Today is August 21, 2018, and you are an audit

Today is August 21, 2018, and you are an audit manager working on an audit plan for the inventory section of Jolanta’s Inc. (Jola) July 31, 2018, year-end financial statement audit. Jola’s year-end inventory balance is $22 000 000. Your notes and the audit file contain the following information:

Jola is an independent Canadian distributor of Nikola batteries used for electrifying homes. Nikola batteries can power an average four-bedroom home for a full day. The batteries can be recharged with green energy sources such as solar power. This allows homeowners to reduce their carbon footprint and offers them, over the long term, potential savings, since they can become self-reliant and disconnect from the main central electricity grid.

Over the past four years, Jola experienced significant growth in sales of the Nikola batteries. This growth was mainly spurred by the British Columbia (BC) and Ontario provincial governments’ new incentives designed to promote green energy. One such incentive, introduced in 2012, offers homeowners a 50 percent rebate on the price of a Nikola battery. The rebate is significant as each battery costs about $17 000. Since this rebate program was introduced, the demand for Nikola batteries in BC and Ontario has grown exponentially.

On April 1, 2017, the federal government introduced new “green” fines. The federal government decided to impose fines on companies that rely on carbon-emitting transportation (diesel-fuelled rail, truck, airplane, or cargo ships) to transport their raw materials or products. Jola was not aware of the new fines and in late July 2017, hired an Indonesian cargo shipping company to transport Nikola batteries from China (where they are manufactured) to Canada. The shipping company operates diesel-fuelled cargo ships. When the batteries arrived in Canada, the Canada Border Services Agency (CBSA) fined Jola $1200000 for shipping its product on diesel fuelled cargo ships. The amount was calculated based on a set fine rate of 15 percent of the value of transported batteries. Jola paid the amount but is in the process of appealing the fine. As a result, the amount wasn’t recognized in its financial records. In addition, Jola received an invoice for 2.5 billion Indonesian Rupiah from the shipping company; this amount was expensed.

After being fined, Jola stopped shipping its batteries on diesel-fuelled cargo vessels and instead switched to companies that operate ships powered by green energy. These ships take twice as long to transport the batteries to Canada, sometimes as long as three months. As a result, on June 15, 2018, the Chinese battery manufacturer changed its shipping terms from FOB Destination to FOB Shipping Point, meaning that Jola takes delivery of the batteries once they leave the Chinese supplier’s shipping dock.

During shipment, the batteries must be stored in specially sealed cargo containers. This is to prevent moist air coming into contact with the batteries. Moist air that’s close to the ocean water carries small particles of salt. If the chemicals inside the batteries come into contact with salt, the battery becomes damaged and in some instances the damage can cause the battery to overheat or even catch fire.

On June 29, 2018, a large shipment of batteries left China. On its way to Canada, the cargo ship ran into a severe storm that caused its cargo to become loose and shift. The shipping company informed Jola that this caused damage to a significant number of the sealed containers that housed the batteries. The batteries are not expected to arrive in Canada until September 2018.

During the summer of 2018, there were three news reports in B about Nikola batteries overheating to the point that the outer shell of the battery melted. The three batteries were recently installed in homes located on Victoria Island. The Island is surrounded by waters from the Pacific Ocean. Residents of Victoria Island are very environmentally conscious, and the demand for Nikola batteries on the Island is very high. To save on shipping costs, in early 2018 Jola decided to lease a warehouse on the Island to store about 25 percent of its battery inventory destined for the BC market. Jola’s management believed that the salt content in the air on the Island is not high enough to damage the batteries.

In Ontario, on May 3, 2018, a newly elected government cancelled all green energy government incentives, including the 50 percent Nikola battery rebate program. As a result, demand for Nikola batteries dropped by 97 percent. In response to this, in early July 2018, Jola slashed its battery prices by 50 percent. Although this forces Jola to sell batteries below their cost, this price reduction is only temporary, as Jola believes that over the next three to six months it can lobby the new government to bring back the 50 percent Nikola battery rebate program.

To reduce labour costs, Jola’s management decided not to undertake a year-end inventory count, but instead last year started to carry out monthly continuous (perpetual) inventory counts and adjust any errors identified in the accounting system for that month. In June and July 2018, the monthly counts were not done as many of Jola’s employees were on vacation.


REQUIRED

a. Audit standards require the auditor to consider inherent risk at the account level. Set the level of inherent risk for inventory. Ensure that you fully justify and support your risk level assessment.

b. Identify and explain which case facts (risks) would impact your assessment of the inherent risk for the inventory account at assertion level.

c. Explain which specific assertions would most likely be impacted by the risks you identified in Part (b).