Amazing Zones Apparel (Ama-Zone) sells workout apparel to department stores in the Pacific Northwest. Ama-Zone's auditor and your audit firm, Jordan, Pippen, Kerr and Kukoc (JPKK) LLC, has historically issued unqualified opinions on the Company's financial reports. Your group is part of the team for this year's Ama-Zone audit, and you are currently in the middle of year end field work in the fourth week of January, 2020. Selected financial data for the Company is provided below: 2016 2017 2018 Sales $300,000,000 $360,000,000 $420,000,000 2019 (prelim.) $370,000,000 80% 100% 100% 90% Credit sales Web-based sales 0% 0% 10% 20% $67,000,000 $42,000,000 $53,000,000 $48,000,000 Accounts receivable Allowance for doubtful accounts $4,150,000 $5,000,000 $4,300,000 $9,700,000 Allowance / accounts receivable 9.43% 8.96% 9.88% $200,000,000 14.48% $320,000,000 Total assets $250,000,000 $300,000,000 $15,000,000 Income bef taxes $10,000,000 $12,000,000 $10,600,00 Note that results are preliminary, while the company is still closing its books for fiscal year 2019. The controller performed an analysis of the allowance account (see the Excel spreadsheet file) using input from the credit manager. Based on this analysis, the controller estimated the ending allowance balance at $9.7 million, a significant increase from 2018's ending balance. The controller and CFO understand that your team must scrutinize the analysis as part of the audit. In an interview with the team, the CFO stated her concern that the allowance is over-stated, given that sales are down approximately 12% from 2018. The CFO tells you that the new credit manager's compensation is tied, in part, to his ability to reduce the write-off rate for receivables starting in 2020 which she believes further justifies her concern. The aging in the spreadsheet file shows the days that the receivable has been outstanding since the shipment to the customer (for example, a 30-day-old receivable indicates the shipment occurred 30 days ago, not that the receivable is 30 days past due). The CFO also mentioned during the interview that the company's debt covenants require, among other things, income before taxes of at least $10.0 million. Your team inquires of other Ama-Zone personnel this month and documents the following items. An economic recession contributed to the sales decline in 2019 (fictionally speaking). In an effort to improve sales, Ama-Zone extended more generous credit terms to its customers. Beginning in the fourth quarter of 2019, customers were granted an additional 30 days to pay their balances, so credit terms were extended from net 30 days to net 60 days. Days sales outstanding have increased slightly from approximately 44 days in 2018 to 57 days in 2019. In 2018, Ama-Zone began to sell directly to consumers using the Web. Web-based sales have little credit risk, as credit card companies must approve the charges before shipments are made. These sales are always settled in fewer than 30 days. The receivables balances for Web-based sales were $3.0 million and $6.0 million in 2018 and 2019, respectively. The allowance is estimated based on general expectations and historical losses for most accounts. The average credit score of customers in 2019 is essentially unchanged from prior years. Except for a few large customers, the receivables are due from small, homogenous customers. For customers with balances higher than $500,000, Ama-Zone does not perform a more detailed analysis of the accounts as historically this has not been an issue for the company. Allowance estimates were slightly under- as compared to the actual write-off losses in 2016 and 2017, and slightly over-estimated in 2018. See the allowance analysis for details. About 22.4% of the accounts receivable balance on December 31, 2019, is over 91 days old. Based on a team discussion with the Senior VP of Sales, the following is a summary of customers with balances over $500,000. . Warrior's Workout World accounts receivable balance from 2018 still remains outstanding at December 31, 2019; its balance is $3.0 million. Earlier in the year, Workout World management agreed to reduce the balance using payments of $200,000 per month starting in August 2018. It made the first three monthly payments, but the payments due in November 2019, December 2019, and January 2020 have not yet been received. Workout World management has not returned the credit manager's phone calls. On December 31, 2018, the balance was 31 to 60 days old and was included in the allowance at the same general percentage as other receivables in this aging category. . A new customer in 2018, Fit Raptors Inc., has always paid its amounts due after selling the product to consumers. On December 31, 2018, the outstanding balance is $10.0 million. Of this, $3.0 million is over 120 days old; $2.0 million is 91 to 120 days old; and $5.0 million is 31 to 60 days old. Ama-Zone continues to receive payments from Fit Raptors and all amounts over 120 days old on December 31, 2018 were collected in January 2019. On December 31, 2019, the outstanding balance was $4.0 million; $500,000 was over 120 days old, $500,000 was 91 to 120 days old, $2.0 million was 31 to 60 days old and $1.0 million was 0 to 30 days old. Ama-Zone made no allowance for Fit Raptor's receivables in 2018, and all amounts owed were collected in 2019. . New Wave Pistons (NWP) has an outstanding balance of $5.0 million on December 31, 2019. Of this, $1.0 million is over 120 days old, $1.5 million is 91 to 120 days old, and $2.5 million is 61 to 90 days old. This company was a new start-up in 2018, so Ama-Zone does not have a reliable credit history for it. Ama-Zone has put a hold on new shipments to NWB until it receives payment of the balance. The credit manager has heard rumors that the company might declare Chapter 11 bankruptcy. Separately, in December 2019, the Senior VP of Sales spoke to the wealthy owner of NWB, who personally assured him that the Company intended to pay its outstanding balance in the coming weeks. In January 2020, the Senior VP of Sales obtained a written personal guarantee of the amounts owed from the owner of NWP. The personal financial statements of the owner show he has a net worth in excess of $20.0 million. Laker Horizon Outlet Stores (Laker Horizon) has a balance of $1.0 million on December 31, 2018. Of this, $500,000 is 61 to 90 days old and the balance is 31 to 60 days old. Long Horizon's owners have just placed another company they own in a troubled industry into bankruptcy. . None of the remaining customer balances are greater than $500,000 on December 31, 2018. . On December 31, 2018, the only two customers with balances over $500,000 were Warrior's Workout World and Fit Raptors. Prior to 2018, the company did not have any customers with a balance greater than $500,000 at year-end. a. Case Requirements (1) For December 31, 2019, perform an ageing analysis assessment of the allowance for doubtful accounts using all of the information your team has gathered. Use an Excel spreadsheet to formally support your team's calculations. Feel free to use the controller's allowance analysis as a starting point for your team's own analysis. Specific items to be answered: For each of the customer's listed in the narrative, document in a Word document and explain your conclusions that are directly supported by your calculations. (i.e. I should be able to see your calculations and then read your conclusions to understand your final decision. If I cannot tie these together, it will be considered an incomplete analysis). You also should explain how you handled all other smaller customer balances and the related collectable balances. b. The company pooled all accounts receivable balances together to perform their aging analysis. What are the advantages of doing this approach? What are the disadvantages of such an approach. Based on what you have learned in class and from this case, what does your team believe to be the best approach for the company to consider using in the future for their aging analysis? C. Explain how the compensation incentive program for the credit manager may contribute, either positively and negatively, to his analysis of collectable balances. What critical audit concept may be impaired because of this arrangement? d. How would the debt covenant impact the decisions made by the CFO and credit manager for the requirement of at least $10M in earnings? What qualitative concerns would the auditor have based on this requirement? What other test of details or substantive procedure would you recommend the auditor performing? Be specific and use your textbook, class discussions, and any research you may perform to list out those additional procedures. Briefly explain each you decide to recommend (2-3 sentences is sufficient) e. Amazing Zones Apparel (Ama-Zone) sells workout apparel to department stores in the Pacific Northwest. Ama-Zone's auditor and your audit firm, Jordan, Pippen, Kerr and Kukoc (JPKK) LLC, has historically issued unqualified opinions on the Company's financial reports. Your group is part of the team for this year's Ama-Zone audit, and you are currently in the middle of year end field work in the fourth week of January, 2020. Selected financial data for the Company is provided below: 2016 2017 2018 Sales $300,000,000 $360,000,000 $420,000,000 2019 (prelim.) $370,000,000 80% 100% 100% 90% Credit sales Web-based sales 0% 0% 10% 20% $67,000,000 $42,000,000 $53,000,000 $48,000,000 Accounts receivable Allowance for doubtful accounts $4,150,000 $5,000,000 $4,300,000 $9,700,000 Allowance / accounts receivable 9.43% 8.96% 9.88% $200,000,000 14.48% $320,000,000 Total assets $250,000,000 $300,000,000 $15,000,000 Income bef taxes $10,000,000 $12,000,000 $10,600,00 Note that results are preliminary, while the company is still closing its books for fiscal year 2019. The controller performed an analysis of the allowance account (see the Excel spreadsheet file) using input from the credit manager. Based on this analysis, the controller estimated the ending allowance balance at $9.7 million, a significant increase from 2018's ending balance. The controller and CFO understand that your team must scrutinize the analysis as part of the audit. In an interview with the team, the CFO stated her concern that the allowance is over-stated, given that sales are down approximately 12% from 2018. The CFO tells you that the new credit manager's compensation is tied, in part, to his ability to reduce the write-off rate for receivables starting in 2020 which she believes further justifies her concern. The aging in the spreadsheet file shows the days that the receivable has been outstanding since the shipment to the customer (for example, a 30-day-old receivable indicates the shipment occurred 30 days ago, not that the receivable is 30 days past due). The CFO also mentioned during the interview that the company's debt covenants require, among other things, income before taxes of at least $10.0 million. Your team inquires of other Ama-Zone personnel this month and documents the following items. An economic recession contributed to the sales decline in 2019 (fictionally speaking). In an effort to improve sales, Ama-Zone extended more generous credit terms to its customers. Beginning in the fourth quarter of 2019, customers were granted an additional 30 days to pay their balances, so credit terms were extended from net 30 days to net 60 days. Days sales outstanding have increased slightly from approximately 44 days in 2018 to 57 days in 2019. In 2018, Ama-Zone began to sell directly to consumers using the Web. Web-based sales have little credit risk, as credit card companies must approve the charges before shipments are made. These sales are always settled in fewer than 30 days. The receivables balances for Web-based sales were $3.0 million and $6.0 million in 2018 and 2019, respectively. The allowance is estimated based on general expectations and historical losses for most accounts. The average credit score of customers in 2019 is essentially unchanged from prior years. Except for a few large customers, the receivables are due from small, homogenous customers. For customers with balances higher than $500,000, Ama-Zone does not perform a more detailed analysis of the accounts as historically this has not been an issue for the company. Allowance estimates were slightly under- as compared to the actual write-off losses in 2016 and 2017, and slightly over-estimated in 2018. See the allowance analysis for details. About 22.4% of the accounts receivable balance on December 31, 2019, is over 91 days old. Based on a team discussion with the Senior VP of Sales, the following is a summary of customers with balances over $500,000. . Warrior's Workout World accounts receivable balance from 2018 still remains outstanding at December 31, 2019; its balance is $3.0 million. Earlier in the year, Workout World management agreed to reduce the balance using payments of $200,000 per month starting in August 2018. It made the first three monthly payments, but the payments due in November 2019, December 2019, and January 2020 have not yet been received. Workout World management has not returned the credit manager's phone calls. On December 31, 2018, the balance was 31 to 60 days old and was included in the allowance at the same general percentage as other receivables in this aging category. . A new customer in 2018, Fit Raptors Inc., has always paid its amounts due after selling the product to consumers. On December 31, 2018, the outstanding balance is $10.0 million. Of this, $3.0 million is over 120 days old; $2.0 million is 91 to 120 days old; and $5.0 million is 31 to 60 days old. Ama-Zone continues to receive payments from Fit Raptors and all amounts over 120 days old on December 31, 2018 were collected in January 2019. On December 31, 2019, the outstanding balance was $4.0 million; $500,000 was over 120 days old, $500,000 was 91 to 120 days old, $2.0 million was 31 to 60 days old and $1.0 million was 0 to 30 days old. Ama-Zone made no allowance for Fit Raptor's receivables in 2018, and all amounts owed were collected in 2019. . New Wave Pistons (NWP) has an outstanding balance of $5.0 million on December 31, 2019. Of this, $1.0 million is over 120 days old, $1.5 million is 91 to 120 days old, and $2.5 million is 61 to 90 days old. This company was a new start-up in 2018, so Ama-Zone does not have a reliable credit history for it. Ama-Zone has put a hold on new shipments to NWB until it receives payment of the balance. The credit manager has heard rumors that the company might declare Chapter 11 bankruptcy. Separately, in December 2019, the Senior VP of Sales spoke to the wealthy owner of NWB, who personally assured him that the Company intended to pay its outstanding balance in the coming weeks. In January 2020, the Senior VP of Sales obtained a written personal guarantee of the amounts owed from the owner of NWP. The personal financial statements of the owner show he has a net worth in excess of $20.0 million. Laker Horizon Outlet Stores (Laker Horizon) has a balance of $1.0 million on December 31, 2018. Of this, $500,000 is 61 to 90 days old and the balance is 31 to 60 days old. Long Horizon's owners have just placed another company they own in a troubled industry into bankruptcy. . None of the remaining customer balances are greater than $500,000 on December 31, 2018. . On December 31, 2018, the only two customers with balances over $500,000 were Warrior's Workout World and Fit Raptors. Prior to 2018, the company did not have any customers with a balance greater than $500,000 at year-end. a. Case Requirements (1) For December 31, 2019, perform an ageing analysis assessment of the allowance for doubtful accounts using all of the information your team has gathered. Use an Excel spreadsheet to formally support your team's calculations. Feel free to use the controller's allowance analysis as a starting point for your team's own analysis. Specific items to be answered: For each of the customer's listed in the narrative, document in a Word document and explain your conclusions that are directly supported by your calculations. (i.e. I should be able to see your calculations and then read your conclusions to understand your final decision. If I cannot tie these together, it will be considered an incomplete analysis). You also should explain how you handled all other smaller customer balances and the related collectable balances. b. The company pooled all accounts receivable balances together to perform their aging analysis. What are the advantages of doing this approach? What are the disadvantages of such an approach. Based on what you have learned in class and from this case, what does your team believe to be the best approach for the company to consider using in the future for their aging analysis? C. Explain how the compensation incentive program for the credit manager may contribute, either positively and negatively, to his analysis of collectable balances. What critical audit concept may be impaired because of this arrangement? d. How would the debt covenant impact the decisions made by the CFO and credit manager for the requirement of at least $10M in earnings? What qualitative concerns would the auditor have based on this requirement? What other test of details or substantive procedure would you recommend the auditor performing? Be specific and use your textbook, class discussions, and any research you may perform to list out those additional procedures. Briefly explain each you decide to recommend (2-3 sentences is sufficient) e