Audit plan for Fast Appliances Inc.

Planning Memo for Audit of Financial Statements of Fast Appliances Inc.

Case Assignment Part 1

It is January 20, 2021. You, a senior auditor with Joakim and Partners LLP, are meeting with audit partner, Robin Joakim, to discuss the year-end audit of a new client, Fast Appliances Inc. (FAI).
Tom Fast, CEO and co-owner of FAI, approached Robin two weeks ago about the audit, and she has since accepted the client.

Jenny Kwong, a CPA student with the firm, started planning for the engagement last week by calculating preliminary materiality as $135,500, based purely on 6.5% of net income. Jenny also
performed a financial statement analysis. Robin reviewed the financial statement analysis and provided review comments directly to Jenny; she hasn’t had a chance to review the materiality
calculation yet.

Robin has asked you to prepare a planning memo for the audit of the financial statements of FAI for the year ending December 31, 2020. The memo should include an assessment of the overall financial statement risk, a discussion of materiality and the audit approach, and a description of the high risk financial statement items along with specific audit procedures that may need to e
performed. The focus should be on the audit plan for now so she would NOT like you to include an assessment of FAI’s internal controls at this point in time. However, she would like you to consider if there are any other engagement issues that should be addressed. Robin has provided you with background information on FAI (Exhibit 1), notes from her interviews with Tom and FAI’s general manager, Robb Chedzey (Exhibits 2 and 3), and the draft financial statements (Exhibit 4).

Required:

Prepare the memo requested by the partner.

(CPA Ontario, Adapted)

Background Information Prepared by Robb Chedzey

In 1974, Nate Fast founded FAI, a home appliance manufacturing company located in Kingston, Ontario. FAI’s reputation was very important to Nate, who valued quality and customer service above all else. Over the years, the home appliance industry expanded significantly and became more competitive. Five years ago, in response to the industry changes, FAI decided to reduce its
product line, and began specializing in niche products while maintaining its focus on customer relationships and quality.

In 2014, Nate Fast retired and transferred ownership of FAI directly down to his three children, Tom, Rachelle, and Brent. Rachelle is a family doctor and Brent is a chef; with successful careers,
their involvement in the business is limited to attending the annual meeting. At the annual meeting, the financial statements are presented by Tom and they go over the previous year’s financial
results. Brent and Rachelle tend to focus on the revenue figures, asking many questions about changes and fluctuations. Annual dividend payments are made at this time.

Case Question

Three years ago, FAI launched a highly anticipated product called the Flash Freezer. This specialized product is able to freeze items four times faster than conventional freezers, resulting in frozen food that is better tasting and, because fewer nutrients are lost during the freezing process, more nutritious. In its first year on the market, demand for Flash Freezers sky-rocketed, and FAI decided to cut all other product lines.

FAI currently employs 180 people. Until 2020, its customer base consisted of large retail firms that purchase the Flash Freezers on a wholesale basis, and restaurants and other food producers that order custom versions of the freezers. Early in 2020, in an effort to improve sales, FAI decided to expand into e-commerce by developing a website to sell freezers directly to retail customers. The website became fully operational in April 2020, and has been quite successful, significantly offsetting declining margins.

Recently, Brent and Rachelle expressed an interest in selling their shares in FAI to Tom. They have begun negotiations and have agreed that the purchase price based on a multiple of 2020
earnings, would be acceptable. The 2020 audit is a direct result of this pending sale. Brent and Rachelle requested the audit, and Tom reluctantly agreed that it would be a good idea.

Notes from Meeting with Tom Fast

Tom would like to take the company public at some point in the future; as such, FAI transitioned to IFRS in 2018. To realize this goal, Tom plans to put a strategic plan together after he buys out
Rachelle and Brent. He doesn’t feel like going through the hassle of obtaining their approval of the plan. Realizing that the business, and control environment, has changed over the years, Tom has asked for an assessment of FAI’s internal controls, along with practical recommendations for improvement. Since 2018, when Brent requested that Tom’s son Simon be let go from the company, there has been an increasing level of tension between the owners. Brent didn’t think it fair that Simon received a job at FAI while his children did not.

During the last half of 2020, FAI began selling maintenance service contracts. By the end of the year, FAI had sold 200 two-year contracts for $2,500 each. The accounting system is tracking both the parts and labour costs associated with the maintenance servicing as a component of cost of sales. To be kept in running order, Flash Freezers require maintenance every three months. FAI sells the maintenance contracts for regular servicing of the freezers to customers who place custom orders. He presented the idea to Brent and Rachelle, who were initially hesitant; they were concerned that customers would not be required to pay for the contract until the end of the term. However, after some convincing, Tom was able to obtain their approval. Last year, Tom’s son Simon incorporated Compressors Inc. (CI), a manufacturing company that produces freezer compressors. Simon was able to set up CI with financial assistance from Tom.

Background Information Prepared by Robb Chedzey

Compressors are a key part of the production of freezers. FAI currently purchases all the compressors required for manufacturing blast freezers from CI, and FAI is CI’s main customer. Salespeople at FAI are responsible for managing client relationships with wholesale and customorder customers. Until recently, salespeople were paid based on a fixed salary scale. When Nate founded FAI, he wanted to create a no-pressure sales environment for his customers, and therefore did not pay commissions. However, the industry has changed, and in order to retain top performing salespeople, Tom decided to add a commission component to the salespeople’s compensation. As such, salespeople receive a 5% commission paid based on the signing of maintenance contracts.

At the same time that the website was developed, FAI also upgraded its computer system. It purchased a top-of-the-line accounting system that significantly improved tracking of sales, accounts receivable, and inventory. FAI performed significant testing on the system when it was implemented, and Tom was very satisfied with the system’s accuracy. As such, he decided to reduce the number of inventory counts performed from monthly to quarterly. As a gesture of goodwill to his manufacturing staff, who usually complained about having to work over the holidays, he also decided not to perform a December 31 count.

Notes from Meeting with Rob Chedzey Prepared by Robb Chedzey

Wholesale and custom orders, and maintenance contract sales, are entered directly into the system by salespeople. The system then tracks the order’s progress, tracking work in progress for custom orders. Because each customer order has different specifications, FAI does not maintain a master price list for custom sales. Instead, salespeople are provided with discretion to set pricing, based on the details of the order. Revenue on custom orders is not recorded until approved by Tom in the system.

Credit is only offered to wholesale and custom order customers. Retail customers are required to pay at the time of ordering, using credit cards. To save time and improve customer relationships,
salespeople are responsible for setting credit limits for new customers. Approval from the sales manager is only required on credit limits set for wholesale customers.

As each part is taken out of inventory and moved into production, manufacturing staff scan the item. The system is updated automatically, based on the scanning process. Manufacturing staff is also required to sign in and out of each shift, using a computer located in the warehouse. If a staff member is working on a custom order, project details must be entered when they sign out for the day. The system uses this information to update production costs for direct labour.

Inventory generally fluctuates between $400,000 and $900,000, and an inventory write-up is usually required when inventory is counted.

The warehouse manager is responsible for all purchases. For any purchase over $500, a purchase order must be created. One copy of the purchase order is sent to the vendor, and the other copy is sent to the accounts payable clerk. When an invoice is received, it is matched to the purchase order (if there is one), and a cheque is prepared by the accounts payable clerk. Cheques are printed on a printer outside of Robb’s office. All cheques over $5,000 require both Robb’s and Tom’s signatures; cheques under $5,000 are signed by Robb only. Tom keeps a signature stamp with his administrative assistant, in case he is unavailable when cheques need to be signed. For any cheque over $50,000, Tom requires supporting documentation.

Excerpts from FAI’s Financial Statements