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 concerned 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 GGI. 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

For the year

ending

December 31, 20X5

(unaudited)

(audited)

Sales

$3,880,000

$4,320,000

Cost of goods sold

3,142,800

3,240,000

Gross margin

737,200

1,080,000

Expenses

Salaries and wages

495,250

635,000

Promotion and travel expense 38,000

28,000

Rent expense

99,000

132,000

Loss from flood

40,000

Miscellaneous expense 22,000

18,000

Total expenses

694,250

813,000

Income before tax

42,950

267,000

Income tax expense (Note 1) 6,657

41,385

Net income

$ 36,293

$ 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.

The following procedures were performed at interim by Liling before he went on parental

leave. Liling has left the following notes in the audit file:

Re summary of procedures performed at interim

The $10,000 grant deposit from the government was traced to the bank statement to

ensure existence and accuracy of the amount. No further work was done.

Purchases were confirmed for major suppliers at September 30, 20X6. A sample

was chosen by reviewing the accounts payable listing and choosing the highest

amounts. Liling performed this procedure, as he believes it is the best way to test

completeness of accounts payable. The payable balance will be updated to

December 31 through roll-forward procedures during year end.

Occurrence of revenues was tested by tracing revenues recorded in the subledger

and tracing them to the general ledger.

Completeness of rebates from vendors (separate from the Southern Ontario farm)

who provide them was verified by multiplying total purchases by the rebate amount

of 1%. Amounts agree, so no further work is required. Rebates last year were

$31,200.

To test accuracy and completeness of the loss from the uninsured flood in the store,

inquiry was made of Jean-Pierre. Per Jean-Pierre, the amount recorded on the

income statement represents the cost of the flooring and shelves that were

damaged. Jean-Pierre also stated that the net book value (cost less accumulated

amortization) of the floors and shelves is difficult to measure because they were

originally recorded as part of the building, but $40,000 is his best estimate. This is a

reasonable explanation, so no further work was done.

No further work is required on expenses that had not changed more than 5% as

compared to the prior period. For amounts in excess of 5%, explanations were

sought from management. Jean-Pierre noted that some expenses had increased

due to the poor economy. This explanation is reasonable, so no further work is

required. Inquiry of management has tested all relevant assertions.

The bank agreement in the permanent file was reviewed. The line of credit amount is

tied to 75% of inventory amounts at year end. As per Ray there are no changes to

the bank agreement from the prior period. No further work is required.

Required:

1. Evaluate whether the audit procedures performed by the former auditor, Liling, at the

interim stage of the audit are sufficient. Outline additional procedures (and the

related assertions) that should be performed by the audit team based on your review

of his work. Use a chart like the one below to structure your response. (24 marks)

Evaluation of each procedure performed Additional procedures required

2. Based on all of the information that has been gathered on GGI (including that in

Assignment 1), the partner has identified a number of areas requiring further

investigation. See the table below for details.

For each of these areas, discuss how the issue presents a risk of a material

misstatement at the assertion level and what assertion is affected, and design a

substantive audit procedure to address the identified risk. Be specific; marks will not

be awarded for generic audit procedures. Include what assertion(s) is being tested.

Use a chart like the one below to structure your response. (18 marks)

Issue

What is the risk of

a material

misstatement?

Account and

assertion impacted

Substantive audit

procedure to

address risk

Inventory is not

being counted as it

is being received.

Example: Inventory

may not be

recorded, and there

may not be

purchases accrued;

therefore, inventory

and the related

payable may be

understated.

Example: Inventory

and A/P

completeness and

existence

Example: Perform

test counts of

inventory and

compare them to the

inventory subledger

to ensure that

inventory on hand is

reflected in the

subledger.

Select invoices

received both

immediately before

and immediately

after year end from

suppliers and trace

them to the

accounts payable

subledger to ensure

that all payables are

captured in the

appropriate period.

Issue

What is the risk of

a material

misstatement?

Account and

assertion impacted

Substantive audit

procedure to

address risk

As a grocery store,

GGI sells many

perishable products

that are only

saleable before their

expiry dates or while

product is still safe

to consume.

GGI sells health

supplements with a

short shelf life (two

to six months).

GGI has not

recorded the 10%

purchase rebates on

beef for the year.

NBYP pays GGI a

25% commission

every quarter based

on reported sales.

GGI waits until the

commission is

received before

recording it.

NBYP inventory is

mixed with GGI

inventory.

Unreconciled

transactions with

Sweet Treats.

Nousha claims she

was charged for

product she never

received from GGI.

Ray could not find

any records of the

deposits for the

invoices in question.