J & M Lumber Corporation

December $31,20$X$6$ Year$-$End Audit Engagement

Assessing Risks & Planning Substantive Procedures

Company Background

J & M Lumber Corporation $($J & M$)$ is a mid$-$size wholesaler founded in $20$X$0$ to supply lumber to commercial and residential builders in Southern Nevada. Until $20$X$5,$ the company operated out of one location in Las Vegas. In early $20$X$6,$ J & M opened two new locations and hired $50$ employees to serve customers better and expand sales to Northern Nevada and California.

J & M is known for providing excellent customer service and high$-$quality products. The company sells several types and grades of lumber to large general contractors and custom home builders. Thus, the company$$s operations depend on factors affecting the commercial and residential construction industries, including inflation and interest rates.

The company$$s $20$X$6$ earnings increased slightly from the prior year. However, management had hoped for significantly higher earnings since most of J & M$$s long$-$term debt is due in the first quarter of $20$X$7.$ At year$-$end, the company was negotiating with several banks regarding potential refinancing options.

All sales are on credit, and terms of trade are FOB shipping point. J & M classifies accounts receivable by type of customer. Nevada law allows the company to file liens against commercial buildings built by general contractors when amounts due to J & M remain unpaid. Filing liens most often results in the collection of past$-$due receivables. In contrast, sales to custom home builders are not subject to lien protection under Nevada law. Thus, past$-$due receivables from custom home builders are significantly more likely to become uncollectible than receivables from general contractors.

Industry Information

Since J & M$\text{'}$s inception in $20$X$0,$ the construction industry has been relatively profitable, and that trend is expected to continue for the next several years. Lumber production has increased steadily, as has commercial and residential construction in Nevada and California. Nevada$$s housing market has been particularly strong as previously vacant land is being converted into large residential housing developments. Much of this land has mountain views and, thus, has attracted high$-$end custom home builders who accounted for approximately half of J & M$$s $20$X$6$ sales.

Although the lumber industry doesn$$t face challenges due to rapid technological change, it faces challenges due to climate change and skilled labor shortages. Despite those risks, the industry$$s most significant concern is whether construction demand will continue to grow. During the past two years, the economy has been recovering from a downturn, yet interest rates remain relatively high.

J & M Lumber Corporation December $31,20$X$6$ Year$-$End Audit Engagement

Risk Assessments

Select the correct answer to each question below and justify your response.

$1.$ A significant factor relevant to fraudulent financial reporting risk is:

Earnings are significantly lower than management had hoped.

The company sells to general contractors and custom home builders.

The lumber industry is subject to rapid technological change.

Sales are made to customers in the construction industry.

Explanation: $\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_$

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$2.$ The most significant risk of material misstatement for the allowance for doubtful accounts at the balance sheet date is:

The collection of receivables from all customers is guaranteed by filing liens.

Receivables from customers for which liens can$$t be filed will be incorrectly classified.

The construction industry has been relatively profitable since $20$X$0.$

The company sells to builders in Nevada and California.

Explanation: $\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_$

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$3.$ The most significant incentive for J & M$$s management to engage in fraudulent financial reporting is that the company:

Operates in states in the Western U$.$S$.$

Added two new locations during the year.

Sells several types and grades of lumber.

Must refinance most of its long$-$term debt.

Explanation: $\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_$

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$4.$ A significant factor relevant to the preliminary assessment of control risk is:

The economy has been recovering from a downturn.

The company hired $50$ employees and opened two new locations.

Interest rates remain relatively high.

The lumber industry faces challenges due to climate change.

Explanation: $\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_$

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