(Answered): Double Ink Printers Ltd (DIPL)

Case Study on Double Ink Printers Ltd (DIPL)

Background Information

You are a senior manager with Stewart and Kathy and you have been approached to

undertake the audit of Double Ink Printers Ltd (DIPL). 2017DIPL print books, magazines and

advertising materials for the publishing, educational and advertising industries on a print-on-

demand basis. Printing on demand means that publishers can print the exact quantities

ordered by retail outlets, rather than estimating in advance how many books are required

and often printing too few or too many. The average printing turnaround time for DIPL is two

business days for small orders and five to ten business days for large orders. In addition, five

years ago, DIPL further expanded its earnings base by having publisher’s titles available as

searchable ‘e-books’ that could be downloaded directly by readers from DIPL’s website.

Purchase and Inventory

DIPL purchases 50% of its inventory requirements of paper, ink and binding materials from

Australian sources and 50% from Asian countries. When inventory received at DIPL’s

warehouse (whether it is purchased from Australia or Asia), the accounts payable clerk, Bill

Jimmy, records the arrival of the inventory and also its value and quantity in the accounts

payable system. Inventory is paid for the relevant currency of the country from which it is

purchased. Raw materials have been valued at average cost and an allowance for inventory

obsolescence has existed in previous years to cover the estimated decline in value from the

effects of storage hazards. Work in progress is immaterial due to the quick turn- around time

of printing jobs. Any work in progress is assessed at the cost of raw materials and labour and

proportion of manufacturing overheads based on normal capacity. At year end, the

warehouse is closed from 28 to 30 June for stocktake, so sales must be invoiced in the system

by close of business on 27 June. The stock must have been sent to the customer (that is, it

must either be on track, ship or plane on its way to the customer, or it must already have

arrived at the customer; it must no longer be in DIPL’s warehouse).

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‘Print on Demand’ revenue and receivables

Each time a publisher wants to add a book to DIPL’s ‘digital library’ (a server storing all of the

publisher’s books in a digital format, ready to print), it emails the book to DIPL in PDF format.

The digital library is backed up at the close of business every day, with the backup tapes kept

off site. Once the book is stored in the digital library, the publishers can order copies to be

printed as required.

When the publishers confirm the order, the accounting system automatically retrieves details

of the publisher’s credit record and stops any orders from publishers that have exceeded their

credit terms and limits. A printout of the transactions history of the publishers is generated

and must be signed by both Helena Keng, the head of publishing, and Jane Roger, the head of

accounts at DIPL, before the order can continue, after the transaction history has been signed

and dated, accounts receivable staff file it.

If there are no credit problems with the order, it is processed and printed by casual staff in

the relevant warehouse, who then load the books onto pallets for shipping. When printing is

finished, the sales clerk, Brown Pall, prepares an invoice and dispatch docket and forwards

them to the accounts receivable department. The accounts receivable clerk Gay Chan, checks

the prices and arithmetic accuracy of the invoices and signs the invoice as evidence of her

check. Gay records the sales both the accounts receivables subsidiary ledger and the general

ledger and books are shipped to the publisher’s nominated destination (or the publisher will

arrange pick up at the warehouse if has its own distributors). The client accepts liability for

the goods when they are received in accordance with the purchase order, and signs the

dispatch docket as proof of delivery.

‘E-book’ Revenue

The proceeds from each e-book sale are paid to the publisher’s net of a 5% commission.

Proceeds are sent to publishers automatically upon download (the commission is withheld by

DIPL). Revenue from the commission is recognised when is withheld from payment to the

publishers.

DIPL also charge publishers an annual “storage fee” payable 12 months in advance, for

keeping the e-book on DIPL’s website. Publishers are invoiced on the date the first download

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of a title occurs. As new books are downloaded on an ongoing basis, the storage fee is invoiced

at different times of the year. Revenue from storage fees has been recognised in the month

the fees are invoiced, notwithstanding the fact that the fees are charged 12 months in

advance.

In September 2016, DIPL acquired Nuclear Publishing Ltd (NPL). The main rationale behind

the lay in the value of the copyright NPL held over a large range of specialised medical

textbooks. Although the potential print run for the textbook was not large, each textbook had

a high profit margin and had been used in universities across the world for many years. DIPL

acquired the business operation of NPL (not the shares), paying net assets (including the right

to the copyright). However, in June 2017 an article was published in a medical journal about

a new theory that could result in NPL’s medical textbooks becoming obsolete. If the new

theory is valid, the textbooks are unlikely to be reprinted or used as textbooks at universities

in the future, effectively making them unviable as e-books.

Cash Receipts

Some Payments from accounts receivables are received by cheque through the mail, and the

cashier, Judy Bones, record these in an inwards remittance register when the mail is opened.

She then banks the cheques and forwards the payment advices to Gay Chan for posting ton

the accounts receivable ledger. Most payments, however, are received by electronic funds

transfer (EFT). Each day, Judy downloaded the previous day’s receipts from online banking

and provides a copy to Gary for posting. Judy then reconciles the total of the batch postings

to accounts receivable to the amount banked for the day. The assistant accountant, Bobby

Fong, prepares a bank reconciliation at the end of each month.

Fixed Assets

Since DIPL’s incorporation, depreciation on assets has been calculated using the straight-line

method to allocate their cost over their estimated useful lives, as follows:

 Printing presses up to 20 years

 Other production equipment up to 15 years

 Other equipment up to 10 years

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Finance

During 2017, DIPL has entered into a 7.5 million loan from BDO Finance Ltd (BDO Finance).

The loan has debt covenant’s requiring DIPL to maintain a current ratio of at least 1.5 and a

debt to equity ratio of less than 1. Failure to maintain these key financial ratios under the

specified benchmarks would result in BDO Finance having the right to recall the loan.

Appointment of New CEO and internal Audit

William Jackson was appointed the new chief executive officer (CEO) of DIPL in January 2017.

William has extensive experience in the printing business. The previous CEO, Rebecca Styles,

who is now semi- retired, will remain on the board as a non-executive director. A component

of William’s remuneration package is a performance bonus based DIPL achieving an annual

growth of 10% in total revenue and 10% in net profit after tax. Based on William’s

recommendation, the board also established a new internal audit department headed up by

Cody Baines, an ex-audit manager with a Big Four audit firm and two other recently qualified

chartered accountants. Cody reports directly to the board.

New IT System

During 2017, DIPL decided to invest in a new IT system that would fully computerised and

integrate all the current accounting processes across the organisation, including integration

into the general ledger system.

Under extreme pressure from the board, the IT department at DIPL managed to get the new

accounting system installed in June, although IT manager, Andy Law, complained several

times about how the installation was handled. Andy claimed that excess pressure had been

placed on staff to get the system installed and that there was simply not enough staff to do

the proper reconciliation’s and testing before the new system went live prior to year-end.

Andy preliminary testing showed that some transactions conducted around year-end were

not being allocated to the correct period. The problem appeared to be the interface between

the new accounting system and one of the existing software systems. A software ‘patch’ had

to be written to fix the problem.

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Board year-end reporting discussions

As a board meeting held in June 2017, issues relating to the forthcoming year end were

discussed. William stated that he believed that the valuation of raw materials inventories at

average cost was no longer appropriate as the current cost of paper was substantially above

the average cost. Further, he argued that the allowance for obsolescence of inventory to

cover the estimated decline in value from the effects of storage hazards was necessary, as

such a loss was unlikely. William also stated that based on his experience in the printing

industry he believed that DIPL’s printing presses had a potential maximum life of 30 years,

although he noted that another leading entity in the printing industry adopted the policy of

depreciating its printing presses over a 20-year period on a straight-line basis, similar to what

DIPL had done in the past. After much discussion, the board resolved that the allowance for

obsolescence of inventory be written back and that raw materials be valued based on a first-

in, first-out (FIFO) basis. In addition, following a review of the e-book facilities by internal

audit, Cody recommended that in a report to the board that DIPL change the method it used

to account for its revenue from e-book publication to ensure compliance with the applicable

accounting standard. The board agreed that the revenue from e-book would be recognised in

accordance with the stage of completion of each transaction (i.e. percentage of completion

method).

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Double Ink Printers Ltd

Statement of Financial Position

Note 2015 2016 2017

(Unadjusted)

Current Assets

Cash

647250 517788 347120

Accounts Receivables 1 2482500 4320000 5073309

Inventories 2 2256188 2671362 4180500

Total

5385938 7509150 9600929

Non-Current Assets

Property, Plant and

Equipment 3 7544062 8394750 15572062

Intangible Assets

——- ——- 975000

7544062 8394750 16547062

Total Assets

12930000 15903900 26147991

Current Liabilities

Accounts Payable

1950000 3035250 3525000

Deferred revenue

—- —- 697500

Interest-bearing liabilities

937500 862500 787500

Provisions

810000 1125000 1267500

Accruals

82500 97500 120000

Total

3780000 5120250 6397500

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Non-current Liabilities

Interest-bearing liabilities

—- —- 7500000

Total Liabilities

3780000 5120250 13897500

Net Assets

9150000 10783650 12250491

Equity

Shareholders Fund

2250000 2250000 2250000

Retained Profits

6900000 8533650 10000491

Total Equity

9150000 10783650 12250491

Double Ink Printers Ltd

Income Statement

2015 2016 2017

Revenues

Revenue from Operations 34212000 37699500 43459500

Cost of Sales 28207500 31620000 36855000

Gross Profit 6004500 6079500 6604500

Allowance for inventory obsolescence written

back ——- ——- 155588

Commission Income 108000 123000 130500

E-book storage fees 667500 1027500 1417500

Income from operating activities 6780000 7230000 8308088

Expenses

Advertising 83725 115923 125778

Audit Fees 112500 127500 135000

Bad Debt 150000 195000 210000

Depreciation 249375 274312 472688

Discounts allowed 195000 285000 335500

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Legal Fees 74000 111500 137000

Foreign Exchange loss 38500 49750 —-

Rates 98500 106000 113500

Repairs and maintenance 224000 276500 306500

Salaries 1965000 2190000 2445000

Telecommunication costs 134750 141478 159785

Total expenses 3325350 3872963 4440751

Net income before interest and tax 3454650 3357037 3867337

Interest expense 84379 83663 808038

Profit before tax 3370271 3273374 3059299

Income tax 1011081 982012 87116

Profit after tax 2359190 2291362 2972183

Notes to the Financial Report

2015 2016 2017

(Unadjusted)

Account Receivable 2647500 453000 5313309

1 Allowance for doubtful debts -165000 -210000 -240000

2482500 243000 5073309

Inventory 2362500 2797238 4180500

2 Allowance for obsolescence -106312 -125876 ——

2256188 2671362 4180500

3 Property, Plant & Equipment

Land 2775000 3375000 3375000

Plant and Equipment 5250000 5775000 13425000

Accumulated Depreciation -480938 -755250 -1227938

7544062 8394750 15572062

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Required:

Question 1:

As part of your planning process, you are considering whether you will need to use the

services of an expert in the audit of Double Ink Printers Ltd (DIPL).

Required:

Based on the background information contained in the case, explain whether it will be

necessary to use the work of an expert in the audit of DIPL. (5 marks).

Question 2:

You are at the planning stage of the audit of Double Ink Printers Ltd (DIPL) for the year ended

30 June 2017 and have been asked by the audit manager to assists determine the materiality

levels.

Required:

(a) Referring to the background information contained in the case, identify five factors that

would influence your determination of the preliminary figure for overall materiality for the

2017 audit of DIPL. (5 marks).

(b) Explain why the factors identified in (a) above are relevant to your calculation of the

preliminary figure for overall materiality. (5 marks).

(c) Describe how the factors identified in (a) above will influence your preliminary figure for

overall materiality in the audit planning process. (5 marks).