Recommendation of new accounting procedures: Investment-equity reconciliation

A good exercise can be undertaken by the holding company is to prepare appropriate documentation to reconcile investor's cost of investment to investee's share capital for any investment-equtiy relationships within the Group.

The procdure appears to be straight forward, simple and non-complex on first thought. However, the reconciliation can turn into a complex procedure, due to:

- impairment been recorded for cost of investment
- difference exchange rate was used to translate the funding (i.e. investor used exchange rate A, while investee used exchange rate B)
- funding remitted / received is not recorded in appropriate account, etc

This recommended procedure is particularly useful for entities with significant number of subsidiaries. Discrepancies (between cost of investment and share capital) are usually expected for large group of entities.

This reconciliation excercise help to ensure that appropriate figures are recorded in respective source ledger, and ensure that appropriate elimination are done at group level.

Inappropriate accounting for payment- Diamond Foods, Inc

As published in Diamond Foods' website on 08 February 2012. Diamond Foods, Inc announced that audit committee's investigation of the Company's accounting for certain crop payments to walnut growers is substantially completed. The findings shows that financial statement for FY 2010 and FY 2011 will need to be restated.
"The Audit Committee has concluded that a "continuity" payment made to growers in August 2010 of approximately $20 million and a "momentum" payment made to growers in September 2011 of approximately $60 million were not accounted for in the correct periods, and the Audit Committee identified material weaknesses in the Company's internal control over financial reporting." [ Quoted from the Company's announcement]

It is not mentioned on the accounting treatment for the payment to walnut growers. Questions we are interested in is:
- what was the accounting treatment that had been recorded for payment to Walnut Growers
- what should be the appropriate accounting treatment
- how would the financials been affected
- will the profit & loss of the Company been affected immediately
- are there any interested party relationship between Diamond Foods, Inc and those walnut growers
- had a proper review of the financials been reviewed earlier

For the 12-month-ended July 2011, Diamond Foods recorded a net profit before tax of about US$69mil. Shareholder's Equity amounted to US$495mil as at 31 July 2011. In our opinion, US$80mil of payment ( i.e. US$20mil + US$60mil) represents a significant amount to the Company's financial statement.

In addition, the audit committee also identified mateiral weakness in the Company's internal control. As evidenced, it is crucial to have a sound internal control environment to support the financial statement closing process of the Company.

Importance of Suppliers' Evaluation Process

One of the key emphasis of internal audit is to evaluate whether your audit client has appropriate process in place to evaluate the suppliers.

Unfavorable event in any part of the supply chain will causes disruption to the distriubtion of products to end-customers successfully. It is important to evaluate the suppliers to ensure that they have the capability and stability to conduct sustainable business with your audit client on a long term basis.

On an ideal basis, management/ procurement of your audit client should have a formal policy on the entire process of evaluating suppliers. The evaluation has to be developed and documented in a proper format.

For instance, a background check on the suppliers is required (e.g. is the supplier a subsidiary of any congolmerates, is the supplier financially sounds). Another key document is the financial statement of the supplier. This is to ensure that supplier is financially stable to operate on a going concern basis.

Please let us know if you would like a detailed format of Suppliers' Evaluation Form. This is available in our Accounting & Auditing blog. Please drop us an email at myauditing@gmail.com.