In 2017, Amazing Apple Cider Limited (AAC) came to an agreement to purchase a 150 acre apple orchard in New Brunswick. The prior owner sold the business as they were looking to retire and were not interested in investing additional money to plant new trees, which was needed to maintain the current production of apples. At the time, the apple orchard was open to the public, who could come onsite to go apple picking. The orchard was also available to rent for weddings and other private functions.

AAC was founded by Johnny Cider who was an early employee of a company in British Colombia that specialized in acquiring and operating fruit orchards. That company went public, which allowed Johnny and other early employees of the company to retire as they had received a number of stock options when they joined the company. Johnny was restless in retirement, so he decided to start his own apple orchard business out east, which has a less developed and less competitive agricultural industry. While Johnny has the majority of shares in the business, he was able to convince four of his former colleagues to join the company as passive investors.

Johnny decided to close the orchard he purchased to the public and focus on producing apple cider, which could then be sold to wholesalers. Apple cider consumption in New Brunswick was growing given the higher demand generated by a growing tourism industry and from local beverage manufacturers using it to create alcoholic ciders, which consumers were starting to drink at a higher rate than other alcoholic beverages.

It is now June 1, 2021. AAC reached out to your firm, Rumyee & Yarmolinsky, LLP as they need an audit of their financial statements for the year ended July 31, 2021. Your firm was selected due to its vast experience auditing businesses within the agriculture industry. In the current year, AAC has had to make significant investments into upgrading the necessary equipment to process apples into cider as well as having to extract a number of older trees on the property and replace them with newer trees.

To fund these initiatives, AAC obtained a bank loan in 2020, which requires AAC to maintain a 0.5-to-1 debt-to-equity ratio. The bank also requires audited financial statements each year that are prepared in accordance with ASPE.

Additionally, AAC is looking to acquire nearby land to increase the amount of apples they can produce. To fund this, AAC is currently in negotiations with several local land developers who have interest in the investing in AAC. The audited financial statements will be used to help value the company and bring in these additional investors.

Before accepting this audit, you contacted the predecessor auditor, who informed you a substantive approach was taken on previous audits because AAC’s financial reporting system had a number of glitches and the controller was not a qualified trained accountant.   During last year’s audit, Johnny was troubled to learn this from the auditors. For that reason, he decided to hire a qualified controller, holding a CPA designation and who had many years of experience working as a controller for a similar company. The new controller also implemented a more sophisticated financial reporting system, which is widely used by many small businesses. AAC also brought two independent directors who have expertise in financial reporting and controls and who have been advising the controller during the transition to the new system. The system was tested during the last fiscal year but was brought into operation at the very start of the current year under audit. The property plant and equipment sub ledger and the related calculation of depreciation is maintained in an excel spreadsheet. In previous years the auditors raised the issue of poor controls over the sub ledger and calculation of depreciation for equipment. AAC has not yet addressed this issue, but plans to before the completion of this year’s audit.

Based on introductory meetings with Johnny, you have learnt the following about AAC:

• While other fruit can be grown successfully in New Brunswick (such as pears), Johnny believes that AAC should continue to focus on growing apples, particularly as local animals and insects are not attracted to eating them.
• The trees AAC owns are classified as property, plant and equipment as they are assets that assist in generating revenue over a number of years while the apples grown are inventory, as they are processed into cider and sold for revenue.
• This year AAC changed the way it determined the value of its trees. AAC decided to hire a company with expertise in the industry to independently count the number of trees that are onsite. The report on the number of trees is multiplied by the average cost per tree that AAC historically pays to ensure the property, plant and equipment account balance is correct. AAC believes this process will result in their financial statements being more precise.
• Most of AAC’s apple trees are located near main city roads. People sometimes are unaware that the apple trees are growing on private property and they pick the apples to eat for themselves.
• The value of apple cider depends on a number of factors, including the size and quality of the apples. AAC processes their own apples into cider and brings them to an externally qualified valuator to determine how much the cider is worth. Sometimes AAC has to sell apple cider at a loss (below the cost of the apples).
• There are a number of wholesalers locally who pay market price (as determined by the valuator) for cider. The wholesalers provide an electronic wire transfer to AAC as soon as the cider is delivered to them. There are no opportunities for refunds.
• While AAC owns its own apple processing equipment, it rents the trucks used to transport the apple cider to wholesalers as these trucks are only needed for about two months of the year (from around June 15^th through August 15^th)

Johnny also indicated that the New Brunswick government informed him that they received a complaint from a local group that indicates the land AAC operates on should have been theirs as part of a land treaty deal entered over one hundred years ago with the government. The government believes this claim is true, which would make the land transfer agreement in place between them and AAC void. The government does not believe the group wants the land back though and believes that they can help work with AAC and the group to arrange a cash settlement. Johnny is not sure at this time if the government or AAC would be responsible to pay for the settlement.

Rumyee & Yarmolinsky, LLP were provided extracts of AAC’s financial statements (Exhibit 1).

Exhibit 1

Extracts from Amazing Apple Cider Limited Financial Statements

Statement of Earnings	Unaudited		Audited
	July 31,2021		July 31, 2020
Revenue
Sales Revenue	5,900,213		5,441,760
Costs and expenses
Total Expenses	5,716,250		5,754,020
Earnings before income taxes		183,963		(312,260)
Income taxes		36,793		(62,452)
Net earnings		147,170		(249,808)

Balance Sheet                                                                       Unaudited                   Audited

                                                                                               July 31, 2021          July 31, 2020      

Assets	8,114,442	7,654,123
Liabilities	6,988,441	6,431,997
Equity	1,126,001	1,222,126

Note: July 31, 2021 figures are estimates based on Amazing Apple Cider’s operations to date as of June 1, 2021.

1. Identify four case facts that impact the risk of material misstatement (inherent risks or control risks) at the overall financial statement level (OFSL). For each factor identified, indicate if the factor increases or decreases risk, the type of risk (inherent or control) and provide your rationale for why the factor increases or decreases risk. (8 marks)

Case fact which impacts Risk of Material Misstatement at OFSL level

Type of risk (control risk or inherent risk?)

Does this factor increase or decrease risk?

Rationale for why this factor increases or decreases risk