Natural Elixirs Ltd is a manufacturer of natural herbal remedies based in Brighton but with franchise operations overseas.

The business was founded eight years ago by Sarah Jones who has a background in holistic therapies, but little prior business experience. She is the Chief Executive Officer and is supported by three other Executive Board members. One of these is the Finance Director on whom she relies for advice on financial matters.

Natural Elixirs Ltd has grown significantly over the last three years and has attracted venture capital investment which has enabled an increase in product lines and expansion into new markets. Part of this expansion has been achieved by granting franchises to existing manufacturers overseas so that Natural Elixirs Ltds products can be manufactured and distributed globally. These franchisees have the right to manufacture and sell Natural Elixirs products using the original recipes and authentic branding. In return, a percentage of the sales revenues are remitted to Natural Elixirs Ltd on a monthly basis.

To ensure the high quality of the end products, franchisees must purchase their essential oils direct from Natural Elixirs Ltd. These are provided on a sale or return basis and remain the property of Natural Elixirs Ltd until they are used in production, at which point the franchisee must account for their use along with the monthly sales figures.

A condition of the venture capital investment was the creation of an Internal Audit department two years ago. It is currently staffed by four part qualified, or qualified by experience, staff. Six months ago, the Internal Audit Manager, a qualified accountant, was promoted to Finance Director of Natural Elixirs Ltd.

The Finance Director has, on occasion, made use of the expertise available in the Internal Audit department to help the finance function during busy periods, for example at the year end when deadlines are extremely tight. The staff are kept at arms length from the finance department to maintain their independence and are only used if needed. This is not a usual part of their role and only occurs when the finance department is short staffed.

The Internal Audit department reports to the Audit Committee which is made up of non-executive directors.

The business sources a wide range of commodities to supply its production of natural remedies. These range from a relatively low-cost carrier oils such as sunflower oil to much higher cost essential oils such as lavender oil. The essential oils are more volatile and need to be stored in specialist warehouses to avoid spoiling. In the past inventory has been overvalued since spoilt inventory has not been identified promptly.

Essential oils account for approximately 50% of the total inventory value included in the Statement of Financial Position for Natural Elixirs Ltd. Of this total, 75% is held by franchisees overseas. The Internal Audit department review internal controls surrounding inventory as part of their regular visits and always witness the year end stocktake, though usually at the head office rather than any of the franchisees.

You are an audit assistant at Smith & Edwards LLP and have been asked to take part in planning the audit of Natural Elixirs Ltd. Natural Elixirs Ltd has a March year end and has been an audit client of Smith & Edwards LLP for many years. The audit is scheduled to take place in late April.

It has recently come to light that a new graduate trainee at Smith & Edwards, Rhys Jones, is the nephew of Sarah Jones. Since Rhys has extensive knowledge of Natural Elixirs Ltd, Sarah having acted as a mentor to Rhys, he is extremely eager to be involved in a key role in the audit.

i. A franchise is a legal agreement whereby franchisor (Natural Elixirs Ltd) allows a franchisee to make use of intellectual property, the business model, branding and contacts of the franchisor to carry out commercial activities under defined rules e.g. limited to a particular geographical location or market. This is done in return for either a fixed fee, agreed percentage of turnover or profit and often subject to many other conditions such as, in this case controls surrounding inventory, agreed marketing spend, agreed selling prices and the provision of regular financial information by the franchisee to the franchisor.

Question: write a summary of recommendations that may be included in the management letter post audit? (The recommendations regarding the internal controls of the entity that can be included in the post audit management letter)

• What are the issues around the audit processes ?

• Give recommendations on what needs to be done.

• Whether Rhys Jones should be included in the Audit Team?