Audit how industrial environment influence the company. Newport Soup Inc.: An interactive inherent risk assessment case ABSTRACT In this role-play case, you will assume the role of an auditor who must gather relevant information about your client and assess inherent risk for six financial statement accounts. To initiate the process of understanding your client’s business, you must email professional inquiries to the “client” (a role played by your instructor) and “ask the right questions” to acquire the information necessary to assess inherent risk. Ultimately, you are asked to prepare a professional memo documenting your assessment of inherent risk for six account balances as part of the audit planning process. An important component of the case is the performance of analytical procedures, which you must interpret using your understanding of the company and the industry in which it operates. Introduction It is November 20X6, and you are part of the audit team that is performing various audit planning procedures for the audit of the financial statements of Newport Soup, Inc. (NSI), as of December 31, 20X6.1 NSI makes soups and sells them in the United States (US) and all around the world. After years of losing popularity domestically, the US Department of Agriculture (USDA) reports that soup has made a comeback. Evidence of the comeback is observed by a ten percent increase in soup consumption in 20X6 relative to 20X5. While end consumers of NSI’s soup are individuals, the bulk of NSI sales are to grocery, department and convenience stores. Three of NSI’s most significant grocery store customers are Hammis Fleeter, Pubticks and Alexis Foods. Table 1 contains six account balances as reported in NSI’s September 30, 20X6 un-audited financial statements. Table 2 contains the balances as reported in NSI’s 20X5 audited financial statements. NSI has never had to restate its financial statements and has a reputation for having a fairly ethical management team. Top management (i.e., CEO, CFO) receives base salaries and bonuses that are triggered by NSI’s ability to grow sales and meet Wall Street analysts’ earnings per share (EPS) expectations. NSI has met or beaten analysts’ EPS forecasts in only five of the last 12 quarters. Table 1 Unaudited balances as of September 30, 20X6, Newport Soup, Inc. Sales revenue $2,325,000 Cost of goods sold $1,453,125 Accounts receivable $1,200,000 Less: Allowance for doubtful accounts ($50,000) Net accounts receivable $1,150,000 Inventory $200,000 Less: Reserve for spoilage ($10,000) Net inventory $190,000 Table 2 Audited balances as of December 31, 20X5, Newport Soup, Inc. Sales revenue $2,400,000 Cost of goods sold $1,500,000 Accounts receivable $800,000 Less: Allowance for doubtful accounts ($50,000) Net accounts receivable $750,000 Inventory $100,000 Less: Reserve for spoilage ($5,000) Net inventory $95,000 Inherent risk assessment To help perform high quality inherent risk (IR) assessments, the Public Company Accounting Oversight Board (PCAOB) provides guidance within Auditing Standard (AS) 2110 (Public Company Accounting Oversight Board (PCAOB), 2010a) regarding factors that auditors should consider when assessing IR. In performing your risk assessment and writing your memo, you should follow the guidance below from PCAOB AS 2110 and read the standard available at Obtain an understanding of the company, its primary products, the industry in which the company operates, and its competitive standing within this industry (PCAOB (2010a) AS 2110, Paragraphs .07 and .09). Evaluate the characteristics and incentives of management, including incentives resulting from management’s compensation structure and analysts’ earnings expectations (PCAOB (2010a) AS 2110, Paragraph .17). Obtain an understanding of recent developments within the company and its industry (e.g., by talking with management and reading news articles and press releases) and analyze the related business risks (PCAOB (2010a) AS 2110, Paragraphs .11 and .15). Obtain an understanding of the financial accounting principles associated with each account balance and the resulting effect on the complexity or subjectivity of the account (PCAOB (2010a) AS 2110, Paragraphs .12–.13). Perform analytical procedures for each account balance using your understanding of the company and the economic environment in which it operates to form expectations about resulting trends and relationships (PCAOB (2010a) AS 2110, Paragraphs .46–.48). Your trend analyses should include the following comparisons: Current year-to-date account balances and financial ratios compared to prior year(s), both in absolute and in common-sized terms. Trends occurring in one account compared to trends in other, related accounts (e.g., the consistency of changes in sales revenue with changes in other accounts affected by the sales and collection cycle). Trends occurring in NSI’s account balances and financial ratios compared to the same trends at peer companies in the industry. Current year-to-date account balances compared to the amount budgeted or expected by the company. Evaluate the complexity of the account balance, taking into consideration the complexity of relevant financial accounting standards and their implementation and complexity of transactions (e.g., non-routine transactions) (PCAOB (2010a) AS 2110, Paragraphs .60 and .71). Evaluate the amount of judgment required on the part of management to arrive at the account balance (PCAOB (2010a) AS 2110, Paragraph .71: PCAOB (2015) AS 2501, Paragraphs .04 and .07). Evaluate the potential for fraud by “brainstorming” how and where fraud is most likely to occur within the company’s financial statements (PCAOB (2010a) AS 2110, Paragraph .52). You may utilize the risk assessment template in Appendix B in order to organize risk factors associated with each account for use when writing your memo. Requirements Your task is to assess the level of IR associated with six account balances, which include two income statement accounts and four balance sheet accounts. You are to assume that your assessment is taking place in November 20X6 (one month before NSI’s year-end date of December 31, 20X6) as part of the audit planning process. In conjunction with the guidance in step #5 above, one of the first things you should do is roll forward the income statement balances. That can be as easy as multiplying the income statement accounts by 4/3 to project annualized numbers (unless there is a reason to expect some other projection for the annualized amount). You do not need to project annualized numbers for the balance sheet accounts, because those accounts reflect balances as of a certain date rather than activity for the year. Between now and the due date, you should obtain an understanding of IR by reading AS 2110, asking questions, and requesting evidence from a client representative at NSI. Your professor will be playing the role of the client. Your client may have some documents that will assist you in your IR assessment. To obtain these documents and any other information about the soup industry and/or NSI, you must email questions to “the client” (i.e., your professor) in a manner that is clear and professional (see Appendix A). While your goal is to obtain all information needed to assess IR, recognize that clients (and professors) are busy, so you should send as few emails as possible to get the information you need. Please include your section and group number when emailing the professor. Remember that high-quality IR assessments involve number crunching, critical thinking, and making professional inquiries in order to obtain information. You will only be able to email your client until March 2 at 3pm. Once you have obtained and evaluated information from the client, you will need to prepare a professional memo that includes an IR assessment for each of the six account balances as reported in NSI’s September 30, 20X6 un-audited financial statements (see Table 1). Keep in mind that certain risks have the potential to affect most, if not all, accounts. You should begin your memo by identifying pervasive risk factors that either increase or decrease the IR of the overall financial statements. Once you have established a baseline level of IR for NSI as a whole, you should then assess IR for each individual account balance. In addition to providing your IR assessment for each account, your memo will also need to provide a detailed explanation of how you arrived at your IR assessments. This IR assessment and documentation process serves as the starting point for determining the testing needed for the audit (although consideration of testing procedures is beyond the scope of this case). There is no minimum required length for this memo, however it should not exceed 10 pages, double-spaced. Grading The maximum amount of points to be awarded for this case will be 80 points. The points will be allocated between the quality of the content of your memo (40 points), quality of writing of your memo (10 points) and the quality of your information search (30 points). Appendix A Guidance for communication with clients When making inquiries of your clients, the quality of the information you receive will often be a function of the quality of your inquiries. For this case, all of your communication will be via email. As such, these guidelines are specifically prepared to support high-quality email inquiries. Edit your emails to eliminate grammar and spelling errors. While no client expects emails from auditors to be perfect, simple mistakes like using “there” instead of “their” can significantly impair a client’s perception of you. Most email software includes spelling and grammar check, but you should also proactively review your emails for errors that the software might not catch (i.e., the aforementioned “there” versus “their” error). When your inquiries are grammatically incorrect, your client may be unable to decipher your request and/or may be less inclined to respond in a complete manner. Use a professional and respectful tone in your emails. Inquiry with audit clients requires sensitivity, especially in an IR assessment task, because the auditor is trying to assess the likelihood that a material misstatement has been made by the client. The use of deferential terms like “please” and “thank you” is obvious, but you should also take special care to use language that is nonthreatening. Accusatory language of any kind is strictly forbidden. If your tone is perceived as being anything less than respectful, your clients will be less likely to respond favorably to your inquiries. Ask direct, well-informed questions. If you are trying to elicit a detailed response to your question, you should ask it in a manner that is direct and clear; ambiguity tends to be met with poor responsiveness. For instance, if you merely ask for “information” or “reports” your client will have no idea what you want. However, if you ask for a report by name (i.e., Monthly Sales Report) then your client will know exactly what you want. Additionally, you should ask questions that indicate that you have done an appropriate amount of analysis prior to asking the client. For example, if you are asking about a trend in your client’s revenues, then you should include your calculations of sales growth within your email inquiry. Clients will have little patience for questions to which you should already have the answers. Communications must be respectful of your client’s time. Clients have responsibilities other than answering your questions. The best way to deal with busy clients is to combine your questions into as few emails as possible. Combining your questions into one or two messages reduces the number of disruptions for the client. You should also ask the client your well-informed questions as early as you possibly can. This gives the client time to respond to your request at their convenience. If you need information by Friday, then you should try to request it on Monday or Tuesday. Requests at 5:00pm on Thursday for information you need from a client on Friday morning will likely be met with contempt. By asking for something at the last minute, you imply that your time is more important than your client’s time. On this assignment, if you do not have everything you need by the communicated deadline, then you will not receive it. Your client does not work weekends. Appendix B Risk assessment template Instructions: Using the following template, describe the risk factors you considered while assessing the level of inherent risk for the account you indicate below. Next to each risk factor, insert a “+” or “−” to indicate whether the item increases or decreases inherent risk. Finally, indicate your overall assessment regarding the level of inherent risk for the account. Name of the account being evaluated: __________________________________ Risk factor description Inc/dec inherent risk 1. 2. 3. 4. 5. 6. 7. 8. Overall, the inherent risk for this account is assessed at: ____________________________

    Newport Soup Inc.: An Interactive Intrinsic Occasion Assessment

    Intrinsic Occasions

    There is a occasion that the directors may be tempted to remodel the statements of accounts in appoint to describe a emend financial heartiness foothold of the community. Nonetheless, there undergo referable been esthetic adjustments control life entries which decreases the Intrinsic occasion gone the chances of doctoring accounts are fewer. The Management team’s sort is if excellent honesty which as-courteous decreases Intrinsic occasion. The community has as-courteous referable conversant a important shrinkage in in the appraise of the appraise of catalogue. This media that there has been referable losses of catalogue decreasing the chances that the community’s hoard succeed be dealt with unbefittingly or equable stolen.

    In adduction, there is a possibility the sales that succeed be aloft the target succeed be misappropriated gone there is no benchmark to assimilate with the sales type (Martin 38). The soup making costs undergo should referable undergo such a great abnormity in appoint to segregate the possibility of wrong.

    The resolution of the dispense trends and emulation deportment, it is certain to determine that the dispense is emotional towards broths and protein soups. Control case, Competitor A is the dispense guide in Broths and protein soups. Competitor B is as-courteous forward of Newport Soup Inc int the protein soups dispense and is courteous placed to catch usage of any slip-ups by the brace adventitious competitors. This increases the intrinsic occasion of the community as a going regard. Newport Inc. as-courteous maintains a excellent raze of catalogue which makes the community undergo the occasion of experiencing a proportionately excellenter intrinsic occasion.

    Work Cited

    Martin Ives CGFM, C. P. A. “Creating Deficits with Balanced Budgets.” The Life of Government Financial Management 60.4 (2011): 38.