You are an auditor for Wallace and Brace, CPA, and you have been assigned to the Green Pastures Cheese, LLC audit. You are familiar with the company because your spouse is an IT specialist for the company, and the current CFO is a former auditor for Wallace and Brace, CPA.

Wallace and Brace, CPA is a regional public accounting firm that provides bookkeeping, assurance, tax, and consulting services. Their largest clients are hospitals, restaurants, manufacturers, and banks. They do not have agri-business experience. They do not audit public companies. The firm has an experienced staff, but rapid growth has led to over-work. The firm is seeking 5 qualified auditors to join its staff.

The engagement team has learned the following information about Green Pastures Cheese, LLC and the industry.

Overview of Green Pastures Cheese, LLC (GPC)

Hans Schmidt is a 3^rd generation dairyman who started a modest cheese store in 1960. He was an early adopter of organic farming techniques and has benefited from his interest in organic products, farm-to-table restaurants/catering, green technologies, and agri-tourism.

The company farm, processing plant, distribution center, office, and main store are located in Green Valley, WI between Madison and Milwaukee. They also have 2 stores each in Milwaukee and Madison.

GPC’s primary objective is to increase revenue 7% and net income 6% in each of the next 4 years prior to a planned initial public offering (in year 5).

The company produces 40% of the milk that they use in their products. The remainder is purchased from local organic farms. Hans refuses to purchase from large corporate farms.

The company cannot expand at its present location without purchasing additional acreage. The cost of farm land has been increasing 5% per year.

Their product has earned numerous awards which has provided strong name recognition in Wisconsin. They sell to grocery stores, restaurants, organic food outlets, and online customers. They also sell to a wholesale distributor with access to Illinois, Iowa, Michigan and Ohio. The company is seeking store locations and distributors in other states.

The business is wholly owned by the Schmidt family, but they are considering doing an initial public offering (“going public”) in 5 years. Hans owns 60% and is the CEO. His four children each own 10%. The board is composed of the 5 owners and a family friend who is a lawyer. Hans is chairman of the board. The board does not have a separate audit committee. GPC does not have an internal auditor. An annual audit is required by their bank, The Lake Country Bank.

Han’s daughter, Leah Scott, CPA, was recently hired as CFO. She replaced her brother Joe who left abruptly after 10 years. Other family members are employed as department heads. Hans encouraged his family to earn advanced degrees and work for other companies before joining the family business.

The company’s sales have been increasing rapidly. The company has reinvested in its operations.

GPC’s former auditor is Wilks and Company. When Leah became the new CFO, she suggested a change of firms. She explained that it would be easier working with her former colleagues. She was a Wallace and Brace staff auditor for 4 years, and “knows how they operate.”

The Organic Cheese Industry

The organic cheese industry is expected to grow 5-8% per year compared to the non-organic segment which are not expected to grow. New competitors are entering the industry because of the higher profit margins. They may use predatory pricing in order to gain market share. GPC is responding by aggressively marketing new products.

GPC’s competitive advantage is that they are the first US cheesemaker to win a world-class award. Since Hans is nearing retirement, they are seeking a highly-skilled cheesemaker from France.

The primary business objective is to increase revenue by 7% and net income by 6% per year for the next 4 years. They will do this through developing new products, aggressive marketing, new stores, and adding new markets. They plan to open a new retail store in each of the next 4 years, assuming they are able to locate desirable locations. This year GPC hired a new marketing firm and has increased its advertising.

This year, they implemented 2 new policies in which they offer credit to grocery stores with higher credit risk. They feel that their past policies were too restrictive and limited their sales. They are also offering their sales staff bonuses based on a percentage of sales to grocery stores. They believe that this will lead to higher sales and ultimately to greater profits.

Higher-income families consume 70% of organic dairy products, and consumption is highest among adults between the ages 25 and 65. Most economists predict modest wage growth in the next 5 years. A few economists predict a recession around year 4.

The industry has seen some merger activity in an attempt to benefit from economies of scale. Large cheese manufacturers are launching organic product lines. This will lead to greater price competition.

In the most recent year, 2.56 billion pounds of organic milk products were sold. That amount represented 5 percent of all milk products. More than 2,500 farms in the United States produced organic milk. Nearly 280,000 dairy cows were certified organic, up from 241,112 dairy cows in the previous year. California produces 20% of the annual organic milk produced. Wisconsin, Texas, and New York produce about 10% each.

Some dairy operations manufacture and sell locally. For national distribution, products tend to move from the farm to a cooperative processor and then to a private distributor before reaching retail outlets.

Organic products sell at a price approximately double the price of non-organic products, but they cost more to produce. Organic feed costs more than standard feed, and organic production uses more labor and capital. Grass-fed cows produce less milk.

USDA standards for organic food were implemented in 2002. Organic dairy is raised in a production system that promotes and enhances biodiversity and biological cycles and uses only organic feedstuffs and health protocol. It is based on minimal use of off-farm inputs. Dairy cattle producing organic milk are not given antibiotics and growth hormone stimulants. In general, organic foods are minimally processed with artificial ingredients or preservatives.

Recent mergers in the organic milk industry could result in lower organic milk prices which reduce the price paid to milk producers. There is also concern that the industry is being dominated by mega-farms. The small producers accuse these large operations of not complying with all the organic regulations. The mega-farms have also created excess supply which suppresses milk prices. The imbalance of power could put small family farms out of the industry. The number of family-farms is expected to decrease. This would allow the larger producers to control the market (and price) of milk.

The company subscribes to industry research in order to monitor economic and industry conditions which may affect future sales. They also monitor competitors’ prices and products.

Information from Predecessor Auditor, Wilks, and Company

The previous auditor replied that they were comfortable working with the staff and management of GPC. The people have integrity and are open to recommendations.

They expressed admiration for Hans’s business instincts and GPC’s distribution channels. Hans is nearing retirement, and though the children are equally dedicated to the business, they do not have his skills.

Wilks and Company will allow Wallace and Brace, CPA to review their audit working papers.

Audit Practice Set Part 1: Audit Planning and Risk Assessment

Instructions:

After reading the document entitled “Green Pastures Cheese, LLC: Background” and completing ratios in the preliminary analytical procedures Excel workbook, respond to each question with complete sentences and reasoning to support your answer. Cite sources.

1. Wallace and Brace CPA assign a partner to screen and recommend (or decline) potential clients prior to acceptance. Discuss at least 4 specific issues which should have been considered prior to accept GPC as a client and how they impacted the decision. (Consider both positive and negative factors.)

Response:

2. How does the ownership structure of Green Pastures Cheese affect the type of audit and the auditing standards to be applied?

Response:

3. Discuss the extent to which Wallace and Brace CPA may be liable to 3^rd parties. Do the 1933 and 1934 Acts apply to this audit? Why or why not?

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4. GPC has adopted 2 new policies which should be considered in planning the audit. Describe the 2 polices and explain how they might lead to material errors. (What accounts could be misstated?)

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5. Identify 3-5 factors which affect GPC’s business risk. For each factor indicate a business objective that could be affected by the particular risk.

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6. Review the ratios which you completed in the preliminary analytical procedures Excel workbook. Identify ratios and trends that cause concern about the client’s ability to continue as a going concern or indicated a high likelihood that the client will continue as a going concern. Use the data to support your conclusion.

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7. Review the horizontal analysis in the preliminary analytical procedures Excel workbook. Identify balance sheet accounts that you believe are most likely to be misstated, and explain why the fluctuation (or lack thereof) is significant.

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8. The client explained that the decrease in General and Administrative expenses was mostly caused by a decrease in bad debt expense due to improved collection efforts. Does this seem likely given your analysis? What accounts could potentially be misstated? What audit procedures could be done to test the client’s assertions?

` Response:

9. The client explained that increase in the Sales and the Commissions/Bonuses Expense are related. They noted a strong increase in year-end sales which resulted in higher sales commissions and bonuses. What accounts could potentially be misstated? What audit procedures could be done to test the client’s assertions?

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10. What are the advantages and disadvantages of using analytical procedures and why are they always used during the preliminary planning phase?

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