Your firm, James & Company, has just accepted Handco, Inc. as a new audit client. You have been assigned as the in-charge auditor and are in the process of conducting a preliminary review. During your inquiries and application of analytical procedures, you discover several aspects of the company, some of which may affect your planning of the audit.

Handco is the consolidated entity (holding company) of seven separate entities of varying sizes that manufacture components for the auto industry aftermarket, general construction hardware, and specialized building products. The companies operate as independent entities: that is, there are relatively few inter-company transactions. Some of the entities were created by Handco; others are spinoffs from existing Handco entities. Handco's recent growth, however, has been through acquisitions using debt financing. Some earlier acquisitions have not turned out to be as profitable as originally anticipated and have struggled to meet earnings expectations due to slow revenue growth coupled with rising operating costs. In the third quarter this year, Handco acquired the seventh company that manufactures specialty pet food and supplies.   The accounting for this purchase has proven to be problematic and has not been finalized. Part of the difficulty was valuing the company's brand name and in-process research and development costs.

The three individuals who started Handco remain the sole owners. You have learned that Handco also holds minority interests in three unconsolidated entities that were originally owned by the company's founders. Handco's seven operating facilities are in three states but, the company does business on a national scale. Handco, the holding company, leases warehouse space in various locations throughout the US that are utilized by multiple operating entities to store inventory in better serve regional customers. Excess warehouse space is subleased to third parties.

While Handco has worked to develop common accounting policies across the entities, the company lacks a uniform financial reporting system. As a result, the closing and consolidation processes have proven challenging in the past. Compounding this situation, you have just learned that two of the larger entities had unexpectedly replaced their controllers this past year. Despite its ownership structure, the company is a C-corporation for income tax purposes. The company has maintained an aggressive tax strategy which has generated some significant deferred income tax liabilities.

The manufacturing entities have historically been profitable but are experiencing declining profits due to greater foreign competition and the uncertainty regarding US international trade policies. Most of the manufactured building products are constructed to customer specifications and are sold directly to contractors. Several years ago, two of the company's created created and operate a separate financing entity that provides the builders and contractors with temporary financing for their Handco purchase and related construction projects.

The pet food acquisition was made to further diversify the company's operations and in anticipation of a growing market for specialty pet foods. You recently read, however, that Purina and Iams have stepped up their efforts to enlarge their operations in this niche of the pet food market. You have no experience in the "pet food" industry, but understand that the company's use of futures contracts is an essential component to managing and controlling the costs of the grain and animal by-product commodities that are the primary ingredients in the pet food.

Epworth and Associates, a local CPA firm, had been Handco's previous auditor. Handco decided to change auditors in anticipation of a public offering of securities within the next year or two. Your firm is widely known for its expertise in mergers and acquisitions and already has several smaller public companied as clients.

What issues are raised by the narrative that might have an impact of your risk assessment and audit planning? Be specific in your answer?

Answer rating: 100% (QA)

There are several issues raised by the narrative that could impact the risk assessment and audit planning for Handco Inc Some of these issues include ... View the full answer