THE FACTS
126 On 26 November 1998 LMP wrote to the Fund enclosing Jaja's audited financial statements together with the AFR form. The profit and loss statement showed a loss for the year ended 30 June 1998 of $23,040. The company's current liabilities were $67,978 and exceeded the current assets of $46,916. The balance sheet showed total shareholders' equity of only $2,742.
127 The audit report which was addressed to 'The Members of Jaja Pty Ltd, The Trustees of the Travel Compensation Fund and the International Air Traffic Association' was qualified:
'Qualification
During the financial year the company changed from a manual accounting system to a computerised general ledger and client accounting system.
We are unable to satisfy ourselves as to the accuracy of certain computer generated records and in particular commission received which has decreased some $42,518 (or 31%) compared to the previous years, despite a 30% increase in turnover. We are also unable to express an opinion on the accuracy of the Client Bank Account and Client Creditors as shown in the attached Balance Sheet.
We are unable to quantify the extent of the above uncertainties.
Qualified Audit Opinion
In our opinion, except for the effects on the financial statements of the matters referred to in the qualification paragraph, the financial statements of Jaja Pty Ltd for the year ended 30th June 1998 are properly drawn up:
a) to give a true and fair view of:
(I) the company's state of affairs as at 30th June 1998 and its profit (or loss) for the financial year ended on that date; and
(II) the other matters required by Divisions 4, 4A and 4B of Part 3.6 of the Corporations law as they apply to large corporations to be dealt with in the financial statements; and
b) in accordance with the provisions of the Corporations law; and
c) in accordance with applicable Accounting Standards and mandatory professional reporting requirements.'
128 The audit opinion therefore contained an 'except for' qualification.
129 In the letter accompanying the provision of those documents, LMP wrote:
'Our client, the Directors of the above, wish to advise that the attached audit report has confirmed their grave concerns regarding the financial ratio position of the company's accounts as at 30 June, 1998.
On presenting our firm with the company's computer generated general ledger and trial balance for the year ended 30 June, 1998 the Directors of the company advised us that they were very concerned as to the position of the client account and the amount of available commission income to be transferred to the general operating account. Furthermore, due to their lack of knowledge and understanding of the software, they felt very insecure regarding the accuracy of the reports generated by their inhouse computer system.
As of 1 November, 1998 the company commenced using an integrated computer travel software package recommended for use by their franchisor, Harvey World Travel. All records were then "backloaded" to 1 July, 1997 onto the new software. A dual manual/computer system has not been in place for the year ended 30 June, 1998.
On investigation by ourselves and the auditor, Mr Robert Young of Rankin & Young we found that the Directors' fears were well founded, as the accounts reflected inadequate working capital and other requirements to satisfy the minimum financial ratios required by TCF/IATA and Harvey World Travel.
This firm has prepared the attached financial statements based on source documents as provided. After our review of these financial statements, we believe that the commission income is inaccurate, and therefore produces inaccurate profit, working capital and equity results for the year ended 30 June, 1998. As a result of lengthy discussions with the Directors, it was decided that due to the prohibitive cost, time and resources available, it is not possible, at this time, to further investigate and determine, the exact cause of the problem, but rather, the Directors have immediately taken steps, based on our advice, to rectify the company's financial and client account position as measured by TCF/IATA.
The following measure have been implemented;
● A $10,000-00 capital injection from shareholders private funds was made into the company, October, 1998. Note this capital injection does not encumber the company's assets.
● The Directors have taken steps to strengthen internal control by making all cash monies paid by travel clients secure until they are actually deposited at the bank by utilising a wall safe and allowing only one staff person access to the safe.
● To enable the Directors to have confidence in the amount available for transfer of commission income from the client account to the general operating account, and to provide working capital, a manual accounting system for the client account has been implemented, effective October, 1998 (operated in conjunction with the integrated computer software). As a result working capital has been generated and funds are being transferred, with greater accuracy into the general operating account. Furthermore, the accuracy of both the client account and the general operating account are now able to be determined and reconciled.
● The shareholders are in the process of selecting a real estate agent for the purpose of listing their home for sale, with the intent of using funds from the sale to contribute working capital into the company.
● To monitor the performance of the company's position and the effect of the above strategies the Directors have decided that interim financial statements will be prepared for the six months to 31 December, 1998 by this firm.
● As soon as surplus working capital becomes available the Directors will invest in comprehensive staff training of the existing integrated travel software package to avoid future problems.
It is our belief that given the resolve of the Directors, combined with the positive effect of the above strategies that the TCF/IATA financial measures of, percentage working capital ratios, ratio of net tangible assets to turnover, and minimum equity requirement, and rectification of accurate client account recording will be restored over the current financial year ending 30 June, 1999.
The company has positive current bookings and trading outlook, with significant positive inroads already being made into the 1999/2000 year by confirmed large party bookings being recorded.
We, together with the Directors of the company fully realise that the attached TCF/IATA financial analysis does not meet the requirements as laid down. However, we trust that you will give fair and due consideration to both the Directors' determination to ensure that the ratios are rectified in order to satisfy the TCF/IATA testing criteria, and to the extenuating circumstances that have arisen resulting in the ratios as per the attached analysis.
Should you have any queries please contact us immediately. On behalf of the Directors of the company, we thank you in anticipation of your support in this matter.'
130 The letter was signed by Mr Lane. In that letter Mr Lane said that the shareholders, who were then the first and second respondents, had injected $10,000 into the company in October 1998. If that had occurred then, of course, that injection would not have been reflected in the balance sheet as at 30 June 1998. If it happened it should have appeared in any balance sheet which was compiled after October 1998.
131 In the penultimate paragraph of that letter Mr Lane referred to Jaja not meeting the requirements as laid down by the Fund.
132 In that regard, he was referring to a calculation termed a 'financial analysis ratio' used by the Fund to determine whether a travel agent met the financial criteria necessary to remain a participant in the Fund.
133 As I have said, the financial criteria requires a travel agent to maintain a minimum level of capital and reserves dependant upon the scale of operations measured by the annual turnover (both travel and non-travel). In addition to the minimum capital and reserve criteria, the review of an agent's financial statements involves the allocation of points for working capital and net tangible asset ratios. Additional points are allocated where a travel agent maintains a client account. The maximum points available are 20 and at least 10 points are required for renewal of membership.
134 In the calculation Jaja presented on 26 November 1998, the total points were minus one (-1).
135 Jaja was colour coded 'red/blue'. It did not meet the financial criteria. It had operated at a loss. It did not meet the minimum capital and reserves requirements or the minimum equity gateway. It attained -3 points for each of the working capital available to the overhead test and the net tangible assets to turnover ratio test.
136 The audited financial statements and the AFR form were considered by Mr Newman, a financial assessor employed by the Fund. Mr Norman had the responsibility of assessing Jaja's application for renewal against the criteria imposed by the Fund. That required a consideration of the financial analysis ratio. The Fund also had the separate responsibility, which in this case was also imposed upon Mr Newman, of determining whether the travel agent, in this case Jaja, met the financial criteria for continued membership of IATA.
137 On 1 December 1998 he wrote to the directors of Jaja advising them that the Fund's assessment of Jaja's financial statements and AFR form reflected a deficiency in capital of $55,000 and that Jaja had not met the minimum financial criteria determined by the trustees 'in that it has insufficient Net Capital & Reserves and Working Capital'. He wrote that the equity in the company would need to be increased by the amount of $55,000 either by providing the Fund with a bank guarantee, which was not secured over agency assets, or issuing shares fully paid for cash and retaining the proceeds of the issue.
138 Jaja was further advised that should the appropriate action not be taken by 8 January 1999 the matter would be referred to the trustees' meeting on 14 January 1999 for determination.
139 On the same day, Mr Newman wrote to IATA and advised that Jaja failed the IATA financial criteria for membership of that organisation.
140 Mr Newman sought an undertaking from Jaja that the proceeds of the $10,000 capital injection which was referred to in LMP's letter would be retained within the company to strengthen its working capital/equity position.
141 On 3 December 1998 LMP replied to Mr Newman's letter and enclosed a copy of a letter addressed to the Fund signed by the first and second respondents 'undertaking that the sum of $10,000 that has been injected into the agency, since the balance date of 30 June, 1998 will remain within the agency to strengthen its working capital/equity position'.
142 LMP also advised that it had a lengthy meeting with the directors and that the directors were confident that the deficiency reflected in the AFR form for the year ended 30 June 1998 was a 'one off occurrence'.
143 LMP reported that the directors also undertook to provide a further $30,000 capital from the unencumbered proceeds of the sale of their home. Moreover, the directors also undertook to provide the Fund with financial statements for the six months ending 31 December 1998 to be tabled for the February 1999 meeting of the trustees.
144 On 19 January 1999 Ms Kirby telephoned the Fund and advised that the financial statements to 31 December 1998 would be available in mid February. She also advised that she and a director of Jaja wished to attend the February Management Committee meeting of trustees. She further confirmed that the directors were selling their house for the purpose of injecting $30,000 of capital.
145 Mr Newman prepared an Assessing Services Report for submission to the Management Committee meeting on 28 January 1999. In due course, that was signed by both Mr Hammond and Mr Brattoni.
146 In that report it was recommended:
'2. RECOMMENDATION:
The Trustees resolve as a condition precedent of ongoing participation the participant is allowed 21 days to provide:
● Monthly management accounts commencing with accounts to 31/12/98.
Review MCM February 1999, and
● Is allowed until 8 March 1999 to provide Audit and Directors' confirmation of cash capital injection of $30,000.
Review MCM March 1999.
The participant wishes the attached letter dated 3/12/98 to be tabled at this MCM, in which they state their intention to attend the February 1999 MCM.
The Shareholder's house is being auctioned on 20/2/99 to provide the cash capital injection.'
147 On 29 January 1999 Mr Newman wrote to the directors of Jaja stating, inter alia:
'Dear Participant,
Fund File No: 3 / 4925
NOTICE OF TRUSTEES' DETERMINATION
This letter is to confirm that, at the Fund's Management Committee Meeting held on 28 January 1999 at which you were offered the opportunity to attend, but declined to do so, the Management Committee resolved that:
As a condition precedent of ongoing membership, you must provide the Fund, with all the following documents and information by the stated date.
A. By 17 February 1999:
● A set of monthly management accounts for the period ended 31 December 1998
The Management Committee will review your compliance or otherwise with the above at their next Management Committee Meeting to be held on 17 February 1999, and make the appropriate further determination.
B. The participant be requested to attend the next meeting of the Fund's Management Committee to be held on 17 February 1999, if there is perceived to be a problem with the cash capital injection requirement of $30,000 by 8 March 1999.'
148 On 9 February 1999 LMP provided Jaja's financial statements for the period ended 31 December 1998 to the trustees. It also provided an AFR form which indicated a financial ratio analysis of seven points. The profit and loss account showed an operating profit for the six months of $3,430. The balance sheet showed an excess of assets over liabilities of $6,482. Current assets were shown as $56,495. They exceeded Jaja's current liabilities of $48,626.
149 The issued capital as at 31 December 1998 was the same as it had been at 30 June 1998. Thus, the balance sheet did not reflect an injection of $10,000 by way of capital between 30 June 1998 and 31 December 1998.
150 The documents were accompanied by a document headed 'Compilation Report to Jaja Pty Ltd' which said:
'On the basis of information provided by the client, we have compiled in accordance with APS9 "Statement of Compilation of Financial Reports" the special purpose financial report of the Client for the period ended 31 December, 1998 as set out in the accompanying Profit and Loss Statement, Balance Sheet and other attachments (as applicable).'
151 The reference to 'APS9' is a reference to an accounting standard. Professional Statement APS9 'Statement of Compilation of Financial Reports' was issued by the National Councils of the Institute of Chartered Accountants in Australia (ICAA) and the Australian Society of Certified Practising Accountants (CPA). The members of both the ICAA and the CPA are obliged by the Code of Professional Conduct to conform with that accounting standard. That Code relevantly provides:
'A.2 Compliance
"Compliance with the Code is mandatory for all members…"
B.6 Technical & Professional Standards
"Members must carry out their professional work in accordance with the technical and professional standards relevant to that work."
B.7 Competence and Due Care
"Members must perform professional services with due care, competence and diligence. A member has a continuing duty to maintain professional knowledge and skill at a level required to ensure that a client or employer receives the advantage of competent professional service based on up-to-date developments in practice, legislation and techniques."'
152 I find that LMP was obliged to comply with APS9 as it represented it had.
153 The relevant clauses of APS9 provide:
'11 In undertaking a compilation engagement, a member must comply with the requirements of Miscellaneous Professional Statement APS 1 "Conformity with Accounting Standards and UIG Consensus Views" ("APS 1").
12 When performing any professional service a member must comply with the Code of Professional Conduct. The basic principles governing an engagement by a member to compile a financial report are as follows:
(a) integrity;
(b) objectivity;
(c) confidentiality; and
(d) professional competence and due care.
…
20 A member must obtain a general knowledge of the business and operations of the client in relation to which the compilation is being prepared and must be familiar with the accounting principles and practices of the industry in which the client operates and with the form and content of the financial report that is appropriate in the circumstances.
…
24 A member must consider whether the compiled financial report appears to be appropriate in form and free from material misstatements.
…
26 If a member becomes aware that information supplied by the client contains any material misstatement or is otherwise unsatisfactory, the member must request the client to provide such additional information as may be required. If the client refuses to provide such additional information as is necessary, the member must consider the effect that this may have on the financial report. The outcome of such consideration must be reflected by comment in the report prepared by the member, or in the member withdrawing from the engagement.'
154 Clause 11 refers to Miscellaneous Statement APS1 'Conformity with Accounting Standards and UIG Consensus Views'.
155 Paragraph 20 of APS1 provides:
'Members who are involved in, or are responsible for, the preparation, presentation or audit of a special purpose financial report of an entity are required, except where it is reasonable to expect that the special purpose financial report will be used solely for internal purposes, to take all reasonable steps within their power to ensure that the special purpose financial report, and any audit report or accountant's statement clearly states:
(a) that it is a special purpose financial report;
(b) the specific purpose for which the special purpose financial report has been prepared; and
(c) the extent to which Accounting Standards and UIG Consensus Views have, or have not, been adopted in its preparation and presentation.'
156 I find that LMP was obliged in compiling Jaja's financial statements to comply with each of the provisions to which I have referred.
157 LMP also said:
'Under the terms of our engagement we have not audited the accounting records of the Client or the Accounts. Accordingly, we express no opinion on whether they present a true and fair view of the years trading and no warranty of accuracy or reliability is given.
To the extent permitted by law, we do not accept liability for any loss or damage which any person (or entity), other than the Client, may suffer arising from any errors or omissions therein however caused. No person should rely on the special purpose financial report without having an audit or review conducted.
The special purpose financial report was prepared solely for the benefit of the Client. We do not accept responsibility to any other person (or entity) for the contents of the special purpose financial report.'
158 On the same day, LMP also provided financial statements for the period ended 31 January 1999. That showed an operating profit to that point of time of $4,323. The shareholders' equity had risen to $7,430. Current assets of $78,411 exceeded current liabilities of $66,743. An AFR form showed a point score of 10.
159 Those documents were enclosed in a letter from LMP dated 9 February 1999. That letter was prepared by Ms Kirby but signed by Mr Lane.
160 In that letter, LMP wrote:
'On behalf of our client we are pleased to report that the positive action of the Directors for the above combined with the effect of strategies implemented (please refer to our correspondence dated 25 November, 1998) has resulted in a positive change of direction of the company with a turnaround in net profit for the seven month period until 31 January, 1999 of $27,728.'
161 LMP further wrote:
'The directors of the above are committed to doing all they possibly can to gradually rectify the deficiency as reflected in the 30 June, 1998 financial ratio analysis.
It is a belief of our firm that, our clients, the directors of the above, are genuine people and given support and the opportunity to continue to trade they believe the company should be able to gradually meet all the financial ratio analysis criteria of both TCF and IATA.'
162 An Assessing Services Report was prepared for the meeting of 17 February 1999 by Mr Newman which was again signed by Mr Hammond and Mr Brattoni.
163 In the Assessing Services Report, the following recommendation was made:
'2. RECOMMENDATION:
The Trustees resolve as a condition precedent of ongoing participation the participant is to provide:
A. On or before 10 March 1999:
● Audit verification and directors' written undertaking, of additional cash capital injection of $30,000, or
● QBE On Demand Guarantee for $30,000.
B. Or, monthly management accounts commencing with accounts to 28 February 1999, due on 15 March 1999.
Review MCM 11 March 1999.'
164 However, following upon a meeting with the first respondent and Ms Kirby the trustees resolved otherwise. The trustees reported and resolved that:
'Mr Yurisich, director and the accountant Ms J. Kirby attended the meeting with the Trustees. Following discussion of all matters, IT WAS RESOLVED that as a condition precedent of ongoing membership, the company must provide the Fund, with all the following documents by the stated dates:
A. By 21st of the month following:
● Monthly management accounts and client account reconciliations commencing with the accounts to 28 February 1999, due on 21 March 1999.
B. By 31 August 1999:
● Lodgement of the 1998/1999 Annual Financial Review and accompanying financial statements.
The Management Committee will review compliance or otherwise with "A" above at their Management Committee Meeting to be held in April 1999, and make the appropriate further determination. The matters in "B" above to be reviewed on 9 September 1999.'
165 Mr Newman wrote to the first respondent on 18 February 1999 advising of the resolution of the Management Committee. In that letter he advised that the Management Committee would review Jaja's compliance or otherwise on 8 April 1999. He suggested that the net capital and reserves position would be improved by capitalising the shareholders' loans of $11,121.
166 Sometime in early 1999 Ms Gottschalk paid the first respondent $40,000 'with the intention that I obtain a half share in the business'. She said in her affidavit:
'9. Sometime in early 1998 I paid $40,000 by personal cheque to Yurisich with the intention that I obtain a half share in the business. This was to entail a transfer of half the shareholding and eventually my appointment as a director. It was agreed with Yurisich that my appointment as a director would be postponed at his discretion. My concern was primarily to obtain some employment security over the long term. It is very difficult to obtain part time employment close to my residence which I required in order to attend to parental duties. I was not instructed such that I was able to develop my role in the business beyond sales matters. I had no reason to doubt Yurisich's management of the business which he had been operating since about 1980 to my knowledge.'
167 She did not receive a transfer of the shares nor was she appointed a director at that time.
168 She paid $40,000 because she was told by the first respondent that there was an existing bad debt. She said in her evidence:
'Did you have any concerns when Mr Yurisich told you about the bad debt?---We did. We knew there was an existing bad debt, namely being Aussie Golf, and we knew that it was approximately $47,000-odd and by injecting that $40,000 we believed that that debt would be, if not - yes, mostly cleared off and we could move ahead from that. That's the only bad debt that we were informed of.
You now know there were a large number of bad debts in excess of that, don't you?---We now know, at that stage we did not.
But you never had any detailed discussion with Mr Yurisich about the debit balances in the client ledger trial balance?---No, we were led to believe all the way along that the company was not making a great profit but it was holding its own and by me working there - have another travel agent working in the business so we could grow the business. Never at any stage did we get notification from either Mr Yurisich or Mr Martin Lane that - anything to the contrary.'
169 The applicants did not proceed against the first and second respondents and, as a result of course, neither of them gave evidence. As I have already noticed, the first respondent is a bankrupt and the second respondent is a apparently impecunious.
170 It is necessary to make a finding about their financial position in 1999 because they were then the directors and only shareholders of Jaja.
171 On 26 November 1998 LMP had represented that the shareholders had injected $10,000 into the company. On 3 December 1998 LMP wrote to Mr Newman enclosing a letter in which the first and second respondents undertook that the sum of $10,000, which had been injected into the agency, would remain within the agency to strengthen its working capital/equity position. No balance sheet prepared subsequent to either of those dates showed an injection of $10,000 by way of capital.
172 On 3 December 1998 LMP said that the directors would be providing a further $30,000 by way of capital after the sale of the proceeds of their house. Apparently, at the Management Committee meeting on 28 January 1999, Mr Newman was told that the first and second respondents' house was to be auctioned on 20 February 1999 to provide the cash capital injection of $30,000. No such injection ever took place.
173 Some time in early 1999 the fourth respondent, Ms Gottschalk paid the sum of $40,000 for 50 per cent of the shareholding of Jaja. That sum was used to be offset a bad debt.
174 I find that by early 1999 the shareholders had not injected $10,000 by way of capital into Jaja. I find that they had not used any monies (if any monies were received) from the proceeds of the sale of their house to inject any further capital into Jaja. I find that, by early 1999, neither the first nor the second respondent had the capacity to support Jaja. I find that the half interest was sold by Ms Gottschalk to meet the loss occasioned by a bad debt.
175 In March 1999, LMP submitted management accounts for the period 1 July 1998 to 28 February 1999. By letter dated 15 April 1999 LMP wrote to Mr Newman enclosing management accounts for the period 1 July 1998 to 31 March 1999, although in that letter they described the accounts for the period 1 July 1998 to 28 February 1999.
176 On 19 April 1999 Mr Newman wrote to Mr Lane reminding him that Jaja was also required to lodge a monthly statement showing the client trust account reconciliation between the cash at bank and the client ledger position certified by the directors as true and correct.
177 On 14 May 1999 Mr Lane wrote apologising for not having responded to that letter earlier, explaining that Ms Kirby had been off from work for nearly two months and that they were attempting to work towards the rebuild of the computerised client account. He wrote:
'Further to our telephone conversation May 11, 1999, we thankyou for your letter of 19 April, 1999 and apologise for the delay of this written response regarding the above.
There are several reasons why this information hasn't been supplied to date. They are:
1] At the Management Committee meeting held 17 February 1999 which Mrs Jenny Kirby of our office and Mr Wayne Yurisich attended, Jenny raised and discussed the issues relating to the disparity between a manual client account reconciliation and the inhouse computerised client account reconciliation, and outlined the problems regarding the quality of information generated from the computerised client account reconciliation.
At that time we had taken steps to ignore the information as produced from the inhouse accounting package, preferring instead to manually reconcile the client account cash at bank to the client ledger. This has been done on a monthly basis.
2] Jenny Kirby has been off work for nearly two months due to her hospitalisation and two operations. The operation and a spell from the office was unexpected. Her anticipated recovery period has been extended due to the need for the second operation. Nevertheless Jenny is making good progress and we anticipate her return to the office by the end of this May.
Jenny as you would appreciate has been instrumental in the rebuilding of Jaja's computerised accounting records. Therefore she has been sorely missed and our timetable in relation to the rebuild of the inhouse computerised client account system has been set back by at least two months.
We advise that without Jenny, we are attempting to work towards the rebuild of the computerised client account and to bring it into line with the manual client account reconciliation.
It is our expectation that the review and rebuild Wayne's computerised client account reconciliation will be finalised in time for the production of the monthly draft June 1999 financial statements.'
178 On 19 May 1999 the first respondent, and on 20 May 1999 the second respondent, signed an Agreement setting out the terms and conditions of LMP's appointment to act as accountants (the Engagement Agreement). The Engagement Agreement announced that it was to apply to all future assignments in which LMP acted as accountants.
179 The purpose and scope of the engagement was stated to be:
'The purpose and scope of the engagement would be for the preparation and lodgement of annual income tax returns, and the preparation of any annual and/or interim financial statements relevant to your business structure as of this date, including preparation of statutory minutes and Australian Securities and Investments Commission annual return of the company.
On the basis of the information you provide, we will compile, financial reports (where applicable), in accordance with APS 9 "Statement on Compilation of Financial Reports". Our procedures use accounting expertise to collect, classify and summarise the financial information, which you provide, into a financial report.'
180 The document continued:
'It is our understanding that no audit or review will be performed regarding your financial statements and accordingly no assurance will be expressed. We will process the financial information as presented to us without any review of your primary source documents being undertaken on the specific understanding that you have the necessary supporting documentation to satisfy the Australian Taxation Office, or other relevant authority, as required. The procedure undertaken by our firm will not include verification or validation procedures. Accordingly, we will not express an opinion as to the truth and fairness of any financial statements and our usual form of compilation report will accompany them.
The special purpose financial report will be prepared (exclusively for your benefit and for the purpose specified to us by you). We will not accept responsibility to any other person for the contents of the financial report. No person should rely on the financial report without having an audit or review conducted.'
181 Having regard to the terms of the Engagement Agreement, there cannot be any doubt, as I have already found, that LMP was obliged to comply with APS9.
182 On 21 May 1999 LMP submitted management accounts to the Fund for the period 1 July 1998 to 30 April 1999. On 21 June 1999 LMP wrote to Mr Newman enclosing management accounts for the period 1 July 1998 to 31 May 1999.
183 LMP wrote:
'On behalf of our client we report that the positive action of the directors for the above combined with the effect of strategies implemented (please refer to our correspondence dated 25 November 1998) has resulted in a positive change of direction of the company with a turnaround in net profit for the 11 month period ended 31 May 1999 of $30,631.'
184 On 29 July 1999 Mr Lane wrote to Mr Newman asking that Jaja be excused from providing management accounts for the period to 30 June 1999. Instead, it offered to lodge the 1998/1999 AFR form together with the audited financial accounts for the year ended 30 June 1999 by 31 August 1999.
185 Ms Kirby compiled Jaja's financial statements for the period to 30 June 1999. She provided those financial statements to Mr Young, together with a number of source documents to enable Mr Young to carry out his audit.
186 Among the documents provided was the client account debtors ledger for corporate clients for June 1999 which showed a total of $57,746.29 owing.
187 Mr Young conducted the audit in accordance with an audit checklist which included as part of the audit plan:
'The main purpose of the audit is to express an opinion on the financial statements and to certify TCF/IATA Annual Review Form. This form must be in accordance with information extracted from the financial statements and its purpose is to determine whether the travel agent obtained sufficient points based on various financial ratios. The main ingredients of the ratios are turnover, net tangible assets, working capital and operation of a client account (trust monies).'
188 He prepared a draft audit opinion which he provided to LMP.
189 The draft audit opinion was in the same form as the final audit opinion. It contained a qualification. Therefore his audit opinion was qualified in the following terms:
'Qualification
a) Current liabilities in the attached balance sheet comprise Trade Creditors $16,090 and Trust Creditors $14,098. The Trust Creditors amount of $14,098 is a net amount after offsetting client debtors of $57,746. As a result current assets and current liabilities are both understated by $57,746. The client debtors total of $57,746 includes $47,217 owing by one debtor. At the date of this report the ageing of that debt is as follows:
over 2 months $12,988
over 6 months 7,318
over 12 months 26,911
_______
$47,217
=====
We are unable to be satisfied that this material debt is collectable. No provision for doubtful debts has been made.
b) To the extent that last year's financial report was subject to an audit qualification on specified balance sheet items, we have had to accept that closing balance sheet amounts at 30th June 1998 have been used as opening balance sheet amounts at 1st July 1998 for those items.
Qualified Audit Opinion
In our opinion, except for the matters referred to in the qualification paragraph, the financial report of Jaja Pty Ltd for the year ended 30th June 1999 is in accordance with:
a) The Corporation Law, including:
(i) giving a true and fair view of the company's financial position as at 30th June 1999 and of its performance for the year ended on that date, and
(ii) complying with Accounting Standards and Corporations Regulations; and
b) other mandatory professional reporting requirements.'
190 The audit opinion did not address the effect upon Jaja's financial statements of the understatement of the current assets and current liabilities of $57,746. The audit opinion drew attention to the debt of $47,217. It referred to the age of the debts. The opinion did not address whether, in the auditor's opinion, any provision should have been made for bad or doubtful debts. Nor, of course, in view of that answer did the opinion address the effect upon Jaja's financial statements if any provision of that kind were made. The audit opinion was, like the audit opinion for the previous financial year, an 'except for' opinion.
191 At the same time as that draft audit opinion was provided to LMP, LMP was also advised that the financial statements should be adjusted as indicated in a handwritten document. I think it might be inferred that if the adjustments had been made the audit opinion would not have been qualified, although if that were the case, in my opinion, the audit opinion would not still have been in accordance with audit standards. The handwritten document was in the following terms:
'JAJA Y/E 30/6/99
ADJUST FINANCIALS AS FOLLOWS
(1) ↑ TRUST CREDITORS 57 746
(2) ↑ TRADE DEBTORS 57 746
↓ TRADE DEBTORS (47 217) VERY DOUBTFUL DEBTS
(assumes remaining $10 529 was collectable)
(3) ↓ PROFIT 47 217 RE ABOVE
ABOVE ADJUSTMENTS AS INDICATED PER QUALIFIED AUDIT OPINION.'
192 Of course, the financial statements are not those of the auditor but are the directors. The auditor cannot insist upon the directors drawing their financial statements in accordance with his/her opinion. All an auditor can do is suggest that the financial statements needs to be redrawn in a particular way to conform with the opinion which he has formed.
193 In this case, on 25 August 1999, Ms Kirby received the copy of the draft qualified audit report enclosed with a facsimile written by Mr Young to Ms Kirby. In that facsimile he wrote:
'(1) Draft audit report for consideration. I feel I need to spell out all that detail on the basis that TCF & IATA place heavy reliance on audit reports.
(2) Could you please fax me a copy of 30/6/99 bank rec and final bank statement for General A/C. Could Wayne contact NAB and ask them to promptly respond to our audit letter which is in tonights [sic] mail.'
194 It is plain that Mr Young was well aware that the Fund and IATA would rely upon Jaja's financial statements and his audit opinion in determining Jaja's eligibility for participation in the Fund and as a member of IATA.
195 I find that Mr Young knew that the Fund and IATA would rely upon his audit opinion for that purpose.
196 His facsimile to Ms Lane brought to LMP's attention the fact that the Fund and IATA would rely upon the audited financial statements and the other financial material forwarded to the Fund in support of Jaja's continuing eligibility as a participant in the Fund.
197 In my opinion, LMP did not need to be advised of that fact. LMP was always aware that the Fund relied upon representations made by Jaja and by LMP in determining whether Jaja remained eligible to participate in the Fund. I find that LMP knew that the Fund would rely upon Jaja's financial statements in considering whether Jaja was eligible to remain a participant in the Fund.
198 Ms Kirby brought Mr Young's draft audit report to the attention of Mr Lane. Subsequently, she received a second document from Mr Young in which he stated that additional notes needed to be made to the accounts. Ms Kirby said that she also brought that to the attention of Mr Lane.
199 Mr Lane said that he had a telephone conversation with Mr Young who told him that the Fund relied heavily on audit reports.
200 It was Mr Lane's evidence that he spoke to the first respondent who told him that the debts, which Mr Young had formed the opinion were uncollectible, were in his opinion collectible. In those circumstances, the directors were not prepared to modify the accounts to provide for any amount for bad and doubtful debts.
201 I think little or no effort was made by the fourth respondent to convince the directors that they ought to make a provision of the kind referred to in the draft audit report.
202 Indeed, if such a provision had been made then the company would have had to report a loss in the order of $40,000.
203 Although Mr Yurisich did not give evidence, I think it may be inferred that he must have thought that if the company reported a loss of that magnitude it would be unlikely that the trustees would continue to allow Jaja to be a participant in the Fund. If that were to occur, then almost certainly Jaja would have to cease carrying on the business as a travel agent.
204 No effort was made by Mr Lane or Ms Kirby to separately assess the collectability of the debts referred to in the draft audit opinion.
205 On 27 August 1999 LMP submitted the company's audited financial statements and AFR form to the Fund.
206 LMP provided a covering letter which included the following:
'We are pleased to report that the commitment of the company's Directors to rectify the problems of the past is beginning to effect a positive result as reflected in the companies [sic] financial statements with a significant turnaround of $28,405 from the loss of 1998 to the profit of 1999. In addition, please note that the majority of the problems relating to the company's "in house" computer system have been addressed. Consequently, the Directors are now in a position to more accurately produce reports than they were in the past. In particular please note, that the in house computer system now produces accurate bank reconciliations for both the general and client accounts.
Given the above improvements combined with the directors having complied with all requirements as imposed by yourselves on 17 February, 1999; they respectfully request that as of this current financial year, you allow them to submit to you six monthly unaudited management accounts together with client travel account bank reconciliations.
The directors acknowledge that there is a lot more that can be done to improve the financial ratio analysis of TCF, and given the continued support of yourselves they believe the company should be able to gradually meet all the financial ratio analysis criteria of both yourselves and IATA without the long term use of QBE's Trade Indemnity guarantee program.
It is the belief of our firm that our clients have made significant changes to their work practices and are determined to succeed in complying with all requirements of a licensed travel agent. We also suggest that they be given the opportunity to do so without the added cost impost of submitting monthly management accounts.'
207 LMP made no reference to the qualified audit opinion attached to Jaja's financial statements.
208 The documents submitted by LMP also included a 'Statement of Auditor' signed by Mr Young and dated 27 August 1999 in the following terms:
'Jaja Pty Ltd
I report and acknowledge that the information in this Annual Financial Review: -
- Forms the basis, together with the audited financial statements,
on which the participant's continued eligibility for participation in the Travel Compensation Fund is determined;
on which the participants continued eligibility as an accredited IATA agent is determined; (Cross out if not reporting to IATA)
2. Has been extracted from the participant's audited financial statements and underlying accounting records on a basis consistent with that of the prior year.
3. In my opinion, discloses all material contingent liabilities of the participant;
4. In my opinion, reports all material investments at values that are not greater their realisable values;
5. That the person signing this report is a Registered Company Auditor.
6. Strike through if not correct That the participant has properly maintained a fully funded Client Travel or Trust Account in accordance with the criteria CLIENT TRAVEL OR TRUST ACCOUNT at the Client Travel Account worksheet of this computer file.
7. Strike through if not correct That any loan from related parties deducted from liabilities in calculating the agency's Net Tangible Assets on the Summary Balance Sheet (Line 107) existed for a substantially similar amount throughout the whole audit period.
8. Strike through if not required That any Capital subscription since balance date included at Line 149 and, if applicable, Line 182, has been made by capitalisation of loans OR for cash for which the related monies have been deposited to the participant's bank account and not subsequently withdrawn and loaned to a related party.'
209 Also enclosed was a Statement by Directors signed by the Directors dated 4 August 1999 and in the following terms:
'STATEMENT BY DIRECTOR(S)
JAJA PTY LTD
ACN 057 681 740
The directors have determined that the company is not a reporting entity. The directors have determined that this special purpose financial report should be prepared in accordance with the accounting policies outlined in Note 1 to the accounts.
In the opinion of the Director(s) of the company:
[a] the balance sheet gives a true and fair view of the state of affairs of the company as at 30 June 1999 and the profit and loss account gives a true and fair view of the result for the year/period ended on that date.
[b] at the date of this statement there are reasonable grounds to believe that the company will be able to pay its debts as and when they fall due.
The accompanying accounts have been made out in accordance with statements of Accounting Concepts and Applicable Accounting Standards.
The company has, in respect of the financial year:
[i] kept such accounting records as to correctly record and explain the transactions and financial position of the company;
[ii] kept its accounting records in such a manner as would enable true and fair accounts of the company to be prepared;
[iii] kept its accounting records in such a manner as would enable the accounts of the company to be conveniently and properly audited in accordance with the Corporations Law.
The accompanying accounts have been properly prepared by a competent person.'
210 Included in the documents provided by LMP to the trustees was a compilation report in the same terms as the compilation report previously referred to.
211 As I have already indicated, the qualified audit opinion which, of course, was also enclosed, was in the same terms as the draft audit opinion which had previously been provided to Ms Kirby and to Mr Lane.
212 On the same day, Risk Financing Solutions, agents for QBE, confirmed in writing in a memorandum to Mr Newman that Jaja had obtained a $60,000 guarantee at a cost of $1,320 which would be supplied direct to the Fund as soon as possible. The Fund received the QBE guarantee on 1 September 2000.
213 The financial ratio analysis, which assumed the existence of the guarantee and the correctness of the financial statements without qualification, scored 16 out of 20. The AFR form which was submitted to the Fund did not make any provision for bad and doubtful debts. It simply ignored the qualification in the audit opinion. The AFR form also did not address the understatement of current assets and current liabilities which was also part of the audit qualification.
214 In the previous financial year Jaja had been initially coded by Mr Hammond with a red or blue marker because the 1999 AFR form indicated that Jaja had operated at a loss for the year, did not meet the minimum capital reserves requirement and had failed the minimum points score.
215 However, in view of the contents of the documents sent and received on 27 August 1999, Mr Hammond coded the renewal material green. They were then forwarded to Mr Newman for assessment.
216 Mr Newman noticed the audit qualification. In particular, he noticed the auditor's opinion that the auditor was unable to be satisfied that a material debt was collectable. Mr Newman recalculated the financial ratio analysis assuming a provision for bad and doubtful debts of $26,911, being those debts which were outstanding in excess of 12 months.
217 Upon that assumption, and upon the assumption that no allowance needed to be made for any further provision in the next year, he concluded that the points score for the financial ratio analysis of 13 was appropriate. A points score of 13 was sufficient for Jaja to remain a participant in the Fund without conditions.
218 In proceeding in that way, Mr Newman presumed that no provision needed to be made for bad and doubtful debts for the next year and that the sum of $26,911 could be treated as a 'one off'.
219 On 30 August 1999 Mr Newman wrote to the directors of Jaja advising them that the company was deficient in meeting the IATA financial criteria by $4,421 in that it had insufficient capital and reserves. On the same day he wrote to IATA advising it of Jaja's failure to meet IATA's financial criteria. He recommended, however, that IATA approve renewal because the shortfall in equity and reserves was below $5,000.
220 On 2 September 1999 Mr Newman prepared an Assessing Services Report for signature by Mr Hammond and Mr Brattoni for submission to the Management Committee meeting of 16 September 1999. He also prepared a 'Deficiency Calculation Workpaper' which showed a surplus and a points score of 16/20. In particular, in that Deficiency Calculation Workpaper, no regard was had to bad or doubtful debts. Mr Newman's evidence was that he did not bring qualified audits to the attention of Mr Hammond or any other person senior in authority to himself if he was able to work out the effect of the qualification for himself.
221 The Assessing Services Report was in the following terms:
'1. AGENT DETAILS: Fund File No : 3 / 4925
Legal Entity Name : Jaja Pty Ltd
Trading Name : Harvey World Travel Croydon
QBE Guarantee Held : $60,000
Profit for year 30/6/99 : $5,300
2. RECOMMENDATION:
The Trustees resolve to rescind the previous resolution requiring the Participant to provide monthly management accounts to the Fund, and to require lodgement of management accounts for the period ending 31 December 1999, by 20 January 2000.