Situation:

You are the audit senior engaged on the audit of Lovely Lawns Ltd. for the year ended June 30, 20X2, and will be responsible for the initial planning work. You have been provided with the most recent management financial statements for the nine months to March 31, 20X2, included in appendix 1.

Lovely Lawns specializes in the manufacturing of lawnmowers, trimmers, and other gardening accessories. The head office and factory are based in Langley, BC. All sales orders are generated by the sales team consisting of four sales representatives and a sales manager. All orders and invoices are processed by the administrative team at head office.

The main customers of Lovely Lawns are "do-it-yourself" (DIY) stores and local garden centres. It also makes cash sales over the counter from the small shop attached to the factory. Revenue from the shop accounts for approximately 10% of total sales. As the business is seasonal, 50% of annual sales are normally generated in the final quarter of the financial year.

In December 20X1, Lovely Lawns launched a new type of lawnmower, the 3X. The 3X aerates and feeds the lawn as the grass is being cut. It is designed mainly for larger lawns, as it saves time by doing three activities at once. The DIY stores showed enormous interest in this product in the initial stages, with predicted third quarter sales of $10,000. Initial sales, however, have been disappointingly low since its release, achieving only 25% of initial expectations. The directors are confident that sales will escalate once the gardening season gets underway in mid-April. The margins are currently very low on the 3X machine due to a low introductory price of $95 (the full price is $115); however, the introductory price has been advertised as a sale price ending on April 30, 20X2.

Lovely Lawns suppliers are generally reliable, and they have used the same approved suppliers successfully in the previous six years. Suppliers usually increase their prices at the beginning of August, and this year the increase was 3%. Lovely Lawns passed this increase directly to the customers through sales price increases. Neither the inflationary price increase nor the release of the new 3X product have affected sales of other products.

The sales director retired at the end of December and the board has decided that the primary responsibilities of the sales director should be passed onto the sales manager, Naeem. In addition to managing the small sales team, she will now be responsible for preparing and presenting the monthly sales report to the board of directors for their review. Naeem will attend these board meetings to explain fluctuations and plans for the following month. On a quarterly basis, Naeem will present the forward plan to the board for approval. Naeem is also responsible for controlling the operation of the monthly inventory counts. Due to work pressures and the implementation of the new computerized inventory system, inventory counts have not been conducted since November 20X1. A year-end inventory count is planned for June 30, 20X2.

One of the audit team members has also started the analytical review, the results of which are included in appendix 2.

Required:

Evaluate the inherent risks (OFSL and account/assertion level) for Lovely Lawns arising from the above discussion and the analytical review results. Remember to identify the risk, explain why it is an audit risk, and for account level risk, indicate the assertion(s) at risk. Provide a preliminary assessment for the overall risk level for the engagement.

Lovely Lawns - Appendix 2 Preliminary Analytical Review Results For the 9 Months Ended Mach 31, 20X2 Revenue Inventory Days Detetermination of expected sales Days in inventory (actual) 191 Calc - (1169/2236) X 365 Days in inventory (budget) 75 Calc - (650/3159 X 365 Total sales and shop revenue 20X1 2,896.0 Days in inventory (prior year) 69 Calc - (395/2097) X 3654 add: 3% inflationary increase 80.0 (approx 80) Note: the 2236 above is the COGS extrpolated for 12 months Total expected revenue 20X2 2,976.0 calc - (529+1148)/9*12months 50% of revenue in 1st 3 quarters 1,188.0 Accounts payable Days Sale of 3 time product (25% x10,000 x $95) 237.5 AP Period (actual) 40 APP = (243/2236) X 365 AP Period (budget) 28 APP = (243/3159) X 365 Total expected sales to March (9 months) 1,725.5 AP Period (prior year) 32 APP = (181/2097) X 365 Revenue per statement 2,928.0 Note: See the inventory for the calc of the 12 months COGS Difference (1,202.5) Solvency ratios Cost of Sales (Direct Parts) Long-term debt to Equity (actual) 0.62 LTD/Equity - 596/969 Long-term debt to Equity [budget) 0.29 LTD/Equity - 210/729 Current % of revenue (actual] 39% Long-term debt to Equity (prior year) 0.53 LTD/Equity - 200/379 Current % of revenue (budget] 54% Current % of revenue (prior year) 49% Gross Profit Current % of revenue (actual] 43% Current % of revenue (budget] 23% Current % of revenue (prior year) 28% unts receivable Average collection period (actual) 50 ACP = 270/(2928/539) Average collection period (budget) 32 ACP = 365/(4100/364) Average collection period (prior year) 39 ACP = 365/(2896/309) Production Labour Current %% of revenue (actual] 11% Current %% of revenue (budget) 11% Current %% of revenue (prior year) 11%Lovely Lawns - Appendix 1 Balance Sheet For the 9 Months Ended Mach 31, 20x2 9 Months Ended Year Ended Year Ended March 31, 20X2 June 30, 20X2 June 30, 20X1 Actual Budget Actual (audited] (0005) (000s) (000s) Current assets Inventory - raw materials 186 100 67 Inventory - work in process 462 150 126 Inventory - finsihed goods 521 400 202 Accounts receivable 539 364 309 Other receivables 32 21 20 Total current assets 1,740 1,035 724 Non-current assets Property, plant and equipment 382 350 241 Total Assets 2,122 1,385 965 Current liabilities Bank overdraft 161 103 86 Accounts payable 243 243 181 Other payables 153 100 107 Total current liabilities 557 446 386 Long-term liabilities Bank term loan 596 210 200 Total Liabilities 1,153 656 586 Shareholders' equity Share capital 100 100 100 Retained earnings 869 629 279 Total liabilities and shareholders' equity 2,122 1,385 365Lovely Lawns - Appendix 1 Income Statement For the 9 Months Ended Mach 31, 20*2 9 Months Ended Year Ended Year Ended March 31, 20X2 June 30, 20X2 June 30, 20X1 Actual Budget Actual (audited (ODOs) [ODOs] [0005) Revenue Sales 2,802 3,800 2,625 Shop 126 300 271 Total revenue 2,928 4,100 2,896 Dierct Expenses Production labour 313 450 319 Distribution costs 216 490 352 529 940 671 Direct parts costs Opening inventory 395 400 320 Purchases 1,922 2,469 1,501 Closing inventory (1,169) (650) (395) 1,148 2,219 1,426 Total direct expenses 1,677 3,159 2,097 Gross Profit 1,251 941 799 Indirect expenses Administration costs 474 491 480 Other 187 100 101 Net income 590 350 218 Selected admin costs include Professional fees 59 60 51 Indirect wages 229 325 LOE Depreciation 126 42 29 Selected other costs include Repairs and Maintenance 120 40 36 Interest payable on term loan 13 13 15