Introduction Home Safety, Inc.’s management has been trying for months to acquire one of its largest competitors in the home security industry—Lock-It-Up Company. Before agreeing to the acquisition, Home Safety’s board of directors wanted Lock-It-Up’s books to be audited. They have asked your firm to perform the audit and due diligence, and they have asked that you specifically examine the owner’s family and roles in the company.
Lock-It-Up Company Lock-It-Up is a large, local home security business that has been in the area for a long time. It has held a large market share for several years and has received many referrals from present users of its home security systems. It owns five large properties in the area from which it performs business and is an optimal takeover target.
Internal Environment
• Management style: The owner of the business, Jeff Johnson, has taken a hands-off approach to managing his business. He frequently takes extended vacations with his family and rarely examines the books of his business. He is happy with his level of income and is not concerned with the future, believing that his company will always be profitable.
• Executives: Several of the owner’s relatives hold high positions in the company. The owner’s brother, Chucky “Gambling Genius” Johnson, is the chief accountant and answers only to his brother, Jeff. He is majority owner of a local amateur sports team, which has struggled to sell tickets and is facing bankruptcy.
• Employees: The company takes advantage of the cheap labor at the large, local university. Each summer, it hires hundreds of students to sell its products door to door. Successful students from previous years train the new students, and expectations and motivations are high. The temporary labor force is paid sub-minimum wage but can earn significant commissions on sales. Last year, some of the students earned over $80,000 in commissions in just four months of summer sales, with some receiving quota rewards such as cruises and new cars.
• Internal controls. In order to facilitate quicker purchases and obtain deals from vendors, Jeff has left Chucky a stack of blank, presigned checks.
Anyone in the purchasing department has access to these checks and can use them as needed.
1. As the auditor, list the concerns you have that may suggest fraud is occurring in the company.
2. What controls would you suggest that the company put in place to prevent potential fraud from occurring for each of the concerns you listed in part (1)?
3. Would you feel comfortable signing off on Home Safety’s financial statements if it were to acquire Lock-It-Up this year? Why or why not?
4. What are some factors in the auditor–client relationship that can make it more difficult for the auditor to detect fraud?