iBee is a private corporation located in
un 'ey oodles Corners, Ontario, that owns and maintains
a large honeybee colony. Tom Doodles established the company
as a small hobby business in 1967. Over time, Tom's
great-tasting and high-quality honey grew into a large bUsiness.
In 2002, Tom incorporated iBee and split the company's
share ownership with his two children, Emilia and
Mark. Following incorporation, Emilia and Mark each
held 33.33 percent of iBee shares. Tom was always the
sole decision maker at iBee, overseeing all production and
administrative matters. He taught Emilia and Mark everything
he knows about good beekeeping practices and honey
production.
During a family vacation to Iceland in 2010, Tom
noticed the potential market that the country presented for
his honey. The following year, Tom signed a contract with
an Icelandic honey distributor named Hnit. The opening of
the Icelandic market caused an increased demand for iBee's
honey. Icelanders strongly prefer iBee's honey over other
brands and will pay a premium price for it because iBee's
honey always comes in a liquid form and it has a high nutritional
value. When honey is stored at low temperatures for
long enough, it will crystallize (change from a liquid to a
solid). Crystallized honey can be changed back to its liquid
form by heating it at a high temperature, but this process
significantly reduces its nutritional value. As a result, honey
processed by this method is priced at 50-60 percent less than
untreated liquid honey.
In response to this increased demand, Tom contemplated
a plan to expand the company by acquiring three nearby,
private beekeeping operations. In anticipation of financing
these acquisitions, Tom approached your accounting firm,
Accounting-iS-fuN LLP, in early 2017, requesting an audit of
iBee's financial statements. The audit was performed and an
unqualified opinion was issued.
It is now November 25,2018, and you are the senior auditor
at Accounting-iS-fuN LLP, in charge of the iBee financial
statement audit for the November 30, 2018, year-end. Following
are the highlights from the iBee engagement team meeting
and audit notes from the prior year.
Change in Management-In the fall of 2018, Tom was
injured in a car accident. His recovery was very slow, which
forced him to transfer iBee's day-to-day operations to his children
in early 2018. Emilia, who recently completed her MBA,
took over all accounting and administrative matters. Mark had
always shown a passion for beekeeping so he became head
beekeeper, managing the bees and the production, storage,
and distribution of honey. Tom, meanwhile, focused on his
recovery and became an inactive owner.
In early 20 18,Emilia pursued her father's plans to purchase
the three private beekeeping companies, but her application
for a bank loan was denied due to the economic downturn. As
a result, Emilia explored alternative financing options. That
summer, she struck a deal with a private financing company
to securitize (also known as factoring or selling) 80 percent of
the outstanding balance of iBee's accounts receivable, based
on the audited financial statements as of November 30, 2018.
During the transitional period in early 2018, Emilia did
not review several monthly bank reconciliations that were
prepared by iBee accounting department employee Lidia
Gdansk. She also did not perform two quarterly budgeted versus
actual sales and expense reviews.
Emilia did not realize her omissions until they were
brought to her attention by Lidia in early July 2018. Lidia said
that Emilia, as she took over Tom's responsibilities, should also
have reviewed and established credit limits for new customers.
Following her discussion with Lidia, Emilia began performing
these tasks. However, Emilia remains unsure if credit
limits for all new customers were reviewed and assessed prior
to year-end. She also did not get a chance to catch up with the
review of all the bank reconciliations prior to year-end.
Previously, Tom would adjust the allowance for doubtful
accounts prior to year-end after reviewing and assessing the
collectability of each outstanding account. This year, Emilia
delegated this task to Lidia, who simply applied the same percentage
as last year because she did not think that demand for
honey changed materially year-over-year.
Renewal of Hnit Contract-Iceland's sudden and severe
economic downturn and associated banking crisis did not
adversely impact demand for iBee's honey. However, on
August 1, 2018, iBee's Icelandic distributor, Hnit, refused to
renew its distribution contract unless it included the following
clause: "Hnit reserves the right to return to iBee all honey
inventory that has crystallized during transportation or storage
within six months of receipt. Hnit is not responsible for any
shipping or storage costs of honey that has crystallized on its
premises."
After some discussion, Emilia and Mark agreed to include
the clause in iBee's agreement with Hnit, which was signed
and went into effect on August 15, 2018.
Emilia instructed Lidia to journalize (process an accounting
entry) all honey sales to Iceland at the time customers
placed their preorders at the beginning of the year. As iBee
always prioritized the Icelandic orders, and all honey sales
were shipped and delivered prior to year-end, Emilia believed
this method would not impact the financial statements and
could be used as a tool to forecast honey demand for the year.
Shipment Accident-Due to a phenomenon called hygroscopy,
honey will absorb moisture directly from the air, including
any pollutants and odours contained in it. Thus, honey
must be carefully packaged to protect it from dust, vehicle
exhaust fumes, strong food odours, and other pollutants. Polluted
honey is usually unfit for consumption and should be
discarded.
On July 1, 2018, due to a shortage of proper transport containers,
Mark resorted to transporting a large quantity of honey
from the beehives to the storage warehouse in unsealed, inadequate
containers. A highway accident caused a delay and the
truck carrying the shipment was forced to idle for an extended
period. Upon testing at iBee's processing facility, it was determined
that the honey had indeed absorbed a large quantity of
exhaust fumes and was polluted.
Mark could not discard the polluted honey because
2018 was already a low production year and doing so could
delay or even cancel the fulfillment of Icelandic orders. To
overcome this challenge, Mark wants to gamble and ship
the polluted honey mixed in with a shipment of "clean"
honey with the hope that it will not be tested by the Icelandic
Food Safety Agency (IFSA). Mark plans to include the
polluted honey with the last shipment to Iceland scheduled
for December 29, 2018. The IFSA has very strict inspection
protocols for all food imports, testing on a sample basis
5-10 percent of all shipments entering the country. IFSA
inspection protocols require testing honey for pollutants and
ensuring that its actual nutritional value matches the facts
indicated on the label.
REQUIRED
a. Audit standards require the auditor to consider audit
risk at the account level. Set the level of audit risk for
accounts receivable and inventory. Make sure to fully
justify and support your risk level assessment.
b. Identify and explain which case facts (risks) would
impact your assessment of the inherent risk and fraud
risk for the financial statements as a whole and at the
account and assertion level.
c. Explain at what level you would set the inherent risk and
fraud risk for the financial statements as a whole.
d. Explain which specific assertions would most likely be
impacted by the risks you identified in Part (b).
e. Identify and explain which case facts (risks) would
impact your assessment of control risk.
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