Smackey Dog Foods Inc.

Scenario

Smackey Dog Foods Inc.—Scenario Summary

Smackey Dog Foods Inc. started in the kitchen of Sarah, Kim, and  Jillian’s family home in the suburbs of Chicago. The three sisters  initially bought the ingredients for their natural dog food recipes from  the local grocery store. They used their dogs and the neighborhood dogs  as their taste testers. Their dog food products were so good, the local  kennels and veterinary offices were glad to distribute the sisters’  products to their customers.

Local demand increased significantly. Local pet stores and small  grocery stores discovered the products and became distributors. The  sisters moved the expanding business into a larger facility and hired a  few more workers. Although their competitors’ sales were flat or  declining, Smackey Dog Food Inc.’s sales were on a vertical climb!

Sales were so good last year that the sisters opened a boutique  division named Best Boy Gourmet, specializing in freshly manufactured,  one-serving packages meant for consumption no later than 3 days after  production. They sell this product at three times the cost of their  other products and by special order only through their new website.  Demand is high, but waste has been an issue.

Sarah is the president and general manager of the operation. Sarah  has been very proactive in growing the business. She has met with her  banker to discuss expanding the facilities and equipment with another  $150,000 loan. Their first loan for $150,000 was secured by the  industrial-size food production equipment purchased with the loan. The  banker now demands an audit of the corporate financial statements before  releasing another loan to the company. Sarah has offered to place the  corporate account receivables up as collateral to secure the second  loan. Based on revenue projections by her sister Jillian’s sales team,  Sarah believes that the company will not have trouble paying down the  loan in a short period of time.

Kim manages the production operations. She oversees the inventory,  production, and shipment of dog food products. The Best Boy Gourmet line  has taken almost all of her attention lately. The winter holidays are  approaching, and sales demand based on forecasts from the sales force  are higher than ever. Attaining fresh, raw ingredients is more difficult  in the winter months. If any of the fresh ingredients are delayed, production comes to a standstill. There has been significant inventory waste as a result.

Kim’s assistant, Henry, monitors the production and shipment of  Smackey Dog Food’s regular line of products. Henry takes pride in his  work and is involved in every facet of the operation. With only one  other warehouse employee to help, Henry personally is involved in  preparing and approving all inventory records. Henry ensures that very  little finished inventory sits in the warehouse. However, the shipping  dock always seems to be full of returned dog food that should be  restocked. When Kim asks him about it, Henry laughs and tells her that  “first in, first out” applies to dog food returns as well. Kim smiles  and just accepts that answer.

Jillian is not very good at understanding accounting. The sisters  placed Jillian in charge of sales. She manages a sales team of 12  salesmen in Illinois, Indiana, and Wisconsin. Her fear of flying and  poor driving skills limit her ability to get around to the areas outside  of Chicago. As a result, she has placed a lot of faith in her sales  team. The sales team complained last year that they did not like waiting  for their commissions until after bookkeeping calculated the actual  revenues. In order to keep their spirits fired up, Jillian has her  salespeople project what their sales will be in the upcoming quarter,  and she pays commissions in advance on those projections. The sales team  loves her, and Jillian loves their approval. Jillian has noticed that  the projections typically are off by 11% on average.

The employees of Smackey Dog Food Inc. all own dogs. It was a hiring requirement on the job application.  One employee was fired when it was discovered she never owned a dog  when she was hired. A lawsuit is pending by the fired employee.

At this time, the receivables represent 29% of the corporate assets.  The Chicago retail chain Pup Stores Co. is Smackey Dog Food’s largest  buyer. It alone represents 31% of overall sales and usually pays within  30 days. However, Pup Stores is facing a major lawsuit from an animal  rights group. The legal fees are eating into the company’s cash  reserves, and it is facing some store closures.

The accounts receivable aging indicates that 38% of the receivables  are 30 days or less, 22% are 31–60 days, 21% of the receivables are  61–90 days old, and 10% are 90–120 days. The remaining receivables are  older than 120 days. Sarah has not written off any of the receivables,  nor will she.

Sales are projected to steadily grow at 16% next year if the company  does not expand its facilities. With the expansion, sales are projected  to rise 26%, with the most significant jump in the last quarter after  expansion is completed and holiday sales pick up.

Your Role
 

You and your firm, Keller CPAs, have never audited a dog food  manufacturer. Although it is late in the year to be accepting a new  calendar year-end audit, you need the work and have the time to devote  to the audit before your 2-week ski vacation in February.

You begin the audit process just prior to year-end by sending your  audit manager, Pete, and two audit staffers, Ben and Maureen, out to the  client. They spend time assessing the client and planning the audit.

During the first month of field work after year-end, Ben and Maureen  note that the dog food bags piled high on the docks are marked  “Returned.” One employee is seen throwing bags of the premium Best Boy  Gourmet dog food into the dumpster in the morning and pulling it out and  throwing it into Henry’s car during the employee lunch hour.

Pete’s new best friend, Alan, was married to Smackey Dog Food Inc.’s  owner, Kim, 4 years ago. Alan is also good friends with the banker from  whom Sarah is seeking the loan. Pete is unaware of the relationship.  Pete has talked about some of the details of the audit to Alan over a few beers.

 Assignment  

Required: During our course, each of you will  prepare one short (five to seven pages, double-spaced) paper based on  the Smackey Dog Food Inc. case facts above. The purpose of the project  is to move you beyond the black letter into the actual practical  application of legal principles in real-life situations. The project  case is due at any point before the end of Week 7. It serves to  highlight the importance of audit opinions and reports. This project  gives you an opportunity to conduct certain audit procedures and  determine the course of action regarding the audit.

Note: You are being graded on analyzing issues you  identify in the project case, in addition to responding to the questions  listed in the YD_Activity (see link below).

Use the  YD_Activity  (Links to an external site.)Links to an external site. document to answer the questions related to this scenario.

                              Workseet for You Decide

Name ____________ Course Code _________ Grade ___/ Date__/__/__

Questions:

Q1: Discuss how the SEC has influence (if any) over the audit of Smackey Dog Foods, Inc.

Solution:

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Q2:  Discuss the essential activities involved in the initial planning of an audit. How do these all specifically to the Smackey Dog Food client?

Solution:

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Q3: Discuss the 4 stages of the audit and the major activities performed by the auditor in each phase. Give an example of how each of these specifically applies to the Smackey Dog Food, Inc audit. For instance, examine the apparent internal control weaknesses and possible negative outcome of each.

Solution:

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Q4: Describe Keller CPAs’ responsibilities related to communications regarding internal control matters. What internal controls issues do you identify?

Solution:

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Q5: You decide that you will address Smackey Dog Food, Inc.’s accounts receivables through confirmations. Discuss the various types of confirmations and what forms you will implement and why.

Solution:

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Q6: What are the major factors affecting sample size for confirming accounts receivable?

Solution:

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Q7: A major issue in verifying the ending balance in property, plant and equipment is the possibility of legal encumbrances. Discuss what specific concern do you have. Describe the procedures your firm will perform to obtain evidence about existing legal encumbrances.

Solution:

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Q8: The client wants to know if you will be present at the year-end inventory. What is your decision and why? What role or actions will you take at the inventory if you decide to attend the inventory. Why?

Solution:

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Q9: Considering the general six functions that make up the inventory and warehousing cycle for Smackey Dog Foods, Inc., identify the related documents and/or records that would be used. From your analysis of the internal controls related to the inventory and warehousing cycle of Smackey Dog Foods, Inc., what internal control weaknesses exist?

Solution:

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Q10: Discuss if Keller CPAs or its auditors are breaching any Professional Rules of Conduct and why or why not?

Solution:

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Q11: Discuss the CPA firm’s legal liability concerns for this audit if they make a material unintentional or intentional mistake. Include any other legal liability concerns regarding possible Professional Rule violations.

Solution:

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