StudentSampleRespons_SwiftyCanoe (6)

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Allama Iqbal College of Commerce, Taunsa Sharif (D.G. Khan) *

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4806

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Accounting

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Nov 24, 2024

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Swifty Canoe and Kayak Memo to: Partner Re: Swifty Canoe and Kayak Year End Audit This memo has been prepared to assist in the audit of Swifty Canoe and Kayak (SCK) for the year ended December 31, 2022, specifically in the revenue, expense, and equity sections. Swift Canoe and Kayak has been in business for a substantial period of time and is a private company that has been audited by our firm for ten years. The company follows ASPE and has moderate users. Users of the financial statements include; Shareholders- The Swifty family (45% Bill Sr, 45% Bill Junior) Freddy Shifty (10%) Iffy Swifty has taken interest in ownership of 10% of the company, prorated based on the net income of SCK. Bank- the bank issued a long term loan in 2018 for the expansion of manufacturing facilities, with the requirement of SCK to maintain a current ratio of 2:1, which they have always met. Government of Canada- As a result of receiving the COVID grant, SCK must maintain 95% of the workforce of its 2020 levels for the grant to not be repayable. The following are some of the key overall audit issues to look out for: ● Iffy (Freddy Shifty's son) was hired in late 2021 as the new CFO, and would like to buy-in to the company, by payment dependent on the 2022 net income. ● Iffy has a lack of experience in the accounting department and has a reputation for not finishing jobs. He also opted not to finish his CPA designation. Overall Inherent Risk Inherent Risk is assessed at high for the following reasons; ● Competition is increasing in the area which may result in lower future result ● There is substantial turnover of staff that increases the learning curve and indicates poor working environment ● The “tone at the top” indicates that all management may not be on the same page with decision making, by fear of hurting family friends feelings. ● There is bias to inflate the financials to comply with bank covenant

● Iffy is biased to overstate expenses to produce a lower net income so he is able to buy-in to the company for a lower cost. ● The company is run by many family members, friendships, and romantic relationships, which introduces personal issues that may indicate suspicious activity or lack of authority within the organization. Billy hired Iffy as a ‘favor’ to Freddy. ● The company has recently started large projects that require research and development costs, which can be complex for Iffy without a CPA designation ● We should also check last year's audit so assess the risk rating and any issues that were identified in prior years. ● The company operates in 3 locations, which may be difficult for management to oversee on the day-to-day basis. ● When Billy inquired with Iffy about the reduction in revenues, Iffy stated that it is because of rising inflation and decreased customer demand. This statement does not align with the industry statistics indicating a strong demand for outdoor equipment and the SCK is in its strongest period of growth in history. ● Financial statements indicate severance has been paid to a past employee who was fired by Iffy after working there for 20 years, this indicated poor management styles by Iffy. Overall Control Risk ● Accounts receivable is run completely by Stella, who is Iffy’s girlfriend. Her work is reviewed only by Iffy, which presents the opportunity for the two employees to overstate expenses to reduce net income for a lower buy-in for Iffy. ● Accounts payable is set up and signed by Iffy, then submitted to be entered into the system by AP staff. Although Billy Jr also signs the cheques, data entry is not dependent on his signature and is entered solely based on Iffy. ● Appendix IV presents a letter from Iffy, indicating he will be changing the way research costs are accounted for, because he is under ‘complete control’ of the accounting decisions. He suggests Ima does not consult with Bill Sr or Jr on this matter. ● There is no further indication of review of accounting records by Billy Sr, Jr, or Freddy, meaning Iffy has control to input virtually anything into the system without being caught. ● Iffy has chosen to present capital advertising costs during COVID as an expense, once again to overstate revenues to decrease net income. Based upon the factors above, I would conclude that the preliminary control risk is very high.

Overall Conclusion & Audit Approach Since inherent risk and control risk are high, we will do minimal testing of controls (TOCs) and rely mostly on substantive tests of cycles to achieve assurance. This would result in setting detection risk at low (inverse relationship). Materiality Users: Shareholders (Bill Sr, Jr and Freddy)- Shareholders are looking to maximize profits to ensure they meet the 2: bank covenant. They will also be concerned about net income to see a return on investment. Iffy- As a potential shareholder, Iffy is interested in net income as it will determine the purchase price for his share buy-in. Bank- The bank will want to ensure that the covenant is being met and SCK will be able to repay the loan. Based on the users, net income is an appropriate base. With a range of 5 to 10% of net income, the materiality amount will be set at the lower end of the range 5% Based on unadjusted net income, materiality will be set at $49,800. There is potential for misstatements in the financials so performance materiality will be set at the lower end. 65% of overall materiality will be the setting or $32,370 Net Income as of December 1, 2022 is $913,000 Extrapolated to December 31, 2022 996,000 x 5% = $49,800 Key Risk Areas Revenue Recognition KCS has entered into an agreement with an Austrian dealer whereby KCS received $120,000 upfront for the delivery of canoes. Half of the goods were sent by FOB shipping on December 22, 2022, with the remaining half being shipped in March 2023. The upfront payment was received November 18th and is currently being presented as unearned revenue on the income statement. Also revenue has gone up 10%, while net income has decreased by 10%, indicating that the company margins are worsening, likely due to Iffy’s overstatement of expenses.

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Accounting: Based on the shipping terms FOB, KCS has completed half of the sale by December 22, 2022. In which case, half of the revenue would have been earned according to ASPE standards with the application of the percentage-of-completion method. Auditing: It is suspicious that Iffy would opt to keep this revenue as unearned until March 22, 2022. We need to discuss with Iffy the nature of this contract and identify any other controls in place for day-to-day point of sale data entry to ensure revenue is not being altered. Research & Development Cost Issue: Iffy has been expensing capital costs to understate net income and lessen his buy-in for share purchase of the company. A purchase sample will need to be complete to identify capital expenditures. In appendix III we can also see maintenance, research, and internet expenses are much higher this year, even though revenue has only increased by 10%. Accounting: Under ASPE, research and development costs are to be capitalized under development costs and expensed once the project is started. As stated in appendix II, 45% of $525,000 research costs relate to work done with the prototype for testing and preparation, which indicates $236,250 should be expensed and $288,750 should be capitalized. Currently the full amount of $525,000 is being expensed. Auditing: We can also conclude that Iffy would choose to expense these items to reduce net income for self-interest. We will need to recalculate project completion and reallocate costs to the proper account. Accounts Receivable Issue: Accounts receivable may be understated as Shelly would be biased to increase expenses in favor of her boyfriend's buy-in option. Auditing: We will need to analyze the accounts receivable balance and verify a sample of invoices received to approve the balance which is currently $290,000. We will need to confirm the balance with clients to review Shelly and Iffy's work. Conclusion There are several items of note that will need to be adjusted to property present net income, which will improve the bank covenant. We will need to discuss with shareholders the performance of Iffy and misstatement findings. Substantial audit and accounting work will need to be done on the income statement to ensure net income is property stated. End of Midterm

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