During the course of completing our audit of Smackey Dog Food, Inc., we found several deficiencies within the companies’ internal controls. This has drastically affected the outcome of our audit investigation into this company. Our firm, Keller CPAs, have complied relevant information pertaining to the completed audit report and the regulations about it.
Smackey Dog Food is a privately held company, and for this reason the SEC does not have direct influence over the audit. They do not have assets in excess of $10 million, and they do not have over 500 stockholders; which are the requirements for public and privately held companies. The SEC does have indirect influence over the audit because all companies are required to comply with General Accepted Accounting Principles. Our auditors, like all auditors, while not bound by SEC rules they are required to obey specific audit rules and guidelines as outlined under the American Institute of Certified Public Accountants (AICPA).
During the initial planning of the audit of Smackey Dog Food, our auditors researched and discussed the dog food industries to gain a full understanding of exactly what Smackey Dog Food’s business is about. We also accessed if Smackey had any potential risk that could affect the audit outcome and audit objectives, implemented some analytical procedures prior to the start of the audit. Lastly, we developed an audit plan that is conducive to Smackey and set goals that would identify the risks and objectives of the audit team to render the audit report and the audit opinion.
During our audit, we uncovered several internal control concerns that Smackey Dog Food, Inc. needs to address. First, the Best Boy Gourmet division is extremely wasteful given the short shelf life and limited supplies on certain materials. Also, Kim overseas inventory, production and shipment of the products although the majority of her attention is spent on the Best Boy line, which leaves Henry alone. This is a major concern because Henry prepares and approves all inventory records while Kim “takes his word for inventory levels” with not physical counts or verification.
Another major concern is sales commissions are given based on estimated sales rather than actuals even though actual sales are off by 11%; they should be given based on actual sales, even if the employees aren’t exactly happy with it. Lastly, there needs to be stronger policy on accounts receivables and returned products.
To address some of the weaknesses that Smackey’s with internal controls, they would need develop best practices for the following issues. First, there does not appear to be any procedures for the receipt, safe storage, and disposal of returned dog foods. This would help to solve the problem of all of that dog food being dumped and then placed into Henry’s car and all of the inventory functions (monitoring, production and shipping, preparing and approving inventory records) are handled by only one person; both of these could be fixed by having another person being involve in the supervising and verifying process. Lastly, inventory functions at Best Boy storage of raw materials and finished goods are not conducted in a safe and sterile manner.
The proper presentation and disclosure of manufacturing equipment in the financial statements must be evaluated carefully to make sure that GAAP is followed. Manufacturing equipment should include the gross cost and should ordinarily be separated from other fixed assets. Leased property should also be disclosed separately, and all liens on property must be included in the footnotes. Auditors must perform sufficient tests to verify that all four presentation and disclosure objectives are met.
The only way the auditor would be able to be present at year-end inventory is to coordinate cutoff tests with the observation of inventory (we do not have the audit dates). At that time, the auditor should review the procedures in the receiving department to determine that all inventory received was counted, and the auditor should record in the audit documentation the last receiving report number of inventory included in the physical count. During the year-end field work, the auditor should then test the accounting records for cutoff. The auditor should trace the previously documented receiving report numbers to the accounts payable records to verify that they are correctly included or excluded.
When the client’s physical inventory takes place before the last day of the year, our auditors still performed an accounts payable cutoff at the time of the physical count. In addition, our auditors verified whether or not all acquisitions that took place between the physical count and the end of the year were added to the physical inventory and accounts payable. While examining the accounting records of a company, our primary technique for verifying the existence of accounts receivable is to use positive confirmations from them with customers and accounts receivable vendors. The six general functions that make up the Smackey’s inventory and warehousing cycle are processing of purchase orders and then purchase requisitions, colleting receipt of raw materials and receiving reports and vendor’s invoices. Third, storage of raw materials or inventory and raw materials inventory master file, and then the processing of raw materials, job cost sheets, and process cost sheets. Lastly, storage of finished goods with finished goods invoices, sales invoices, sales order form and shipping finished goods with shipping documents and invoices.
Yes, Keller accepted the audit without any prior knowledge of the type of business Smackey is involved in or even the industry. Even though this is a year-end audit, it appears that we – Keller CPAs – did not plan to devote enough time on the completion because the plans for a vacation so soon after a year-end are still in place. Two members of the audit team, Ben and Maureen noticed some irregularities involving dog food that has been returned to the company but neither mentioned it to the audit manager or other superiors. Pete should have never discussed any process of the audit or details with Alan.
SAS no. 99 requires the audit team to discuss the potential for a material misstatement in the financial statements due to fraud before and during the information-gathering process. This required “brainstorming” is a new concept in auditing literature, and early in the adoption process firms will need to decide how best to implement this requirement in practice. Keep in mind that brainstorming is a required procedure and should be applied with the same degree of due care as any other audit procedure. In addition to brainstorming, SAS no. 99 requires audit team members to communicate with each other throughout the engagement about the risks of material misstatement due to fraud. In fact, the standard requires the auditor with final responsibility for the audit to determine whether there has been appropriate communication among team members throughout the engagement.
The audit profession agrees that the failure of an audit to uncover material misstatements which then resulted to the issuance of an incorrect audit opinion makes the auditor’s discharge of his audit responsibility and services questionable, particularly on whether such were exercised with due care. When an audit has failed to uncover material misstatements and a mistake in the audit opinion is issued, it is proper to question whether the auditor exercised due care in completing the audit. There are laws in place now that will allow those who suffered a loss to recover some or all of the loss that was caused by the mistake. In the case of Smackey’s audit, it appears that the audit team failed to exercise the audit with due care.