INTRODUCTION:

In June of 2017, Baby Sitter, Inc., a large publicly traded company, started negotiating the acquisition of Toddlers Lane, Inc., a start-up internet company. Toddlers Lane is a company that provides care packages of baby products that are delivered to consumers on a recurring monthly basis. These care packages include toys and other educational material that are age suitable to children up to the age of five years. The packages are delivered to consumers that subscribe to their care package program. The company started in August of 2012, but as many start-up companies, it incurred significant operating losses. However, its customers base has increased significantly during its four years of operation. This increase in the number of customers has been reflected in a dramatic increase in its sales revenue that showed a huge growth potential, which made it an attractive acquisition for Baby Sitter that is growing through the acquisition of a number of successful smaller companies.

Since its inception, the company was highly leveraged with loans from close family members to the founder of the company, Ms. Maria Forster, as well as a couple of virtual capital funds (GNC Capital and Armlock Capital). The company still needs additional funds to support current operations. However, the acquisition of the company by Baby Sitter can be an attractive opportunity for Ms. Forster to reap the benefits of her substantial effort in developing the company and to pay back the debt she owes to her family and to the virtual capital funds.

McLawrence, LLP, a large national CPA firm, was hired by Baby Sitter to conduct an audit that can provide the company with an opinion about the financial statements of Toddlers Lane before it acquires it. McLawrence need to complete the audit within a three month period so that the companys attorney can initiate the legal requirements of the acquisition. Toddlers Lane has never been previously audited before; however, the companys founder was somewhat prepared for an audit fieldwork, and the companys Director of Finance was also ready to provide the last three years financial statements, related disclosures, and all accounting documentation..

THE COMPANY BACKGROUND:

Maria Forster is the founder and CEO of Toddlers Lane. After earning her undergraduate degree in computer science and a Master of Business Administration (MBA) degree in one of the prestigious private universities in San Francisco, Maria began her ecommerce career as a product manager during the early days of the internet. Throughout her fourteen years career, she has held leadership positions and handled major product and social media initiatives at leading technology companies all over the Silicon Valley. She also served on the board of a start-up communication company that was acquired by a large national internet service providing company. In the fall of 2012, she left her employer to follow her entrepreneurial dream and start her own company. Remembering how exhilarating and exhausting it was to be a first time mom, her vision was to create an ecommerce company that could make parents life easier and help them make healthy product choices for their families. And thats how Toddlers Lane came to be.

The company does not have a CFO. The highest ranking finance employee is Ms. Lihan Peng. Lihan has served as the companys Director of Finance and Analytics since September 2014. She previously served as an analyst with one of the companys venture capital funds. Even though her entire professional experience is only limited to six years, she has adequate knowledge about the company and a good understanding of accounting and reporting.

The company has three other employees who update the companys website, advertise the services through social media and other internet channels, send orders to third party warehouses that send packages to customers, and handle customers questions. All three employees are business graduates with experience ranging from two to four years.

The Board of Directors is comprised of Maria Forster (CEO), Mr. Jeffrey Johnson (of GNC Capital), and Mr. Larry Brown (of Armlock Capital). Jeffrey and Larry have professional experience appropriate to serve on the Company's board. Jeffrey has over 20 years of executive experience and serves on the boards of other technology companies and is active in investments made by the fund for which he is the Managing Partner. Larry was previously the CEO of a large internet corporation. Lihan, the companys Director of Finance and Analytics, previously worked as an analyst at one of the virtual capital funds (Armlock) under one of the company's board members (Larry Brown). The Company does not have an Audit Committee of the Board of Directors.

OPERATIONS OF TODDLERS LANE:

The Company was founded in fall of 2012, in Mountain View, California. The Companys primary product offering consists of compiling and selling surprise packages for new mothers and mothers of children up to five years old. These surprise packages contain an assortment of goods (i.e., toys, lotions, books, etc.), and are available for purchase on a one-time basis, or on a multi-month subscription basis (i.e., three, six, or twelve months), whereby customers receive a different box each month during the subscription. At the end of each subscription term, customers are automatically renewed for another term (i.e., same number of months as original subscription), although customers also have the option to cancel the renewal.

In addition to box sales, the company also offers additional products on an individual basis via its online shop; and in May 2015, the Company introduced the add-to-box concept, whereby customers can purchase individual items to be included with their monthly boxes and not incur additional shipping charges.

THE AUDIT BY MCLAWRENCE LLP:

Toddlers Lane is in the late start-up/early growth phase. The CEO has been focused on growing operations in fiscal year 2016 and continuing in fiscal year 2017. She has also been involved and is expected to close the sale of the company to a third party company (Baby Sitter, Inc.) in early July 2017. The audit firm, McLawrence, believes that due to the sale of the business in 2017, there would be an incentive for the CEO to make operations look better (i.e., increase revenues and assets, or decrease expenses and liabilities) to make the company more attractive to the buyer and increase the acquisition price.

McLawrence audit team will test the completeness of expenses and liabilities as well as the cutoff and existence of revenue and assets to ensure they are not overstated. The audit firm will also perform testing of payroll and other operating expense accounts to determine if there are any material understatement.

During the initial fieldwork, McLawrence audit team noted that there is a shortage of accounting staff with only the Director of Finance, Lihan Peng, and her part-time assistant. Due to this shortage, the company outsources most of its controller and accounting work to a third party accounting firm to perform the necessary accounting tasks. Lihan reviews all work performed by the accounting assistance she receives each month; so while she is not an experienced controller and not completely competent in GAAP accounting, she does perform a high level review of amounts entered into the system. The audit team also notes that cash is not handled by the third party accounting firm and generally all cash received is from third party credit card companies. Lihan and Maria Forster are the two check signers, and they both review all payments prior to processing. Thus, there does not appear to be a high risk of opportunity related to cash misappropriation.

The audit team also believes that there are enough controls in place to limit the opportunities to commit fraud. Further, the CEO and top level management are actively involved via board meetings and in operations. All accounting and finance activities have a top level review process, and misappropriation of assets are unlikely with the processes and amount of transactions for cash, inventory, and fixed assets. Most of the company's inventory is held at third party warehouses, which are managed by the third party with periodic counts by the company to ensure that inventory level are within reason.

Although management is made up of competent personnel, the company has limited control efforts related to financial accounting/reporting. For example, all manual journal entries appeared to be reviewed by Lihan Peng. The audit team believes that management has the ability to increase earnings or lower expenses by booking improper cutoffs and fictitious entries to revenues or expenses. Therefore, they will perform journal entries testing and revenue/deferred revenue detailed testing to ensure that controls over the recording of journal entries are proper.

QUESTIONS:

1. Identify the significant factors that make Toddlers Lane an attractive investment for Baby Sitter, Inc.

2. Based on your understanding of Toddlers Lane and its business environment, identify the risk factors unique to this industry that McLawrence audit team should consider (Refer to AICPA, AU-C 315, 2012).

3. What additional information is needed by McLawrence audit team to be able to conduct their audit?

4. Given the information provided, and the additional information you recommend the audit team to collect, develop an audit plan to assist in completing the audit on time (Refer to AICPA, AU-C 300, 2012).