Reference no: EM133327720

Case: Bazaar buys computers, parts, and related equipment and resells them at a mark-up to a loyal base of corporate customers. Competition is growing, but the market is favourable, and Bazaar offers excellent customer service, giving it a competitive advantage. The owner is very involved in most of the important operating decisions. His capable assistant steps in when necessary. The owner plans to implement a code of ethics at some point and also wishes to improve certain controls.

Bazaar is a medium-sized private company that operates multiple warehouses, each carrying a mix of inventory items. The first type of inventory, which can be quite costly, consists of specialized computer hardware, desktop computers, and laptop computers. The turnover rate for this inventory is high since new technology is always emerging. Because the company orders months in advance, Bazaar occasionally overestimates demand. After three or four months, products are difficult to sell, but they are kept because most cannot be returned to the supplier, and Bazaar is reluctant to hold liquidation sales for fear they would negatively affect the sales at regular prices. The second type of inventory, parts and peripherals, generates a significant portion of Bazaar's sales. This category includes items such as monitors, printers, and toner cartridges. The third type of inventory includes software packages ranging from sophisticated operating systems to games. This inventory can be returned to suppliers if unsold after a certain period.

This year, Bazaar implemented an integrated computer system to manage the general ledger as well as inventory, purchases, and sales. Sales representatives enter orders into the sales database, and can modify the information, including quantities and selling prices. Any changes are usually made to orders before shipping. Problems result if representatives make changes after shipping since they should issue credits instead. The timing differences create reconciliation problems for both customers and Bazaar when settling invoices. Also, sometimes credits have been issued in error. For example, the owner described one example where a credit was issued for a price adjustment made by a sales representative. The supporting paperwork stated that the credit had been issued in error (which seems to happen often) and the refund cheque was cancelled. However, the details of the refund cheque could not be located. When asked, the clerk said he left the cheque copies on his desk and the next morning they were gone. He gave up looking for them.

Electronic purchase orders require authorization from either the owner or his assistant through the use of a personal identification number (PIN). Each user has a specific PIN. Orders greater than $5,000 require the owner's authorization. Occasionally, the owner is not available. He has given one of the accounting clerks he trusts his PIN to be used for emergency situations. Before making a payment, the accounting department matches the invoice to the authorized purchase order and the receiving slip.

Other Information

The owner noted that Bazaar's costs seem higher than expected, particularly since this year he decided to pay suppliers faster in order to benefit from discounts. According to his calculation, the cost of goods sold should have decreased by around 2% over last year, since most suppliers offer discounts and did not increase prices. Instead, he noted a 3% increase in costs.

The sales mix has not changed significantly from previous years. Purchases increased and were distributed across the inventory types in amounts similar to the overall sales mix. To help retain the sales team, stock options were given this year for the first time as an added form of compensation. The options are available of Bazaar's net income after tax is at least $5 million per year.

Customers have 30 days to pay invoices, but most take advantage of a 2% discount offered for payment within 10 days. Customers make payments in full payments and discounts are reimbursed later by system-generated cheques. Cheques may be issued with or without supporting documentation.

The owner noted he just received a memo from a clerk at one of the warehouses. It says the amount of damaged inventory has been gradually increasing over the past eight months. The clerk suggests this is because the forklift is not operating properly, and items are being dropped as they are loaded for shipment. He wants the forklift replaced. He asks what he should do with the damaged inventory that has been piling up in a corner of the warehouse. He suggests holding a liquidation sale to get rid of it.

Required:

(a) Assess and conclude on inherent risk. Be sure to discuss items that both increase and decrease risk for a balanced discussion. (you should have at least 3 for each increase and decrease and make an overall conclusion)

(b) Assess and conclude on the control risk. (you should have at least 3 and make an overall conclusion)

(c) Based on your inherent and control risk assessment, conclude on detection risk.

(d) Based on the risk assessment, what type of audit strategy (approach) should be implemented? (be sure to include some support as well)

(e) Identify three control weaknesses at Bazaar. For each weakness, indicate the implication and make a specific recommendation how Bazaar can fix it.

(f) What is the auditor's responsibility with respect to fraud when performing a financial statement audit? Assess the fraud risk at Bazaar and indicate what should be done when planning the audit.