Bright Spark Fashion has retail outlets in six large regional cities in eastern Canada. The shops are run by local managers but purchasing decisions for all stores are handled by Ray Bright, the owner of the business. Fashion is an extremely competitive business. Bright Spark Fashion sells only for cash and generates sales through a reputation of low prices for quality goods. The winter range is quite slow moving, but summer fashion sells very well, providing a disproportionate amount of the business's sales and profits. Ray is constantly monitoring cash flow, and negotiating with suppliers about payment terms and banks about interest rates and extensions of credit.
Jenna Kowalski has the tasks of assessing the liquidity and solvency of Bright Spark Fashion and identifying the audit risks arising from this aspect of the business. She discovers that a major long-term debt is due for repayment two months after the close of the financial year, but Ray is having difficulty obtaining approval from his current bank for a renewal of the debt for a further two-year term. In addition, interest rates have risen since the last fixed rate was agreed upon two years ago, adding an additional 2 percentage points to the likely rate for the new debt (if it is approved).
The seasonality of the business means that inventory levels fluctuate considerably. At the end of the financial year (December 31), Ray placed pre-paid orders for the summer fashion line, and the goods started arriving in the stores by February.
Required
(a) What liquidity and solvency issues does Bright Spark Fashion face? Explain the likely impact of each issue on the usual liquidity and solvency ratios.
(b) Advise Jenna Kowalski about the audit risks for Bright Spark Fashion and suggest how she could take these into account in the audit plan.