Special auditors were initially engaged to review transactions of Daka Designs Ltd (DDL) and its subsidiaries, and its investee companies, Daka Manufacturing Limited (DML) and its parent, Daka Industrial Limited (DIL).
The scope of the work was enlarged to assess if DML was a controlled subsidiary or an associate of the Group.
Serious irregularities was discovered in the financial management of the Group’s operations.
Non-consolidation of investment, DML that was in substance, controlled by the Group
Non-disclosure of the Group’s plan to acquire DML in its IPO Prospectus => As a result of not consolidating the substantial losses of HK$19.2m incurred by DML for period ended 31 March 2004, the Group’s results were overstated
Significant fictitous sales transactions with 2 major customers to overstate revenue => As a result, its financial results for the intended IPO was overstated
Disclosure issues: ~ Non disclosure of nominee shareholding ~ Non disclosure of loans to executive directors ~ Non disclosure of acquisition of new subsidiaries
No actual repayment of loan by investee company – Repayment of outstanding loan owning by DIL to Group was by way of accounting adjustments and funds originating from the Group
IPO proceeds were not used in purposes as stated in Prospectus
Breach of laws, rules and regulations, e.g.,. criminal breach of trust for misappropriating company funds, breach of directors’ fiduciary duties, breach of The Listing Rules.
Internal controls, e.g., weak internal controls and a failure of checks and balances within the company. Weak corporate governance arising from top management
Considerations by Auditors:
~ Reliance on management representation? For example, could the auditors have probed more into the relationship between Group and its investee companies?
~ Professional Competence and Due Care? For example, could the auditors have performed more work, e.g to look beyond the form of sales transactions and identify that those were fictitious sales ? why did the auditors not find out about the loans made to directors that was a direct breach of the Companies Act.