You are a CA employed at B & B, Chartered Accountants. On November 20, 2012, the partner in your firm sends you the following e-mail:
Our firm has been reappointed auditors of Floral Impressions Ltd. (FIL) for the year ending December 31, 2012. I met with the president and major shareholder of FIL, Liz Yamani, last week, and I toured the Vancouver warehouse and head office. I have prepared the following background information on FIL for you to review:
• FIL, a small public company listed on a Canadian stock exchange, is a wholesaler of silk plants with three warehouses located in Ontario, Alberta, and British Columbia. It imports its inventory of silk flowers and accessories from Indonesia. FIL employees arrange bouquets, trees, wreaths, and decorative floral products for sale in Canada to flower shops, grocery stores, and other retailers. The silk-plant concept was novel when FIL was incorporated in 2001. For the first three fiscal years, sales grew at approximately 40 percent per year, and FIL expanded to meet the demand. However, increased competition resulted in declining sales and operating losses over the next six years.
• Liz inherited the shares of the company in 2010. She had just completed a marketing course and was very excited about becoming involved in the business and applying her new skills. The fiscal year ended December 31, 2011, brought a return to higher sales levels and a modest net income. Liz's management contract, which was renegotiated in 2011, provides for stock options to be granted to her each year based on the percentage increase of FIL's revenue from one year to the next. On October 31, 2012, Liz was granted stock options for the first time. She received 4,500 stock options at $2.25 each, the market price on that date.
• To gain greater exposure on the Internet, FIL is developing its own website. FIL will pay for the costs of running the site by selling advertising spots on the site to home-decorating companies. So far, FIL has pre-sold 10 spots for $200 each. The advertisements are to run for one month. Unfortunately, the site delays have caused some advertisers to cancel their contracts. Others are threatening to cancel their contracts unless FIL gets the site up and running within the next month. The controller has recorded the advertising revenue as sales.
• Craig Olthuis was hired by FIL in September 2012 as the controller. FIL's previous controller resigned in June 2012 due to illness, and the position was temporarily filled by the accounts payable clerk. Craig anticipates that he will have all year-end information ready for our audit team by March 15, 2013.
• Historically, FIL's sales are highest during February and March, and from August to October. Accounts receivable consist of a large number of small-dollar-value accounts, with the exception of five large chain store customers that account for approximately 40 percent of the total accounts receivable. The allowance for returns typically has been 1 percent of fourth-quarter sales.
• During the year, management negotiated an operating line of credit with a new financial institution. The amount authorized is limited to 75 percent of accounts receivable under 90 days old and 50 percent of inventory, to a maximum of $2 million. The loan bears interest at prime plus 3 percent. Under this agreement, FIL is required to provide audited financial statements within 90 days of its fiscal year end.
Required
(a) Evaluate three factors that have changed over the prior year that impact the audit risk assessment for the current year. Indicate how these factors influence audit risk (that is, how they increase or decrease audit risk) and draw a conclusion on overall audit risk.
(b) What are the two primary audit assertions B & B, Chartered Accountants, should be concerned with regarding the accounts receivable of FIL?
(c) Design a substantive audit program of at least five procedures for B & B over the accounts receivable.
(d) Design a substantive audit program for B & B of at least five procedures relating to the new line of credit.