You are the senior auditor at Dhaliwal & Company, CPAs, and have been assigned to the December 31, 20X6, year-end audit of Green Grocers Inc. (GGI). GGI is a grocery store located in Windsor, Ontario, and is owned 100% by Ray Thompson. The grocery store has seen huge growth in profits quarter over quarter. Ray is surprised that results in the last quarter have been worse than he expected, especially because the Windsor economy has been booming in the last year. It is now January 5, 20X7. You have recently taken over from Liling, the auditor in charge of the GGI audit until he went on parental leave. GGI has not yet prepared financial statements for its December 31 year end. The most current financial statements are provided in Appendix 2. In reading through the prior-year files, you have discerned that the audits have typically gone smoothly in the past. Jean-Pierre has been the grocery manager of GGI since the store opened. Ray has been relying on Jean-Pierre to run the store more heavily since the summer months and thinks that Jean-Pierre is a solid choice for taking over his store. Ray first pitched Jean- Pierre the idea of buying Ray's shares in early July 20X6, after the end of the second quarter. As Ray is frequently away from the store, he added Jean-Pierre as a signing officer on GGI's bank account so that he is also able to sign cheques. Ray is keen to retire and sell his shares in the next year. Jean-Pierre told Ray he is interested in purchasing the shares pending the current-year fiscal results, but he is concemed about getting the best possible price for the GGI shares. Similar privately held grocery stores in Ontario have typically sold for five times operating earnings before tax. Ray has given Jean-Pierre a draft purchase and sale agreement with the shares' selling price outlined at five times operating earnings before tax. GGI's controller resigned at the end of September 20X6 to take another job. With no controller, most accounting tasks have been delegated to Jean-Pierre's son, Brandon, who just finished his first accounting course at a local community college. Ray feels lucky that Brandon can help because no one else at GGI has any accounting expertise. Brandon has been dating your cousin for the last six months. You remember meeting Brandon at Thanksgiving dinner in October. Ray is also interested in having Dhaliwal represent Ray and negotiate the sale price of his shares, since the accounting firm, having recently completed the audit, will be very familiar with GGI's financial records. In October 20X6, Liling started to plan for the year-end audit. Based on his interim discussions with Ray, he noted that GGI had a number of new transactions and an agreement they entered into in 20X6. His notes to the audit file can be found in Appendix 1. On December 31, 20X6, you visited Ray at GGI and walked through the store to become familiar with the premises. During your visit, you made some notes of your observations, which can be found in Appendix 3. APPENDIX 1: NOTE TO FILE, COMMENTS FROM LILING Audit planning notes Inherent risk and control risk are both assessed as low because GGI is a repeat client with consistent income and no change in circumstances from the prior period. Materiality has been calculated based on 10% of normalized income after tax because Ray is the only user of the audited financial statements. Liling believes that a combined approach should be used based on the fact that historically, the audits of GGI have gone smoothly. Notes from meeting with Ray about significant events for the period GGI received a $10,000 government grant in May 20X6 to cover the payroll costs incurred for hiring summer students in the summer of 20X6. Ray mentioned that Brandon set up the government grant as deferred revenue because Jean-Pierre advised him to do so, and that GGI may hire summer students again next summer. Brandon is not sure if this is the correct way to record this transaction. Ray noted that the store looked better than ever after it had been cleaned up following a flood in early August 20X6. The flooring and some shelving, which unfortunately were not covered by insurance, had to be replaced. GGI stocks Nature's Best for Your Pet (NBYP) dog food, which is manufactured by a local producer operating in Kitchener. In May 20X6, GGI signed an agreement with NBYP that states that GGI gets a commission of 25% on the sale of NBYP products in exchange for a set amount of shelf space and a minimum purchase commitment per month for a set amount of dog food from NBYP. Any dog food not sold within three months of delivery is returned to NBYP.NBYP pays the required commission every quarter based on sales GGI reports. GGI waits until it is paid by NBYP to make an accounting entry for the commission. The NBYP product is kept in the same warehouse as GGI's grocery inventory. GGI sells an extensive variety of health supplements, such as vitamins and protein powder. The lifespan of these products ranges from two to six months. Sales of these supplements accounted for a significant portion of revenue during the year. GGI has recently started ordering products such as flour and sugar directly for Sweet Treats, a bakery in a neighbouring town. This allows Sweet Treats to take advantage of volume discounts received by GGI and to avoid paying higher shipping costs. Nousha, the owner of Sweet Treats, recently complained to Ray about being charged for products she never received from GG. She said that she paid all of her bills in the past, but she is frustrated and feels that GGI owes her money for those products. When Ray tried to investigate the payment history from Sweet Treats, he couldn't find any records of deposits for the transactions in question. Ray asked Jean-Pierre for more information about this, but Jean-Pierre always seemed to be unavailable or at a conference out of town. He has been doing a lot of travelling in the last year. GGI receives rebates from several vendors. GGI has an agreement with a large farm in Southern Ontario that gives GGI a rebate of 10% on purchases of beef as long as sales volume reaches a certain level. Not only have volumes been met, but they have also increased every quarter since the agreement was signed. The rebate is paid to GGI in the quarter following purchases. GGI has always recorded this discount as a credit to cost of goods sold and a debit to accounts payable as each purchase is made. From what you can tell, this discount has not been recorded this year. When you asked Ray about the apparent omission, he told you that Jean- Pierre instructed Brandon to wait until after year end, when the discount is received, to make the journal entry because Jean-Pierre is not sure that GGI will receive the discount There are no changes to the bank loan agreement from the prior period. APPENDIX 2: EXCERPTS FROM FINANCIAL STATEMENTS AS AT SEPTEMBER 30, 20X6, AND DECEMBER 31, 20X5 Green Grocers Inc. Income statement For the nine months ending September 30, 20X6 (unaudited) Sales $3,880,000 Cost of goods sold 3,142,800 Gross margin 737,200 Expenses Salaries and wages 495,250 Promotion and travel expense 38,000 Rent expense 99,000 Loss from flood 40,000 Miscellaneous expense 22,000 Total expenses 694,250 For the year ending December 31, 20X5 (audited) $4,320,000 3,240,000 1,080,000 635,000 28,000 132,000 18,000 813,000 Income before tax Income tax expense (Note 1) Net income 42,950 6,657 $ 36,293 267,000 41,385 $ 225,615 Note 1: Tax rate is 15.5% for 20x5 and 20X6. APPENDIX 3: NOTES FROM DECEMBER 31, 20X6, VISIT TO GGI You noticed there was a large pallet of inventory by the receiving door in the back room, where goods from suppliers are delivered. You overheard one of the clerks tell a younger staff member, "Don't unpack that order. If we unpack it, we have to count it in inventory tomorrow when the store is closed, so just leave it for now." You overhead a conversation where one employee asked another to "punch out" for him because he had to leave early. The time card reader is right next to the break room. Each employee has a cardboard time card they use to clock in at the beginning of their shift and clock out at the end of their shift. Time cards are reviewed by the department managers when they have time. You were waiting to speak with the head cashier, Brenda, when you overheard her tell another cashier not to worry about counting the cash at her cash register before the start of her shift because they were too busy and it would take too much time. Brenda counts the cashiers' tills at the end of their shifts and prepares the deposit for the bank. GGI policy states that every newly hired cashier is on probation for the first three months of their employment. A cashier will receive a violation notice if their cash register is either short or over by more than $5.00 per shift. Liling's notes from the interim audit indicate that he was surprised by the number of violations that were just below the $5.00 mark. Brenda supervises all cashiers and handles any personnel matters with them directly. While waiting for your ride, you noticed that the cashier who rang in your groceries at the checkout did not log out of her register when another cashier relieved her. 5. Provide an assessment of the inherent risk and control risk of the GGI audit, and support your analysis with at least four factors. Based on the inherent risk and control risk assessment, determine whether the overall risk of material misstatement should be assessed as low or high. (6 marks)