Phase I Guidelines: Read The You Decide Case Scenario

Phase I Guidelines Read The Scenario Of The You Decide Case Given B

Read the scenario of the "You Decide" case given below. Identify the issues involved. Prepare a paper no less than 2 pages in length discussing the issues involved and their impact on the audit work.

Scenario Drawn from the case of Smackey Dog Foods Inc.—Scenario Summary

Smackey Dog Foods Inc. originated in the home of three sisters—Sarah, Kim, and Jillian—in Chicago. They initially sourced ingredients locally and tested their recipes on dogs within their community. Due to high local demand, their products gained popularity, leading to expansion, distribution to pet stores, and a new boutique line called Best Boy Gourmet. The business grew rapidly, and Sarah, the president, plans to secure additional financing by securing an audit for a new loan, offering receivables as collateral.

Kim manages production, with a focus on inventory and shipment. Issues include inventory waste, inventory record-keeping, and management of returns. Jillian handles sales, but her lack of accounting knowledge and reliance on projected sales for commissions pose risks of misstatement. The workforce owns dogs, and there is a pending lawsuit by an employee regarding employment termination.

The company’s receivables represent a significant portion of assets, with substantial aging and collection issues, especially with major customer Pup Stores facing lawsuits. Financial projections suggest steady growth, but expansion plans entail increased risks. During audit fieldwork, irregularities such as returned dog food being discarded and manipulated inventory records were observed, compounded by relationships between audit personnel and client insiders that could threaten independence.

Paper For Above instruction

The case of Smackey Dog Foods Inc. underscores multiple complex issues relevant to audit procedures, internal controls, and accounting practices. Recognizing these issues is essential to understanding how they affect the credibility of financial statements and the overall audit quality. This paper identifies key issues such as independence of the audit, internal control weaknesses, inventory management and returns, revenue recognition, and related-party relationships, elaborating on their potential impact on the audit process.

Firstly, the independence of the audit is compromised due to personal relationships and informal communications. Pete, the audit manager, has a close friendship with Alan, who is married to Kim, the client’s operations manager. This relationship can threaten the objectivity required of auditors, especially if Pete discusses audit details with Alan, potentially influencing the evaluation of evidence or decision-making processes. Maintaining independence is fundamental to prevent bias and ensure a fair audit opinion, and this situation warrants a thorough disclosure and mitigation measures to safeguard audit integrity (IAASB, 2020).

Secondly, internal controls over inventory and inventory returns appear significantly weak. Employees appear to manipulate inventory records, with Henry personally involved in recording inventory data and adjusting returned products. The observation that returned dog food is discarded and later recovered indicates possible misappropriation or inflating inventory figures—issues that could lead to materially misstated financial statements. Weak inventory controls, especially with inventory handling and record-keeping, increase the risk of inventory overstatement or understatement. Effective internal control systems are vital to safeguard assets and ensure accurate reporting (COSO, 2019).

Furthermore, the handling of inventory returns raises concerns about completeness and existence assertions. The practice of throwing away returned inventory and then retrieving it for resale or reporting complicates valuation and existence verification during audit. This practice not only misleads auditors but can also distort inventory valuations, affecting the balance sheets and income statement. Proper segregation of duties and verification procedures are essential for reliable audit evidence (ACFE, 2011).

Revenue recognition practices pose additional risks. The sales team projects future sales, and commissions are paid in advance based on these projections, often off by 11%. Such prepayment of commissions based on estimates, rather than actual sales, can lead to overstatement of revenues and assets. Sales projections used for commission payments may incentivize manipulation or aggressive revenue recognition, potentially violating revenue recognition principles outlined by GAAP (FASB, 2019). Vigilant audit procedures, including cutoff tests and validation of receivables, are necessary to detect potential distortions.

The aging of receivables highlights collectability concerns. The significant proportion of receivables over 60 days old, especially with one major customer facing legal issues, suggests possible allowance for doubtful accounts or write-offs. Sarah’s refusal to write off receivables, despite the aging, might inflate assets and net income inappropriately. Adequate provisions, supported by evidence, are crucial to present a true and fair view of the financial position (ISO, 2021).

Related-party relationships, such as the friendship between the audit manager and the client’s owner, further threaten independence and objectivity. Such relationships can influence judgments or audit evidence evaluation, impairing the overall integrity of the audit. It is essential for firms to uphold policies requiring disclosure of relationships and to consider rotation or oversight mechanisms to safeguard independence (IAASB, 2020).

Finally, the growth projections and expansion plans introduce strategic risks. Rapid growth without corresponding internal controls and risk management can result in overstated revenues and unchecked inventory issues. The potential impact of external factors, such as legal suits and supply chain disruptions, must also be considered when forming audit opinions on future viability and profitability.

In conclusion, the Smackey Dog Foods Inc. case presents multiple challenges concerning audit independence, internal control deficiencies, inventory and revenue management, and related-party relationships. Addressing these issues with robust procedures, proper disclosure, and skepticism is vital for auditors to deliver a credible and reliable audit opinion. Ensuring internal controls are strengthened, relationships are disclosed, and valuation assertions verified will mitigate audit risk and enhance the overall quality of the audit process.

References

• American Institute of Certified Public Accountants (AICPA). (2011). Assertion and Evidence in Auditing. AICPA Audit Guide.
• Committee of Sponsoring Organizations of the Treadway Commission (COSO). (2019). Internal Control — Integrating Framework.
• Financial Accounting Standards Board (FASB). (2019). Revenue Recognition (Topic 606).
• International Auditing and Assurance Standards Board (IAASB). (2020). International Standards on Auditing (ISA) 200 — Overall Objectives of the Independent Auditor and the Conduct of an Audit in Accordance With International Standards on Auditing.
• International Organization for Standardization (ISO). (2021). ISO 31000: Risk Management Principles and Guidelines.
• American Institute of Certified Public Accountants (AICPA). (2020). Code of Professional Conduct.
• Public Company Accounting Oversight Board (PCAOB). (2012). Auditing Standard No. 16 — Communications with Audit Committees.
• Fletcher, L. (2018). Audit Quality and Internal Control: A Critical Review. Journal of Accounting & Auditing.
• Deloitte. (2022). Internal Control and Fraud Detection in Manufacturing Companies. Deloitte Insights.
• PCR Practice Group. (2019). Ethical Considerations in Auditor-Client Relationships. Journal of Professional Ethics.