Required a) (10 marks) Fill out the client acceptance checklist. This will require you to do research on the coffee shop industry. You may wish to contact the library if you need help with research. Feel free to expand the Knowledge of Industry section to have enough room to give the results of your research. b) (8 marks) Perform a preliminary analysis of the financial information. c) (4 marks) Calculate materiality based on the information you?ve been given and justify your calculation. d) (8 marks) Identify four areas of inherent risk that might affect your audit planning. Would you say these are high risks or low?

SCHOOL OF FINANCIAL SERVICES Term ACCOUNTING DIPLOMA Assignment COURSE NAME: Auditing I PROFESSOR: Rand Rowlands AGENDA: Term Assignment Part 1 DUE DATE: June 28, 2013 12 noon This assignment is expected to take you the following time: Internet research - 3 hours Industry analysis - 2 hours Completing the checklist - 1hour Preliminary analysis - 2 hours You are being asked to complete part of the checklist for the knowledge of a client's business, as you would do for any new client of your audit firm. It is expected that you will study at least two competitors for the fictional company described below. The case is as follows. Java Stop Limited (JSL) is a private company with corporate offices at 10 Bay Street, Suite 409 in Toronto. It was founded July 2, 2002 by Michael Beber. Mr. Beber was working as a banker at the time. While visiting a client in the import business, his client pointed to the coffee Mr. Beber had bought at the corner coffee shop for $1.75 and told him that the beans to make one cup cost about 20 cents. Knowing that the other main ingredient was water, which was almost costless, Mr. Beber did the math on the other fixed and variable costs then looked at the competition and the market and decided there was room for one more coffee chain. The first store, run by his now ex-wife Lori, opened October 1, 2002. Java Stop quickly distinguished itself from its competitors in three areas. First, they use distilled water instead of tap water. Technically speaking, anything added to tap water is mostly boiled away during the brewing process. Displaying the water jugs to the customers reinforces the image of purity. Surveys have shown this to be a positive feature of their locations. The second advantage was that right from the beginning free internet was made available to customers. While this is common in the competitors today, it was not as common in 2002. Lastly, Java Stop prices its products at 90% of the price at the leading chain. When incorporated, 1,000,000 shares were issued. Mr. Beber owned 75% and his wife owned 25%. Mr. Beber and his wife were divorced in 2006, at which time there were 7 locations in Toronto, and one in Kingston. After their divorce settlement, Lori owned 200,000 shares, Mr. Beber 400,000 and a family trust had 400,000. The family trust was set up to benefit the couple's two children. Mr. Beber quit the bank in 2006 to run the company. By 2009 it had 23 locations. Lori ceased to be involved in operating the company in 2005. Page 1 of 4 SCHOOL OF FINANCIAL SERVICES Term ACCOUNTING DIPLOMA Assignment The current management team is composed of Kathy Kus, CFO, Hy Haberman, V.P. Operations and Michael Beber, CEO. All three sit on the Board of Directors along with four others who are mostly friends of Mr. Beber. The management team has been in place for three years. Ms. Kus is a CA with over 20 years experience and there ten employees in the accounting department, including the Accounting Manager, Joan Zhou, who completed her CGA in 2008. They are currently using ACCPAC v 5.4 operating on a Dell Data Server. JSL outsources its IT services to FC DataNet, Limited which is headquartered in Calgary and has offices across Canada. Ms. Kus believes this system will be scalable up to 100 locations, at which time it is likely the company will bring its systems in house and upgrade to a larger software platform such as SAP. Ms. Kus is familiar with SAP through her work as Controller for Nabisco Canada prior to joining JSL. There are several challenges faced by the company. In 2010 JSL changed its incorporation from the Ontario Corporations Act to the Federal Canada Corporations Act. While not necessary in order to expand into other provinces it does make it easier to expand into the United States and the first two stores opened in Buffalo, New York in 2011. When changing jurisdictions, all old shares were cancelled and replaced at a ratio of 100:1 with shares in the reincorporated company. Kathy Kus and Hy Haberman bought Lori's shares in 2010 for $500,000 using a non-interest bearing loan from JSL. The loan is repayable over ten years or immediately upon their leaving the company. Each executive now owns 10,000,000 shares. The company planned to go public in 2010 and use the funds to expand rapidly. For this reason they chose to have the financial statements audited. Because of Mr. Beber's contacts at the Bank of Nova Scotia, 100 Yonge St., 9th floor Toronto ON, M5H 1H1, operating lines of credit were secured by a general charge on assets and internally prepared financial statements were deemed to be acceptable. However, the economic downturn meant the public offering was shelved. The $183,000 spent on going public was capitalized as an intangible asset. JSL issued 25,000,000 shares to a venture capitalist firm, Arbrent on June 30 in exchange for $5,000,000 in operating funds. Arbrent also got four places on the board of directors, two replacements and two new positions, meaning the BoD is now nine directors in total. They also put one of their employees in as the Chief Operating Officer, Amanda O'Leary. She holds no shares in JSL. JSL uses its buying power to buy beans and roast them on behalf of smaller coffee shops. This helps use up capacity at its own roasting plant but also helps strengthen its competitors and has a low gross margin of less than 15% even though there is no extra operating costs. As locations continue to expand, sales from the roasting business have fallen from 20% of sales in 2009 to 12% in 2010. It also accounts for all of the accounts receivable. Three of the 58 locations of JSL open in 2011 were takeovers of former roasting clients. The 2010 statements were audited by Farber and Shurman, LLP. They were reappointed auditors at the May, 2011 annual general meeting. In August, Mr. Shurman suffered a fatal heart attack. In looking at the resources of the firm, Mr. Farber decided they were too small to continue performing the audit and advised Ms. Kus to consider other auditors. Mr. Farber said that he would cooperate fully with the new auditor. The year end is December 31. Page 2 of 4 SCHOOL OF FINANCIAL SERVICES Term ACCOUNTING DIPLOMA Assignment Required (10 marks) Fill out the client acceptance checklist. This will require you to do research on the coffee shop industry. You may wish to contact the library if you need help with research. Feel free to expand the Knowledge of Industry section to have enough room to give the results of your research. b) (8 marks) Perform a preliminary analysis of the financial information. c) (4 marks) Calculate materiality based on the information you've been given and justify your calculation. d) (8 marks) Identify four areas of inherent risk that might affect your audit planning. Would you say these are high risks or low? a) JAVA STOP LIMITED State me n t of In come Ye ars e nde d De ce mb e r 31 Audited 2010 Sale s and othe r re ve nue s C o st of g oo ds sold Sto re o pe rating costs Unaudited 2009 2 1,734,951 6,865,934 1 0,703,500 13,674,687 4 ,186,570 6 ,799,050 Store marg in 4,165,517 2 ,689,067 Se lling, g e n e ral, and administrative 2,320,505 1 ,897,267 O p e ratin g Income 1,845,012 791,800 Amo rtizatio n Inte re st Ne t inco me b e fore fe de ral inco me taxe s 1,440,817 7 2,500 3 31,695 522,584 7 2,500 196,716 P ro vision for inco me taxe s 1 19,410 7 0,818 NET INCOME 2 12,285 125,898 Page 3 of 4 SCHOOL OF FINANCIAL SERVICES Term ACCOUNTING DIPLOMA Assignment JAVA STOP LIMITED Balance She e t As At De ce mb e r 31 A SSETS Cu rre nt Asse ts: Cash Accoun ts re ce ivab le le ss allo wance for doub tful accoun ts In ve nto rie s P re paid e xpe nse s To tal Cu rre nt Asse ts Audited 2010 Unaudited 2009 521,096 649,562 294,500 1 ,465,158 3 44,937 4 07,766 2 04,500 9 57,203 3 ,829,179 2 10,588 6 10,406 4 ,650,173 2 ,359,878 2 ,290,295 O rg anization costs TOTAL ASSETS 5 ,441,858 290,992 771,543 6 ,504,393 3 ,800,695 2 ,703,698 183,000 4 ,351,856 LIABILITIES AND STOCKHOLDERS' EQUITY C u rre nt Liab ilitie s: Bank line of cre dit Accoun ts payab le Accrue d liab ilitie s In come taxe s payab le To tal cu rre nt liab ilitie s 256,964 1 ,237,004 108,022 2 9,853 1 ,631,843 4 0,689 6 29,732 5 1,644 1 7,705 7 39,770 Lon g te rm Liab ilitie s: Bank lo an du e April 1, 2013 (7.25% ) 1,000,000 1 ,000,000 Total Liab ilitie s 2 ,631,843 1 ,739,770 Sto ckholde rs' Equity: C o mmo n sto ck issue d and ou tstan ding 100,000,000 share s Re taine d e arnings To tal Stockh olde rs' Equ ity TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY 200,000 1 ,520,013 1 ,720,013 4 ,351,856 2 00,000 1 ,307,728 1 ,507,728 3 ,247,498 P ro pe rty, plan t, & e quipm e nt, at cost Machin e ry an d e q uipme nt Au tomo tive e quip me nt O ffice fu rnitu re an d fixture s Le ss accumu late d de pre ciation 3 ,247,498 Page 4 of 4 Prepared by: Date: Name of client: Year end: KNOWLEDGE OF THE CLIENT'S BUSINESS CHECKLIST This appendix provides a checklist that may help the auditor obtain and document knowledge of some of the characteristics of the client's business. This checklist is not meant to be an exhaustive list of the characteristics of the client's business that may be important for the audit. In addition, this checklist is not designed to group all of the information necessary for understanding internal control for planning purposes and assessing control risk. I. KNOWLEDGE OF THE ENTITY A. CHARACTERISTICS OF OWNERSHIP AND MANAGEMENT 1. Type of entity: Corporation Private Public Sole proprietorship Crown corporation General partnership Not-for-profit organization Limited partnership Joint venture Other (describe) 2. Jurisdiction of incorporation: Statute: Date: 3. Listed on stock exchange: (name of stock exchanges, listed securities) 4. Principal owners, directors and officers: Name Title % interest Page 1 of 5 Prepared by: Date: Name of client: Year end: I. KNOWLEDGE OF THE ENTITY B. 1. OPERATIONS Nature of activities (manufacturing, distributing, service, etc.; industrial, commercial, residential, individual, etc.): Description of products and services 2. % of activities Territory covered Location 3. Production or sales cycles 4. % of activities Patents, trademarks, rights, permits: Page 2 of 5 Prepared by: Date: Name of client: Year end: I. KNOWLEDGE OF THE ENTITY C. FINANCIAL POSITION 2. Sources of financing: Financial institutions (name, address, bank accounts) Other sources of financing: 3. Is there a doubt as to the entity's ability to continue as a going concern? D. INFORMATION SYSTEMS 1. Accounting records and documents: Accounting cycle or subsystem 2. System or software Frequency Description of computerized system: Our IS specialty group will look at system after we agree to audit. Current system is a small network with a PC server. Manufacturing systems are based on a DELL T610 with numerically controlled integrated management software. The manufacturing system does not produce accounting information so we do not need to study it. Page 3 of 5 Prepared by: Date: Name of client: Year end: II. KNOWLEDGE OF THE INDUSTRY 1. Economic conditions of the industry: (market conditions, decline or expansion of business, price changes, economic cycle of products, etc.): 2. Description of technological changes, internationalization of business transactions and their effects on the market: 3. Major competitors: Name Products or services offered 4. Financial statement users and reporting requirements: 5. Specific knowledge required of the audit team: Type of knowledge Description Canadian accounting standards US accounting standards Other accounting standards Specific industry guidance Page 4 of 5 Prepared by: Date: Name of client: Year end: Materiality: Materiality should be calculated as: This amount is appropriate for the following reasons: Page 5 of 5 Prepared by: Date: Name of client: JAVA STOP LIMITED Year end: DECEMBER 31 KNOWLEDGE OF THE CLIENT'S BUSINESS CHECKLIST This appendix provides a checklist that may help the auditor obtain and document knowledge of some of the characteristics of the client's business. This checklist is not meant to be an exhaustive list of the characteristics of the client's business that may be important for the audit. In addition, this checklist is not designed to group all of the information necessary for understanding internal control for planning purposes and assessing control risk. I. KNOWLEDGE OF THE ENTITY A. CHARACTERISTICS OF OWNERSHIP AND MANAGEMENT 1. Type of entity: Corporation Private Public Sole proprietorship Crown corporation General partnership Not-for-profit organization Limited partnership Joint venture Other (describe) 2. Jurisdiction of incorporation: Statute: Federal Canada Corporations Act Date: 2010 3. Listed on stock exchange: (name of stock exchanges, listed securities) Canada Stock Exchange, JSL 4. Principal owners, directors and officers: Name Title % interest Kathy Kus CFO 8% Hy Haberman V P Operations 8% Michael Beber CEO 32% Page 1 of 6 Prepared by: Date: Name of client: JAVA STOP LIMITED Year end: DECEMBER 31 I. KNOWLEDGE OF THE ENTITY B. 1. OPERATIONS Nature of activities Service Industry Description of products and services Coffee Shops 2. % of activities 100% Territory covered Location % of activities United States Buffalo, New York 3. 33.33 66.67 Production or sales cycles Java Stop quickly distinguished itself from its competitors in three areas. First, they use distilled water instead of tap water. Technically speaking, anything added to tap water is mostly boiled away during the brewing process. Displaying the water jugs to the customers reinforces the image of purity. 4. Patents, trademarks, rights, permits: Currently they do not own any patents, trademarks, rights or permits. Page 2 of 6 Prepared by: Date: Name of client: JAVA STOP LIMITED Year end: DECEMBER 31 I. KNOWLEDGE OF THE ENTITY C. FINANCIAL POSITION 2. Sources of financing: Financial institutions (name, address, bank accounts) Bank of Nova Scotia, 100 Yonge St., 9th floor Toronto ON, M5H 1H1 Other sources of financing: Arbrent, Venture Capitalist. Equity Financing 3. Is there a doubt as to the entity's ability to continue as a going concern? Yes there are doubts in the continuity of the business since the current ratio has dipped from 1 and the company does not possess cash In hands as well as the net income does not fare well. D. INFORMATION SYSTEMS 1. Accounting records and documents: Accounting cycle or subsystem Accounting cycle Subsystem 2. System or software Frequency ACCPAC V5.4 FC Data Net Description of computerized system: Our IS specialty group will look at system after we agree to audit. Current system is a small network with a PC server. Manufacturing systems are based on a DELL T610 with numerically controlled integrated management software. The manufacturing system does not produce accounting information so we do not need to study it. Page 3 of 6 Prepared by: Date: Name of client: JAVA STOP LIMITED Year end: DECEMBER 31 II. KNOWLEDGE OF THE INDUSTRY 1. Economic conditions of the industry: (market conditions, decline or expansion of business, price changes, economic cycle of products, etc.): The economic conditions of the coffee industry is good but the margins are on the lower side. This is mainly due to the varied tastes and preferences of the customers as well as the industry faces a stiff competition from competitors as well as the substitute product tea. The price of the products vary from stores to stores and depend upon the quality of the products so offered. The stores costs are generally on the higher side which is why the recovery of the costs takes time in the industry. 2. Description of technological changes, internationalization of business transactions and their effects on the market: The technological changes have led to the centralization of business and the financials. The major changes that have taken place is that technology has widened the business ambience where the monitoring process can be tracked from one place and helps in assessing all the business stores. The Effect on the market is quite surprising as the markets have been widened and the overall scope has increased as well for the business. 3. Major competitors: Name Starbucks Products or services offered Coffee 4. Financial statement users and reporting requirements: The financial statements users are the stakeholders associated with the company including the management, the employees, the creditors and lenders, the shareholders, and the people who use the services. The reporting requirements of the firm are to produce the annual statements after the year ending for the users of the report as well as complying with the compliances of the taxation requirements. 5. Specific knowledge required of the audit team: Type of knowledge Description Canadian accounting standards Complying with GAAP (Canada) US accounting standards Complying with US GAAP Other accounting standards IFRS Specific industry guidance Page 4 of 6 Prepared by: Date: Name of client: JAVA STOP LIMITED Year end: DECEMBER 31 Page 5 of 6 Prepared by: Date: Name of client: JAVA STOP LIMITED Year end: DECEMBER 31 Materiality: Materiality should be calculated as: Materiality should be calculated as anything over and above 1% of the Total revenues or 20% of the total income or 5% of the total assets of the company. This is because the bar sets a materiality level based on these parameters which might change from period to period. This amount is appropriate for the following reasons: This amount is appropriate because it is tied directly to the sales and net income of the company. The materiality levels can be judged as the percentage is on the higher side. The materiality level is good because the auditors can judge anything above that and would be easily able to meet any material error in the financial statements of the company. Page 6 of 6 Prepared by: Date: Name of client: JAVA STOP LIMITED Year end: DECEMBER 31 KNOWLEDGE OF THE CLIENT'S BUSINESS CHECKLIST This appendix provides a checklist that may help the auditor obtain and document knowledge of some of the characteristics of the client's business. This checklist is not meant to be an exhaustive list of the characteristics of the client's business that may be important for the audit. In addition, this checklist is not designed to group all of the information necessary for understanding internal control for planning purposes and assessing control risk. I. KNOWLEDGE OF THE ENTITY A. CHARACTERISTICS OF OWNERSHIP AND MANAGEMENT 1. Type of entity: Corporation Private Public Sole proprietorship Crown corporation General partnership Not-for-profit organization Limited partnership Joint venture Other (describe) 2. Jurisdiction of incorporation: Statute: Federal Canada Corporations Act Date: 2010 3. Listed on stock exchange: (name of stock exchanges, listed securities) Canada Stock Exchange, JSL 4. Principal owners, directors and officers: Name Title % interest Kathy Kus CFO 8% Hy Haberman V P Operations 8% Michael Beber CEO 32% Page 1 of 6 Prepared by: Date: Name of client: JAVA STOP LIMITED Year end: DECEMBER 31 I. KNOWLEDGE OF THE ENTITY B. 1. OPERATIONS Nature of activities Service Industry Description of products and services Coffee Shops 2. % of activities 100% Territory covered Location % of activities United States Buffalo, New York 3. 33.33 66.67 Production or sales cycles Java Stop quickly distinguished itself from its competitors in three areas. First, they use distilled water instead of tap water. Technically speaking, anything added to tap water is mostly boiled away during the brewing process. Displaying the water jugs to the customers reinforces the image of purity. 4. Patents, trademarks, rights, permits: Currently they do not own any patents, trademarks, rights or permits. Page 2 of 6 Prepared by: Date: Name of client: JAVA STOP LIMITED Year end: DECEMBER 31 I. KNOWLEDGE OF THE ENTITY C. FINANCIAL POSITION 2. Sources of financing: Financial institutions (name, address, bank accounts) Bank of Nova Scotia, 100 Yonge St., 9th floor Toronto ON, M5H 1H1 Other sources of financing: Arbrent, Venture Capitalist. Equity Financing 3. Is there a doubt as to the entity's ability to continue as a going concern? Yes there are doubts in the continuity of the business since the current ratio has dipped from 1 and the company does not possess cash In hands as well as the net income does not fare well. D. INFORMATION SYSTEMS 1. Accounting records and documents: Accounting cycle or subsystem Accounting cycle Subsystem 2. System or software Frequency ACCPAC V5.4 FC Data Net Description of computerized system: Our IS specialty group will look at system after we agree to audit. Current system is a small network with a PC server. Manufacturing systems are based on a DELL T610 with numerically controlled integrated management software. The manufacturing system does not produce accounting information so we do not need to study it. Page 3 of 6 Prepared by: Date: Name of client: JAVA STOP LIMITED Year end: DECEMBER 31 II. KNOWLEDGE OF THE INDUSTRY 1. Economic conditions of the industry: (market conditions, decline or expansion of business, price changes, economic cycle of products, etc.): The economic conditions of the coffee industry is good but the margins are on the lower side. This is mainly due to the varied tastes and preferences of the customers as well as the industry faces a stiff competition from competitors as well as the substitute product tea. The price of the products vary from stores to stores and depend upon the quality of the products so offered. The stores costs are generally on the higher side which is why the recovery of the costs takes time in the industry. 2. Description of technological changes, internationalization of business transactions and their effects on the market: The technological changes have led to the centralization of business and the financials. The major changes that have taken place is that technology has widened the business ambience where the monitoring process can be tracked from one place and helps in assessing all the business stores. The Effect on the market is quite surprising as the markets have been widened and the overall scope has increased as well for the business. 3. Major competitors: Name Starbucks Products or services offered Coffee 4. Financial statement users and reporting requirements: The financial statements users are the stakeholders associated with the company including the management, the employees, the creditors and lenders, the shareholders, and the people who use the services. The reporting requirements of the firm are to produce the annual statements after the year ending for the users of the report as well as complying with the compliances of the taxation requirements. 5. Specific knowledge required of the audit team: Type of knowledge Description Canadian accounting standards Complying with GAAP (Canada) US accounting standards Complying with US GAAP Other accounting standards IFRS Specific industry guidance Page 4 of 6 Prepared by: Date: Name of client: JAVA STOP LIMITED Year end: DECEMBER 31 Page 5 of 6 Prepared by: Date: Name of client: JAVA STOP LIMITED Year end: DECEMBER 31 Materiality: Materiality should be calculated as: Materiality should be calculated as anything over and above 1% of the Total revenues or 20% of the total income or 5% of the total assets of the company. This is because the bar sets a materiality level based on these parameters which might change from period to period. This amount is appropriate for the following reasons: This amount is appropriate because it is tied directly to the sales and net income of the company. The materiality levels can be judged as the percentage is on the higher side. The materiality level is good because the auditors can judge anything above that and would be easily able to meet any material error in the financial statements of the company. Page 6 of 6