Question

In: Accounting

4. You have recently been appointed the auditor of Freak Beans Ltd., which operates a chain...

4. You have recently been appointed the auditor of Freak Beans Ltd., which operates a chain of health food shops in the south-west of England. Originally, the company began 10 years ago with just one store catering to less conventional customers but with increasing concern about consumers’ health and the sustainability of food sources, the company attracted more mainstream customers. Demand in the last five years has grown to the extent that the company has opened a new store every year. Control is largely through the daily involvement of the owner, Mr. Semolina. Each store has a manager hand-picked by Semolina himself. Each is paid a basic salary with a generous profit-related bonus. Semolina believes this not only incentivises the managers to work hard but also to be honest – if they skim from the takings, their bonus will be reduced.
The accounting and control systems have remained much the same as when only one store was operating. Semolina has noticed that one of his six stores routinely reports modest sales figures but high net profits; it has high inventory levels but not very much cash. Semolina is concerned but has been too busy to investigate fully.
Semolina recognises the need to formalise the financial control systems especially as he is keen to continue to expand the business. However, he has no more of his own money to invest and does not want to increase the company’s indebtedness to the bank. One day, a friend of a friend introduced Semolina to a business contact, an overseas investor, John Sago. Semolina instantly liked Sago who seemed very knowledgeable about the health food industry and especially about the emerging market for hemp-based food supplements. Sago explained that UK and European regulations allowed the sale of certain hemp-based products. Sago went on to explain that he believed he had discovered a loophole in the regulations which allowed him legally to import and sell products that the regulators had yet to approve. These products could produce very high profit margins while they remained unregulated, but Sago warned that tighter regulations could be introduced in two or three years. Sago said that he could sign contracts of supply that very day and he urged Semolina to act fast.
As if to demonstrate his credentials, Sago showed Semolina a briefcase full of cash. On the spot, Sago offered to invest £1million for a 10% stake in Freak Beans Ltd. Sago said that his offer would stand until the end of the week; Semolina could either take it or leave it.
Semolina comes to you, as the auditor, for advice.
Required:
a) From the above scenario, what are you principal concerns about your new client and his request for advice?

b) Set out what you understand to be the extent of auditors’ responsibilities when faced with situations where clients either have committed acts or are about to commit acts which auditors know or suspect may be in breach of laws or regulations.

Solutions

Expert Solution

The principle concerns after reading the above scenarios are:-

A. What if all the investment done doesn't yield the same profits or outcomes which Semolina has expected from the new market.

B. If it doesn't follow the rules and regulations properly or if he sets up the business by finding the loopholes in the regulatory system , although it is not illegal but it will impact the ethical values of the concern.

C. If Semolina sets up business with the help o these loopholes and then they got caught the goodwill of the business will get a set back worldwide. And the result may be that the costumers will nor rely on the products of the entity.

As an auditor I had the following responsibilities:-

A. To obtain the relevant evidence regarding the breach or non compliance of rules and regulations.

B. To perform specified audit procedures to help identify instances non compliance with other laws and regulations that may have significant impact on the financial statements.

C. Being a responsible auditor must caution the client about the possible consequences of the breach of laws.

D. The auditor have had a civil liability from the society's point of view.

E. It is the moral duty of the auditor to disclose all the relevant facts in front if all the stakeholders of the company.


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