2017.12 DYNASTY WINES

Company Name: Dynasty Fine Wines Group Limited
Stock Code: 00828
Year end: December 31, 2012

Basis for Disclaimer of Opinion

  1. Issues Arising from the Investigation and Scope Limitations

As disclosed in note 2.2 to the consolidated financial statements, the Company was informed in 2013 of certain anonymous allegations which might have an impact to the consolidated financial statements of the Group in relation to the sales arrangements with certain distributors, discrepancies in inventories held by the Group, recognition and classification of selling expenses and certain other matters. In response to these allegations, the audit committee of the Company (“Audit Committee”) commissioned an independent investigation (“Investigation”) involving third party consultants to investigate certain of these allegations. The Investigation was completed in 2016. The Investigation has identified certain sales agreements and arrangements, storage of inventories in the offsite warehouses and other arrangements, as described in note 2.2(i) to the consolidated financial statements, that were not previously identified and accounted for by the Group and not disclosed to us during or prior to our audit of the Group’s consolidated financial statements for the year ended 31 December 2011.

Based on the findings of the Investigation, the directors considered it necessary to make adjustments to the Company’s consolidated financial statements for the year ended 31 December 2011 and before, and consequently prior year adjustments were considered by the Group in respect of the following matters:

(i) Sales arrangements with certain distributors

Revenues arising from the sales transactions under the sales arrangements with certain key distributors from 2009 to 2011 were previously recognised in the consolidated financial statements at the time when goods were shipped out of the Group’s manufacturing plants. As described in note 2.2(i) to the consolidated financial statements, the Investigation revealed that the goods were in fact shipped to certain offsite warehouses. The Group was responsible for the continuing management of such inventories, bore the inventory risk before the shipments to the downstream distributors and end customers, and was obliged to assist the distributors to identify downstream distributors and end customers to further distribute the goods. Some of these goods were shipped to these downstream distributors and end customers in subsequent periods.

Based on the findings of the Investigation, the directors considered that revenue arising from these sales arrangements should have been booked when the goods were shipped to the downstream distributors or end customers as instructed by the distributors, i.e., when the actual risks and rewards associated with these goods were transferred to the downstream distributors or end customers. As a result, a prior year adjustment was recorded in the consolidated financial statements of the Group as at and for the year ended 31 December 2011.

(ii) Discrepancies in inventories

As described in note 2.2(ii) to the consolidated financial statements, the Investigation has identified that, as at the time when the Investigation was conducted, certain of the Group’s inventory records in 2012 and prior years were not properly maintained and a substantial number of documents supporting the movements of inventories prior to 31 December 2014 and other supporting documents were missing. During management’s process of reconstructing the Group’s inventory records as at 31 December 2014, a net aggregated unexplained difference made up by different inventory items between the physical count result and the accounting records of inventory amounting to HK$53,148,000 was recognised as stock loss for the year ended 31 December 2014 based on the judgement and estimation made by the Group.

Besides, during the physical count of inventory balances at 31 December 2014 the Group identified significant balances of obsolete inventories amounting to HK$244,451,000 for unsellable finished goods due to quality issue. Together with other adjustments, provisions for inventory write-down of HK$210,244,000 was charged to the Group’s consolidated financial statements for the year ended 31 December 2013, while the related balance as at 31 December 2014 was HK$263,389,000.

The directors considered that the events leading to the discrepancies in inventories might have happened in and/or prior to 2012. However, due to the missing supporting documents and inventory records, the Group was unable to quantify the impact, if any, in and prior to 2012. As a result, no adjustment was made by the Group on the consolidated financial statements of the Group as at and for the years ended 31 December 2012 and 2011 in respect of the discrepancies in inventories relating to the unexplained difference and obsolete inventories mentioned.

(iii) Recognition and classification of selling expenses

As described in note 2.2(iii) to the consolidated financial statements, the Investigation has identified certain arrangements with respect to selling and other expenses payable to the distributors in respect of the sales transactions conducted under the sales arrangements described in (i) above. The directors considered that certain selling expenses had not been recorded in the proper reporting periods. Also, as at the time when the Investigation was conducted, it was found that the accounting records and supporting documents in relation to these selling expenses incurred in and prior to 2012 were not properly maintained. Although the Group has attempted to reconstruct its records in relation to selling expenses, due to the loss of the relevant records and documents the Group was unable to accurately and completely reallocate these selling expenses to the relevant accounting periods in and prior to 2012. Based on the limited information available, the directors estimated that distribution expenses of HK$45,517,000 had been understated in the Group’s consolidated financial statements for year ended 31 December 2011 and a prior year adjustment was recorded accordingly.

Further, during the process of reconstructing the selling expenses records, the Group considered that certain marketing expenses reimbursed to the distributors or incurred in other marketing activities previously recorded as distribution expenses were related to the sales transactions with the distributors, and thus should have been adjusted and accounted for as a reduction of the revenue earned from the distributors. Due to the loss of the relevant records and documents, the Group was unable to quantify the impact, if any, in and prior to 2012. As a result, no adjustment was made by the Group in this respect on the consolidated financial statements of the Group as at and for the years ended 31 December 2012 and 2011.

The details of the above prior year adjustments together with their impacts are more fully described in note 2.2 to the Group’s consolidated financial statements.

As explained above, during or prior to our audit of the Group’s consolidated financial statements for the year ended 31 December 2011, we were not provided by management or the directors with the aforementioned sales agreements and other supporting documents governing the terms of sales arrangement, inventory management and the relevant selling activities entered into between the Group and certain key distributors as mentioned above, nor were we informed of the existence of the inventories stored in the offsite warehouses. In response to such matters identified in the Investigation, we have planned to conduct extended procedures in the audit of the Group’s consolidated financial statements as at and for the year ended 31 December 2012. However, there were scope limitations encountered in our audit as outlined below.

Management did not maintain adequate accounting records and supporting documents, in particular, the sales agreements and shipping documents, for a substantial portion of the sales transactions to enable us to assess the sales transactions for the year ended 31 December 2012. The management was also not able to provide adequate supporting documents to enable us to satisfactorily complete the independent confirmation procedures in relation to the trade receivables balances as at 31 December 2012 and the sales transactions for the year then ended.

Management did not maintain adequate accounting records and supporting documents to support the calculation of the costing of the inventory balances together with the related costs of goods sold as at and for the year ended 31 December 2012. Management was also not able to provide any satisfactory evidence and explanation to the unexplained differences in the accounting records of inventory balance as at 31 December 2012. In addition, the management did not perform proper physical count of inventory balance at 31 December 2012 to cover the quantity of the inventory stored in all of the offsite warehouses and identify any obsolete inventories. Moreover, although the directors considered that the events leading to the significant unexplained differences of HK$53,148,000 between the physical count results at 31 December 2014 and the accounting records and the obsolete inventories described in note 2.2(ii) to the consolidated financial statements might have happened in and/or prior to 2012, the directors were unable to quantify the impact of these matters, if any, in and prior to 2012 due to the missing supporting documents and inventory records.

Management did not maintain adequate accounting records and supporting documents for the selling expenses incurred in and prior to 2012 to enable us to assess whether the marketing activities were carried out in the same period in which the selling expenses were recorded. Further, although the directors considered that certain marketing expenses reimbursed to the distributors or incurred in other marketing activities previously recorded as distribution expenses should have been adjusted and accounted for as a reduction of the revenue earned from the distributors, the directors were unable to quantify the impact of this, if any, in and prior to 2012 due to the loss of the relevant records and – 21 – documents. Management was also not able to provide adequate supporting documents to enable us to satisfactorily complete the independent confirmation procedures in relation to the selling expenses for the year ended 31 December 2012.

Because of the above scope limitations, we were unable to obtain sufficient appropriate audit evidence and there were no alternative audit procedures that we could perform to satisfy ourselves as to:

(1) the occurrence, cut-off, accuracy, valuation, rights and obligations, existence and completeness of the sales transactions, the related receivables and payables balances and the related tax impacts as at and for the year ended 31 December 2012;

(2) the occurrence, cut-off, accuracy, valuation, rights and obligations, existence and completeness of the inventory balances together with the related cost of goods sold and the related tax impacts as at and for the year ended 31 December 2012;

(3) the occurrence, cut-off, accuracy, rights and obligations, existence and completeness of the selling and other expenses and the related payable balances and the related tax impacts as at and for the year ended 31 December 2012; and

(4) the accuracy and completeness of the prior year adjustments identified and recorded by management in relation to (1) and (3) above in all material respects.

Accordingly, we were not able to determine whether any adjustments to the consolidated financial statements were necessary.

  1. Impairment of Property, Plant and Equipment

As described in note 15 to the consolidated financial statements, the Group’s consolidated balance sheet included property, plant and equipment with a carrying amount of HK$556,504,000 at 31 December 2012. During the year, Group has been making losses and incurring operating cash outflows that were considered to be an indicator of impairment. However, the directors did not carry out an impairment assessment of its property, plant and equipment at 31 December 2012 because the directors were unable to estimate the recoverable amounts of these assets as at 31 December 2012 due to the loss of the relevant records and documents.

Failure to perform impairment assessment when there is an indicator of impairment is a departure from Hong Kong Accounting Standard 36, “Impairment of Assets”. Had an impairment assessment been performed, an impairment loss might have been recognised in the Group’s consolidated income statement for the year ended 31 December 2012. As the directors did not carry out an impairment assessment as at 31 December 2012, we were unable to determine the effects of the impairment provision, if any, on the consolidated financial statements of the Group as at and for the year ended 31 December 2012.

Disclaimer of Opinion

Because of the significance of the matters described in the Basis of Disclaimer of Opinion paragraphs, we have not been able to obtain sufficient appropriate audit evidence to provide a basis for an audit opinion. Accordingly, we do not express an opinion on the consolidated financial statements. In all other respects, in our opinion the consolidated financial statements have been properly prepared in accordance with the disclosure requirements of the Hong Kong Companies Ordinance.