Case Study - Avalon Holdings Ltd.

• AHL, a small public company listed on a Canadian Stock Exchange, is a wholesaler of silk plants with three warehouses located in Ontario, Alberta, and British Columbia. It imports its inventory of silk flowers and accessories from Indonesia. AHL employees arrange bouquets, trees, wreaths, and decorative floral products for sale in Canada to flower shops, grocery stores, and other retailers. The silk-plant concept was novel when AHL was incorporated in 2015. For the first three fiscal years, sales grew at approximately 40% each year, and AHL expanded to meet the demand. However, increased competition resulted in declining sales and operating losses over the next six years.
• Jamie inherited the shares of the company in 2017. She had just completed a bachelor's degree in accounting, and was very excited about becoming involved in the business and applying her skills and education. The fiscal year ended December 31, 2018, brought a return to higher sales levels and a modest net income. Jamie's management contract, which was renegotiated in 2019, provides for stock options to be granted to her each year based on the percentage increase of AHL's revenue from one year to the next. On October 2019, Jamie was granted stock options for the first time. She received 4,500 stock options at $2.25 each, the market price on that date.
• To gain greater exposure on the internet, AHL is revamping it website and developing a mobile app. AHL will pay for the costs of running the site and maintaining the app by selling advertising spots to home-decorating companies. So far, AHL has pre-sold 10 spots for $200 each. The advertisements are to run for one month. Unfortunately, delays in website upgrades as well as mobile app testing and launch have caused some advertisers to cancel their contracts. Others are threatening to cancel their contracts unless AHL gets the website and mobile app up and running within the next month. AHL's controller has already recorded the advertising revenue as sales.
• Shirley Holmes was hired as AHL's corporate controller in September 2019. AHL's previous controller resigned in February 2019 due to illness, and the position was temporarily filled by a payroll clerk. Shirley anticipates that she will have all year-end information ready for our audit team by March 15, 2020. AHL uses a proprietary accounting software package that includes a purchases journal, perpetual inventory account, and sub-ledgers for both accounts receivable and accounts payable.
• Historically, AHL's sales are highest during February and March, and from August to October. When a customer order is received, by phone, email, or through the website, the Customer Service Clerk (CSC) receiving the order, checks that AHL has the items in stock and the correct price by checking an online database of inventory on hand. If available, the CSC sends an order confirmation to the customer either via email or phone, including both quantity and price. The CSC then prepares a sales invoice and sends a copy to the customer. AHL's policy is for the sales invoice to show a shipping date of one day from the order date. The clerk then walks to the adjacent warehouse, selects the ordered items, and walks them to shipping.
• AHL has a shipping staff of four people, and the shipping department will not ship any goods without a sales invoice initialled by the CSC. If the sales invoice does not indicate who is to pay for the shipping costs, then AHL sends the goods FOB shipping point. When a shipment is delivered to an incorrect address it is the CSC's job to contact the customer and obtain the correct information.
• If the account is unpaid after the due date (30 days), the receptionist mails a reminder invoice to the customer. Accounts receivable consist of a large number of small dollar value accounts, with the exception of five large chain store customers that account for approximately 40% of the total accounts receivable. The allowance for returns typically has been 1% of the fourth-quarter sales.
• During the year, management negotiated an operating line of credit with a new financial institution. The amount authorized is limited to 75% of accounts receivable under 90 days old and 50% of inventory, to a maximum of $2 million. The loan bears interest at prime plus 3%. Under this agreement, AHL is required audited financial statements within 90 days of its fiscal year-end.

Required:

1. List at leasttwoinherent risks and at leasttwocontrol risks affecting AHL as well as comment on theoverall control environmentof AHL.

2. Evaluate at leasttwofactors that have changed over the prior year that impact the audit risk assessment for the current year. Indicate how these factors influence audit risk and draw a conclusion onoverall audit risk.

3. Identifyfivecontrol weaknesses within AHL's order receipt, processing, and shipping process as well as specify the corresponding control objectives impacted.

4. List thetwoprimary audit assertions, your audit team should be concerned with regards to the accounts receivable of AHL. Why?

5. Design a substantive audit program with at leasttwoaudit procedures over the advertising revenue recognition process.

6. Design a test of controls audit program with at leastthreeaudit procedures over the new line of credit.

For each audit procedure in (5) and (6),

• Write the control test along with the corresponding control objective
• Indicate the financial statement assertion addressed by the control test
• Describe the test of control by specifying the population used to select sample, extent of sample selection along with a rationale, relevant audit evidence gathering technique to be applied, and expected results.