Hello,

I was wondering if i could get some help with the Business Risks and Audit Risks for this case.

Business risks such as:

• going concern
• impact of computer virus
• management integrity
• corporate governance
• summary/conclusion of business risks

Audit risk such as:

• effect of business risk
• materiality considerations
• users
• conclusion of audit risk

AutoPlus Automotive Parts and Accessories Manufacturing Inc. Rita Quong has been running AutoPlus Automotive Parts and Accessories Manufacturing Inc. (AutoPlus) since her father died 10 years ago. At that time, the company had 150 employees, healthy annual revenue of over $4 million, and was considered a leader in the field of automotive tools, dies, and machining parts. Rita's father had extensive contacts in the business community, and his death resulted in AutoPlus's financial results decreasing from a net income of $495,000 per year to a loss of $300,000 two years later. The number of employees shrank to 95. At that point, Rita called in Shirley Thong, a CA at her local accounting firm, for ongoing help in managing the business. Over the ensuing two years, the unprofitable tool- and die-making business was sold for very little proceeds to one of the operational managers who started a separate company. The quality control manager left and her monitoring responsibilities were assigned to a shift supervisor. The controller's position was replaced with a full-time bookkeeper, and the departing controller accepting a severance settlement. The bi-weekly payroll was outsourced to the bank, with data entry done online using a webbased interface. An accountant from Shirely's accounting firm still goes to AutoPlus once a month to assist in the preparation of the monthly financial statements. These staffing changes, together with more careful management of quoting and costing, resulted in a rapid turnaround. Shirley, now retired from the accounting firm, still maintains contact with Rita. AutoPlus now has 65 employees, operating in one shift, and the most recent financial statements show revenue of over $5 million. (See Exhibit 7-1.) Two new shareholders contributed capital seven years ago and collectively own 40% of the company. In addition to capital, these new shareholders provided management advice and had plans to take AutoPlus public on the Toronto Stock Exchange by next year. Ambitious sales targets and a marketing plan were being developed to strengthen financial results, but when the automotive sector was hit with a significant economic downturn, the plans for going public were put on hold. Those plans will be revived when the company's profits improve. In the meantime, the company expects that unqualified audit opinions will be needed to support its future plans. AutoPlus uses a CAD/CAM (computer-aided design and manufacturing) system for many drawings and pricing proposals. All supervisors and managers use the system. In particular, there are three large customers who require all proposals to be in a standard format. In the last year, those customers mandated that AutoPlus use EDI (electronic data interchange), and now all business with these customers is done using EDI. AutoPlus receives purchase orders and receiving documents from these companies electronically, and sends invoices and shipping documents via EDI. Payments are received via electronic transfer 10 days after the goods have been received and approved by these customers. To minimize overhead costs and to avoid implementing a second shift, which would not operate at capacity, AutoPlus outsources any work that would require a second production shift. This allows AutoPlus to employ only the number of employees needed to operate one shift at full capacity. This has made AutoPlus more resistant to fluctuations in different industries, as internal work can be shifted to outside contractors as necessary. The current trend is a disastrous drop in the automotive area. No new purchase orders have been received in the automotive sector in the last six months, and many pre-existing purchase orders were Page 1 of 10 cancelled. To compensate for this downturn, AutoPlus has been able to shift somewhat into health care and computing technologies. Exhibit 1 shows that AutoPlus's financial results have worsened considerably due to the drop in automotive revenues and its acceptance of new customer orders with smaller margins. Rita is adamant that the automotive accounts receivable will not be written off, however, as she is expecting collections in the coming year and an improvement in the automotive sector. On the sales front, Rita is facing a difficult decision with respect to her brother, Allan, who joined the company as a salesperson last year. This is explained further in Exhibit 2. Allan seems to be having difficulty obtaining solidly profitable jobs for the company and Rita is not sure whether he should be kept on with the company as a salesperson. She has discussed this with Allan, and they have agreed that the competition for non-automotive jobs is fierce as manufacturing companies of all sizes struggle to survive. It is early June 2015. You, CPA, are responsible for the AutoPlus audit planning for the May 31, 2015 audit using the audit risk model. This is the second year that AutoPlus' financial statements will be audited by your firm. The audit partner responsible for the engagement would like an assessment of the impact of the information systems on the risks of the engagement as part of the audit planning process. In particular, he would like a thorough assessment and impact evaluation of the controls over the new EDI and inventory management systems, and the testing that is required in response to the impact of a computer virus that AutoPlus discovered yesterday. (See Exhibit 2.) He would like you to identify specific actions that you will undertake to assess the bad debt allowance (currently set at 10% of accounts receivable, as in prior years), and the net realizable value of inventory. Required Write the documentation for the engagement partner that includes (1) a planning memo for the financial statement audit as requested by the partner, including your assessment of any issues that could prevent the issuance of an unqualified audit opinion, and (2) a memo assessing the issues raised by Rita for the partner to discuss with the client. Page 2 of 10 EXHIBIT 1 Financial Information May 31, 2015 AUTOPLUS MANUFACTURING LIMITED Balance Sheet ($000s) 2015 (Unaudited) Assets Current Cash and marketable securities Accounts receivable1 Inventory2 Fixed Building3 Office and computing Manufacturing equipment Less: accumulated amortization Liabilities and shareholders' equity Current Accounts payable and accruals Current portion of bank debt Due to shareholder4 Long-term Bank loan5 Shareholders' equity Share capital Retained earnings Page 3 of 10 2014 2013 $ 600 2,003 1,658 4,261 $ 1,200 747 803 2,750 $ 1,800 693 459 2,952 $ 175 128 2,500 2,803 (2,300) 503 $ 4,764 $175 53 2,500 2,728 (1,821) 907 $ 3,657 $ 158 53 2,300 2,511 (1,112) 1,399 $ 4,351 $ 381 165 1,501 2,047 $ 125 150 - 275 $ 215 135 - 350 $ 600 $ 765 $ 915 400 1,717 2,117 $ 4,764 400 2,217 2,617 $ 3,657 400 2,686 3,086 $ 4,351 EXHIBIT 1 (CONTINUED) Earnings and Retained Earnings ($000s) 2015 (Unaudited) $ 5,001 4,206 795 98 235 333 462 185 277 2,217 2,494 777 $1,717 Revenue Cost of goods sold6 Administrative expenses Selling expenses Earnings before income taxes Income taxes Opening retained earnings Dividends paid Closing retained earnings 2014 2013 $ 4,970 4,030 940 95 113 208 732 293 439 2,686 3,125 908 $ 2,217 $ 5,504 4,454 1,050 99 114 213 837 335 502 3,395 3,897 1,211 $2,686 Notes 1 Includes $1.3 million in automotive receivables. 2 Includes $900,000 in automotive parts returned or not shipped due to orders that have been cancelled prior to shipment. 3 Market value estimated at $1.8 million. 4 Due to Rita. 5 Secured by manufacturing equipment. 6 Includes salary of $125,000 for Rita, plus bonus ($200,000 in 2013 and 2014, none accrued in 2015). Page 4 of 10 EXHIBIT 2 AUTOPLUS MANUFACTURING LIMITED Cost of Sales Information Allan's sales Allan joined AutoPlus in June 2014. He had previously worked for a large financial institution and he used his contacts to obtain substantial sales for AutoPlus in plastic or metal forming. This helped offset the decline in revenue due to the cancellation of numerous automotive parts contracts. Rita usually requires that jobs have an estimated gross profit of at least 30% before AutoPlus accepts them. However, to keep her employees working and to cover fixed costs, she approved numerous contracts, including those brought in by Allan, which had target gross profits below the 30% threshold. Many of these jobs were new to the company, and had larger than expected set-up and rework costs, resulting in a lower than expected gross profit, as shown below. Large Sales Contracts Obtained by Allan City Automotive auto parts1 Big Ben Auto Parts2 Big City Hospital Group Jenny Furniture Group Jenny Furniture Group Northern School Board Eastern School Board Cable Systems Inc. Cable Systems Inc. Matt Building Group Quoted Gross Estimated Actual Gross Profit Actual Estimated Gross Costs Profit Percent Sales Price Costs Profit $ 150,000 $ 125,000 $ 25,000 $ 147,000 $ 3,000 2.00% 75,000 63,000 215,000 53,000 23,500 47,530 125,000 275,000 61,000 $ 1,088,030 65,000 36,000 172,000 35,000 20,000 40,000 101,000 222,750 41,000 $ 857,750 10,000 27,000 43,000 18,000 3,500 7,530 24,000 52,250 20,000 $ 230,280 63,000 38,000 176,000 39,000 28,000 51,000 99,000 221,750 47,000 $ 909,750 12,000 16.00% 25,000 39.68% 39,000 18.14% 14,000 26.42% (4,500) (19.15%) (3,470) (7.30%) 26,000 20.80% 53,250 19.36% 14,000 22.95% $ 178,280 16.39% Notes: 1 2 Payment for this sale has not been received. These parts were returned and the contract cancelled. Allan's salary arrangement was $40,000 per year plus 5% commission on approved sales, which came to $58,000 in 2015, bringing his total salary to $98,000 for 2015. Given that $225,000 of his 2015 sales have either not been paid for or were returned, thereby eliminating the whole expected gross profit, Rita is feeling somewhat bitter about this arrangement. However, Rita knows that Allan could not have predicted what occurred in the automotive sector, nor could he have done anything about these losses. She did approve the sales contracts, after all. Allan is not interested in owning part of the company, and is requesting a higher commission: 10% of sales. Allan's argument is that the sales he has brought in to the company are approximately 20% of a year's worth of sales, and without them, AutoPlus would be in a much worse position. Page 5 of 10 Production and payroll management software In July 2014, at the urging of one of its major automotive customers, AutoPlus acquired and implemented the TSAH (Tracking System Assembly and Handling) perpetual inventory system. The system is capable of tracking raw materials, issuing raw materials to production, linking to CAD/CAM and numeric-controlled equipment, tracking costs, and providing cost records that can transfer into accounting systems. It is EDI-compatible, and has modules that can read and prepare EDI standard documents for several industry sectors. In addition, AutoPlus has a stand-alone EDI module that has been customized to read and submit sales documents and other documents from the old accounting system. Automated data transfer from the TSAH system to the existing accounting system is not possible with AutoPlus's accounting systems, which are over 10 years old. As of today (June 2015), only the automotive and ISO 9000 contracts (certain contracts for producing computer components) have been implemented. This means that inventory movement and costing is generally handled in the following way: Automotive Other and ISO 9000 1. Receive raw materials using receiving documents; match to AutoPlus purchase order 2. Place duplicate in customer file and match with customer purchase order. 3. Record raw material quantities and cost in TSAH inventory system. 4. Issue materials into production using issue form; record issue into TSAH. 5. Issue materials into production without issue form. 6. Employees swipe their employee card into the JPAY (Job-costing and PAYroll cost tracking) costing system, entering the job number and machine code; JPAY records the employee shift time in and out for payroll processing. 7. Record production cost code used for production into TSAH by job number. 8. Record quantity produced into TSAH. 9. Record quantity produced on job card. 10. Swipe employee card into JPAY system, entering the job number to indicate job completion. 11. Record hours worked, by job code, into TSAH. X X X X X X X X X X X X Effectively, this means that employee time worked and the machine code used are entered twice, once into the JPAY production costing system, and again into the new TSAH system. The TSAH system adds support to the documentation required for ISO 9000 jobs, but is cumbersome to use as each new job has a lengthy set-up required. In most cases, AutoPlus still uses the JPAY system (which tracks employee hours worked by machine code) together with a manual file folder, where the shift supervisors are responsible for checking that the necessary information has been added to the folder (materials used, number of pieces produced, other materials used, scrap details). One supervisor is responsible for the numeric-controlled equipment, while the other supervisor handles the remaining jobs. Page 6 of 10 Sam, the bookkeeper, then reviews the job folders and enters needed information into the JPAY system so that job costs can be provided by job. Every two weeks, he prints a report from the JPAY system to provide total hours worked, so that he can compare this to the total day's hours worked. As of the year end, about two-thirds of the finished goods inventory was recorded in the TSAH system, while the remainder was counted manually, computed from the job cost records and supplier invoices. Unfortunately, numerous errors occur with both the TSAH and JPAY systems. Employees forget to sign out during breaks and lunch, or even at the end of a shift, so jobs end up with unreasonably high time charges assigned to them. Supervisors then have to provide adjustments for job costing that Sam makes before processing the bi-weekly payroll information. Employees also sometimes enter the wrong job numbers, such as job numbers for jobs already completed or job numbers that do not exist, or they forget to swipe their cards when starting a job and the costs are not recorded. They may also enter the wrong machine code, which results in the incorrect cost being assigned to a job. The JPAY system is an old system that has been used by the company for over 15 years. AutoPlus was going to switch all of the jobs into the TSAH system, but with set-up times of at least 30 minutes for each job, making the switch was deemed to not be worth doing for many jobs. The general manager, Jerome McCallum, and Rita, use the CAD system or Excel spreadsheets to do their job quotes for new jobs, based on the costs that have been assigned for machines and employees. The same hourly rates are entered into the TSAH and JPAY systems to cost work done. When assessing Allan's jobs, Rita found a number of errors that contributed to both quoting problems and job costing errors, as noted below: 1. Lathe # 2 has different costs in different systems. (It was recorded as $55 per hour in JPAY and $5 per hour in TSAH, and as $45 in the CAD quoting system). 2. No hours were allocated to one of the jobs. (A detailed review of time records indicated that there were four non-existent job numbers, so an employee entered the wrong number, but it was impossible to tell which ones should go where). 3. Two of the job cost cards had incorrect material descriptions, resulting in an understatement of the material cost for the job. 4. Sam made data entry errors, resulting in an overstatement of job costs. Rita has described all of these system issues to you, and would like some recommendations to improve the company's payroll and production costing processes. Your firm's inventory count working papers for the current year-end noted several errors in the TSAH perpetual records (primarily overstatements of raw materials), and errors in both directions of finished goods that were corrected upon discovery in the count records. There was also a lengthy description of the state of the materials that had been returned or were not shipped with respect to automotive parts. Several skids of parts were in a fenced-off area behind the AutoPlus building. Some crates on the skids were broken, with rusted automobile parts showing through. Some of the skids appear to have just been dumped off trucks, with two skids standing at angles and several boxes smashed. Rita indicated that she hopes that the parts can be reshipped or resold when automotive sales resume, and is reluctant Page 7 of 10 to write down this inventory. She also believes that about one-third of the returned inventory (products made from just one metal, such as steel seat belt parts) can be scrapped at relatively high metal values. EDI system In addition to implementing the TSAH system within the last year, AutoPlus also implemented a standalone EDI system that uses the Internet for data communications. Although connected to the Internet, it is considered stand-alone because it does not automatically import or export information to other software. All data to be transmitted must first be exported from the accounting system into a spreadsheet, which is then imported into the EDI system for transmission. Alternatively, AutoPlus could enter the EDI information directly into an input template that comes with the EDI software. Sam has found that this method is easier than the import/export method, so he usually enters the information directly into the EDI system. When the system was first used, no one checked Sam's work. However, there were several embarrassing keying errors on transmitted sales invoices, so now one of the operations supervisors has been assigned the task of checking all of the information that Sam enters into the EDI system. Sam was also embarrassed by the errors, so he is now more careful and conscientious with his work. Information received via the EDI system is simply printed and filed with the appropriate jobs. Information systems Rita's detailed examination of the costs associated with the jobs that Allan sold made her realize the extent of the duplication of effort that is occurring due to AutoPlus's outdated information systems and the new TSAH inventory management system. She wants some advice about the options available to the company with respect to improving its information systems and the approach it should take in upgrading its systems, keeping in mind that she does not want to spend a lot of money right now. She is frustrated by the demands of large customers who are insisting on some of these changes. For example, in the last year, three companies mandated that AutoPlus implement EDI or they would take their business elsewhere. With the exception of TSAH and the new EDI systems, AutoPlus has built on the information systems equipment and software that was in place when Rita took over the business 10 years ago. There is a nine-station local area network, organized as follows: One station in Rita's office with a printer One station in Sam's office with a printer Two CAD/CAM machines with local software used only with a specialized draft printer by Rita and the supervisors Main server with router and modem for Internet connection Three stations in the production area used for TSAH and JPAY data entry One station used for EDI and e-mail Page 8 of 10 Software on the local area network includes office automation software and accounting software. Sam runs a backup tape run every night. One copy is kept on site, and one copy, normally the tape that is two days old, is taken home by Rita. There is no formal operations support; Benjamin, one of the production supervisors, has an interest in information systems and provides informal support. Two weeks ago, while Benjamin was away on holidays, something unexplained started happening with the accounting systems. Sam was having trouble accessing some data files first thing in the morning. He reloaded the data from the backup files, but continued to have trouble accessing the files. After reloading several times, everything seemed to be working. However, every two or three days the files are difficult to access, and the resulting reports contain serious logic errors. Benjamin came back from holidays just yesterday. After updating the virus scanner, he found that the local area network had been infected with a virus. Hundreds of data files had been infected and were tagged as damaged by the anti-virus software. These files have been segregated, but cannot be accessed. Benjamin spent several hours on the phone with software suppliers, whose only suggested solution was that the data in the damaged files would have to be re-entered. Rita is thinking that, since it was recently the company's year end, they will print off all of the accounting records, and then close all of the accounts. They would like your firm to help them reset the accounting systems so that they can start the new accounting year all over again in their software, so they would only need to re-enter one month's worth of the new financial year's data. This would mean that AutoPlus would lose the detailed history from the prior years, but they would enter monthly transaction totals from reports so that comparative information could still be prepared. The virus has not affected production as the production equipment is not linked to the network. Any errors in sales invoices have been dealt with by editing the sales invoices in the word processing software. There have been no cheques run since the virus infection, but Rita will be sitting down with Sam tomorrow to look at unpaid accounts payable so that the company can issue manual cheques. Payroll is processed by the bank so it was not affected. Rita is not particularly concerned about any loss of records as the company regularly prints all reports and has a full set of hard copies of all reports on file. She's unhappy about the need to pay overtime over the next few weeks to get the computer records straightened out, though. The JPAY job-costing equipment requires employees to use magnetic stripe cards to record their time by job; this is particularly important for certain customers where AutoPlus needs to track jobs carefully in accordance with its ISO 9000 certification (now also tracked in TSAH). Due to numerous inconsistencies, standard punch-card time cards approved by the supervisors are used as the data input source for payroll rather than the times recorded in either job costing system. Job costing is not integrated with the accounting system. Page 9 of 10 Business continuity planning Rita is concerned about keeping AutoPlus's information systems and operations running smoothly, and about potential costs in the event of problems. One of the buildings down the street burned down recently due to an equipment failure, alerting her to the need to plan for unanticipated problems. She also wants to know what AutoPlus can do to ensure that, if its computer network is infected by a virus again, they have preventive measures in place so that information does not have to be re-entered. In addition to the accounting and costing systems, AutoPlus has four computer controlled manufacturing stations, ranging in cost from $150,000 to $750,000, all purchased within the last six years. The programs for these stations are entered directly into the machines and are available either on small cassette tape or can be ported to or from a laptop computer. Rita would like specific guidance with respect to the development, implementation, and testing of a planning process that addresses both administrative and operational system continuity. Page 10 of 10