Attached is a case study that I need the answers to, it's due tomorrow and I desperately need the excel document to go with it. Thanks

ISSUES IN ACCOUNTING EDUCATION Association Vol. 31, No. 3 August 2016 pp. 355-366 51218 American Accounting DOI: 10.2308/iace- Trading Styles, Inc.: An Analysis of the Going Concern Assessment Velina K. Popova Sarah E. Stein Virginia Polytechnic Institute and State University ABSTRACT: This instructional case focuses on the auditor's going concern decision for a private retail client. The primary objective of this case is to understand and examine the auditor's consideration of the client's ability to continue as a going concern in a real-world setting. The case provides students with the financial aspects as well as the personal aspects of such a decision. Specifically, students must complete analytical procedures and evaluate information from several sources when forming their opinion. We also ask students to contemplate the auditor's relationship with the client in order to understand issues involving auditor independence. Throughout the case, students have the opportunity to review applicable auditing standards and to draft a going concern audit report. We expect this case would be most applicable for an undergraduate or a graduate audit course. Keywords: going concern; auditor's report; analytical procedures; auditor independence. CASE Introduction You are an audit senior on the Trading Styles, Inc. engagement, which is a private retail company. You work for the audit firm Elliott & Roan, LLP in the Denver, Colorado office. This is your first year on the engagement; however, the company has been your firm's audit client for the past six years and represents approximately 15 percent of your audit office's revenue. Your audit firm issued a standard unqualified opinion for the audits of Trading Styles, Inc. in each of the last six years. You are currently working with your team to complete the fiscal year 2014 audit and your manager asked you to research and prepare an assessment of the company's ability to continue as a going concern. To approach this task, you begin by pulling together specific background and financial information to develop your consideration of the going concern assumption. Company Background Trading Styles, Inc. was founded in 1991 and is headquartered in Ohio. The company operates in the highly competitive business of apparel-based specialty retailer and personal care and beauty categories. Trading Styles defines itself as ''a place that provides a luxury shopping experience and focus on fashion'' and is a trend-setter in the industry. The company targets its products toward the high-end segment of the market, appealing to women of all ages who are concerned with fashion as well as value. Trading Styles sells merchandise through specialty retail stores in the United States and Canada, which are primarily mallbased, as well as through websites and catalogues. The majority (approximately 75 percent) of company sales come from the stores and the remaining 25 percent are generated online and through catalogs. Based on the competitive nature of the We thank Lori Holder-Webb (editor), Elizabeth Carson (associate editor), and two anonymous reviewers for their helpful and constructive feedback during the review process. We also thank Sanaz Aghazadeh, Rebecca Fay, Garrett Ford, Christine Gimbar, Greg Jenkins, Zachary Morris, Jennifer Parlier, Mark Sheldon, Padmakumar Sivadasan, and Vicky Yu for their valuable comments and suggestions on previous versions of the case. Supplemental material can be accessed by clicking the link in Appendix B. Editor's note: Accepted by Lori Holder-Webb. 355 Submitted: January 2015 Accepted: July 2015 Published Online: July 2015 35 6 Popova and Stein industry, your client strives to maintain brand image through marketing, design, price, service, assortment, and quality. The company also engages in aggressive advertising campaigns during major television events to promote its products. As in any other retail business, the operations are seasonal in nature and consist of two principal selling seasons: the first half of the year (the first and second quarters) and the second half of the year (the third and fourth quarters). The fourth quarter, including the holiday season, accounted for approximately one-third of net sales during fiscal years 2014, 2013, and 2012 and is typically the company's most profitable quarter. Accordingly, cash requirements are highest in the latter part of the second quarter and the third quarter as inventories are built up in advance of the holiday season. Similar to other apparel companies, the client adopts a fiscal year-end ending on the 1 Saturday closest to January 31st. This practice provides the company with more time to recognize customer returns, count inventories, and produce its annual financial statements following the heavy selling season. During fiscal years 2010 and 2011, the company was mismanaged, with actual growth severely lagging expected growth. During this time, management overinvested in inventory from overseas vendors, and the expected increase in sales from these vendors did not materialize. In fiscal year 2011, the company was required to write down a significant portion of its inventory due to obsolescence and also recorded a goodwill impairment charge. As a result of the poor financial performance, the board of directors decided to restructure the management team in hopes of returning to more successful operations as experienced in the late 1990s and early 2000s. The board of directors was able to recruit the prior CFO, Jonathan Smith, from several years ago, to rejoin the company as the new CFO. Jonathan has prior experience in public accounting as well as extensive knowledge of the client and the retail industry. The remainder of the management team is new to Trading Styles, Inc. and began employment at the beginning of fiscal year 2012. Risk Factors The management team identified the following risk factors that may affect Trading Styles Inc.'s future performance. Due to their significance, management closely monitors each of these factors during the year. The audit team also analyzes these factors during planning and throughout the audit to determine whether these factors increase the risk of material misstatement in the current period financial statements. The risk factors identified by management include the following: Net sales, operating income, and inventory levels fluctuate on a seasonal basis: The company experiences seasonal fluctuations in net sales and operating income, with a significant portion of operating income typically realized during the holiday season (fourth quarter). Any decrease in sales or gross profit margins during this period could have a material adverse effect on the company's statements of income, financial position, and cash flows. The following schedule includes historical trends for quarterly sales and operating income. FY 2014 Net $488,91 Sales 0102,672 Q1 Total Q2 107,560 Q3 112,449 Q4 166,229 Operating Income: (excluding impairments recorded in Q4) Total $8,090 Q1 1,739 Q2 1,772 Q3 1,820 Q4 2,759 FY 2013 FY 2012 $434,65 0 97,796 93,449 99,970 143,435 $391,89 0 87,979 84,256 88,371 131,284 $11,490 2,551 2,505 2,585 3,849 $10,020 2,265 2,104 2,255 3,396 Issues in Accounting Education Volume 31, Number 3, 2016 Trading Styles, Inc.: An Analysis of the Going Concern Assessment 1 35 The company's ability to grow depends in part on new store openings and 7 existing store remodeling and expansions: Accomplishing new and existing store expansion goals will depend upon a number of factors, including the ability to identify landlords and developers to obtain sites for new and expanded stores at acceptable costs, the hiring and training of qualified personnel (including store management), and the integration of new stores into existing operations. Throughout this case, fiscal year (FY) refers to the year ending on the Saturday closest to January 31st. Specifically, FY 2014 ends on January 31, 2015, FY 2013 ends on February 1, 2014, and FY 2012 ends on February 2, 2013. Issues in Accounting Education Volume 31, Number 3, 2016 No assurance exists that the company will be able to achieve store expansion goals, manage growth effectively, or operate new, remodeled, and expanded stores profitably. The following schedule shows the company-owned store count and selling square feet for the last three fiscal years. FY 2014 Store count Selling square feet (000s) FY 2013 Store count Selling square feet (000s) FY 2012: Store count Selling square feet (000s) Reconstruction and Change in Square Feet Beginning of Fiscal New Stor es 172 11 (2) 5 880 55 (10) 10 181 935 164 824 9 45 (1) (5) 8 16 172 880 159 795 7 35 (2) (10) 2 4 164 824 Closur es End of Fiscal Year Failure to protect the company's reputation could have a material adverse effect on its brand image: The company's reputation could be jeopardized if management fails to maintain high standards for merchandise quality and integrity. Although the company has maintained a solid reputation over time, it faced negative publicity in fiscal year 2010 from one of its Asian suppliers that was in the press for using child labor in its factories. The company has since stopped using that particular supplier. Negative publicity arising from these types of events may reduce demand for the company's merchandise and can have a significant impact on financial performance. The company's inability to compete in its highly competitive segment of the retail industry could negatively impact results: The company competes for sales with a broad range of other retailers, including individual and chain specialty stores, department stores, online sites, and discount retailers. Despite growth in sales over the last two years, the company's market share in the apparel-based retail industry has remained stagnant at approximately 5 percent. However, the company's gross profit margin of 31 percent remains consistent with the industry's gross profit margin of 32 percent. If the company does not develop and maintain a competitive advantage in this industry, then a material adverse effect on future financial performance may result. The company may be unable to service its debt: Existing debt agreements contain covenants that require maintenance of certain financial ratios. The company's cash flow from operations provides the primary source of funds for the debt service payments. If cash flow from operations declines, then the company may be unable to service or refinance current debt obligations. Company Financial Performance Trading Styles, Inc. experienced improvements in operations over the past three fiscal years, including continuous growth in sales as reflected in the financial statements (see Appendix A). This increase was consistent with management's expectations of annual sales growth between 10 and 11 percent. Since continued growth of this magnitude cannot be supported by domestic sales only, management plans to support future sales growth by expanding the company's core products into the European market. The company's growth strategy also includes targeting more customers through online channels. Management recently enacted tighter expense policies; however, the company has yet to generate a significant amount of operating income. One of their primary cost-cutting strategies includes implementation of more efficient printing, mailing, delivery, and order-fulfillment systems for online and catalogue sales. As reflected in the financial statements, the company experienced a small net loss during fiscal year 2014 related primarily to a goodwill impairment charge recorded in the fourth quarter. However, the statement of cash flows shows net inflows of cash provided by operations in each of the past three fiscal years. The current period's goodwill impairment charge relates to the discontinuation of one older product within the company's personal care line. The impairment loss removes the entire goodwill balance related to this product from the balance sheet. As a result of this impairment, management re-evaluated the remaining goodwill and is confident that this balance will not require additional impairments in the near future. Management expects to focus on more profitable products and views this discontinuation as a positive step forward. With this increased focus, management estimates that the company will continue to experience doubledigit sales growth over the next three fiscal years, which is expected to generate net income in excess of $7.5 million in each of those years. Management provided the following income and expense projections for the next three fiscal years to your audit team: (in thousands) Net Sales Costs of Goods Sold Gross Profit Total Operating Expenses Operating Income Other Income/ (Expenses) Income Before Income Taxes for Income Provision Taxes Net (Loss)/Income Audite d FY 2014 $488,9 10 (335,92 0) 152,99 0 (150,48 0) Projections FY 2015 $542,6 90 (369,02 9) 173,66 1 (157,38 FY 2016 $596,959 (405,932) 191,027 (170,133) 0) 16,28 1(4,34 20,894 0) (38 0) 130 2) 11,93 9(4,17 16,118 $(25 0) 9) $7,76 0 $10,477 2,51 0 (2,89 (4,776) (5,641) FY 2017 $656,65 5(446,52 5) 210,13 0 (183,86 3) 26,26 7(5,25 3) 21,01 4(7,35 5) $13,65 9 Discussion with Management During this year's testing of the long-term debt balance, you noticed that the company has two outstanding loans with regional banks. The company does not have a line of credit and uses the funds from these loans to finance most of its ongoing operations. One of these two loans requires a balloon payment of $50 million on the maturity date, which is November 15, 2015. Therefore, this balance has been reclassified as the current portion of long-term debt for purposes of the fiscal year 2014 financial statements. The debt is secured by substantially all of the company's assets; therefore, the bank could call the debt and sell the assets to re-coup its investment if the company's cash flows are not sufficient. Since this balloon payment requires a significant cash outflow within the next 12 months, you need to discuss this issue with Jonathan Smith (CFO) to determine management's plan for repaying or refinancing the debt. You enjoy working on this engagement as you have developed a positive working relationship with Jonathan over the course of the audit. The audit partner on the engagement also considers Jonathan a good friend since they worked together in public accounting many years ago. You feel uneasy about discussing the company's current debt situation with Jonathan as you know it has become a sensitive topic that has caused stress in their office over recent months. However, the debt situation is an important factor in your audit firm's decision about possible going concern disclosure, so you request an informal meeting with Jonathan and he agrees to meet with you this afternoon. After a few moments of friendly exchange, you get to the primary reason for requesting a meeting with himthe large balloon payment. Jonathan immediately states that the balloon payment is not an issue. He is confident that they will be able to secure a lender to buy out their current loan and avoid the payment due at the end of fiscal year 2015. He adds that management has a great relationship with their lenders, which is why the company was able to obtain a waiver on the current year's debt covenant that requires positive net income. Since Jonathan has prior experience in public accounting, you can tell that he understands the purpose of your questions. Jonathan reiterates that he does not see any reason for a going concern audit opinion and explains how critical a standard unqualified opinion is for continuation of Trading Styles, Inc.'s recent success. To illustrate, he points out that the company's sales and gross profit margins have steadily increased over the last three fiscal years, which signals the company's revival. Finally, Jonathan emphasizes that negative news like a going concern opinion could result in a self-fulfilling prophecy, wiping out all of management's recent efforts. You leave the meeting feeling confused and decide to spend some additional time researching the audit standards and evaluating the client's financial statements before proposing a plan of action to the audit manager. Requirements 1. Examine AU-C Section 570, The Auditor's Consideration of an Entity's Ability to Continue as a Going Concern, to understand the auditor's responsibilities when testing the going concern 2 assumption. The AICPA's Clarified 2 Available at: http://www.aicpa.org/Research/Standards/AuditAttest/DownloadableDocuments/AU-C-00570.pdf Statements on Auditing Standards can be found on the AICPA's website. Summarize important provisions in this audit standard that you find relevant to your decision in this case. 2. Describe what is meant by ''self-fulfilling prophecy'' and how it might play a role in this scenario. Should the auditor be concerned with the self-fulfilling prophecy? 3. Perform analytical procedures using Excel to examine the company's historical financial statements (included in Appendix A) as well as management's projections for the next three years. If necessary in your analysis, the FY 2012 statement of income and statement of cash flows have been provided in Appendix A. Further, you can assume that the company reported the following balances in its balance sheet as of February 2, 2013: Cash $44,900 Accounts receivable $36,140 Inventory $45,650 Long-term debt $100,000 Total owners' equity $16,990 4. (a) Using the background information as well as the analytical procedures from Requirement 3, identify and discuss the issues that may raise substantial doubt about the entity's ability to continue as a going concern for the next 12 months. Be sure to include specific financial information to support your response when applicable. (b) What mitigating factors are present that may lessen the doubt about the entity's ability to continue as a going concern? Identify and discuss the mitigating factors that you observe in this case. (c) What procedures would you perform to verify the feasibility of management's plans to obtain a loan from a new creditor or refinance the loan with an existing creditor? (d) What audit report recommendation would you make to the audit manager (i.e., should the audit firm include a going concern explanatory paragraph in the opinion)? Why or why not? 5. (a) Do you believe an auditor should have a friendly relationship with the client? Does the Code of Professional Conduct (which can be found on the AICPA website) say anything about forming friendships with clients? What are the pros and cons of developing such a relationship? (b) Assume the audit partner on your engagement determines that a going concern audit report is necessary. Since you had a significant role in identifying and documenting the important factors supporting your audit firm's position, the audit partner asked you to observe and join in on the conversation with the client about this decision. How do you think the partner would approach the conversation about this type of audit opinion if you had a contentious client? What would your audit team do if client management refuses to agree with a going concern audit opinion? 6. If your client is public instead of private, what additional factors might influence your decision to issue a going concern opinion? 7. Assume that your audit firm decides to issue a going concern audit report and management has included their disclosures in footnote 2 of the financial statements. Draft a copy of the auditor's report that includes the modification for going concern. When doing so, base the report on the following assumptions: (1) the appropriate addressee is the board of directors, (2) the statement of changes in owners' equity is included in the financial statements, and (3) the end of fieldwork occurs on April 17, 2015. APPENDIX A Financial Statements a Panel A: Balance Sheet TRADING STYLES, INC. Balance Sheets (in thousands) 1/31/2015 2/1/2014 ASSETS Current Assets: Cash and Cash Equivalents Accounts Receivable, Net Inventories Other Assets $25,990 41,750 50,310 5,390 $36,580 36,620 41,660 8,150 Total Current Assets Deferred Income Taxes Property and Equipment, Net Goodwill Trade Names and Other Intangible Assets,Assets Net Other 123,440 3,520 78,080 36,970 16,750 2,580 123,010 3,150 75,570 42,550 19,600 370 $261,340 $264,250 $27,010 45,580 50,000 7,950 $24,290 43,990 9,770 130,540 9,980 50,000 24,270 78,050 10,120 100,000 29,280 26,350 20,200 26,350 20,450 46,550 46,800 $261,340 $264,250 Total Assets LIABILITIES AND EQUITY Current Liabilities: AccountsExpenses and Other Accrued Current Portion of Long-Term Debt Income Taxes Payable Total Current Liabilities Deferred Income Taxes Long-Term Debt Other Long-Term Liabilities Owners' Equity: Owners' Retained Earnings Capital Total Owners' Equity Total Liabilities and Equity (continued on next page) Panel B: Statements of Income APPENDIX A (continued) TRADING STYLES, INC. Statements of Income (in thousands) For the Year Ended: Net Sales Costs of Goods Sold Gross Profit Store Operating Expenses General and Administrative Expenses Impairment of Goodwill Operating Income Interest Expense Other Income Income Before Income Taxes Provision for Income Taxes Net (Loss)/Income 1/31/20 15 (FY 2014) $488,910 (335,920) 2/1/20 14 (FY 2013) $434,650 (299,110) 152,990 (109,880) (35,020) (5,580) 135,540 (96,340) (27,710) 2,510 (8,350) 5,460 11,490 (8,110) 5,790 (380) 130 9,170 (3,110) $(250) $6,060 2/2/20 13 (FY 2012) $391,89 0(270,57 0) 121,32 0(88,44 0) (22,86 0) (1,65 0) 8,370 (8,05 0) 4,950 5,270 (1,81 0) $3,46 0 (continued on next page) Panel C: Statements of Cash Flows APPENDIX A (continued) TRADING STYLES, INC. Statements of Cash Flows (in thousands) OPERATING ACTIVITIES For the Year Ended: 1/31/20 15 (FY 2014) 2/1/20 14 (FY 2013) 2/2/20 13 (FY 2012) Net (Loss)/Income $(250) $6,060 Adjustments to Reconcile Net (Loss)/Income to Net Cash Provided by Operating Activities: Depreciation and Amortization of Long-Lived Assets 7,710 6,970 Amortization of Landlord Allowances (1,750) (1,750) Goodwill and Intangible Asset Impairment Charges 5,580 Deferred Income Taxes (510) (1,200) Changes in Current Assets and Liabilities: Accounts Receivable (5,13 480 0) Inventories (8,65 (3,99 0) 0)(580 Other Assets 2,76 0 ) Accounts Payable, Accrued Expenses and Other 4,31 1,36 0 0 Income Taxes Payable (1,82 (2,24 0) 0) Net Cash Provided by Operating Activities 2,25 5,11 0 0 INVESTING ACTIVITIES (10,81 (11,30 Capital Expenditures 0) 0)2,09 Proceeds from Sale of Assets 1,27 0 0 Other Investing Activities (3,30 (4,22 0) 0) Net Cash Used for Investing Activities (12,84 (13,43 0) 0) FINANCING ACTIVITIES Proceeds from Long-Term Debt Payments of Long-Term Debt Net Cash Provided by Financing Activities 0 Net (Decrease)/Increase in Cash and Cash Equivalents Cash and Cash Equivalents, Beginning of Year Cash and Cash Equivalents, End of Year a (10,59 0) 36,58 0 $25,99 0 0 (8,32 0) 44,90 0 $36,58 0 $3,460 6,510 (1,800) 1,650 450 (1,20 0) 1,56 0 490 (1,50 0) 70 9,69 0 (10,16 0)1,60 0 50 (8,51 0) 50,00 0 (24,02 0) 25,98 0 27,16 0 17,74 0 $44,90 0 The financial statements are available as a downloadable Excel file, see Appendix B. APPENDIX B Trading Styles, Inc. Financial Statements in Excel: http://dx.doi.org/10.2308/iace-51218.s01