Reference no: EM131337976

Farmco is in the agricultural industry and has five branches located in Saskatchewan. Farmco's year end is June 30. Farmco is well established and has been profitable for many years. It is privately owned, and its inventory and receivables turnovers and debt to equity ratio are all comparable to industry averages.

Half of Farmco's revenue is derived from the sale of animal feed supplements and animal health products. This revenue is earned fairly evenly throughout the year. The products are purchased from 20 regular suppliers, and another 20 suppliers are used on an occasional basis. Sales are roughly equal at Farmco's five locations, and each location normally keeps one month's inventory of these products on hand. The credit terms that the feed division's suppliers allow Farmco are varied, but most suppliers require payment from Farmco in 30 days, with some offering small discounts for early payment. The credit terms Farmco offers its feed division customers are net 30, 2/10. The other half of Farmco's revenue is from the sale of fertilizer and herbicides. This revenue is very seasonal, with most fertilizer sales occurring between mid-March and mid-May, and most herbicide sales in May and June.

The fertilizer is delivered directly from the manufacturer to the customer by Farmco trucks, so no inventory is kept on hand, except for the occasional truckload of product in transit. By year end (June 30), fertilizer sales are complete. Farmco purchases all fertilizer from one supplier. Any herbicides that remain unsold at the end of the season cannot be kept for the next year because they expire, so any amounts on hand on June 15 are returned to the supplier. This is the normal industry procedure.

The herbicides are purchased from three different suppliers. The credit terms for the fertilizer and herbicide division's customers are quite different from the credit terms for the feed division's customers. Fertilizer and herbicide customers can get a substantial discount for placing and paying for orders early. However, many customers prefer to take advantage of another option Farmco offers, which is to pay interest on unpaid balances and then pay for their purchases in October, after crops have been harvested. Farmco receives the same credit terms from its fertilizer and herbicide suppliers, and pays them when cash is received from its own customers.

The five branch managers and one company sales representative report to the general manager. The general manager reports to the president of Farmco's parent company, who lives in Regina. Management team meetings, attended by the parent company's president, are held quarterly, and branch revenue and profits are compared in detail. The managers receive an annual bonus based on the net income before taxes of their branch, and the general manager and the controller receive bonuses based on Farmco's overall net income.

At Farmco's head office, the full-time accounting staff consists of the following people:

Joan (the controller)

Ernesto (full-time senior accountant)

Wendy (a temporary accounting assistant who is hired from March to August to deal with the extra work required by the seasonal sales of fertilizers and herbicides)

Each of the five branches also has one office administrator, who handles mainly accounts receivable and general office duties.

All purchases are made using a purchase order system. Branch managers order products directly from the approved suppliers using pre-numbered purchase orders, one copy of which is sent to the head office when the order is placed. Ernesto files these purchase orders numerically until the supplier's invoice is received.

When goods are received, the branch's warehouse supervisor prepares a pre-numbered receiving report, signs it, and sends it with any delivery documents to head office, where Ernesto files it numerically. Once a month, Ernesto reviews the purchase orders and receiving report files, and follows up on any missing numbers.

Suppliers' invoices are normally sent directly to head office, where Ernesto matches them with the signed purchase order and receiving report, checking the supplier's calculations and initialling the invoice to note that he has done so. He then posts the payable invoice. The accounts payable system requires that the due date and any discounts available are entered when the invoice is posted. Once a week, Ernesto runs a cheque requisition listing, which is a list of payables due that week. Joan reviews the listing and initials all that are to be paid. Ernesto then prepares the cheques, attaching the supplier's invoice, purchase order, and receiving report to each cheque. During the busy months, Wendy helps out with all of these tasks, mainly focusing on the fertilizer and herbicide accounts, but available to help wherever asked to.

The cheques, together with the supporting documentation, are routed to Joan and the general manager for signing. Joan initials each supplier invoice before signing the cheque. The general manager double-checks the purchase order for price and for branch manager approval, then initials the purchase order before signing the cheque.

Each month, Joan prepares the bank reconciliation, which is reviewed and initialled by the general manager. Accrued liabilities are recorded only at year end, and Ernesto and Joan have divided responsibility for these calculations and entries.

Required

(a) Identify four specific factors that would either increase or decrease the inherent risk for Farmco's accounts payable and/or accrued liabilities. State whether the factor would create an increase or decrease.

(b) State your conclusion on the risk level.

(c) Identify four internal control objectives that appear to be met for the acquisition and expenditure cycle; describe one specific control procedure to meet each of the objectives identified; and indicate how the auditor would test the control(s).