CHAPTER 59
REVIEW OF THE 1990 EXTERNAL AUDIT
OF BENEFICIAL FINANCE
TABLE OF CONTENTS
59.1 PURPOSE OF CHAPTER
59.2 PLAN OF CHAPTER
59.3 BUSINESS OF BENEFICIAL FINANCE CORPORATION LIMITED AND SUBSIDIARIES
59.4 ACCOUNTS OF BENEFICIAL FINANCE CORPORATION LIMITED
59.5 INVESTIGATION OF THE AUDIT PROCESS
59.5.1 PLANNING OF THE AUDIT PROCESS
59.5.1.1 Preamble
59.5.1.2 Matters Noted
59.5.1.3 Professional Standards and Practices
59.5.1.4 Opinion - Planning of the Audit
59.5.2 EXECUTION OF THE AUDIT PROCESS
59.5.2.1 Preamble
59.5.2.2 Matters Noted - Shockproofing
59.5.2.3 Matters Noted - Provision for Doubtful Debts
59.5.2.4 Matters Noted - Equiticorp
59.5.2.5 Opinion - Execution of the Audit
59.5.3 CONCLUDING PROCEDURES
59.5.3.1 Preamble
59.5.3.2 Matters Noted - Shockproofing
59.5.3.3 Matters Noted - Provisions for Doubtful Debts
59.5.3.4 Matters Noted - Disclosure of information pertaining to Off-balance Sheet Entities
59.5.3.5 Opinion - Concluding Procedures
59.6 CONCLUSION
59.1 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 1989-1990 and significant features of the statutory accounts in respect of the 1989-1990 financial year. The Chapter then reports on matters arising from the assessment of the audit process applied by the External Auditors in the audit of the accounting records and accounts of Beneficial Finance for the year ended 30 June 1990. The Chapter also concludes as to the appropriateness and adequacy or otherwise of the audit process undertaken.
59.2 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.
59.3 BUSINESS OF BENEFICIAL FINANCE CORPORATION LIMITED AND SUBSIDIARIES
The Beneficial Finance Group recorded a severe decline in profitability for the 1989-90 financial year, representing its worst operating result since its inclusion into the State Bank Group in 1984-85.
The steep fall in profitability reflected the deterioration in the loan book of Beneficial Finance, associated, to some extent, with the poor operating performance of its off-balance sheet entities.
In June 1990, the Beneficial Finance Board approved a major corporate restructure to refocus the Group on its core business, which had been profitable in past years. The restructuring included the sale of a number of off-balance sheet entities associated with Beneficial Finance and the off-balance sheet holding entities Kabani Pty Ltd, Malary Pty Ltd, Fortina Pty Ltd, and Lagan Pty Ltd. The entities were sold to Southstate Corporate Holdings Ltd, a company wholly owned by the State Bank. I comment on this in more detail below.
Up to the latter part of September 1989, consistently with previous financial years, the Beneficial Finance Group operated under the requirements of the following Trust Deeds:
(a) the First Charge Debenture Stock Trust Deed (consolidated 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;
Arising from amendments to the 1960 and 1974 Trust Deeds in September 1989, Beneficial was required only from that date to comply with the provisions of the 1985 Trust Deed. On a six monthly basis, the External Auditor was required, under that Deed, 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 1990.
59.4 ACCOUNTS OF BENEFICIAL FINANCE CORPORATION LIMITED
On 13 August 1990, 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 1990. 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 1990 and the financial position of the Beneficial Finance Group at that date.
|
Beneficial Finance Group |
|||||||||||||||||
|
|
1989 |
1990 |
Per Cent Increase |
||||||||||||||
|
Revenue |
329.1 |
421.1 |
28 |
||||||||||||||
|
Operating Profit |
|||||||||||||||||
|
Pre Tax |
36.0 |
(21.5) |
(160) |
||||||||||||||
|
After Tax |
|||||||||||||||||
|
and Extraordinary Items |
30.0 |
4.7 |
(84) |
||||||||||||||
|
Balance Sheet |
|||||||||||||||||
|
Assets |
|||||||||||||||||
|
Receivables |
2047.7 |
2436.1 |
19 |
||||||||||||||
|
Other |
214.0 |
238.5 |
|||||||||||||||
|
2261.7 |
2674.6 |
18 |
|||||||||||||||
|
Liabilities |
|||||||||||||||||
|
Borrowings |
1954.5 |
2353.1 |
20 |
||||||||||||||
|
Other |
139.4 |
132.0 |
|||||||||||||||
|
2093.9 |
2485.1 |
19 |
|||||||||||||||
|
Net Assets |
167.8 |
189.5 |
13 |
||||||||||||||
|
Shareholders Equity |
|||||||||||||||||
|
Share Capital |
125.0 |
150.0 |
|||||||||||||||
|
Reserves |
42.8 |
39.5 |
|||||||||||||||
|
167.8 |
189.5 |
13 |
|||||||||||||||
|
Doubtful Debts |
|||||||||||||||||
|
Expense for the Year |
16.5 |
51.2 |
210 |
||||||||||||||
|
Provision at Balance Date |
31.1 |
63.2 |
96 |
||||||||||||||
The 1989 comparative balances presented in the 1990 audited accounts include some re-classifications of figures appearing in the 1989 audited accounts.
59.5 INVESTIGATION OF THE AUDIT PROCESS
59.5.1 PLANNING OF THE AUDIT PROCESS
59.5.1.1 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. .
59.5.1.2 Matters Noted
(a) Risk Assessment
Consistently with previous audits, two planning documents were prepared by Price Waterhouse for the December 1989 and June 1990 audits:
(i) A strategic plan was prepared for the December 1989 audit, and approved in November 1989 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 (assistant manager).
(ii) A strategic plan was prepared for the June 1990 audit to reflect conditions then relevant. This document was signed by Mr Giles, Mr Clark, Mr Hirst, Mr Acutt, and Mrs Anthon in June 1990.
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 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 1990 strategic plan and included:
(i) the increase in interest rates and adverse economic conditions;
(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) a deterioration in the quality of the receivables portfolio; and
(v) an increase in non-producing assets and the consequential adverse impact on cash flow.
It is further evident that Price Waterhouse considered key aspects of the audit to include:
(i) receivables and the recoverability of advances - Price Waterhouse planned to perform "an extremely stringent review of receivables ... to ensure all potential loss accounts identified are adequately provided";
(ii) accruals and the recognition of fee income - these being two specific areas which Price Waterhouse planned to review for evidence of profit smoothing; and
(iii) the liquidity position of Beneficial Finance.
(b) Internal Audit
The planning documentation declares that 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:
"We have audited the Group for many years and have found management to be control conscious and the information accounting and control systems generally reliable.
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 only until 30 June 1990. This will be replaced by a review of internal audit work papers with a view to ensuring that all aspects of branch audits are covered with acceptable regularity.
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 experience shows that the department is usually adequately staffed, internal auditors are competent and staff members well supervised. However, as mentioned earlier, the company is undergoing a period of organisational change which has left the Internal Audit Section with a need to reorganise. We continue to liaise with the section to ensure continued adequacy of coverage and quality of the audits." ()
It is evident from the audit working papers that Price Waterhouse performed sufficient audit work to satisfy themselves that reliance could be placed on work performed by Internal Audit.
59.5.1.3 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 programme.()
59.5.1.4 Opinion - Planning of the Audit
Based on the evidence examined by the Investigation, I have formed the opinion that, the planning phase of the 1990 external audit of Beneficial Finance was appropriate and adequate.
59.5.2 EXECUTION OF THE AUDIT PROCESS
59.5.2.1 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.
59.5.2.2 Matters Noted - Shockproofing
As discussed in Chapter 58 - "Review of the 1989 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:
(a) creating provisions for future expenses for which no liability existed at balance date (referred to as prudent accruals by Price Waterhouse); and
(b) 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:
(a) were aware of the intentions of Beneficial Finance to adopt shockproofing measures;
(b) identified individual shockproofing measures adopted by Beneficial Finance and categorised them as shockproofing actions; and
(c) considered the aggregate impact of shockproofing on the reported profits of Beneficial Finance.
The reported consolidated pre-tax loss for the year ended 30 June 1990 was $21.5M. The Investigation observed that, in arriving at this result, the prudent accruals that existed at 30 June 1989 had been released to profit. As discussed in Chapter 58 - "Review of the 1989 External Audit of Beneficial Finance", the level of prudent accruals at 30 June 1989 was not material. There were no prudent accruals at 30 June 1990. Accordingly, the net effect of shockproofing on the reported consolidated results of Beneficial Finance for the year ended 30 June 1990 was not material.
59.5.2.3 Matters Noted - Provision for Doubtful Debts
The audited consolidated accounts of Beneficial Finance for the year ended 30 June 1990 disclose a provision for doubtful debts of $63.2M (1989 - $32.2M). The audit working papers() state that this provision comprises two elements, namely, an allocated provision and an unallocated provision. The balance of these provisions was:
|
30 June 1990 |
30 June 1989 |
||||
|
Allocated provision |
39.8 |
9.2 |
|||
|
Unallocated provision |
23.4 |
23.0 |
|||
|
63.2 |
32.2 |
||||
The audited consolidated accounts note that the result for the year ended 30 June 1990 was arrived at after charging, as an expense, an amount of $48.2M (1989 $14.5M) relating to bad and doubtful debts.
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 six years ended 30 June 1990 was:
|
30 June 1990 |
1.02 per cent |
|
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 |
The Investigation determined that Price Waterhouse sought, and obtained, increases in provisions totalling $13.4M, of which $2.5M related to specific accounts, and $10.9M comprised an increase in the general provision. The audit working papers() record that:
"... all material identified specific provisions have been made and the general provision percentage has been built up to over 1% so we can conclude that the final provision for losses of $63.2 million is adequate."
(a) Approach to Provisioning
By 1990, declines in property values were generally apparent across Australia. Consequently, many exposures which had previously been covered by the value of security moved into loss. In determining the degree to which provisions were needed, judgements had to be made, for many accounts secured by property assets, as to the likely amount that would be recovered through realisation of the security.
In forming these judgements, the view that appeared to be adopted by Price Waterhouse in completing the June 1990 audit, was that, for reasonable quality properties, the experience of previous years' property slumps, whereby property values had recovered within two to four years, would in all probability be repeated. Therefore, where Beneficial Finance had indicated an intention not to sell the property into a depressed market, but to hold until such time as the market recovered, Price Waterhouse accepted the view that the exposure was likely to be recovered, and therefore no provision was needed.
This view was also taken in respect of real estate assets, whether completed or under development, in which Beneficial Finance, or an off-balance sheet entity, held an equity interest.
Although subsequently it became clear that the slump in property values was likely to be both deeper and longer than had been the case in previous property slumps, I have formed the view that the approach taken by Beneficial Finance and accepted by Price Waterhouse in mid 1990 was not unreasonable at that time.
(b) Allocated Provision for Doubtful Debts
In Chapters dealing with the external audit of previous years, I noted that, on a regular basis, Beneficial Finance prepared Non Performing Loans Review reports which were used as a basis for determining the level of allocated provisions for non-performing loans. The audit working papers() stated that, with effect from 1 July 1990, an organisational restructure within Beneficial Finance was implemented to reduce the number of operating divisions to three, namely:
(i) Asset Management division, incorporating all large and/or problem accounts requiring special management;
(ii) Australian Business division, incorporating all branch offices; and
(iii) Investment Banking division.
As a consequence of this reorganisation, the Non Performing Loans Review reports were largely replaced by "status" reports prepared by account managers on a monthly basis. These reports provide a comprehensive discussion on the status of exposures under the control of those divisions. The reports, provide similar information to that contained in the Non Performing Loans Review reports 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.
In addition, these reports provide an estimate of losses that may be incurred by Beneficial Finance on each exposure under three possible scenarios, namely, "best" case, "probable" case and "worst" case. The criteria for each scenario is defined in the Asset Management division report, dated 19 July 1990, as follows:
"- Best case - current sale/as is or with minor enhancements only/cash or potential terms purchaser with structured package.
- Probable case - Current sale as is/cash or terms basis to arm's length purchaser; given an orderly disposal program which may take up to 6-12 months in some cases (18 months may be required for some properties)
- Worst case - Recognised distress sale on an as is basis - cash terms only"
The Asset Management division report of 19 July 1990, which was contained in the audit working papers,() reported that the result of this analysis was as follows:
|
|
Estimated Loss |
|
Best Case |
19.5 |
|
Probable Case |
34.4 |
|
Worst Case |
123.2 |
As noted earlier in this Chapter, the allocated provision for doubtful debts, at 30 June 1990, was $39.8M which compares favourably with the probable scenario noted above.
The audit working papers indicate that the audit procedures adopted by Price Waterhouse, at 30 June 1990, in assessing the adequacy of the allocated provision for doubtful debts, were more extensive than those applied in earlier years. Such a change is consistent with the matters identified in the audit planning documentation, namely, that during the period under review:
(i) there had been a deterioration in the quality of the receivables portfolio;
(ii) there had been an increase in the level of non producing assets; and
(iii) interest rates had continued to increase and economic conditions were not favourable.
In response to these matters, Price Waterhouse planned to perform an "extremely stringent review of receivables ... to ensure that all potential loss accounts identified are adequately provided".() The increased level of audit testing referred to above is evidence that this took place.
The audit procedures that Price Waterhouse adopted, in assessing the adequacy of the allocated provision for doubtful debts, included:
(i) a detailed review of all exposures appearing on the Asset Management division and Australian Business division status reports;
(ii) a detailed review of significant amounts receivable from off-balance sheet entities;
(iii) a review of all Internal Audit reports and risk asset reviews to ensure that problem accounts were identified on the various status reports;
(iv) a review of special Board reports listing exposures in excess of $5.0M to ensure that problem accounts were identified on the various status reports;
(v) a review of selected credit submissions for large exposures; and
(vi) other audit tests designed to ensure that all significant loan accounts in arrears were identified on the various status reports.
In addition to their normal audit work at 30 June 1990, Price Waterhouse was also commissioned to prepare a report ("the independent report") on the financial position of Beneficial Finance at 30 June 1990. That report, addressed to Mr M G Hamilton (Managing Director, Financial Services Group, State Bank of South Australia), dated 30 July 1990, was issued prior to the completion of the 1990 audit, and dealt with a number of issues including, inter alia:
(i) a review of the adequacy of provisions for doubtful debts; and
(ii) the level of non producing assets and the consequential impact on future cash flow.
In the independent report, Price Waterhouse sought increases in the level of provisions (both specific and general). These recommendations were largely accepted by Beneficial Finance, and gave rise to the adjustments to provision levels noted earlier in this Chapter (ie an increase in provisions of $13.4M).
The independent report identified several exposures against which no specific provisions had been raised on the basis of a likely recovery in property values within a reasonable time. In accepting this view, Price Waterhouse recognised the risk of loss inherent in those and other exposures, and accordingly sought and obtained an increase in the level of general provision to a minimum of 1 per cent of net receivables.
I have, however, formed the opinion that for the Somerley Exposure of $24.2M, the evidence contained in the audit working papers does not support the conclusion of Price Waterhouse that no specific provision was required. On the contrary, in my opinion, the evidence suggests the probability that a loss of $24.2M would be incurred, and that a further specific provision was therefore required.
At 30 June 1990, the audited consolidated accounts included, as a receivable, an amount of $24.2M, recoverable from Somerley Pty Ltd, which is described in the audit working papers as a construction facility that had been converted from a guarantee facility. This exposure arose under a guarantee facility that Beneficial Finance had provided to State Bank of Victoria in relation to a development project in Melbourne being undertaken by the Interwest Group. A liability arose under the guarantee facility on the default of the Interwest Group in January 1990. Beneficial Finance was called upon to make a payment under the guarantee in March 1990. No loss was recognised in the accounts of Beneficial Finance at 30 June 1990 because management believed that this loss would be fully recouped through completion of the development project, and the realisation of the securities that Beneficial Finance had over the project, namely, a registered second mortgage.
At 30 June 1990, a registered first mortgage over the project was held by the Bank in its capacity as primary financier to the project. The Bank was originally a member of what was known as the First Tier Syndicate lenders to the project. In April 1990, the Bank bought out the remaining members of that syndicate for $34.2M.
The audit working papers indicate that Price Waterhouse first became aware of problems with the account in January 1990 when completing their audit on the accounts of Beneficial Finance for the half year ended 31 December 1989. The audit working papers() record notes of a meeting, held on 25 January 1990, between Mr Giles and Mrs Anthon (from Price Waterhouse) and Mr J A Baker, Mr M Chakravarti and Mr S Spadavecchia (from Beneficial Finance):
"Somerley deal was discussed and JAB expressed concern. BFCL is ... mortgagee on a development property in Melbourne and prior charges are $200M. Some development proposals are to be reviewed."
The audit working paper records that this matter was further discussed on 15 February 1990, at a meeting attended by Mr Giles, Mrs Anthon, Mr Baker, Mr Chakravarti, and Mr Spadavecchia:
"JAB advised PW that the company was extremely concerned about potential losses on the Somerley (Interwest) guarantee. At this stage BFCL is reviewing submissions which outline its options and cannot say with any certainty whether a loss will be made and at what value. The options at present are:
1) loss of $22.5m;
2) develop the site, with a partner, to a lesser extent than first planned and lose [about] $10M;
3) develop the site with a substantial partner (large hotel group) and eventually make a [profit].
A copy of the submission will be sent to PW."
A copy of the submission referred to above (Beneficial Finance Special Submission 297) was subsequently forwarded to Price Waterhouse on 19 February 1990. The submission outlined the status of the project, identified available strategy options, and sought Board approval for a recommended course of action. In summary, the submission outlined, inter alia, the following matters:
(i) The estimated cost of completing the full project, ie construction of a 459 room hotel, seven level car park, and two levels of retail accommodation, was $252.0M, an additional commitment for the first tier syndicate of $148.0M, including interest.
(ii) The value of the project on completion had been assessed by Colliers at $200.0M in January 1990 (by letter updating their original June 1988 valuation of $270.0M),() and by Jones Lang Wootton at $146.0M in February 1990.
(iii) A number of options were available to Beneficial Finance including:
. proceed with Stage 1 of the development, which required completion of the car park and retail component of the project. A preliminary financial feasibility of this option projected a loss to Beneficial Finance of $10.5M. It was noted that this was based on cost and value estimates, which were currently being independently reviewed by Richard Ellis in conjunction with the builder;
. proceed with full completion of this project . A preliminary financial feasibility of this option revealed that for Beneficial Finance to fully recover its exposure, plus interest, the project would need to sell on completion for a minimum of $212.0M ($200.0M on an interest foregone basis); and
. walk away from the project in which case no recovery would be achieved, resulting in a $22.5M loss (Beneficial Finance's exposure at that date).
(iv) In relation to full development, it was stated that this option "provides an opportunity to recover full exposure", but it was pointed out that there was a risk even with this option that "there may be insufficient justification to avoid taking up a $22.5M allocated loss provision (subject to valuations) - a provision of this size would adversely impact Beneficial Finance's perceived credit standing."
Approval was sought to proceed with Stage 1, subject to completion of the feasibility assessment referred to above. Approval was also sought to proceed to full development, in the event that the feasibility assessment of Stage 1 proved to be unsatisfactory.
The Beneficial Finance Board approved the proposal to proceed with Stage 1 on 20 February 1990(). The Bank Board approved the proposal to proceed with Stage 1 on 22 March 1990()
The audit opinion on the accounts of Beneficial Finance, for the six months ended 31 December 1989, was dated 20 February 1990. The feasibility assessment of Stage 1 had not been completed by that date. In paragraph 9.8 of their written submission to the Investigation, dated 18 August 1992, Price Waterhouse made the following points in support of their decision to accept that a specific provision need not be raised against the Somerley exposure at 31 December 1989:
"In summary, the decision that it would be inappropriate to specifically provide against the Somerley exposure as at 31 December 1989 was taken based on the following factors:
i) The exposure existed as a result of a guarantee facility provided to SBV. The guarantee had not been called by 20 February 1990 and although it was probable that a liability would crystallise, this could have occurred at some discount to face value.
ii) Various options were available to BFCL to allow work out of the exposure. It was apparent that the strategies to be adopted would involve further development of the project although whether full completion would eventuate was not possible to determine at that time. A loss of $22.5 million would certainly not crystallise in the short term as the "walk" option would not be adopted.
iii) Once a decision had been taken to proceed further with the development, it was evident from management intentions that this exposure would be worked out on a long term basis. Potential losses on the project principally arose from the impact of the severe downturn in the economic environment and the property market in 1989/90. It was unrealistic to require provisioning based on the then existing market conditions given the probability of recovery in the property market due to its cyclical nature ...
iv) Numerous legal issues, including potential claims against the valuers Colliers and SBV, required resolution before BFCL's exposure could be properly determined.
v) The general provision against doubtful debts had risen to $29.9 million by 31 December 1989 representing 1.3% of unallocated risk assets. The general provision had been established to meet uncertainties such as the Somerley exposure and BFCL was adequately covered in the event of a loss ultimately arising."
A special submission was prepared by Mr J Blunt, dated 7 March 1990, for the Beneficial Finance Board. This submission considered further the strategy options available to Beneficial Finance, following the completion of the feasibility assessment of Stage 1. The submission asserted, inter alia, that:
(i) The feasibility of Stage 1 had been based on independent valuations from Richard Ellis and Jones Lang Wootton. This assessment indicated that Beneficial Finance would make a loss of $24.2M under this proposal, compared with the $10.5M loss previously forecast in Special Submission 297.
(ii) In order for Beneficial Finance to reduce its potential loss, it would be necessary, in conjunction with the Bank, to proceed with full development of the project.
(iii) Strategies for Beneficial Finance to proceed with full development of the project were discussed, including the take out of the First Tier Syndicate.
(iv) A number of possible legal actions against various parties were discussed.
By the time that Price Waterhouse conducted its audit of the accounts of Beneficial Finance for the year ended 30 June 1990, the status of the project had not changed significantly from that described above.
Although Board approval to proceed with Stage 1 had been granted, construction on site had not recommenced. The Asset Management division reports of July and August 1990, extracted from the monthly Board folders, confirm that Beneficial Finance faced a total loss of $24.0M if the project only proceeded as far as Stage 1. The best prospects of recovery, although this was not assured, was thought to be full completion. The risk prognosis in both documents was as follows:
|
$M |
|
|
Best case loss |
- |
|
Probable loss |
24 |
|
Worst case loss |
24 |
The Asset Management division's status reports in the Price Waterhouse audit working papers()included draft and final reports for July, showing, in relation to Somerley, the "Prognosis of Risk (to podium level only)":
|
Draft dated |
Final dated |
|
|
Best Case |
Loss 24.2 |
- |
|
Probable Case |
Loss 24.2 |
TBA |
|
Worst Case |
Loss 24.2 |
Loss 24.2 |
The aggregate range of cases in the reports on Beneficial Finance's debt portfolio were:
|
Draft dated |
Final dated |
|
|
Best Case |
45.6 |
19.5 |
|
Probable Case |
60.5 |
34.4 |
|
Worst Case |
129.4 |
123.2 |
Price Waterhouse noted in their workpapers that the change affecting "best case" and "probable case" was substantially due to re-classifying the Somerley exposure of $24.2M, and a minor adjustment on one other account.()
The various Asset Management division reports are, however, consistent in their comments that Beneficial Finance was pursuing various options to proceed to full development of the project. These included following up enquiries from potential hotel operators and/or equity participants in the project.
The reports contained the following commentary on Beneficial Finance's security position():
"The present approvals are predicated on a build out to podium level only. On the basis the first tier lenders may not realise their exposure and as such the net value of Beneficial's exposure is Nil. On a full buildout to completion there is a possibility of recovery, on which basis a provision policy needs to be formulated for this account ...
Prognosis of Risk past podium level buildout depends on ability to find equity participants, a suitable hotel operator and the extent of income guarantees required."
The final report contained the following explanation of the "TBA" designation under the column headed "Specific Provision Allocated":
"A specific provision has not been made at this time pending Group policy on final workout strategy.
It appears most likely that a full buildout will be the only commercial solution to this problem in the current environment."
The Price Waterhouse consideration of this exposure, at 30 June 1990, as documented in the audit working papers(), is as follows:
"This was originally a guarantee to SBV which was called. Beneficial rank behind SBSA on this debt. Current options are to develop completely (at an enormous cost) and perhaps recover all debts. Secondly, to sell site now and incur a loss of 100%. Or, thirdly, to develop to Podium stage and incur a loss somewhere in between (including penalties payable to the builder). At present neither Beneficial's board or the board of SBSA (who would need to provide the funding) have decided on a course of action. As a result, we are unable to assess the potential loss at this time and this account will need to be discussed with the board. In any event it would be conservative to provide some portion of this debt in order to minimise the impact of a large loss on the company's profits. Such a provision could be in the order of $6M (25% of the due balance).
Discussed with John Malouf who acknowledged that it was impossible to formulate an assessment of the probable loss on this deal at this stage. He did add that an Indonesian party had shown some interest in the final development of $225M (break even) and discussions are continuing. There is a small parcel of associated land that may be able to be sold in the short term to provide some recovery.
Overall though, it is impossible to quantify the amount of any provision required at this stage and the account will have to be discussed with the directors."
"Somerley B650 & B713
Due balance $24.2M and Beneficial is still determining what level of development will occur. Generally agreed that recovery of full due balance is in doubt but it is far too early in this project to quantify the loss so no provision has been made."
Price Waterhouse have submitted that they were entitled to rely on the opinion of Mr J D Malouf that it was too early to assess the probable loss on Somerley.() Mr Malouf was the Beneficial Finance executive in charge of the Asset Management division. He subsequently held the position of Managing Director of Beneficial Finance. Price Waterhouse submitted that Mr Malouf had recently joined the Asset Management division, and was someone who took a tough, sceptical, and realistic, view of provisions.() In my opinion, it was appropriate for Price Waterhouse to have regard to the opinions of management, but Price Waterhouse should, nevertheless, have obtained reasonable assurance that there was an adequate basis for the opinion; ultimately, Price Waterhouse should have formed their own view.
Mr Malouf provided information to the Investigation regarding the above.() He confirmed speaking to Price Waterhouse and expressing an opinion to the effect that it was impossible to quantify a loss at the stage of finalising the 1990 accounts. His recollection was that, in July or August 1990, he was advised that there was a reasonable chance that the Board would approve the additional funds to take the project to full completion. He added, however, that it was, at that stage, becoming increasingly difficult to get an owner/operator, and, when he reported to the Board in July on provisioning, he put it to the Board, as he did to the auditors, that basically, on Somerley, it was a "toss of the coin". I accept that the information provided by Mr Malouf supports the discussions attributed to him in the Price Waterhouse working papers.
In their written submissions to the Investigation, Price Waterhouse have made the following points in support of their decision to accept that a specific provision need not be made against the Somerley exposure at 30 June 1990:
"We considered that no provision against Somerley was required at 30 June 1990 ... Our decision not to require a provision at 31 December 1989 had been further strengthened by 30 June 1990 as a result of the following factors:-
i) The introduction of an interested Indonesian investor which increased the possibility of the project proceeding to full completion without any loss to BFCL.
ii) A "walk" strategy was no longer an option and the steps necessary to proceed to at least stage 1 were clearly in hand.
iii) Our knowledge that the Bank had during the period to 30 June 1990 advanced significant amounts to the Somerley project to enable its development.
iv) A special review of loss provisions at 30 June 1990 had taken place and significant additional provisioning had resulted. This provisioning was considered aggressive and enhanced our view that any problems ultimately arising from exposures such as Somerley would be adequately covered by general provisions".()
"We totally reject [a contrary] finding on the following grounds:
. no "probable loss" had been identified with any degree of certainty, ie it had not been possible to quantify any loss or indeed establish whether a loss would be incurred at all.
. various work out scenarios were being actively pursued by management the results of which could have resulted in no loss being sustained
. ... The Somerley exposure was examined at the time that the Price Waterhouse special report of 30 July 1990 was being prepared. At that time, we had been put on notice that the Bank expected us to conduct a rigorous independent examination of the Beneficial Finance exposures without discussing our findings with Beneficial Finance management. We conducted a rigorous examination, made appropriate judgements and reported our findings directly to Mr M Hamilton a senior Bank executive who had been specifically directed by the Bank Board to investigate the operations of Beneficial Finance. These findings were not influenced in any way by Beneficial Finance management ...
. the Bank had committed substantial funds to the Somerley project to enable its development
. as with other BFCL projects it was not unreasonable, should a suitable alternative not emerge, for a long term view to be taken with respect to the Somerley project and for it to be held by the Bank group until the property market had recovered sufficiently to ensure that either no, or at least a minimal, loss was suffered ...
The [Auditor-General's] finding should be that there was considerable uncertainty surrounding the recovery of the Somerley exposure which required Price Waterhouse to use its judgement to decide whether or not a specific provision was required. Based on the information available within BFCL at the time of the audit Price Waterhouse was of the opinion that no specific provision was required."()
As I have noted above, in relation to the overall approach to provisioning in 1990, the "long term view" referred to in Price Waterhouse's submission could, in my opinion, apply to reasonable quality properties. In my opinion, the same considerations do not necessarily apply to a development project, because one has to determine whether the slump in the anticipated value for the fully developed property represents the depressed property market generally, or the market for the specific end-use, (eg the hotel accommodation market in the case of Somerley), which might be affected by quite different factors. Further, while the "long term view" might be argued to apply to the value of the project, based on the proposal to proceed to Stage 1 which had been approved, it should not, in my opinion, enable one to speculate as to the possibility of other development options being proposed in future, which might lead to an enhancement of the value of the property.
My principal findings are as follows:
(i) The guarantee had been called and, prima facie, a loss of $24.2M had been incurred.
(ii) The Board had approved a proposal to proceed with Stage 1, which, on their own estimates, was expected to result in a loss of $24.2M.
(iii) The only likelihood of Beneficial Finance being able to recover some of this loss was to proceed with full development of the project.
(iv) Neither the Beneficial Finance Board nor the Bank had approved a proposal to proceed with full development.
(v) There was no evidence that a proposal was likely to be put for full development which would produce a better outcome for Beneficial Finance and the Bank than the proposal to proceed with Stage 1 which had been approved. Special Submission 297 in February 1990 recorded that, to achieve this result, the project would need to sell on completion for at least $212.0M.
(vi) The most recent financial assessment of the full development option on a revised configuration, was that the Bank's exposure would increase to $211.0M whilst Beneficial Finance's exposure would remain at $24.2M, giving a total exposure of the Bank Group of $235.0M, on an interest included basis,() or $198.0M, excluding interest.() The value of the revised configuration on completion had been estimated at $214.0M, however, it was emphasised by management that the estimate had not been tested, and was based on the Bank Group fully guaranteeing the rental income.() Management also noted that the untested estimate of $214.0M should be compared with the January/February 1990 independent valuations ranging from $146.0M to $200.0M for the original configuration. Assuming the highest value, this assessment might see recovery of $24.2M by Beneficial Finance. The Bank Group would, however, have foregone about $37.0M in interest it could have earned elsewhere if the project had not gone beyond Stage 1.
(vii) The project was experiencing delays, and work on the construction of Stage 1 had still not recommenced by July 1990().
(viii) The most recent financial assessment of the Stage 1 option confirmed the March 1990 Special Submission, mentioned above, that Beneficial Finance would make a loss of $24.2M under this proposal.()
(ix) As will be discussed later in this Chapter, the level of general provision ($23.4M) was inadequate to cover the identified risks associated with the Somerley exposure.
Price Waterhouse submit that the Investigation may have had regard to information available within the Bank, which was not available either to Beneficial Finance or Price Waterhouse(). In my opinion, the matters noted in paragraphs (i)-(ix) above would have been available to Price Waterhouse.
The statements of the Professional Accounting Bodies require an auditor to obtain, and document in his working papers, sufficient appropriate audit evidence to support his audit opinion.()
Based on the evidence examined by the Investigation, including written submissions made by Price Waterhouse, and for the reasons set out above, I have formed the opinion that:
(i) The probability of Beneficial Finance's receiving $24.2M in full, from completion of the project and realisation of its security, had not been demonstrated, and that outcome should have been regarded by the auditors as only a remote possibility.
(ii) In these circumstances, it was inappropriate for the auditors to accept the decision by management of Beneficial Finance to defer recognition of the loss of $24.2M arising under the guarantee obligation to State Bank of Victoria on the basis of a likely full recovery from the realisation of securities.
(iii) The loss of $24.2M that had been incurred under the guarantee obligation to State Bank of Victoria should have been provided for in full in the accounts of Beneficial Finance for the year ended 30 June 1990.
(c) 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 $23.4M (1989 - $23.0M). 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 1990 (1989 - 1.02 per cent).
As discussed earlier in this Chapter, Price Waterhouse sought, and obtained, an increase in the general provision of $10.9M. In their independent report to Mr Hamilton, dated 30 July 1990, Price Waterhouse commented as follows:
"You will note that as agreed between us yesterday I have emphasised both in the Executive Summary and on page 10 that we regard a general provision of 1% of receivables as a minimum requirement ..."
"The general provision of $11.0M represents 0.53% of the risk assets for which a specific provision has not already been made. From our review of Minutes of Board Meetings in past years we understand the directors' objective has been to have an unallocated provision of 1%. In view of prevailing economic conditions, particularly the depressed property market and the uncertainty about settlement of major problem accounts, particularly those set out in Appendix 9, we strongly believe that minimum of 1% is required. Adjusting the unallocated provision to 1% would result in an additional charge against profit of $10.9M providing the above additional recommendations concerning specific provisions are implemented."
It is evident, both from these comments and the audit working papers in general, that Price Waterhouse, whilst accepting that specific provisions had been made on the basis of a likely recovery in property values within a reasonable time, recognised that the risk of loss had increased, and should be accounted for by an increase in the general provision to a minimum of 1 per cent of net receivables.
It is a matter of judgement as to the level of general provision that is required at a given time. Price Waterhouse compared the level of Beneficial Finance's general provision with those of similar financial institutions. This analysis was based on information contained in the eighth edition of KPMG Peat Marwick's annual Financial Institution Performance Survey, which, in turn, was based on annual reports released in 1989 and early 1990.
The audit working papers() assert that, for each of the four major finance companies in Australia, the general provision expressed as a percentage of net receivables was less than 0.5 per cent. Price Waterhouse recognised that these ratios were based on 1989 accounts, at which stage economic conditions were more buoyant. Accordingly, against the background of this information, and for the reasons noted above, Price Waterhouse concluded that an increase in the general provision to 1 per cent of net receivables was the minimum position that they would accept.
As discussed earlier in the Section of this Chapter dealing with the Somerley exposure, Price Waterhouse stated in their written submission to the Investigation that:
"... a special review of loss provisions at 30 June 1990 had taken place and significant additional provisioning had resulted. This provisioning was considered aggressive and enhanced our view that any problems ultimately arising from exposures such as Somerley would be adequately covered by general provisions".
Having regard to the nature of the general provision, the size of the identified risk exposure on Somerley, the approach to provisioning adopted by Beneficial Finance at 30 June 1990, the matters referred to above, and the evidence contained in the audit working papers, I have formed the opinion that:
(a) specific provisioning at 30 June 1990 was not adequate;
(b) the general provision did not adequately cover the real risk of loss associated with the Somerley exposure; and
(c) there is insufficient evidence in the audit working papers to support the conclusion reached by Price Waterhouse that the unallocated provision was adequate, in the absence of specific provisions being made against the Somerley exposure.
Apart from the acceptance, by the auditors, of management's failure to make a specific provision of $24.2M against the Somerley exposure, in my opinion, the audit procedures carried out by Price Waterhouse with regard to the Provision for Doubtful Debts were appropriate and adequate.
59.5.2.4 Matters Noted - Equiticorp
As discussed in Chapter 58 - "Review of the 1989 External Audit of Beneficial Finance", I have formed the opinion that, at 30 June 1989, Beneficial Finance need not have raised a $10.0M provision for loss against the guarantee given to the Bank in relation to its exposure to Equiticorp. The Investigation noted that this amount continued to be disclosed as a contingent liability in the accounts of Beneficial Finance at 30 June 1990, and no specific provision for loss was raised.
Price Waterhouse have submitted that they received further assurances from Mr K L Copley and Mr Baker, at various times, in connection with the half year audit at December 1989, confirming that the Bank would ensure that Beneficial Finance would not suffer any loss as a result of the underpin agreement.()
The evidence before the Investigation is that the joint auditors of the Bank did not pursue the matter with Price Waterhouse in connection with the audit for the year ended 30 June 1990.()
Based on the evidence examined by the Investigation, and for the reasons set out above and in the preceding Chapter, I have formed the opinion that no provision was required in the accounts of Beneficial Finance in respect of Equiticorp for the year ended 30 June 1990.
59.5.2.5 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 set out below (under Concluding Procedures), and subject to my finding that Price Waterhouse failed to identify the need for a specific provision regarding Somerley, the execution of the 1990 external audit of Beneficial Finance was otherwise appropriate and adequate.
59.5.3 CONCLUDING PROCEDURES
59.5.3.1 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; and
(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 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 require the person responsible for signing the auditor's report to consult 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) provisions for doubtful debts;
(b) the impact of shockproofing on the accounts at 30 June 1990; and
(c) the disclosure of information pertaining to off-balance sheet entities.
59.5.3.2 Matters Noted - Shockproofing
As discussed earlier in this Chapter, the effect of shockproofing on the results for the year under review was not material.
Based on the evidence examined by the Investigation, and having regard to applicable professional standards and practices, I have formed the opinion that the effect of shockproofing on the accounts of Beneficial Finance for the year ended 30 June 1990 was not material.
59.5.3.3 Matters Noted - Provisions for Doubtful Debts
As discussed earlier in this Chapter, I have formed the opinion that the specific provisions were understated by $24.2M at 30 June 1990 in respect of Somerley.
Accordingly, in my opinion, the reported pre-tax loss of Beneficial Finance, for the year ended 30 June 1990, of $21.5M was materially understated by $24.2M.
59.5.3.4 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 pursuant to ASRB 1017 (Related Party Disclosures):
"Ownership interests in related parties
Subsidiaries
Interests held in subsidiary Companies are set out in Note 20.
Other controlled entities
There are no individually significant investments in other related parties apart from a $13,180,000 investment comprising all of the units in the IBM Centre Unit Trust and $8,550,005 investment in non voting preference shares in Campbell Capital Ltd. Interests in other controlled entities held through the Kabani Ordinary Settlement Trust include the following items:
|
Company Name |
Activity |
Participation in |
|
Kabani Pty Ltd |
Financier and equity investor |
100 |
|
Gumflower Pty Ltd |
Equity investor in the Mindarie Keys |
50 |
|
Monash Gateway |
Property developer |
50 |
|
Ravlick Pty Ltd |
Financier |
100 |
The contribution of the above entities are reflected in Beneficial Finance Corporation Limited by way of dividends received and provisions on loans. These entities are partly financed by Beneficial Finance Corporation Limited, material amounts are disclosed elsewhere in this note.
Amounts receivable from or payable to related parties:
|
Holding Company |
Group |
||||||||||||||
|
30 June |
30 June |
30 June |
30 June |
||||||||||||
| Aggregated loan amounts receivable at balance date | |||||||||||||||
| Current | |||||||||||||||
|
8.0 |
11.0 |
8.0 |
11.0 |
|||||||||||
|
125.8 |
23.4 |
125.8 |
23.4 |
|||||||||||
|
104.0 |
92.2 |
124.0 |
92.2 |
|||||||||||
|
88.9 |
131.4 |
88.9 |
131.7 |
|||||||||||
|
326.7 |
258.0 |
346.7 |
258.3 |
||||||||||||
| Non-Current | |||||||||||||||
|
- |
2.8 |
- |
2.8 |
|||||||||||
|
32.3 |
5.7 |
32.3 |
5.7 |
|||||||||||
|
23.2 |
22.5 |
29.9 |
22.5 |
|||||||||||
|
21.4 |
31.9 |
21.4 |
32.0 |
|||||||||||
|
76.9 |
62.9 |
83.6 |
63.0 |
||||||||||||
| Aggregated loan amounts payable at balance date | |||||||||||||||
|
2.6 |
- |
2.6 |
- |
|||||||||||
|
0.5 |
- |
0.5 |
- |
|||||||||||
|
13.2 |
16.5 |
13.2 |
16.6 |
|||||||||||
|
- |
0.4 |
- |
3.7 |
|||||||||||
|
16.3 |
16.9 |
16.3 |
20.3 |
||||||||||||
| Significant loan amounts included in the above amounts receivable are: | |||||||||||||||
| Southstate International Pty Ltd |
26.5 |
24.1 |
26.5 |
24.1 |
|||||||||||
| East End Co Ltd and Group |
41.1 |
3.3 |
41.1 |
3.3 |
|||||||||||
| Beneficial Investments |
46.8 |
- |
46.8 |
- |
|||||||||||
| Equus Financial Services Ltd |
29.9 |
29.1 |
29.9 |
29.1 |
|||||||||||
| Mortgage Acceptance Corporation Ltd |
34.3 |
39.9 |
34.3 |
39.9 |
|||||||||||
| Leasefin Corporation Ltd |
25.7 |
17.4 |
25.7 |
17.4 |
|||||||||||
| IBM Centre Trust |
1.4 |
23.9 |
28.0 |
23.9 |
|||||||||||
| Gumflower Pty Ltd |
22.9 |
15.5 |
22.9 |
15.5 |
|||||||||||
| Kabani Pty Ltd |
70.9 |
- |
70.9 |
0.3 |
|||||||||||
Transactions with Related Parties
Transactions with related parties are generally made on normal commercial terms and conditions.
Interest is generally 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 | |||||||||||||||||||||
|
30 June 1990 |
30 June 1989 |
30 June 1990 |
30 June 1989 |
|||||||||||||||||||
| Interest Revenue | ||||||||||||||||||||||
|
0.3 |
- |
0.3 |
- |
||||||||||||||||||
|
11.4 |
- |
11.4 |
- |
||||||||||||||||||
|
7.11 |
9.7 |
7.1 |
9.7 |
||||||||||||||||||
|
29.2 |
18.1 |
29.2 |
18.1 |
||||||||||||||||||
|
48.0 |
37.8 |
48.0 |
37.8 |
|||||||||||||||||||
| Dividend revenue | ||||||||||||||||||||||
|
6.7 |
0.4 |
6.7 |
0.4 |
||||||||||||||||||
| Interest expense | ||||||||||||||||||||||
|
2.7 |
- |
2.7 |
- |
||||||||||||||||||
|
0.6 |
- |
0.6 |
- |
||||||||||||||||||
|
3.3 |
- |
3.3 |
-" |
|||||||||||||||||||
In June 1990, management of Beneficial Finance obtained Board approval for a corporate restructuring, the purpose of which was to transfer certain off-balance sheet companies to a subsidiary of the Bank, to be called Southstate Corporate Holdings Ltd.() The Board paper states that the effect of the restructure was to reduce off-balance sheet assets from $679.0M to $425.0M, although Kabani and certain associated off-balance sheet entities remained off-balance sheet.() The total aggregate position, as at 30 June 1990, after restructuring, was expected to be:()
|
Off-balance |
Total |
||||||||
|
Beneficial |
Southstate |
Sheet |
Consolidation |
Aggregate |
|||||
|
Net profit after tax |
21.3 |
(10.8) |
(9.7) |
15.0 |
15.8 |
||||
|
Shareholder’s equity |
193.2 |
7.0 |
9.5 |
(4.6) |
211.4 |
||||
|
Total assets |
2,351.9 |
417.6 |
424.5 |
(379.0) |
2,815.0 |
||||
|
Provisions |
39.0 |
7.2 |
4.2 |
(6.2) |
44.2" |
||||
The actual figures turned out to be quite different, as pointed out below.
The Board Paper maintained that an equity accounting note would not be required because the significant companies which would be subject to equity accounting were to be transferred to Southstate Corporate Holdings Ltd,() although it was mentioned that Price Waterhouse were reviewing the paper to ensure consistency with accounting principles.()
On 30 June 1990, the trustee of the Kabani Pty Ltd Ordinary Share Settlement had resolved to distribute trust income, being dividends from Kabani, to Beneficial Finance as beneficiary of the trust.() The trustee was Bondi Investments Pty Ltd, a wholly owned subsidiary of Beneficial Finance.
On 27 June 1990, the trustee exercised its powers to add beneficiaries, with the consent of Beneficial Finance, and the trustee nominated itself, Bondi Investments, as a beneficiary.() The trustee then proceeded, on 29 June 1990, to distribute to itself income from each of the relevant trusts, in the form of dividends from Kabani and Fortina. The sum involved was in total $6.147M. This was then paid by Bondi as a dividend.() Price Waterhouse have submitted that the dividend of $2.5M paid by Fortina represented current year profits, and that the Kabani dividend of $3.6M was substantially offset by Beneficial Finance writing down its on-balance sheet investment in the Asset Risk Management Group, and therefore the payment of the dividends should not be construed as "profit smoothing".()
(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 Audits 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. 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.
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 1990. This analysis was prepared by referring to the respective audited accounts of each relevant entity at 30 June 1990, and the figures have not been adjusted for additional matters identified in this Chapter.
|
|
BFCL Group |
|
||||||||
| Current Assets | ||||||||||
| Property developments |
- |
17.2 |
17.2 |
|||||||
| Other |
1,626.6 |
1,619.1 |
(7.5) |
|||||||
|
1,626.6 |
1,636.3 |
9.7 |
||||||||
| Non-Current Assets | ||||||||||
| Property developments |
4.3 |
79.6 |
75.3 |
|||||||
| Property, plant & equipment |
20.2 |
20.6 |
0.4 |
|||||||
| Investments |
33.3 |
18.3 |
(15.0) |
|||||||
| Other |
990.2 |
996.9 |
6.7 |
|||||||
|
1,048.0 |
1,115.4 |
67.4 |
||||||||
| Total Assets |
2,674.6 |
2,751.7 |
77.1 |
|||||||
| Current Liabilities |
1,461.1 |
1,476.6 |
15.5 |
|||||||
| Non-Current Liabilities |
1,024.0 |
1,085.7 |
61.7 |
|||||||
| Total Liabilities |
2,485.1 |
2,562.3 |
77.2 |
|||||||
| Net Assets |
189.5 |
189.4 |
(0.1) |
|||||||
| Profit After Tax | ||||||||||
| and Extraordinary Items |
4.7 |
(0.3) |
7.7 |
|||||||
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 observed 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, however, indicate that :
(a) Price Waterhouse had performed audit procedures on the underlying financial records of material off-balance sheet entities prior to finalisation of the 1990 Beneficial Finance audit to satisfy themselves as to the adequacy of provisions made against amounts receivable by Beneficial Finance from those entities.
(b) The financial position of the relevant off-balance sheet entities disclosed in the audited accounts for the year ended 30 June 1990 did in certain cases differ materially from that shown in the underlying financial records referred to at (a) above. It is apparent that these material differences (principally relating to provisions) arose through the effluxion of time and would not have been evident either to Beneficial Finance or Price Waterhouse at the time of finalising the 1990 audit. Accordingly, the relevant audited accounts have been adjusted in preparing the pro-forma financial information.
The above analysis shows that the effect of consolidating the off-balance entities at 30 June 1990 would have resulted in Beneficial Finance reporting that:
(i) Consolidated assets of Beneficial Finance were approximately $77.1M (2.9 per cent) greater than those disclosed in the statutory accounts.
(ii) Consolidated liabilities of Beneficial Finance were approximately $77.2M (3.1 per cent) greater than those disclosed in the statutory accounts.
(iii) Beneficial Finance's equity participation in property developments was approximately $92.5M or 22 times greater than that disclosed in the statutory accounts ($4.3M).
(iv) The consolidated after-tax result of Beneficial Finance and off-balance sheet entities was a loss of $3.0M compared with a profit of $4.7M disclosed in the statutory accounts. If adjustments were made for Somerley, the $7.7M loss effect of the controlled entities would represent approximately a 75 per cent increase in the adjusted loss.
It is evident from the above that, at 30 June 1990, the off-balance sheet entities were, in aggregate, material business undertakings of Beneficial Finance.
Price Waterhouse have submitted that the figure in paragraph (iii) above incorrectly includes an amount of $53.4M in respect of the relevant interests in the Mindarie Keys Hotel, the IBM Centre and Palawan, 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 that 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 1990, 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 1990.
(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 1990 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
Approved Accounting Standard ASRB1017 "Related Party Disclosures" ("ASRB1017"), (October 1989) issued by the Australian Accounting Profession, sets standards for the disclosure of information concerning relationships with and transactions between related parties.
The Investigation noted that the disclosures made by Beneficial Finance at Note 26 to the accounts for the year ended 30 June 1990 generally complied with the requirements of ASRB1017 and Regulations 33 and 34.
59.5.3.5 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 in the absence of disclosure of adequate information pertaining to the controlled off-balance sheet entities.
(b) Consequently, information and notes pertaining to the off-balance sheet entities corresponding to that applicable to subsidiaries was omitted from the accounts;
(c) Price Waterhouse concluded that it was too early to assess whether a loss of $24.2M, which had been incurred on discharging a guarantee facility in respect of Somerley, should have been recognised in the profit and loss account when the available audit evidence supports a conclusion that the loss should have been brought to account in full.
By reason of the foregoing, Price Waterhouse's opinion that the accounts for the year ended 30 June 1990 complied with Section 269 of the Companies Code and gave a true and fair view was inappropriate.
59.6 CONCLUSION
In my opinion, the audit opinion expressed by Price Waterhouse on the accounts for the year ended 30 June 1990 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, and their contribution to the Beneficial Finance Group result of a $7.7M loss;
(c) It was inappropriate for Price Waterhouse to accept management's decision not to raise a provision of $24.2M in respect of Beneficial Finance's exposure concerning Somerley.
(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 provide for the loss on Somerley.