iBee is a private corporation located in Punkeydoodles Corners, Ontario, that owns and maintains a large honeybee colony. Tom Doodles established the company as a small hobby business in 1967. Over time, Tom's great-tasting and high-quality honey grew into a large business. In 2002, Tom incorporated iBee and split the company's share ownership with his two children, Emilia and Mark. Following incorporation, Emilia and Mark each held 33.33 percent of iBee shares. Tom was always the sole decision maker at iBee, overseeing all production and administrative matters. He taught Emilia and Mark everything he knows about good beekeeping practices and honey production.
During a family vacation to Iceland in 2010, Tom noticed the potential market that the country presented for his honey. The following year, Tom signed a contract withan Icelandic honey distributor named Hnit. The opening of the Icelandic market caused an increased demand for iBee's honey. Icelanders strongly prefer iBee's honey over other brands and will pay a premium price for it because iBee's honey always comes in a liquid form and it has a high nutritional value. When honey is stored at low temperatures for long enough, it will crystallize (change from a liquid to a solid). Crystallized honey can be changed back to its liquid form by heating it at a high temperature, but this process significantly reduces its nutritional value. As a result, honey processed by this method is priced at 50-60 percent less than untreated liquid honey.In response to this increased demand, Tom contemplated a plan to expand the company by acquiring three nearby, private beekeeping operations. In anticipation of financing these acquisitions, Tom approached your accounting firm, Accounting-iS-fuN LLP in early 2014, requesting an audit of iBee's financial statements. The audit was performed and an unqualified opinion was issued.
It is now November 25, 2015, and you are the senior auditor at Accounting-iS-fuN LLP, in charge of the iBee financial statement audit for the November 30, 2015, yearend. Following are the highlights from the iBee engagement team meeting and audit notes from the prior year. Change in Management -In the fall of 2014, Tom was injured in a car accident. His recovery was very slow, which forced him to transfer iBee's day-to-day operations to his children in early 2015. Emilia, who recently completed her MBA, took over all accounting and administrative matters.
Mark had always shown a passion for beekeeping so he became head beekeeper, managing the bees and the production, storage, and distribution of honey. Tom, meanwhile, focused on his recovery and became an inactive owner.
In early 2015, Emilia pursued her father's plans to purchase the three private beekeeping companies, but her application for a bank loan was denied due to the economic downturn. As a result, Emilia explored alternative financing options. That summer, she struck a deal with a private financing company to securitize (also known as factoring or selling) 80 percent of the outstanding balance of iBee's accounts receivable, based on the audited financial statements as of November 30, 2015. During the transitional period in early 2015, Emilia did not review several monthly bank reconciliations that were prepared by iBee accounting department employee Lidia Gdansk. She also did not perform two quarterly budgeted versus actual sales and expense reviews. Emilia did not realize her omissions until they were brought to her attention by Lidia in early July 2015. Lidia said that Emilia, as she took over Tom's responsibilities, should also have reviewed and established credit limits for new customers. Following her discussion with Lidia, Emilia began performing these tasks. However, Emilia remains unsure if credit limits for all new customers were reviewed and assessed prior to year-end. She also did not get a chance to catch up with the review of all the bank reconciliations prior to year-end.
Previously, Tom would adjust the allowance for doubtful accounts prior to year-end after reviewing and assessing the collectibility of each outstanding account. This year, Emilia delegated this task to Lidia, who simply applied the same percentage as last year because she did not think that demand for honey changed materially year-over-year. Renewal of Hnit Contract -Iceland's sudden and severe economic downturn and associated banking crisis did not adversely impact demand for iBee's honey. However, on August 1, 2015, iBee's Icelandic distributor, Hnit, refused to renew its distribution contract unless it included the following clause: "Hnit reserves the right to return to iBee all honey inventory that has crystallized during transportation or storage within six months of receipt. Hnit is not responsible for any shipping or storage costs of honey that has crystallized on its premises."
After some discussion, Emilia and Mark agreed to include the clause in iBee's agreement with Hnit, which was signed and went into effect on August 15, 2015.
Emilia instructed Lidia to journalize (process an accounting entry) all honey sales to Iceland at the time customers placed their preorders at the beginning of the year. As iBee always prioritized the Icelandic orders, and all honey sales were shipped and delivered prior to year-end, Emilia believed this method would not impact the financial statements and could be used as a tool to forecast honey demand for the year.
Shipment Accident -Due to a phenomenon called hygroscopy, honey will absorb moisture directly from the air, including any pollutants and odours contained in it. Thus, honey must be carefully packaged to protect it from dust, vehicle exhaust fumes, strong food odours, and other pollutants. Polluted honey is usually unfit for consumption and should be discarded.
On July 1, 2015, due to a shortage of proper transport containers, Mark resorted to transporting a large quantity of honey from the beehives to the storage warehouse in unsealed, inadequate containers. A highway accident caused a delay and the truck carrying the shipment was forced to idle for an extended period. Upon testing at iBee's processing facility, it was determined that the honey had indeed absorbed a large quantity of exhaust fumes and was polluted.
Mark could not discard the polluted honey because 2015 was already a low production year and doing so could delay or even cancel the fulfillment of Icelandic orders. To overcome this challenge, Mark wants to gamble and ship the polluted honey mixed in with a shipment of "clean" honey with the hope that it will not be tested by the Icelandic Food Safety Agency (IFSA). Mark plans to include the polluted honey with the last shipment to Iceland scheduled for December 29, 2015. The IFSA has very strict inspection protocols for all food imports, testing on a sample basis 5-10 percent of all shipments entering the country. IFSA inspection protocols require testing honey for pollutants and ensuring its actual nutritional value matches the facts indicated on the label.
REQUIRED
a. Audit standards require the auditor to consider audit risk at the account level. Set the level of audit risk for accounts receivable and inventory. Make sure to fully justify and support your risk level assessment.
b. Identify and explain which case facts (risks) would impact your assessment of the inherent risk and fraud risk for the financial statements as a whole and at the account and assertion level.
c. Explain at what level you would set the inherent risk and fraud risk for the financial statements as a whole.
d. Explain which specific assertions would most likely be impacted by the risks you identified in part (b).
e. Identify and explain which case facts (risks) would impact your assessment of control risk?