CASE: You are planning the June 30th 2021 audit of Collingbourne Pty Ltd (Collingbourne) a family- owned company that operates three ballroom dance studios across metropolitan Adelaide. Collingbourne has been in business for sixty years. Today, it is managed by the grand-children of the original owners, Bill and Betty Spriggs.
At its height, Collingbourne was the premier dance academy in Adelaide, and earned sufficient revenue to purchase good quality premises from which to operate. However, in recent years, revenue has decreased due mainly to lower demand for dancing lessons because of changes in consumer taste, and competition from dance instructors who provide tuition via UTube. Fortunately, the firm foundations put in place by Bill and Betty Spriggs have allowed Collingbourne to still trade profitably while some other dance studios have had to close down because of the lack of demand.
Collingbourne’s current management team has not been complacent and has invested in new technologies, mainly virtual dance programs, and high-fidelity sound systems. Despite this, some costs, including insurance, have risen steeply in the past three years. While insurance costs have increased across the industry, Collingbourne’s insurance costs have increased more because of a major accident that occurred eighteen months ago, when a water pipe burst, flooding the dance floor and causing serious injuries to four customers. Collingbourne’s insurer is disputing its obligation to pay-out on the claim, arguing that Collingbourne was negligent because it failed to maintain the pipes to the required standard.
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The case brought by the insurer is likely to conclude within the next three months. If Collingbourne loses the case, which its solicitor believes will happen, it will be required to pay damages estimated to be around $4m.This would have significant impacts on working capital. Also, Collingbourne’s bank has indicated that it is closely monitoring the situation because the debt covenant on Collingbourne’s short-term loan requires it to maintain a current ratio of >=2, otherwise immediate repayment is required.
You ask your assistant for a summary of Collingbourne’s key financials. She provides you with the following:
Current assets (including cash of $2m) $ 6m
Non-current assets (including Land and Buildings valued at $6m) $ 8m
Total Assets $14m
Current Liabilities (including short-term debt of $2m) $ 3m
Non-Current Liabilities (including a bank loan of $1m) $ 2m
Total Liabilities $ 5m
(i) Indicate whether you believe that that going concern should be assessed as high risk for Collingbourne, and provide reasons for your risk assessment. In so doing,
(ii) State the facts from the case that indicate any going concern issues, and classify the indicators (for example, “financial”).
(iii) State the facts from the case that indicate any mitigating factors, and classify the factors (for example, “equity”).