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[answered] Module 7 Audit and Assurance Project Chartered Professional


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6. Identify nine different risks at the financial statement level. For each risk, identify a relevant substantive audit procedure and the specific audit assertion that is being tested. Ensure that these audit procedures you identify are specific to the case facts. Use a chart like the one below to structure your response. (27 marks)

Financial statement risk Substantive audit procedure Related assertion

Module 7 ? Audit and Assurance Project
4 / 11
7. Jennifer has asked you for some business advice related to controls. Describe at least eight weaknesses in Charm?s business processes, explain the implications of each weakness, and provide recommendations to reduce or eliminate the weaknesses. Use a chart like the one below to structure your response. (24 marks)

Weakness Implication Recommendation


Module 7

 

Audit and Assurance

 

Project Chartered Professional Accountants of Canada, CPA Canada, CPA

 

are trademarks and/or certification marks of the Chartered Professional Accountants of Canada.

 

? 2016, Chartered Professional Accountants of Canada. All Rights Reserved. Module 7 ? Audit and Assurance PROJECT (100 MARKS)

 

Charm Studios Inc. is a hair salon owned and operated by Jennifer. Jennifer had worked as a

 

stylist in a high-traffic salon for over 10 years, and then on July 1, 20X5, she decided that the

 

time was right to open her own salon, so she took out a loan for the initial costs of setting up

 

her salon.

 

Over the last year, the salon?s business has grown so much that, in order to extend the salon?s

 

business hours to include evenings and all weekends, Jennifer has hired one full-time and two

 

part-time stylists, as well as a part-time receptionist who will help manage the front desk. In

 

addition, an esthetician operates her own company, Nail Art ? an entity separate from Charm

 

? in a room within the salon.

 

As the salon premises are being fully used and the salon?s clientele is continuing to grow,

 

Jennifer is hoping to expand her storefront and is seeking an additional loan to do this. The

 

bank has requested audited statements for Charm in accordance with ASPE for its most recent

 

fiscal year end (June 30, 20X6). Jennifer has provided the draft income statement for the year

 

ended June 30, 20X6, in Appendix 1.

 

In July 20X6, Jennifer approached Tracey, a CPA, to inquire whether her firm, Connolly, Drake

 

and Associates (CDA), could complete Charm?s financial statement audit. Tracey is one of four

 

partners at CDA. Jennifer has been Tracey?s hair stylist for years. They have become close

 

friends and have often chatted about their mutual friends, and Jennifer has sought Tracey?s

 

opinion on some accounting matters such as the correct accounting treatment for Charm?s

 

expenditures over the last year. Jennifer has implemented some of Tracey?s

 

recommendations.

 

Jennifer uses an off-the-shelf software package used by many salons. The software package

 

allows for easy input of sales transactions. As a sale is made, it is automatically recorded in

 

both the sales subledger and the general ledger. The software can quickly generate reports by

 

customer, type of service, and total purchases for each period, although Jennifer has said she

 

never has time to do this. She uses a laptop to track everything, which she is hoping to replace

 

soon because it sometimes crashes.

 

Jennifer is a skilled hair stylist and a natural leader, but she will be the first to admit that she

 

had a lot to learn about running her own business. She is usually prompt at paying bills and

 

she waits until invoices are paid before recording them. Once she records payments, they are 2 / 11 Module 7 ? Audit and Assurance Project updated in the general ledger. Lately she has been so busy that sometimes bank deposits

 

don?t even get made for up to a few days at a time.

 

Appendix 2 shows extracts from the monthly income statements for March to June 20X6;

 

Jennifer would like you to review the impact of the changes to operations during these months

 

on revenues and costs. Appendix 3 contains the notes from Tracey?s meeting with Jennifer.

 

Appendix 4 contains the memo that Jennifer has prepared to describe the sales process at

 

Charm.

 

Required:

 

1. Identify any threats to independence that would prevent CDA from accepting Charm

 

Studios Inc. as a client. Discuss how each threat could affect independence and how, if

 

possible, CDA can mitigate each threat. (7 marks)

 

2. Perform the planning analytical review for Charm?s revenues. In particular, use the

 

information related to the number of services that Charm has provided, and distinguish

 

between full-time and part-time staff revenues. Include any supporting calculations.

 

Interpret the results from the analytical review. Which accounts and related assertions will

 

be most impacted by the results of your analytical review? (16 marks)

 

3. Discuss whether there is any evidence to support the possibility of fraud occurring at

 

Charm. Discuss the auditor?s responsibility with regards to detecting fraud at Charm. If

 

fraud did occur, discuss what steps CDA should take now. (10 marks)

 

4. Complete the preliminary planning of the audit by determining the level of audit risk, and

 

support your analysis by discussing seven risk factors associated with the engagement.

 

Indicate what type of risk (inherent risk or control risk) is associated with each factor.

 

(8 marks)

 

5. Calculate overall planning materiality and performance materiality for the 20X6 fiscal

 

year-end audit. Provide both quantitative and qualitative analysis supporting your

 

assessment of preliminary materiality. (8 marks)

 

6. Identify nine different risks at the financial statement level. For each risk, identify a relevant

 

substantive audit procedure and the specific audit assertion that is being tested. Ensure

 

that these audit procedures you identify are specific to the case facts. Use a chart like the

 

one below to structure your response. (27 marks)

 

Financial statement risk 3 / 11 Substantive audit procedure Related assertion Module 7 ? Audit and Assurance Project 7. Jennifer has asked you for some business advice related to controls. Describe at least

 

eight weaknesses in Charm?s business processes, explain the implications of each

 

weakness, and provide recommendations to reduce or eliminate the weaknesses. Use a

 

chart like the one below to structure your response. (24 marks)

 

Weakness 4 / 11 Implication Recommendation Module 7 ? Audit and Assurance Project APPENDIX 1: DRAFT INCOME STATEMENT FOR THE YEAR ENDED JUNE 30, 20X6

 

Year ended June 30, 20X6

 

Unaudited

 

Notes

 

Revenues ? full-time staff

 

Revenues ? part-time staff

 

Product sales

 

Total revenues 212,150

 

30,300

 

13,825

 

256,275 Cost of goods sold

 

Products used in services

 

General and administrative

 

Wage expense

 

Interest expense

 

Rent expense

 

Total expenses 8,485

 

4,828

 

7,547

 

79,771

 

1,554

 

9,000

 

111,185 Total income before taxes 145,090 1

 

2

 

3

 

4

 

5 Notes:

 

1. This includes hair products purchased from Nova Scotia Beauty, which Charm normally

 

sells to customers at a 50% markup.

 

2. Products used in hair services are mostly made up of hair colour, shampoo and conditioner.

 

Sometimes a client will need two colour treatments, depending on their hair length and type

 

of colour method.

 

3. Jennifer has used $5,000 of her own money to purchase new lights, painting and custombuilt supply cupboards for the salon, which is included in general and administrative

 

expense. Sometimes she uses her personal credit card to buy supplies for Charm, and

 

then takes money out of the cash register to reimburse herself for these purchases. She

 

has kept all of the receipts for these items in a separate envelope.

 

4. Interest expense relates to the $100,000 loan that Jennifer took out to finance the initial

 

costs of setting up the salon. The loan must be paid back over five years. There are

 

covenants on the loan that require Charm to maintain specific ratios, including a current

 

ratio of 1.5 to 1 and a debt-to-equity ratio of 1.2 to 1.

 

5. Charm is required to remit 5% of its gross sales to the lessor in addition to a monthly rental

 

amount of $1,000. No amount has been recorded for this yet; it will be done when the

 

financial statements are finalized.

 

6. Charm is being sued by a customer who had a severe allergic reaction after having her hair

 

coloured at the salon ? most of her hair fell out within 24 hours of the treatment. The 5 / 11 Module 7 ? Audit and Assurance Project customer was supposed to get married three days after her hair service, but her fianc?

 

decided not to proceed with the nuptials due to the incident.

 

Jennifer always completes a profile on each new customer as required by The

 

Cosmetology Association. In the profile, there is a section where the client must indicate

 

whether they have any allergies and the client signs to acknowledge that they understand

 

that there are risks involved with chemicals used in hair colouring. After the incident

 

occurred, Jennifer couldn?t find a profile created for this customer. The Cosmetology

 

Association has the ability to cease operations of any stylist or esthetician found to be in

 

violation of their guidelines. 6 / 11 Module 7 ? Audit and Assurance Project APPENDIX 2: EXTRACTS FROM MONTHLY FINANCIAL STATEMENTS

 

Monthly income statements for March to June 20X6 Revenues ? full-time staff

 

Revenues ? part-time staff

 

Product sales

 

Total revenues

 

Cost of goods sold

 

Products used in services

 

General and administrative expense

 

Wage expense

 

Interest expense

 

Rent expense

 

Total expenses

 

Total income before taxes 7 / 11 March April May June 17,450

 

7,200

 

1,000

 

25,650

 

700

 

399

 

247

 

9,224

 

125

 

1,000

 

11,695

 

13,955 17,700

 

8,500

 

1,300

 

27,500

 

910

 

557

 

342

 

9,224

 

118

 

1,000

 

12,151

 

15,349 17,500

 

7,600

 

900

 

26,000

 

630

 

337

 

378

 

9,224

 

145

 

1,000

 

11,714

 

14,286 17,350

 

7,000

 

800

 

25,150

 

560

 

285

 

457

 

9,224

 

154

 

1,000

 

11,680

 

13,470 Module 7 ? Audit and Assurance Project APPENDIX 3: NOTES FROM TRACEY?S JULY 20X6 MEETING WITH JENNIFER

 

Charm staff consists of Jennifer, Meryna, who is another full-time stylist, and three part-time

 

employees, Sherri, Marjan and Kaitlin. There is a full-time esthetician, Ayana, who operates a

 

spa called Nail Art within Charm, but she is not on Charm?s payroll because her business is a

 

separate entity from Charm. Nail Art is owned 100% by Ayana.

 

Nail Art shares Charm?s cash register. Ayana rings in services and products sold using a

 

certain code to distinguish Nail Art?s sales from Charm?s sales. Jennifer and Ayana have a

 

verbal agreement that Charm will collect 20% of Nail Art?s revenue in lieu of charging rent.

 

There appears to be some tension between Ayana and Jennifer in the salon.

 

In March of this year, Sherri and Marjan had come to Jennifer looking for employment. Jennifer

 

hired them both on the spot because they seemed to have the trendy appearance she thought

 

was important for stylists to have in her salon. Jennifer was so excited about not having to

 

search for new stylists and was so eager to have Sherri and Marjan start right away that she

 

did not ask for their Cosmetology Association member numbers to verify that they were

 

licensed.

 

Sherri and Marjan are best friends and they told Jennifer that they had just graduated from

 

Choice Hair Academy and were eager to work for Charm because they both have big student

 

loans. They always seem to have many friends in the store, and Jennifer is hoping this will

 

lead to a new under-20 clientele base. They all want their hair to look just like Star Sims, a

 

popular teen celebrity.

 

Jennifer had always answered the phones and booked appointments herself until two months

 

ago, when she hired Kaitlin to take on this role. When clients book an appointment, it is entered

 

into a master schedule, which is maintained electronically so that a historical record is

 

available for each client. Jennifer has been so impressed with Kaitlin that she has also tasked

 

her with doing the bank deposits and handling clients? transactions when their services are

 

complete.

 

All Charm employees have access to process the salon?s payment transactions so they can

 

help out when Kaitlin is busy, to ensure that customers are not kept waiting after their service

 

is complete. Also, Ayana often processes payment transactions for Charm?s services and

 

products sales, since her clientele is still growing and she often is not busy. Likewise, Kaitlin

 

will sometimes process Nail Art?s payment transactions when Ayana is busy.

 

Jennifer is seeking a loan to expand Charm?s storefront location. Charm currently has a threeyear lease. Jennifer is not happy with the amount of rent Charm is being charged ? a rate of

 

5% of Charm?s monthly sales in addition to the $1,000 fixed rent amount per month. The lessor

 

had provided an upfront incentive of free rent for the first three months because there had

 

been some robberies in other stores at the strip mall.

 

Charm has a loan with covenants tied to working capital ratios. The bank requires the audited

 

financial statements to be provided within two months of the year end. A breach of the 8 / 11 Module 7 ? Audit and Assurance Project covenants means that the loan will become payable on demand. Jennifer does not have

 

sufficient cash flows to repay the loan if the bank were to call it.

 

Jennifer purchases 85% of her products from Nova Scotia Beauty, a local beauty supply shop.

 

Charm sells these products in the salon and uses them during client services. Jennifer pays

 

her employees a 10% commission on the sale of each product. On the employees? pay stubs,

 

the total commission amount is shown separately, recorded as part of wage. 9 / 11 Module 7 ? Audit and Assurance Project APPENDIX 4: MEMO ON DESCRIPTION OF SALES PROCESS FROM JENNIFER

 

Memo

 

To:

 

From:

 

Date:

 

Re: Tracey

 

Jennifer

 

July 15, 20X6

 

Description of Sales Process at Charm I try to keep Charm product sales separate from Nail Art?s product sales, but lately, I?ve noticed

 

that the inventory records have reflected more product on hand than what is actually in stock

 

when we are looking for items.

 

The new customer loyalty card that Charm implemented a few months ago has been a huge

 

success. Customers earn one point for every $1 spent, and once they have earned 750 points,

 

they can redeem their points for a free hair service or merchandise worth up to $50. The cash

 

register tracks points by customer. The only customers who have not signed up for the loyalty

 

card are walk-in customers, so I estimate that 90% of customers use the loyalty card.

 

I?m thrilled that the amount of customer bookings has been increasing so quickly. I?m actually

 

kind of surprised that the bank deposits aren?t higher. Given the number of appointments we?ve

 

had, and the amount of hair colour we?ve gone through since hiring the new part-time staff, I

 

had expected sales to be even higher.

 

A women?s haircut costs $50, and a colour service can range from $100 to $200 depending on

 

the hair length and type of service. The average charge for a colour service done by the parttime staff has been $125. Right now, the new part-time staff are charging $40 per haircut to try

 

to encourage business, which seems to be working ? they are busy all the time!

 

Charm is open from Tuesday to Sunday, and is closed on Mondays. Meryna and I have

 

decided to each work four days per week because the part-time staff work two full days on the

 

weekends and three evenings. During the four days Meryna and I work per week, we are

 

booked 100% of the time. Normally we each do five haircuts and two colour treatment services

 

per day. The two new part-time staff could do the same number of haircut and colour services

 

on the weekends as Meryna and I do each day through the week, and sometimes more. In the

 

three evenings that they each work, the schedule that Kaitlin keeps shows them as being busy,

 

each doing five haircuts and one colour treatment service on most evenings.

 

I?m kind of surprised that we have constantly been running out of colour needed for hair

 

dyeing. I used to know how much product I would go through each month, but for the last few

 

months I have been consistently running out of product, especially a particular brand that has

 

become popular after Star Sims started doing advertisements for the manufacturer. It?s a great

 

product but it?s really expensive compared to the other brands. I really should count inventory

 

more often; it seems like it?s the last thing I have time for after my salon bookings, running the

 

store and doing all the bookkeeping myself. 10 / 11 Module 7 ? Audit and Assurance Project At the salon franchise where I worked previously, the payment system had product and service

 

codes that employees could not change at the register. I don?t really want to get into that

 

because I trust my employees; they can override the standard price and input the price they

 

feel is most appropriate to charge. I want my regular clients who followed me from my last

 

employer to be happy, so I give some of them discounts on services. 11 / 11

 


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