Tweedie Implements Limited (TIS) is owned 100% by Outdoor Holding Inc. (OHI). OHI recently hired a new VP of Finance who has instituted a new policy that all wholly-owned subsidiaries are to be audited. To comply with this new policy, TIS has appointed Trim and Weed Chartered Professional Accountants, LLP (TW) as their auditors for the year ending March 31, 2019. This is a new audit engagement for TW. In the past TIS had a review prepared by a small independent chartered accountant. The timing of the change in policy was fortunate as the other CPA was about to retire.
You, CPA, have been assigned as the audit senior on the audit engagement for TIS. Last week, the manager on the account provided you with a summary of background information on TIS (Exhibit I) and the draft financial statements (Exhibit II). The manager has asked you to spend a week at the client to identify and analyze audit and accounting issues, review internal controls and perform some interim audit procedures. You have been assigned a junior staff assistant to help carry out these tasks. The manager has asked you to prepare a memo documenting the audit plan and discussing the accounting and auditing issues. He will use the information in the memo as the basis for a discussion with TIS management. The manager reminded you that the parent company, OHI, is particularly interested in internal control weaknesses and you should make sure to keep your eyes open for problems and include a discussion of weaknesses that you have noted in your memo.
It is now Thursday afternoon. You have spent most of the week gathering information (Exhibit III) and it is time to write your memo for the manager. You also need to review some working papers prepared by the staff assistant (Exhibit IV).
Required:
Prepare the memo to the manager.
EXHIBIT I
BACKGROUND INFORMATION
TIS manufactures high-efficiency lawn mowers, edge trimmers and other landscape machinery. This year, TIS expanded its product lines to include pots and other metal containers used for ornamental design in gardens.
TIS entered into a licensing agreement with English developer of the “English Mower” which uses highly efficient rechargeable power cells to run its lawn mower. TIS is hoping to manufacture and market this product in North America. TIS is required to pay a royalty of 5% of the revenue earned from the sales of the lawn mower. TIS negotiated a contract with a supplier for the power cells required for this new product.
TSI sells materials used on landscaping jobs (e.g. Sod, fertilizer, grass seed etc.) at their head-office location. Because TIS also sells directly to contractors, they like to sell these materials to provide one-stop shopping for their contractors. Because they are not in the wholesaling business for these miscellaneous items, TSI does not track the inventory for this merchandise. All goods sold at the counter are entered into the system as “Supplemental Income”. The ordering is handed by the shipping department supervisor, who fills in a pre-authorized requisition when the supply levels get low. Because this is not their real line of business, TSI includes the cost of these items under marketing expense.
TIS is a very seasonal business with 90% of its business being earned from April to October. From November to March, staff spend time negotiating new contracts and renewing old contracts. The accounting department has a very difficult time keeping up with the billing during the busy months. They spend the slow period trying to get caught up on the other accounting functions such as reconciliations, collections and financial statement preparations. Sales and marketing staff are also affected by the seasonality and need to work longer hours. As a result, most employees have keys to the building and know the security alarm codes to allow them to work the needed overtime when it is convenient to them.
EXHIBIT III
INFORMATION OBTAINED TO DATE PERTAINING TO THE AUDIT OF TIS
The English Mower
TIS has entered into a contract with a major Canadian retailer to supply the retailer with 2,500 of the lawn mowers at a total contract price of $750,000. As at March 31, 2019, 1,000 of these lawn mowers had been delivered to the retailer. The remainder is to be delivered in April 2019 before the grass-cutting season begins. The retailer is required to pay TSI within 30 days of delivery of the lawn mowers. As at March 31, 2019, TSI had manufactured all of the lawn mowers required by this contract and has recognized revenue in the amount of $ 750,000 from this contract.
Cost of Sales is reported in the amount of $175 per unit or $962,500, excluding the licensing royalty. Advertising Royalty
An internal memo from OHI to TIS dated December 2018, indicated that, starting with 2019 fiscal year, an advertising royalty of ½ % of net sales would be payable by TIS to OHI. The amount was not paid or accrued in the general ledger.
Income Taxes
TIS has paid monthly income tax installments based on a schedule provided by the previous accountant. These payments have been charged to “cost of goods sold”.
Accounting Department
In addition to the controller, the accounting department is made up of two people:
¨ one person handles the billing, collection functions, cash receipts and customer service.
¨ one person handles all the cash disbursements including payroll and general ledger responsibility.
Due to the high volume of transactions and the large number of customers the two employees work very hard and long hours. They are often asked to work weekends and work minimum of 60 hours weekly during the peak periods (April – October).
There is one receptionist that answers the phone, handles some customer service issues and opens the mail daily.
EXHIBIT IV
EXCERPTS FROM WORKING PAPERS PREPARED BY STAFF ASSISTANT
Inventory
The inventory and cost of sales had been adjusted by $25,000 to correct an error in the physical count of the lawn mowers. There appeared to be less on hand than the books indicated. The controller believes the difference could be because of counting errors made by part-time employees that helped with the inventory count.
The staff assistant noted that during the year ended March 31, 2019, TSI received 10,000 rechargeable power cells that are required for the English Mower. One power cell is used for each lawn mower. The physical inventory count performed on March 31, 2019, identified that 1,700 power cells were on hand that had not been used in the manufacture of the lawn mower and identified that 2,000 completed lawn mowers were on hand, including the lawn mowers to be delivered to the Canadian retailer.
The staff assistant was not sure what is wrong in the calculation and did not know what to do next to complete the working paper.
The staff assistant also tried to perform cut-off testing of inventory but could not complete the test. The staff assistant learned that shipping documents are to be manually numbered and dated before inventory is sent but when it is really busy the shipping department doesn’t always remember to do this. The last entry in the shipping log was a few weeks before year-end.
EXHIBIT IV (continued)
EXCERPTS FROM WORKING PAPERS PREPARED BY STAFF ASSISTANT
Cash
Monthly bank reconciliations were not prepared for every month. The bank statements were filed in an enveloped labeled “pending”. When the accounting clerk was asked about the reconciliation process, he said that he reviews the bank statements and investigates unusual items.
When discussing the bank reconciliations with the accounting clerk, the staff assistant noted that there were some blank company cheques that were already signed. The clerk indicated that the controller signed the blank cheques as he was going to be away the following week. The clerk indicated that he made sure every night to lock these cheques in his desk drawer.
Accounts Receivable
TIS does not use the allowance method for accounts receivable. All uncollectible receivable are written directly off the income statement (the debit is put to advertising expense). The accounting clerk likes to use only supportable numbers in the financial statements. The clerk doesn’t have much time to review older accounts. He makes sure he follows up on accounts that are over 90 days old.
The staff assistant summarized the accounts receivable confirmations that she mailed for a sample of customers as at March 31, 2019. It was noted in the working paper that the controller asked the staff assistant not to confirm one of the smaller receivables that was a special deal with the customer and they paid partially by cash to avoid HST. The staff assistant selected another account to replace this item in the sample.
The case is based on Canadian Audit Strategy. Based on the facts as outlined in the case attached, in your own words (do not plagiarize) provide a detailed memo documenting: a. a detailed Audit Plan (structured as follows: Risk, Approach, Materiality, Procedures); b. and a detailed assessment of internal control weaknesses identified, the implications of those weaknesses, and recommendations for improvement
