It is August 2018. You are the manager on the audit of The Sophisticated Listener, Inc. (TSL) a company that until recently had operated a large retail store in Lindsay selling CDs and music accessories. George, the managing director and principal shareholder of TSL, has for some time held the view that the future of the retail trade lies in the potential offered by Internet shopping. Shortly after its year end, December 31, 2017, the company closed its retail store and rented premises on the outskirts of Lindsay from where the business is now run and inventory is stored. All sales are now made through its website. Following a major investment in computer systems, all customer orders are processed electronically. When required, the company's sophisticated ordering system generates purchase requisitions that are transmitted electronically to its suppliers. TSL ships goods to customers by first class mail with the aim of fulfilling all customer orders within three days. At a recent lunch meeting with the audit partner, George explained his plans for the new business. The plans included laying off 13 staff members. This would leave TSL operating with a staff of four. He enthused that the lower costs of the new premises and the significantly lower staff levels required to run the business would contribute to profitability in the longer term. Sales so far have been encouraging. With an advertising campaign underway and linkages from a number of high-profile music websites under negotiation, he is hopeful that the financial statements will show a break-even position within two years. George has also explained that an Internet business joint venture agreement has been entered into with a prominent music magazine publisher. Under the terms of the agreement, "the auditors of TSL shall certify the commissions that may be payable between the two parties." The first of these reports will cover the period to December 31, 2018. A note of the meeting with George has been prepared by the audit partner and is included in the Appendix. Following the meeting, the audit partner has asked you to give some thought to the planning of the audit for the year to December 31, 2018, as the interim audit is due to commence shortly. In particular, he has asked that business and related audit risks be documented. He noted that as TSL intends to publish the financial information electronically, last year's engagement letter may need to be amended. He also wants you to respond to George's request for advice in relation to the assurance work on commission payments. Required: a) Write a note for the audit file that evaluates the following: i. The company's business risks ii. The related inherent risks b) Write a letter for the audit partner to send to George: i. Analyzing the nature of the assurance that your firm could provide in connection with the commissions payable under the joint venture agreement ii. Explaining the contents that might be included in the report Appendix Note of meeting between audit partner and George Introduction I met with George on August 23, 2018 to discuss the changes to the business that he had been implementing at the time the audit of the financial statements was finalized for the year to December 2017. The changes are far more extensive than I had anticipated and I will need to think carefully about how this will affect the audit for the current year. Business plan George's aim is to have 100,000 regular customers by December 2018. He estimates that a regular customer will order one CD per month on average, which would give the company sales in excess of $12 million. This is well beyond the $2.75 million sales that the company achieved selling from its retail outlet in town. He acknowledges that the new business will take time to build up, but the company's bankers have been very supportive. A $500,000 loan is currently in place, although I believe that this is on the strength of a personal guarantee from George's father-in-law. The main marketing activities to date are summarized below: 1. George has so far negotiated two advertising deals with companies running other websites. One of these companies sells concert ticket package tours, the other sells musical instruments. In return for advertising their websites, TSL receives an annual fee from these companies plus a commission of 2% on any sales made by customers who link from the TSL site. 2. A major advertising campaign is underway using local radio and the music press. This is expected to cost around $250,000 in the first year. 3. The "TSL Club" has been established in order to encourage regular customers. In return for an annual subscription of $25, club members are entitled to a club magazine and 25% off the normal price of all CDs purchased. 4. An introductory offer provides first-time buyers with a $5 discount off their first CD purchase. George has been pleased with the number of "hits" to the TSL site in the relatively short period since it was set up. He thinks this is partly attributable to having a good website address and domain name. The company paid $30,000 to acquire the rights to the name at the start of the year. There has been a lot of interest in the website from abroad and 15% of revenue to date has been to overseas customers. According to George, revenue margins are lower compared with the old business but there are opportunities for higher sales volume. Commission agreement with magazine publisher George has negotiated a commission agreement with Still Spinning magazine, a major music publication with a monthly worldwide circulation of over five million. Under this agreement TSL provides electronic distribution of the magazine through its website. In return, TSL receives a full page of advertising space in every issue; an arrangement which George believes is worth $30,000 per year at current rates. TSL receives commission from the magazine publishers at a rate of 20% of magazine sales or subscriptions generated through the TSL website. TSL pays commission to the magazine publishers at a rate of 5% of the sales value of CD sales generated by a special Internet address published only in Still Spinning. The agreement provides that commission figures are calculated monthly by TSL based on monthly sales figures agreed by the two parties. The agreement also provides for TSL's auditors to certify the commission figures every six months. George would like us to plan to carry out this work at the end of the first six-month period in December. We will need to consider what work will be required and what form of report we might be able to provide. Computer systems To ensure prompt dispatch of CDs most in demand, the company has doubled its inventory levels of current CDs. Older CDs are not held in inventory but are requisitioned from suppliers electronically as and when they are ordered by customers. At the year end, the inventory levels were as follows: Actual per Management F/S June 30, 2018 Actual per F/S December 31, 2017 675 Current Assets (units) Inventory: current CDs Inventory: older CDs Inventory: Packaging and containers 320 780 170 21 5 Financial information George has promised to forward me the balance sheets extracted from the company's management financial statements as at December 31, 2017 and June 30, 2018 together with an income statement projection for the year to December 31, 2018. He also mentioned that he intends to present the year-end financial statements on the website. It is August 2018. You are the manager on the audit of The Sophisticated Listener, Inc. (TSL) a company that until recently had operated a large retail store in Lindsay selling CDs and music accessories. George, the managing director and principal shareholder of TSL, has for some time held the view that the future of the retail trade lies in the potential offered by Internet shopping. Shortly after its year end, December 31, 2017, the company closed its retail store and rented premises on the outskirts of Lindsay from where the business is now run and inventory is stored. All sales are now made through its website. Following a major investment in computer systems, all customer orders are processed electronically. When required, the company's sophisticated ordering system generates purchase requisitions that are transmitted electronically to its suppliers. TSL ships goods to customers by first class mail with the aim of fulfilling all customer orders within three days. At a recent lunch meeting with the audit partner, George explained his plans for the new business. The plans included laying off 13 staff members. This would leave TSL operating with a staff of four. He enthused that the lower costs of the new premises and the significantly lower staff levels required to run the business would contribute to profitability in the longer term. Sales so far have been encouraging. With an advertising campaign underway and linkages from a number of high-profile music websites under negotiation, he is hopeful that the financial statements will show a break-even position within two years. George has also explained that an Internet business joint venture agreement has been entered into with a prominent music magazine publisher. Under the terms of the agreement, "the auditors of TSL shall certify the commissions that may be payable between the two parties." The first of these reports will cover the period to December 31, 2018. A note of the meeting with George has been prepared by the audit partner and is included in the Appendix. Following the meeting, the audit partner has asked you to give some thought to the planning of the audit for the year to December 31, 2018, as the interim audit is due to commence shortly. In particular, he has asked that business and related audit risks be documented. He noted that as TSL intends to publish the financial information electronically, last year's engagement letter may need to be amended. He also wants you to respond to George's request for advice in relation to the assurance work on commission payments. Required: a) Write a note for the audit file that evaluates the following: i. The company's business risks ii. The related inherent risks b) Write a letter for the audit partner to send to George: i. Analyzing the nature of the assurance that your firm could provide in connection with the commissions payable under the joint venture agreement ii. Explaining the contents that might be included in the report Appendix Note of meeting between audit partner and George Introduction I met with George on August 23, 2018 to discuss the changes to the business that he had been implementing at the time the audit of the financial statements was finalized for the year to December 2017. The changes are far more extensive than I had anticipated and I will need to think carefully about how this will affect the audit for the current year. Business plan George's aim is to have 100,000 regular customers by December 2018. He estimates that a regular customer will order one CD per month on average, which would give the company sales in excess of $12 million. This is well beyond the $2.75 million sales that the company achieved selling from its retail outlet in town. He acknowledges that the new business will take time to build up, but the company's bankers have been very supportive. A $500,000 loan is currently in place, although I believe that this is on the strength of a personal guarantee from George's father-in-law. The main marketing activities to date are summarized below: 1. George has so far negotiated two advertising deals with companies running other websites. One of these companies sells concert ticket package tours, the other sells musical instruments. In return for advertising their websites, TSL receives an annual fee from these companies plus a commission of 2% on any sales made by customers who link from the TSL site. 2. A major advertising campaign is underway using local radio and the music press. This is expected to cost around $250,000 in the first year. 3. The "TSL Club" has been established in order to encourage regular customers. In return for an annual subscription of $25, club members are entitled to a club magazine and 25% off the normal price of all CDs purchased. 4. An introductory offer provides first-time buyers with a $5 discount off their first CD purchase. George has been pleased with the number of "hits" to the TSL site in the relatively short period since it was set up. He thinks this is partly attributable to having a good website address and domain name. The company paid $30,000 to acquire the rights to the name at the start of the year. There has been a lot of interest in the website from abroad and 15% of revenue to date has been to overseas customers. According to George, revenue margins are lower compared with the old business but there are opportunities for higher sales volume. Commission agreement with magazine publisher George has negotiated a commission agreement with Still Spinning magazine, a major music publication with a monthly worldwide circulation of over five million. Under this agreement TSL provides electronic distribution of the magazine through its website. In return, TSL receives a full page of advertising space in every issue; an arrangement which George believes is worth $30,000 per year at current rates. TSL receives commission from the magazine publishers at a rate of 20% of magazine sales or subscriptions generated through the TSL website. TSL pays commission to the magazine publishers at a rate of 5% of the sales value of CD sales generated by a special Internet address published only in Still Spinning. The agreement provides that commission figures are calculated monthly by TSL based on monthly sales figures agreed by the two parties. The agreement also provides for TSL's auditors to certify the commission figures every six months. George would like us to plan to carry out this work at the end of the first six-month period in December. We will need to consider what work will be required and what form of report we might be able to provide. Computer systems To ensure prompt dispatch of CDs most in demand, the company has doubled its inventory levels of current CDs. Older CDs are not held in inventory but are requisitioned from suppliers electronically as and when they are ordered by customers. At the year end, the inventory levels were as follows: Actual per Management F/S June 30, 2018 Actual per F/S December 31, 2017 675 Current Assets (units) Inventory: current CDs Inventory: older CDs Inventory: Packaging and containers 320 780 170 21 5 Financial information George has promised to forward me the balance sheets extracted from the company's management financial statements as at December 31, 2017 and June 30, 2018 together with an income statement projection for the year to December 31, 2018. He also mentioned that he intends to present the year-end financial statements on the website