Reference no: EM132909071

Alterra Coffee Roasters Inc. (ACRI) is a manufacturer and distributor of decaffeinated green coffee. The company was founded by Leonard Blix who is currently the chairman and CEO and owns 35% of the company. ACRI's shares also trade on the Toronto Stock Exchange. ACRI owns a proprietary ALTERRA WATER Process to decaffeinate coffee without the use of chemicals. By comparison, the vast majority of other decaffeination processes use chemicals to remove caffeine. The system is certified organic by the Organic Crop Improvement Association. Operations are conducted from a 38,000 sq. ft. leased facility in Burnaby, B.C. The company's year-end is December 31st and is audited by Khan & Lin LLP, a public accounting firm.

• The demand for decaffeinated coffee and specialty coffee has been steadily increasing over the past decade and ACRI has attempted to increase awareness of the Alterra Water© Process through public relations, customer co-marketing events, social media and web management. ACRI has enjoyed a steady growth in sales and always achieves or outperforms performance targets. In the current year ACRI revenues increased by about 6.5% from $82 million last year to $87.4 million.

• Leonard, is known throughout the Canadian coffee industry as a man of principle and integrity. He has grown the company based on the principles of corporate social responsibility, financial discipline and offering superior quality products. The company has grown to 93 dedicated employees; employee turnover is extremely low. Each new employee is vetted by Leonard himself along with a the HR manager and the employee's direct report. All shortlisted potential employees also undergo background and reference checks. New employees are given extensive training on the key principles of the organization. Following these principals, ACRI has a strong balance sheet which includes: 10 million in cash, virtually no debt and shareholders' equity of $47 million. ACRI enjoys a strong credit rating with a "AA" score from Moody's.

• ACRI corporate social responsibility efforts have been recognized internationally and the company has been awarded major awards in the area. Unfortunately, in the current year a consumer protection agency claimed that it tested some of ACRI's coffee and discovered that some ACRI coffee had been exposed to some chemicals. A number of customers have filed a class action lawsuit relating to the matter. Management of ACRI has vehemently denied these allegations and has asserted that these allegations will not be substantiated in court. Leonard believes a competitor tainted the results.

• ACRI's largest asset is inventory, which consists of premium-grade green Arabica coffees. ACRI works with various coffee importers to source their coffee from producing countries located in Central and South America, Africa, and Asia. The purchase price is based on the N'Y'C' coffee commodity price on the Intercontinental Exchange, plus a quality differential and therefore fluctuates, as all commodity prices, based on demand and supply. All inventory is purchased in U.S. dollars.

• Due to space limitations in the current facility ACRI began using the services of Seaforth Inc. which provides warehousing, handling and storage services. Seaforth is equally owned by Leonard and his two children. ACRI purchased approximately $3.3 million in services from Seathforth in the current year. ACRI is Seathforth's largest customer comprising of 95% of Seaforth's sales. ACRI also provided Seaforth with a non-interest bearing loan to help it get started with it's operations.

• In September 2020, ACRI implemented a new general ledger and inventory management system. ACRI spent a significant amount of time and effort into investigating the new system as the old system could not deal with the increased volumes and would frequently crash causing disrupted operations. A steering committee was established to oversee the purchase and implementation of the new system. The committee consisted of management from the operations, finance and legal departments, several other key users of the system and Tom Khan, the external audit partner. Detailed system requirements were devised and the committee selected the software that best fit these requirements. Inclusion of Tom on the committee was particularly valuable because he was able to use his knowledge of ACRIs business to provide control recommendations for the new system. For instance, the selected system has state of the art access and security controls; each employee is only granted access to functionality that they require for their job responsibilities. The system selected calculates cost based on the FIFO method and can easily handle the issues that arise when inventory purchase prices fluctuate and when inventory is purchased in a foreign currency. The new system was also tested by many employees and the IT team prior to the implementation.

• Unfortunately, there was one glitch in the system conversion and a $500,000 batch of coffee beans which existed at the time conversion was not transferred into the new system. The beans were never sold because they were not showing as available in the system. The beans became spoiled and the company was forced to record inventory loss of $500,000. Even with the write-down, total assets were $58 million; however the write down resulted in a net income before taxes of $3.6 million expected for the year ending December 31, 2020, a reduction from the previous year's net income before taxes of $4 million. ACRI performed an audit of the conversion after the glitch was discovered and found that this was the only error that was missed.

• ACRI success and attractive balance sheet has made it a target for takeover in the market. Recently, management of Nestle, a large international coffee roaster, approached ACRI's senior management and proposed an attractive buyout offer for the shares of ACRI.

• Khan & Lin LLP has been the auditor of ACRI for the past 10 years. In that time there have been very few misstatements discovered during the audit that required adjustments. The audit of ACRI has been fairly routine without any significant issues arising. Today is October 22, 2020 you are the audit manager for the ACRI audit for the year ending December 31, 2020. Tom, the audit partner, has told you to begin the audit planning for this year's audit as this would be a busy a year. He told you to also include some more time in the audit budget for the ACRI audit. Nestle had recently approached him and asked for the audit team to perform some additional procedures during the audit of ACRI. Nestle asked that the results of the procedures remain confidential and not tell ACRI about this additional work.

Problem 1: Determine overall planning materiality and performance materiality. (Explain the rationale for all components of the calculation and support your analysis with calculations).

Problem 2: Identify 4 case facts that impact the risk of material misstatement (inherent risks or control risks) at the overall financial statement level (OFSL). For each factor identified, indicate if the factor increases or decreases risk, the type of risk (inherent or control) and provide your rationale for why the factor increases or decreases risk.
Case fact which impacts RMM at OFSL level
Does this factor increase or decrease risk
Type of risk (control risk or inherent risk)
Rationale for why this factor increases or decreases risk

Problem 2: Identify 3 case facts that increase/decrease the risk of material misstatement at the account balance and assertion level. For each case fact identified indicate: the account balance and assertion affected, whether the factor increases or decreases risk, the type of risk (inherent or control) affected and provide your rationale.