In: Accounting
Top Notch Homes Ltd. (TNH) is a privately owned company selling
a luxury range of home equipment. Fiona Fielding, the daughter of
the company’s founder, took over responsibility for running the
company in December 2018. She has little management experience. Her
main interest is in developing a new business line to broaden the
company’s activities. She has no interest in day-to-day internal
control activities preferring instead to adopt a more informal
management style.
Fiona found a supplier of a new design of hot tub in Norway. She
immediately started to import these hot tubs financed by a
substantial bank overdraft. The company sells to retailers at
£2,000 per unit representing a typical mark-up of 100% on cost. At
first sales averaged 50 units per month. Demand was so great that
Fiona was forced to engage a second supplier in Finland but at a
purchase cost of £1,500 per unit. That supplier required Fiona to
sign a three-year contract committing to purchase 400 units per
annum.
In the last two months of the accounting period ended 31 December
2019, sales of the hot tubs have fallen significantly and the
selling price has had to be reduced by 30%. The hot tubs are sold
with a three-year warranty. Some of the units bought from Finland
have developed faults which cannot be rectified on site. Customers
have insisted that the faulty units be replaced or a complete
refund given. Fiona is reluctant to tell the auditors exactly how
many units have had to be replaced. At the year-end, inventory
consisted of 200 saunas. Fiona is adamant that these should be
valued at cost.
Payments due to the suppliers have been delayed because there have
been problems reconciling the invoices payable to suppliers with
the deliveries received from them. The supplier in Norway is
threatening legal action to enforce payment and the supplier in
Finland is insisting on cash upfront before any more deliveries are
made.
REQUIRED:
1. Identify EIGHT specific factors that should concern the auditors
and explain why each factor is of concern?
2. Outline FIVE substantive audit procedures that the auditors of
TNH could undertake and explain the purpose of each.
1.
The factors that need to be looked into:
The daughter of the founder took over the company who is incompetent and also not interested in day to day matters. As the top management has the ultimate responsibility to look over the functioning of the operations and the fairness in the operations , it is important to check the competence of the same .
The new hot tub was new in the market , yet the company was able to sell those at a typical mark up of 100% . Usually , new products require promotion and pursuance to the customers. Yet the demand was also hugh and also the markup.
The status of the substantial overdraft taken by the company. Since , to finance the imports the amount must be very high ,, also overdraft has a low maturity period.
The contract entered with the second supplier. Because the contract was for a long term, also for a substantial number of units. And also the unit cost was higher by 50%.
The fall in demand and its impact on the operations of the company. Since the product was earning good profit and the company had incurred huge liablities for the same, the decrease in demand can have large impact on the stakeholders of the company.
The company entered into a 3 year contract with Florida's supplier and the units received from them were defective. Also Fiona was reluctant to provide the number of units replaced. If the number of units not replaced or refunded is large, the customers can react adversely towards the company. And also the reputation of the company is at stake.
Inventory valuation should be done at cost at NRV , whichever is lower. In this situation it is apparent that the realisable value will be lower than the cost. For true presentation of the financial statements, inventory valuation should be done appropriately.
The company has due payment towards the suppliers . And also threats for legal action have been given. It should be checked whether the company will be able to pay the same. If not, the growth prospects and present position of the company will deteriorate and also the profits of the company will be adversely affected.
2. The first audit procedure to be taken by the auditor is to check the internal controls of the company. As Fiona is incompetent and also not interested in day to day affairs, the internal controls have to be checked to check it's reliability and also the competence and integrity of lower level managers.
Since Fiona is reluctant to provide number of units replaced , the auditor needs to check the number of units sold, the customers of the product and enquire from them about the same. The sales team can also be enquired about the problem face by the customers and what is done for the same .
The auditor has to check with the bank to know whether the overdraft has been paid or if not paid, what are the terms and conditions on which the overdraft is taken.
The auditor should collect information about the supplier from Florida. For this he can enquire other companies which import such tubs. And also check, if there is any connection with the company. This is because the 3 year contract shows nothing but losses.
The supplier has to be enquired to find out the due amount to them . Since they are threatening to take legal action