CLEAN & DRY

You are conducting the annual financial statement audit engagement of Clean & Dry, a large dry cleaning operation with 100 outlets all across Canada. Clean & Dry is 100% owned by Bob Clarke.

This is the first time you have worked on the Clean & Dry engagement. However, they have been your firms client for the past five years. You know, however, from previous audit engagements in which chemicals are used, that there is an environmental risk of improper disposal of the waste water containing contaminants. You also know that companies such as Clean & Dry are required to hire a toxic waste disposal company to regularly remove the contaminated liquid on a regular basis.

As part of your endeavour to gain knowledge of the clients business, you arrange a tour of one of the dry cleaning outlets with Sammy Chu, the companys Chief Operating Officer (COO) who oversees all operations. Sammy is excited to explain the process to you. Dry cleaning is a process that cleans clothes without water. The cleaning fluid that is used is a liquid, and all garments are immersed and cleaned in a liquid solvent. The fact that there is no water is why the process is called dry. After the process is complete, waste sludge is produced, which contains a combination of water, solvent, and soils. These are considered hazardous waste by the governmental regulations. You then learn that each outlet collects the sludge in metal drums. Each outlet produces approximately 5,000 litres of waste sludge per month that has to be removed at each facility at a considerable cost to the company.

When you arrive at the head office to start your audit, you are provided with a copy of the draft financial statements for the year-ended September 30, 2012. You start by analyzing the financial results and comparing the numbers to last year. You notice that revenue has remained constant this year, which is consistent with prior years. However, you notice that net income is up 30%. Further income statement analysis shows that waste disposal costs are considerably lower this year compared to last year. Discussions with the accounts payable manager indicate that the disposal company charges $100 per drum. Each drum contains 400 litres of water. You estimate that they have only expensed 2 months worth of disposal costs for the entire year.

When you question Sammy Chu about this, he starts to get a little uneasy. Why are you asking so many questions? This is not an environmental audit so you dont have to worry about any of that.

Required: Uncomfortable with his response, you decide to send an e-mail to the engagement partner outlining your concerns along with your recommended course of action. (Assume that the owner, Bob Clarke did not know what Sammy was doing)