Based on our audit team’s assessment of the entity and its environment, we believe that the inherent risk is high overall with the control risk being medium, as Big Rock Brewery does have controls in place but they have also stated in their financial statements’ that in management’s view their “internal controls are not expected to prevent and detect all misstatements” (“About Big Rock Brewery,” n. d. , p. 18).
Big Rock Brewery has several inherent risks existing, for instance they have suppliers internationally so the valuation of cash and therefore the cost of sales is prone to fluctuations in foreign exchange rates leading to a possible area of valuation error. Due to the industry it operates in, it’s difficult to predict government regulation or legislation changes, for example, the communication manager at Big Rock Brewery noted that the tax increase of 27. 5% had “hit [them] hard” (Hopkins, 2015) causing them to “[review] all of [their] operational costs” (Hopkins, 2015).
This indicates their lack of preparedness or predictability in terms of reacting to industry regulation changes. PPE accounts for a significant amount on their balance sheet, as this account is mainly based on estimation and judgement; the risk that amount may be overstated easily, increasing inherent risk; we will have to include property, plant, and equipment valuation into our audit plan. The company operates within various provinces, as “each provincial authority has its own tax or ‘mark-up’ structure” (“About Big Rock Brewery,” n. d. , p. 14) this complicates the calculation of net revenue.
During the year of 2015, Big Rock Brewery had commenced operations in their BC location, which should represent an increase in expenses such as hiring fees, this may prove to be an inherent risk as it is their first time operating outside of Alberta, and our audit plan would need to include substantive procedures on their BC operational expenses as well (“Big Rock Brewery Inc. ,” 2015). The company also launched several new private label products, as this is a new innovation and the company may not necessarily know how to account for it properly.
Our audit team has chosen to use gross revenue as the base in calculating planning materiality, as Big Rock Brewery is a public company consisting of investors and shareholders, maximizing profits should be their key objective. Planning materiality was $261,555 (refer to Figure 1. in Appendix B). As the company suffered a loss in 2015, it wouldn’t be reasonable to use negative net income for materiality.
Please refer to Appendix B for information as to why we decided against net revenue. 0. % was chosen for materiality as the company faces a high and medium level of inherent and control risk respectively, a low percentage was chosen; more evidence will be collected as a result to reduce detection and the overall audit risk. An example of qualitative materiality would be at the year ending December 30th 2015; Big Rock Brewery was outside the required range of one of its financial covenants and received a waiver from the corporation’s bank (“About Big Rock Brewery,” n. d. ). In conclusion, we believe that the inherent risk of Big Rock Brewery is relatively high.
In Appendix A under Table 1, the Finance Expense amount increased dramatically from 2014 to 2015 and that the 2015 Revenue amount only increased half as much as the COGS amounts, we should look into why these unusual fluctuations exist (refer to Appendix E for clarification). By observation the percentage changes in table 2 under Appendix A, one could conclude that there has been a significant increase in A/R Balance (there has been a 64% increase compared to 2014), indicating the company experienced problems with the collection of credit sales.
In addition, there has been a significant increase of inventory proved by the 65% increase compared to 2014 (“About Big Rock Brewery,” n. d. ). Significant increase in inventory indicates the company is producing more than it can sell, though there is also the possibility this is due to the company anticipating a spike in sales in their BC location. Inventories stays in the storage room and are not being sold in a timely manner. Valuation of inventory may be at risk as some of the inventory may have become obsolete and need to be written off.
By observing Table 4 and 5 under Appendix A, one can compare the performance of Big Rock Brewery to its direct competitors, Molson and Anheuser-Busch InBev. Both companies are active in Canadian liquor business. Compare to its direct competitors, Big Rock Brewery’s inventory turnover is low (5. 02171925 vs. 9. 324139217). Indicating the company is struggling with selling inventory and that some of the inventory may have become obsolete (expire), for certain type of liquor such as beer.
Also, Big Rock Brewery has a low debt to equity ratio compared to its competitors (0. 136814065 vs. 0. 796454832). This ratio indicates the amount of debt “[used] to finance its assets relative to the amount of value represented in shareholders’ preposition” (“Debt/Equity Ratio,” n. d. ) A low ratio means the company has taken on “relatively little debt and thus has low risk” (“Debt/Equity Ratio,” n. d. However, it is worth noting that the finance expenses increased dramatically from 2014 to 2015 as indicated in Table 1, contradicting with what is shown by the Debt to Equity ratio.
This may indicated that debt account on balance sheet may be understated or equity account might be overstated. These two accounts are prone to unfair presentation and further audit work is required to verify the preposition. In addition, Big Rock Brewery’s return on shareholders’ equity ratio is negative, which makes sense as the company experienced a loss in the current year.
The competitors’ positive ratio indicates the cause of Big Brewery’s ratio is firm-specific, meaning the cause does not impact all companies in the liquor industry (refer to Table 4 in Appendix A). There has been a significant (363% ; 166%) increase in Consignment product and dry goods store (resale goods), indicating a risk of overstatement of consignment product and resale goods. The company’s new operation in BC is not enough to account for the unreasonably high percentage increase. Assertions affected are the valuation and allocation.
The account affected would be an understated finished product account. Based on observation of percentage changes in table 6, one can conclude that investigation need to be carried out for consignment good transactions in the first and third quarter of 2015 since it increases by 326% and 52% in Consignment product account respectively. A test of control would be ensuring the process to record the amount of raw material is correct; all purchases of materials and payables are recorded completely, materials purchased for production exist.
We should check the purchase process, such as checking whether the requisition department, purchase department, and accounting department have a proper segregation of duties in place; by inquiring the staff and managers at Big Rock Brewery or observing the departments. We should observe how the return/discount is recorded to make a conclusion on whether the approach Big Rock Brewery undertakes is reasonable. Another test would be ensuring the process to record and value work-in-process is acceptable.
We can compare the account to prior years to see if there has been a dramatic change, which could indicate an area of focus. We can observe the manufacturing floor to check what exact procedures the employees does, if it correlates with set procedures, and what controls does are in place to ensure all levels of employee adheres. For example, we would be looking for whether or not a supervisor is on site, if time cards are used and work hours are approved before it’s sent to payroll.
During the observation, auditors can look for any spillage and waste of materials, whether it is identified and recorded separately in the company’s book. We should also ensure that the quantity of materials and labor used for the production of products meets the reasonable output produced, such that there is no indication of theft of materials or overstatement of labor hours. Also another area of concern would be the potential understatement of Cost of Goods Sold and overstatement of finished goods.
We will inquire management about whether or not they have a control system which tracks all sales of the company. We can also observe employees through the process of shipping goods, for specific examples and details refer to Appendix D. The total inventory of the company increased approximately 30% in 2015. Since the company has not been profitable for the past a couple of years, there is a possibility that the company overstates the total value of inventory, to increase current assets.
By vouching, which is tracing from the account records to a source document, the auditor can find evidence of completeness and detect errors of overstatements. The auditor can take a sample of suppliers’ invoices and compare it to the inventory account records and general ledger. In addition to that, appraising the general condition of the inventory is highly recommended in order to detect any damaged, obsolete, and slow moving items. The auditor can take a sample of one batch per product type and test for any damaged, obsolete, or slow moving items within those batches.
We will also ask management how they account for damaged or obsolete goods in their financial statements, and what procedures they take to ensure no obsolete goods exist within their inventory during the count. From year 2014 to 2015, inventories of consignment products and dry goods store increased dramatically (363% and 166% respectively) (“About Big Rock Brewery,” n. d. ). Hence, substantive procedures need to be performed in order to ensure the existence of the goods and the valuations of inventories are correct.
In order to ensure that the numbers of goods on consignment are actually on consignment, we can check the shipping documents from Big Rock Brewery to the individual retailers to ensure the quantity of goods on consignment are accurate. The audit team can also call the individual retailers to see if they actually have Big Rock Brewery’s goods on hand. Although the company has its own internal control system, according to management, the internal controls are not as effective as expected; therefore an attendance at an inventory count for their dry goods store would be necessary.
While observing inventory, an auditor should take a sample and make sure if inventory tags are properly controlled and no empty containers are counted as inventory. Another substantive test could be a test on raw material and glass containers. The amount of the RM and glass containers increased by 32% and 18% yearly since 2013 (“About Big Rock Brewery,” n. d. ). In order to validate the amount of raw material supplied from suppliers, we should verify with the suppliers to see how much they have supplied to Big Rock Brewery and compare with purchases recorded.
As auditors, we can also check the purchase requisition, purchase order, the receiving report, and invoices. Since Big Rock is a brewery, their RM is mostly grains such as malts and hops, as it is hard to measure the right amount and therefore easy to overstate the value. To ensure those grains are valued correctly (not overstated), the auditor should attend an inventory count with a specialist. While observing inventory, the auditor should take a sample and make sure if grains are identified and price tagged correctly, since each grade of grain may have a different value.
The auditor should also make sure if the right units of the measure is used for each type of grains. For glass containers, the auditor should be aware of the existence of empty containers and empty spaces between containers which could lead to overstatement of inventory. Although their raw material consists mainly of dry goods, there still remains a possibility of spoilage, so as auditors, we should also be checking for expiration dates or date of production on the raw materials.
As a result of a 100-hectolitre batch of Dark Cherry Abbey Ale having a possibility of contamination, the audit team will have to check the rest of their inventory of it to make sure the other batches were not in risk of contamination either, ensure all their inventory was not spoiled. We would have to include testing of whether or not the company had written down inventory due to this batch of Dark Cherry Abbey Ale being spoiled for accuracy assertion.
Not only will this affect the inventory count balance on their financial statements, it will also affect their goods on consignment balance, as goods have been returned by the retailers. Since the company had incurred many expenses this year in opening a branch in BC, and their net income has been on the low side since 2014, they may have an incentive to improperly revalue or not even make an adjustment to their inventory balance in order to make their current assets seem larger than it actually is (“About Big Rock Brewery,” n. d. ).
For the remaining 150 bottles, these may have already been sold to customers and would have to be recalled from individual customers or they may face a huge impact on their company image by selling spoiled goods. Since the company needs to recall products from individual customers, we should also include in the audit plan a negative confirmation with the individual customers seeing if the company had indeed recalled those bottles, if not there may be a risk that the company is overstating its sales revenue by including the sale of the contaminated bottles as revenue.
In order to check if the company has adjusted its revenue, we can also include in the audit plan a substantive procedure such as tracing what the company does after they recall the bottles from customers; answering the questions of what the company does to the recalled batch, do they dispose of it or do they try and amend it, and how do they adjust for the recall on an accounting basis. The main assertion at hand would be the valuation.
In addition since the cause of this risk of contamination for the batch of Dark Cherry Abbey Ale roots from the failure during the pasteurization process, as auditors, we should ask management what actions they have taken to ensure there will be no recurrence of the same scenario, and what expenses they have incurred to fix their pasteurization process, such as the cost of hiring a specialist in to give recommendations on how to improve the process, or cost of buying new equipment if the equipment was the cause of the failure of the pasteurization process. Then we should adjust our audit plan into ensuring that management had followed appropriate steps to record their expenses to follow up on this incident.