Discuss the significant business risks of overclocked

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Reference no: EM132627327

City Partners are a firm of chartered certified accountants and are planning the audit of Overclocked, a domestic manufacturer and retailer of personal computers. The following background information is pertinent.

Revenue for the year ended 30 June 2020 was $7m (2019: $5m), profit before tax was $2m (2019: $1m) and total assets were $5m (2019: $3m). Overclocked has strategies for growth and to improve efficiency and requires finance to:

  • Broaden its available market by selling computers through national retail chains
  • Set up a division in Germany to purchase and warehouse computer components
  • Construct new manufacturing premises

Overclocked sets annual operating budgets at the start of each financial year and these typically underestimate actual revenues and expenses, because of consistently higher than expected growth in sales. Management accounts are produced infrequently. The cost of sales used for the management accounts is calculated using standard percentages of selling prices. Actual gross margins on major product lines have become materially varied, because of negotiations with individual customers and suppliers.

The CEO takes personal charge of buying, selling and inventory management. She is the main contact with suppliers and customers and she negotiates prices directly with both.

A recently installed, internally developed computer system provides basic payroll, sales, receivables and inventory information. The software was written to the CEO's specifications by an IT graduate, who has since taken full-time employment with the public service.

A senior bookkeeper (not a qualified accountant) was recently appointed to tighten credit control, reduce receivables and to set up more formal accounting systems and procedures. Purchasing is recorded manually because of the complexity of foreign currency conversion (many purchases of materials are from European suppliers). Purchase prices and quantities are entered into the inventory system manually, by the bookkeeper. The system can then generate a current listing of both the computers and the components in inventory. At the end of the year, inventory totalled $1.5m (2019: $0.8m). Overclocked also experienced an increased level of returns because of faulty products. In 2020 returns totalled $0.1m (2019: $0.05m).

The growth of the business has resulted in the company outgrowing its premises. The CEO is negotiating a loan from her bank to cover the cost of constructing new premises. The design stage is complete and building of the premises has commenced. Overclocked's bank is waiting for a profit forecast before considering whether to approve a $1m loan, to finance construction of the new premises.

Overclocked often encounters liquidity shortages because of the high rate of growth in sales. It has an overdraft and often exceeds the limit agreed with the bank. The CEO expects a large receipt from a major customer at the beginning of next month, which will be used to clear some tax payment arrears.

Required:

Question 1: Identify and discuss the significant business risks of Overclocked, that City Partners should consider when planning the audit.

Reference no: EM132627327

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