is a prudent accrual.
Professional Standards and Practices
At the time that the audit of Beneficial Finance for the year ended 30 June 1989 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.()
Based on the evidence examined by the Investigation and having regard to applicable professional standards and practices, I have formed the opinion that the provision for Head Office refurbishment amount of $0.7M was regarded as shockproofing.
(d) Managing Director's Contingency Fund - $1.0M
The audit working papers() note that:
"... this account is simply used to "store profits" being intentionally raised to "shockproof" any downturns in future profit ..."
As discussed in Chapter 57 - "Review of the 1988 External Audit of Beneficial Finance", the balance in this account at 30 June 1988 was $0.5M.
Professional Standards and Practices
At the time that the audit of Beneficial Finance for the year ended 30 June 1989 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.()
Based on the evidence examined by the Investigation and having regard to the applicable professional standards and practices, I have formed the opinion that the increase in the Managing Director's contingency fund amounting to $0.5M had not been incurred at 30 June 1989, and accordingly should not have been treated as an expense in the Profit and Loss Statement for that year.
(e) Immediate Write-off of Goodwill - $0.5M
The audit working papers record that:
"Goodwill arising on the acquisition of First Pacific Insurance Brokers has been prudently written off because of the sustained losses of the company" ()
"Recommended treatment under AAS18 & ASRB1013 involves systematic amortisation against profit (State Bank policy is the same - with amortisation over 20 years).
However treatment can be justified on two grounds:
1 It is immaterial ($480K vs $30m profit)
2 Any carrying value could not be supported by probable future benefits, as the company continues to make losses and is dependent upon Beneficial for continued operations (AAS18 para 41)" ()
"The future of FPIB is unclear because of sustained losses. For this reason together with materiality we can accept the write-off which, in any event, is prudent" ()
Professional Standards and Practices
Approved Accounting Standard ASRB1013 "Accounting for Goodwill" ("ASRB1013"), August 1988, issued by the Professional Accounting Bodies, requires goodwill arising on the acquisition of subsidiaries to be written off to the extent that future benefits are no longer probable.
Paragraph 35 of ASRB 1013 provides that:
"Goodwill which is purchased by the company shall be systematically amortised to the profit and loss account over the period of time during which the benefits are expected to arise. The period over which goodwill is to be amortised shall not exceed twenty years."
Paragraph 36 of ASRB1013 provides that:
"The unamortised balance of goodwill shall be reviewed at each balance date and charged to the profit and loss account to the extent that future benefits are no longer probable."
Based on the evidence examined by the Investigation, and for the reasons set out above, I have formed the opinion that it was appropriate to write off the goodwill arising on acquisition of First Pacific Insurance Brokers Ltd in full in the year ended 30 June 1989, hence the amount was not a shockproofing item.
(f) Change in Long Service Leave Provision - $0.5M
In June 1989 Beneficial Finance revised the basis on which it calculated provisions for long service leave, so as to comply with a new policy endorsed by the directors of the Bank. The effect of this change was to reduce the provision that would otherwise have been calculated by $0.5M.
The new policy is as follows:
"All group companies are to comply with the requirements of their industrial awards and agreements. Liability for long service leave is to be based on completed years of service.
PROVISION FOR LONG SERVICE LEAVE IS TO COMMENCE TWO YEARS PRIOR TO THE COMMENCEMENT OF THE LEGAL LIABILITY TO PAY THE BENEFIT.
Provision for long service leave does not apply to operating outside of Australia."
As discussed in Chapter 57 - "Review of the 1988 External Audit of Beneficial Finance", Beneficial Finance previously determined long service leave provisions on a pro rata basis, irrespective of length of service.
Based on the evidence examined by the 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 item was not a shockproofing item.
(g) Sundry Prudent Accruals - $1.2M
The audit working papers() indicate that Price Waterhouse viewed the sundry balance of $1.2M, which comprises a number of immaterial prudent accruals, as provisions for expenses that had not been incurred at 30 June 1989. As discussed in Chapter 57 - "Review of the 1988 External Audit of Beneficial Finance", sundry prudent accruals at 30 June 1988 amounted to $0.8M.
Professional Standards and Practices
At the time that the audit of Beneficial Finance for the year ended 30 June 1989 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.()
Based on the evidence examined by the Investigation and for the reasons set out above, I have formed the opinion that the increase in sundry prudent accruals amounting to $0.4M, represented provisions for expenses that had not been incurred at 30 June 1989, and accordingly should not have been recognised in the Profit and Loss Statement in that year.
(h) Provision for loss on Equiticorp not Recognised - $3.1M
In a letter, addressed to Mr J A Baker (Managing Director) from Mr D C Masters (General Manager, Corporate Banking, State Bank of South Australia), dated 13 January 1989, Beneficial Finance was offered the opportunity to underpin $10.0M of the Bank's exposure to Equiticorp Australia Limited ("Equiticorp"). Relevant extracts from that letter are as follows:
"Equiticorp Australia Limited ("Equiticorp")
1. Further to our telephone conversation earlier today I confirm that the exposure of State Bank of South Australia ("the Bank") to Equiticorp is as set forth in Schedule A hereto. Security held by the Bank in respect of its exposure is as set forth in Schedule B hereto ("the Securities").
2. As discussed, the Bank is proposed to offer to your company an opportunity to underpin the last $10,000,000.00 of its exposure to Equiticorp, in consideration of the Bank paying the sum of $100,000 forthwith upon your company's acceptance of this offer, if any of the following events occur:
(a) an application or order or resolution is passed for the winding up of Equiticorp;
(b) a receiver, receiver and manager, official manager or trustee is appointed or the holder of a security interest takes possession of any part of the property of Equiticorp;
(c) Equiticorp enters into or resolves to enter into any arrangement, composition or compromise with or assignment for their benefit of any of its creditors.
(d) Any action or proceeding is commenced in any court of any jurisdiction seeking to recover from Equiticorp any sum, or by way of distress, attachment, sequestration or other execution or relief for $100,000 or more.
3. If any of the occurrences described in paragraph 2 above result in the Bank exercising its powers pursuant to the Securities the Bank will use its best endeavours to recover all amounts available from the realisation thereof, firstly in respect of its own exposure, and secondly in respect of the amount underpinned by your Company.
4. The fee of $100,000 referred to above is consideration for your company's underpin and in the event of an occurrence described in paragraph 2 above, no recourse to the Bank by your company will be available, other than by way of the Bank's realisation of the Securities as set forth above.
5. Should this offer be acceptable to you please sign and return the attached duplicate copy of this letter forthwith, whereupon immediate payment of the fee of $100,000 above mentioned will be made."
" SCHEDULE A
|
EXPOSURE |
||
| Commercial Bill Acceptance |
$7,000,000.00 |
|
| Commercial Bill Acceptance/Discount |
$35,000,000.00 |
|
| Commercial Bill Acceptance/Discount (of which $5,000,000.00 is underpinned by R. & I. Bank of W.A.) |
$12,000,000.00 |
|
|
TOTAL |
$54,000,000.00 |
|
SCHEDULE B
SECURITIES
Guarantee dated 4th January 1989 from Equiticorp International plc"
Mr Baker signed that letter in the space required to signify acceptance of the offer on behalf of Beneficial Finance.
Equiticorp was placed in provisional liquidation on about 23 January 1989, and an official liquidator was appointed on 27 April 1989.
No specific provision was raised against this exposure in the accounts of Beneficial Finance at 30 June 1989. Rather it was simply included in a total amount of $266.0M disclosed as contingent liabilities at Note 17 to the accounts. I will discuss possible provisioning of Beneficial Finance's exposure under the underpin agreement in the section below on provisioning.
The audit working papers record that Price Waterhouse accepted this situation on the grounds that they believed that the Bank had agreed that Beneficial Finance need not provide:
"The State Bank have instructed Beneficial that a provision will not be necessary as the Bank will provide for any loss in its own books." ()
The statutory accounts were signed on 11 August 1989.
I accept the submissions of Price Waterhouse that, on about 18 August 1989, Mr Giles asked Mr Baker to confirm the arrangement with the Bank in writing to the auditors.()
Notwithstanding that what Mr Giles sought was confirmation, in a letter addressed to Mr Giles from Mr Baker dated 18 August 1989, only the following comment was made in relation to Beneficial Finance's guarantee to the Bank:
"Subject: JUNE 30, 1989 PROVISIONS
With regard to the $10 million contingent liability that Beneficial has in relation to Equiticorp, we will fully assess the need for a specific loss provision prior to completion of our half yearly accounts for the period ending December 31, 1989.
As we have discussed, Beneficial has surplus "shockproofing" accruals/provisions that would more than cover any potential loss on Equiticorp. This is particularly so on a present value basis, because any loss could not be quantified for many years."
Price Waterhouse then attempted to satisfy themselves, as recorded in the workpapers, that any possible under-provision could have been offset by the level of shockproofing included elsewhere in the accounts:
"However as the accounts contain a certain amount of profit-smoothing reserve, it was agreed between PW and Beneficial that the amount of prudent reserves be reduced by the discounted present value of $10m at 17% for seven years. This equates to $3,067,723." ()
Price Waterhouse submitted that this calculation was done only as a precaution against the unlikely event that, contrary to representations from management, Beneficial Finance might, at a later date, be called on by the Bank to suffer a loss under the underpin agreement.()
The Investigation found no evidence in the audit working papers that Beneficial Finance applied discounting concepts to the measurement of other assets and liabilities in its accounts.
Furthermore, the Investigation found no evidence in the audit working papers to support the use of a 17 per cent discount rate and seven year term in the discounting calculation adopted by Price Waterhouse in this context.
I accept the submissions of Price Waterhouse that the discounting of the $10.0M underpin amount was not a procedure they carried out in connection with forming their conclusion that they could properly sign an unqualified audit report in respect of the year ended 30 June 1989.()
Based on the evidence examined by the Investigation and for the reasons set out above, I have formed the opinion that, while the reduction of prudent accruals by $3.1M for, provision for loss on Equiticorp exposure not recognised, was not appropriate, it was not relied on by Price Waterhouse when concluding on the accounts.
(i) Sundry Provisions not Recognised - $1.2M
In their audit management letter, dated 30 October 1989, Price Waterhouse identified a number of provisions which, although individually immaterial, should, in their view, have been raised at 30 June 1989.
Based on the evidence examined by the Investigation, and having regard to applicable professional standards and practices, I have formed the opinion that Beneficial Finance should have included these Sundry Provisions as expenses of the year.
Based on the evidence examined by the Investigation, and having regard to applicable professional standards and practices, I have formed the opinion that the impact of shockproofing on the accounts for the year ended 30 June 1989 was not material.
58.5.2.3 Matters Noted - Provision for Doubtful Debts
The audited consolidated accounts of Beneficial Finance for the year ended 30 June 1989 disclose a provision for doubtful debts of $31.1M (1988 - $23.4M). The audit working papers() assert that this provision comprises two elements, namely, an allocated provision and an unallocated provision. The balance of these provisions was:
|
30 June 1989 |
30 June 1988 |
|||||
|
Allocated provision |
9.2 |
6.6 |
||||
|
Unallocated provision |
21.9 |
16.8 |
||||
|
31.1 |
23.4 |
|||||
The audited consolidated accounts show that the result for the year ended 30 June 1989 was arrived at after charging as an expense an amount of $14.5M (1988 $17.6M) relating to bad and doubtful debts.
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 five years ended 30 June 1989, was:
|
30 June 1989 |
1.02 per cent |
|
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) recommendation provision.
Price Waterhouse performed audit procedures to satisfy themselves as to the reliability of the Non-Performing Loans Review reports.
According to Beneficial Finance internal memoranda,() Mr T M Clark, Managing Director of the Bank, late in 1988, approached Mr Baker, Managing Director of Beneficial Finance, with the request that, for a fee, Beneficial Finance should agree to underpin the Bank's exposure to Equiticorp to the extent of $10.0M. The Beneficial Finance Executive Committee objected to the proposal, but Mr Baker put it to them that any resultant loss by Beneficial Finance could be claimed as a tax deduction, and that Mr Clark had undertaken that the Bank would restore Beneficial Finance's profit if a loss actually occurred.
The transaction was concluded by letter, dated 13 January 1989, signed on behalf of the Bank and Beneficial Finance. The text of the letter is set out above.
In my opinion, it was the Bank's intention that Beneficial Finance would not ultimately suffer any loss on the underpin agreement. This is confirmed by the evidence of Mr K L Copley, at that time General Manager, Group Finance, of the Bank.() Mr Copley gave evidence that it was the Bank's intention that the underpin agreement would be enforced for tax purposes, and compensation for the after tax loss of about $6.0M would be provided, but it was not clear how this would be implemented.
Mr Copley deposed that his view was that the Bank's intention to compensate Beneficial Finance for any loss would not in itself justify Beneficial Finance in not making a provision, but that he believed that no provision was required, because Beneficial Finance had a general provision which would be adequate to cover any loss.() Mr Baker provided a statutory declaration to the Investigation, dated 10 December 1992, in which he stated that Beneficial Finance did not need to raise a specific provision of $10.0M in relation to Equiticorp because there was a firm commitment from the Bank that Beneficial Finance would be compensated for any loss in relation to the Equiticorp underpin agreement. He stated that he believed that Beneficial Finance's general provision adequately covered the risk.
Price Waterhouse, in their submissions, have referred to a diary note of 4 May 1989 of Mr Copley, contained in their working papers, which discussed possible ways in which Beneficial Finance could be cushioned against the impact of the underpin agreement.() That diary note does not expressly evidence an undertaking by the Bank to compensate Beneficial Finance for any loss. Mr Copley confirmed, however, that he would have discussed the matter with Mr Giles of Price Waterhouse at some stage in the course of the 1989 audit, and that Mr Copley would have confirmed to Mr Giles that the ultimate arrangement would ensure that Beneficial Finance would not suffer any loss.
Mr Giles gave evidence that he attended a meeting, on 19 July 1989, with Mr Copley and Mr T J Whimpress and Mr M C H Burgess of the Bank's external auditors.() Mr Giles said he informed the meeting that, in view of the Bank's intention that Beneficial Finance would not suffer any loss, the Bank, and not Beneficial Finance, should provide for the $10.0M underpin amount in the 1989 accounts. Mr Giles said that no contrary view was put by Mr Copley. Mr Giles' said that, following the meeting, he believed that no doubt existed that Beneficial Finance would not be providing, and that it was therefore the responsibility of the Bank to provide. Mr Burgess asserted, however, that the joint auditors put their position at this meeting that Beneficial Finance should provide for the loss, and that, so far as they were concerned, the matter was not resolved at the meeting.() Mr Burgess' evidence supports Mr Giles, in that Mr Burgess had no recollection of Mr Copley reacting or commenting at all upon the position taken by Price Waterhouse.() That would be consistent with Price Waterhouse's position coming as no surprise to Mr Copley. I accept Mr Giles' evidence concerning his belief as to the outcome of the meeting.
Mr Copley prepared a paper, dated 24 July 1989, which was presented to the Bank Board at its meeting on 27 July 1989.() In the section dealing with specific provisions, Mr Copley drew attention to Equiticorp, which was a major item for 1989:
"... we have provided on the basis of a loss of $0.40 [in the dollar] which amount totals $20M."
"However, directors would be aware that an arrangement exists with Beneficial Finance Corporation whereby Beneficial will accept responsibility for the first $10M of any loss incurred. Accordingly, an amount of $10M representing the balance has been included in the specific provision.
It should be noted that the accounts of Beneficial Finance will include the possible loss from Equiticorp as a contingent liability as at this time no loss has been incurred. However, the provision for doubtful debts within Beneficial of $31M, includes $22M of general provision, which would be adequate to cover any loss should it occur in the future.
The auditor of Beneficial has indicated his acceptance of the treatment as specified above."
Mr Copley's paper went on to deal with other matters relating to the Bank's doubtful debt provisioning, and concluded:
"The matters outlined above have been discussed in detail with the External Auditors, [of the Bank], who have indicated their agreement to the plans outlined."
Neither Price Waterhouse nor KPMG Peat Marwick were aware of Mr Copley's paper at the time of the 1989 audit.() The Bank's joint auditors have submitted that the paper did not accurately record their views.()
I deal with the evidence of the Bank's external auditors on this matter in Chapter 51 - "Review of the 1989 External Audit of the State Bank". Price Waterhouse's audit working papers asserted that discussions between Mr Giles, various company officials, and the joint auditors of the Bank, indicated that the $10.0M underpin amount was to be provided for by the Bank, not Beneficial Finance.()
The Price Waterhouse 1989 working papers also contained a statement, dated 6 August 1989, that:()
"The State Bank have instructed Beneficial that a provision will not be necessary as the Bank will provide for any losses in its own books."
Price Waterhouse signed their Audit Report on 11 August 1989. The joint auditors of the Bank signed their Audit Report on the accounts of the Bank and the Bank Group on 24 August 1989.
The Bank did not, in its own accounts or the Group accounts, provide for the $10.0M relating to the Equiticorp underpin agreement. I deal in Chapter 51 - "Review of the 1989 External Audit of the State Bank" with the question whether the accounts of the Bank or Bank Group were underprovided in respect of the Equiticorp underpin amount. In the present Chapter, I will consider only the position concerning Beneficial Finance's accounts.
Price Waterhouse have asserted that they did not know, before they signed their Audit Report on 11 August 1989, that the Bank did not intend to provide the $10.0M relating to the underpin.() Price Waterhouse added that they had no knowledge as to whether the Bank's accounts subsequently signed on 24 August 1989 provided for the underpin or not.() In my opinion, Price Waterhouse had no responsibility to concern themselves with what the Bank did or did not do in its own accounts.
In my opinion, having regard to the evidence examined by the Investigation, the audit procedures carried out by Price Waterhouse on the allocated provision for doubtful debts in the year ended 30 June 1989 were appropriate and adequate.
(b) Unallocated Provision for Doubtful Debts
As previously discussed, the audit working papers() state that the total provision for doubtful debts included an unallocated provision of $21.9M (1988 - $16.8M). Price Waterhouse determined that the unallocated provision represented 1.02 per cent of net receivables (including amounts due from off-balance sheet entities) at 30 June 1989 (1988 - 1.09 per cent).
The audit programme prepared by Price Waterhouse to evaluate the unallocated provision for doubtful debts included the following 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 the 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.
58.5.2.4 Opinion - Execution of the Audit
Based on the evidence examined by the 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 (which are set out under Concluding Procedures below), the execution of the 1989 external audit of Beneficial Finance was appropriate and adequate.
58.5.3 CONCLUDING PROCEDURES
58.5.3.1 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 the accounts of the entity show a true and fair view in accordance with applicable law, and to ensure that other significant matters that do not affect 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 Price Waterhouse dealt with issues brought to their attention during the execution phase of the audit. In particular I focus on:
(a) the auditor's response to the shockproofing measures employed by Beneficial Finance; and
(b) the disclosure of information pertaining to off-balance sheet entities.
58.5.3.2 Matters Noted - Shockproofing
As discussed earlier in this Chapter, Price Waterhouse determined that shockproofing had the effect of increasing the pre tax profit for the year ended 30 June 1989 by $0.7M. Given that the reported pre-tax profit for the year was $36.0M, it is evident that Price Waterhouse considered this to be immaterial. I accept it was not material in 1989.
58.5.3.3 Matters Noted - Disclosure of information pertaining to Off-balance Sheet Entities
The Investigation noted that the audited accounts contained the following disclosures relating to various off-balance sheet entities:()
"
|
Holding |
|
|
|
Aggregate amounts receivable at balance date from: |
||
|
Equuus Financial Services Ltd |
29.1 |
29.1 |
|
Pegasus Leasing Ltd |
60.4 |
60.4 |
|
Mortgage Acceptance Nominees Joint Venture |
39.9 |
39.9 |
|
Southstate International Pty Ltd |
24.1 |
24.1 |
|
Gaimop Pty Ltd |
28.5 |
28.5 |
|
Leasefin Corporation |
17.4 |
17.4 |
|
IBM Centre Trust |
23.9 |
23.9 |
|
Sunland Homes Pty Ltd |
21.2 |
21.2 |
|
Other related entities |
76.4 |
76.8 |
|
$320.9 |
$321.3 |
|
|
Aggregate amounts payable at balance date to: |
||
|
Other related entities |
$16.9 |
$20.3 |
|
Transactions with Related Parties |
||
All transactions with related parties are made on normal commercial terms and conditions.
The remuneration levels of those Directors who are remunerated are commensurate with their responsibilities and duties.
Interest is charged at commercial rates on the loans and advances between related parties. The aggregate amounts received, receivable, paid or payable to related parties during the year are:
|
Holding Company |
Group |
|
|
Interest revenue |
37.8 |
37.8 |
|
Dividend revenue |
0.4 |
0.4 |
|
Interest expense |
- |
- |
On 28 October 1988, the Beneficial Finance Board expressed its concern to management that financial information about off-balance sheet activities, which is not declared in the consolidated accounts, should be notionally grouped to ensure an understanding of their effect on group activities.()
In February 1989, Price Waterhouse were given a memorandum of advice from Beneficial Finance's solicitors on the impact of the new Approved Accounting Standard on Equity Accounting, ASRB1016, which was to apply for the year ending 30 June 1989.
The standard required Beneficial Finance to disclose, by way of note to its accounts, certain information concerning associated companies in which Beneficial Finance had an "ownership interest" and over which Beneficial Finance exerted "significant influence". ()
Thomson Simmons & Co concluded that ASRB1016 did not apply to treat Beneficial Finance as an investor in the off-balance sheet companies, and did not require the disclosure of the information specified in the standard.() The following opinions were expressed by Thomson Simmons & Co in their advice:
"10.3 Shares may be held by the trustee of a discretionary trust under which there is a mere power of appointment in favour of the potential investor, (that is, a power to appoint from time to time if and when and at such times and in such manner as the trustee in its absolute discretion should think fit but not otherwise). Under such a trust the potential investor will not have any proprietary interest in the shares. It is not therefore, in our opinion, appropriate to say that the trustee of the trust holds the shares the subject of the trust directly or indirectly for any of the objects of the trust in whose favour the trustee can exercise its power of appointment ...
12. The existing off-balance sheet companies are structured with all shares held through appropriate discretionary trusts. Prima facie, Beneficial Finance Corporation Ltd. ("Beneficial") does not, for the purposes of the Standard, have an ownership interest in any of them. The shareholding of each and the terms of each trust should, however, be checked to verify this."
The opinion in paragraph 10.3 is, in my view, incorrect because it overlooks the provisions of the relevant deeds of settlement constituting the trusts whereby Beneficial Finance is named as the person who takes in default of appointment by the trustee. As I have reported in Chapter 41 - "Management and Financial Information Reporting", the legal effect is that Beneficial Finance had a vested equitable interest in the issued share capital of the off-balance sheet entities, Kabani, Lagan, Malary and Fortina, subject to divestment by the trustee. No divestment had been made as at 30 June 1989.
I am not satisfied that these details were adequately checked,as Thomson Simmons & Co had suggested they should.
Price Waterhouse have submitted:()
"During the course of the audits for 1985-1990 we gave consideration to the legal opinions referred to above and the relevant trust deeds relating to Bondi Investments Pty Ltd and Thomson Simmons Nominees Pty Ltd. We did not consider that BFCL held a vested equitable interest in all the issued share capital of the companies at each balance date in the period under review ..."
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.
Mr Giles, however, contacted Price Waterhouse's national office for technical and research matters. He sent them copies of the Thomson Simmons & Co advices dated 7 April 1985, 19 July 1985, and 28 February 1989. He did not send copies of any of the deeds establishing the relevant trusts. On 9 March 1989, Mr Thomsett, of Price Waterhouse's national office, provided the following advice:
"Thank you for sending the Thomson Simmons letters. They are interesting reading!
With regard to the 19 July 1985 letter we reluctantly conclude that the "legislative structure" is effective and if Kabani Pty Ltd has been set up in accordance with that advice it is not a subsidiary of Beneficial."
It does not appear that Price Waterhouse checked whether Kabani or any of the other off-balance sheet entities had been set up in accordance with the initial advice of Thomson Simmons & Co (which had not given detailed consideration to the terms of the applicable trusts).
Price Waterhouse did not obtain its own legal advice, either in Adelaide or elsewhere, on whether Beneficial Finance held an "ownership interest" in the off-balance sheet entities.
On 14 March 1989 Price Waterhouse prepared, in consultation with their national office in Sydney, a discussion paper on Equity and Aggregate Accounting, apparently for internal purposes. The paper considered the options available to Beneficial Finance regarding accounting for the off-balance sheet structures in the light of the view taken by Price Waterhouse that consolidation in the statutory accounts was not possible. The aim of the "aggregate accounting exercise" was stated to be:
"to prepare a set of financial statements that will enable the Board to review all of the assets and liabilities within their control in an effective manner ...
Consolidation is our preferred option in aggregate accounting for all business structures where control or significant influence exceeds 50%."
The following observations and recommendations were made in the paper:
"D AAS22 - Related Party Transactions
This standard defines related parties to be where one party has the power to control the Board of Directors of another or has control of the voting power or decision making of another. Clearly this applies in the case of BFL's control of Kabani, Malary etc. As a result, the following must be disclosed:
. the identities of related parties and the nature of the relationships
. each different type of transaction
. nature and terms of conditions of the different types of transaction.
Thus even if disclosure of Kabani and others as required by ASRB1016 is avoided, the relationship that exists will need to be explained under AAS22. Although it may be possible to explain the relationship in a tactful manner, it will not be possible to hide the fact that a relationship does exist ...
4 Summary of Current Position
The legal interpretation of the precise relationships within the BFG bases consideration of both consolidation and equity accounting on strict voting power. This interpretation has been provided by John Tucker of Thomson Simmons.
Whilst we must accept the legal interpretation as provided by Thomson Simmons, we must also consider the presentation of a true and fair view. Both ASRB1016 and AAS14 require that the substance rather than the strict legal form be applied when considering significant influence. There can be no doubt that all entities in the group structure diagram are under significant influence of BFG and as a result are candidates for equity accounting. For those entities that are material in a group context, we must consider an alternative presentation to that proposed by Thomson Simmons.
AAS22 will require disclosure of information affecting parties, including the identities of related parties and the nature of the relationships. BFG then have the dilemma of following the strict legal view outlined by Thomson Simmons and the requirement of AAS22 which demand that entities such as Kabani and Malary be disclosed.
An alternative and compromise disclosure is that as Kabani and other companies are entirely within the BFG group they should be equity accounted as such. Clearly, this option has problems, particularly as equity accounting usually applies where the voting power is between 20 and 50%. In the case of Kabani, the voting power is nil, but the degree of influence is 100%. This is a situation where substance over form applies with equity accounting being the best option available." [Emphasis added]
The minutes of the Beneficial Finance Board Meeting, on 28 April 1989, record that Price Waterhouse would accept exclusion of the Kabani type entities from equity accounting at 30 June 1989, subject to materiality, provided the Board was furnished with a comprehensive aggregate accounting statement. Aggregate accounts, as at 31 December 1988, were tabled at this time, and a presentation given by management on the Kabani structure.
(a) Companies Code - "True and Fair" Override
I have discussed the concept of the true and fair override in Chapter 57 - "Review of the 1988 External Audit of Beneficial Finance".
Certain of the assets included in Beneficial Finance's accounts as receivables were, in fact, loans to off-balance sheet entities which owned property or were developing property for resale. In other words, in substance, those receivables represented direct property exposures (rather than traditional credit risk). Had the off-balance sheet entities been consolidated, the consolidated balance sheet would have shown these assets as property exposures rather than receivables. In the absence of such consolidation, consideration should have been given as to whether additional disclosures should have been made so as to properly inform the users of the accounts.
Similarly, interest on loans made by Beneficial Finance to an off-balance sheet entity which was operating as a property developer, may have been reversed if consolidation had been performed. Thus, income arising from the property development activities would have been included in group profit only when realised through sale of the development, not through the raising of intra-group interest charges. Based on the evidence examined by the Investigation, the amount of interest income derived by Beneficial Finance from off-balance sheet entities engaged in property development appears not to have been material. In the absence of consolidation, consideration should have been given as to whether, in the circumstances, the accounts of Beneficial Finance, should have contained additional disclosures so as to properly inform the users of the accounts.
As noted in the Price Waterhouse discussion paper of 14 March 1989, Price Waterhouse appear to have considered the need for disclosure of the activities of the off-balance sheet entities in order for Beneficial Finance's accounts to give a true and fair view.
I have referred in Chapter 57 - "Review of the 1988 External Audit of Beneficial Finance" to Price Waterhouse's written submission on this subject.
My examination of the audit files of both Beneficial Finance and the material off-balance sheet entities identified the following:
|
$’M |
|
|
Amounts receivable by Beneficial Finance from |
|
|
3.3 |
|
146.3 |
|
171.7 |
|
Amounts payable by Beneficial Finance to |
|
|
7.1 |
|
13.1 |
|
Equity investments in associated companies |
7.2 |
* These balances total $321.3M, details of which were disclosed at Note 26 to the accounts.
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 1989. This analysis was prepared by reference to the respective audited accounts of each relevant entity at 30 June 1989, and the figures have not been adjusted for additional matters identified in this Chapter.
|
|
BFCL Group |
|
||||||||
| Current Assets | ||||||||||
| Property developments |
- |
15.8 |
15.8 |
|||||||
| Other |
1,453.4 |
1,474.9 |
21.5 |
|||||||
|
1,453.4 |
1,490.7 |
37.3 |
||||||||
| Non-Current Assets | ||||||||||
| Property developments |
4.0 |
78.5 |
74.5 |
|||||||
| Property, plant & equipment |
13.2 |
48.8 |
35.6 |
|||||||
| Investments |
33.0 |
37.0 |
4.0 |
|||||||
| Other |
746.8 |
799.7 |
52.9 |
|||||||
|
797.0 |
964.0 |
167.0 |
||||||||
| Total Assets |
2,250.4 |
2,454.7 |
204.3 |
|||||||
| Current Liabilities |
1,142.0 |
1,245.1 |
103.1 |
|||||||
| Non-Current Liabilities |
940.6 |
1,036.9 |
96.3 |
|||||||
| Total Liabilities |
2,082.6 |
2,282.0 |
199.4 |
|||||||
| Net Assets |
167.8 |
172.7 |
4.9 |
|||||||
| Profit After Tax | ||||||||||
| and Extraordinary Items |
30.0 |
28.6 |
(1.4) |
|||||||
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 Investigation noted that the audited accounts of the off-balance sheet entities included in this analysis were not, in all instances, signed by the directors and Price Waterhouse prior to finalising the statutory accounts of Beneficial Finance. The audit working papers indicate that:
(i) Price Waterhouse had performed audit procedures on the underlying financial records of material off-balance sheet entities prior to finalisation of the 1989 Beneficial Finance audit to satisfy themselves as to the adequacy of provisions made against amounts receivable by Beneficial Finance from those entities.
(ii) The financial position of the relevant off-balance sheet entities disclosed in the audited accounts for the year ended 30 June 1989 did not differ materially from that shown in the underlying financial records referred to at (i) above.
The above analysis shows that the effect of consolidating the off-balance entities at 30 June 1989 would have resulted in Beneficial Finance reporting that:
(i) Consolidated assets of Beneficial Finance were approximately $204.3M (9.1 per cent) greater than those disclosed in the statutory accounts.
(ii) Consolidated liabilities of Beneficial Finance were approximately $199.4M (9.6 per cent) greater than those disclosed in the statutory accounts.
(iii) Beneficial Finance's equity participation in property developments was approximately $90.3M or 23 times greater than that disclosed in the statutory accounts ($4.0M).
(iv) The consolidated after tax profit (after extraordinary items) of Beneficial Finance and controlled entities was approximately $1.4M (4.7 per cent) lower than that disclosed in the statutory accounts.
Price Waterhouse have submitted that the figure in paragraph (iii) above incorrectly includes an amount of $38.8M in respect of the 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 losses 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 1989, 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 1989.
(iv) It was inappropriate for Price Waterhouse to accept management's treatment of the off-balance sheet entities, which failed to make adequate 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 1989 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
I have referred, in Chapter 57 - "Review of the 1988 External Audit of Beneficial Finance", to Price Waterhouse's written submission on their consideration of the disclosure requirements of Regulations 33 and 34 of Schedule 7 to the Companies Code in 1988 and 1989.
Furthermore, Australian Accounting Standard AAS22 "Related Party Disclosures" ("AAS22"), June 1988, issued by the Australian Accounting Profession, sets standards for the disclosure of information concerning relationships with, and transactions between, related parties. It provides:
(i) Paragraph 2(f) of AAS22:
""Related party" means an entity that, at any time during the financial period, has control or "significant influence" over another entity or was subject to control or "significant influence" by another entity ..."
(ii) Paragraph 2(g) of AAS22:
""Significant influence" means the capacity of an entity to affect substantially (but not control) the financial and/or operating policies of another entity."
(iii) Paragraph 25 of AAS22:
"Where there have been transactions between the reporting entity and its related party or parties during the period the reporting entity shall disclose the following:
(a) the identities of related parties involved and the nature of the related party relationships;
(b) each different type of transaction; and,
(c) the nature of the terms and conditions of each different type of transaction."
(iv) Paragraph 26 of AAS22:
"The following, where applicable, shall be disclosed separately by the reporting entity:
(a) the aggregate amounts of the following items received or receivable from or paid or payable to related parties recognised in the financial statements for the period:
(i) interest revenue;
(ii) dividend revenue; and
(iii) interest expense;
(b) amounts, other than dividends, receivable by or payable by the reporting entity as at balance date in relation to:
(i) a parent entity;
(ii) related corporations (other than the parent entity);
(iii) directors; and,
(iv) other related parties; and,
(c) any ownership interest in each related party."
Price Waterhouse submitted that compliance with AAS22 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 observe that the Auditor's Report stated their opinion that the accounts complied with Australian Accounting Standards.
The Investigation noted that the disclosures made by Beneficial Finance, at Note 26 to the accounts for the year ended 30 June 1989 (as set out earlier in this Chapter), did not include the following:
(i) the nature of the related party relationships, as required by Paragraph 25(a) of AAS22; and
(ii) details of any ownership interest in each related party, as required by Paragraph 26(c) of AAS22.
It is evident from the proforma consolidated balance sheet and profit and loss statement shown above that, at 30 June 1989, the off-balance sheet entities were, in aggregate, material business undertakings of Beneficial Finance.
Based on the evidence examined by the Investigation and for the reasons set out above, I have formed the opinion that the accounts did not comply with Paragraphs 25(a) and 26(c) of AAS22.
I acknowledge, however, on the view Price Waterhouse took of the relevant disclosure requirements, the disclosure in Note 26 of the amount of receivables due from related entities was beyond the particular requirements.
58.5.3.4 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 did not adequately address whether the truth and fairness of the accounts was impaired by the absence of disclosure of adequate information pertaining to the off-balance sheet entities.
(b) Consequently, inadequate 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 1989 complied with Section 269 of the Companies Code, and gave a true and fair view, was inappropriate.
58.6 CONCLUSION
In my opinion, the audit opinion expressed by Price Waterhouse on the accounts for the year ended 30 June 1989 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.