ap1 comprehensive problem

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this is a sample exercsise given by our professor.

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  • AUDITING PROBLEMS 1

    COMPREHENSIVE PROBLEM

    SRV & Co. CPAs accepted a new client, Global Home Depot, Inc., on November 2014. Your Senior

    Auditor assigned you as the Audit Clerk for the new engagement for the calendar year 2014. On the

    same month, you visited their principal address to obtain an understanding of the nature of their

    business.

    Global Home Depot, Inc. was incorporated in the Philippines and registered with the Philippine Securities and

    Exchange Commission (SEC) on March 12, 2010. The Company is primarily engaged in the business of

    retailing, merchandising, buying, selling, marketing, trading, or otherwise dealing household and builder

    hardware.

    Merchandising industry makes products in retail outlets available to customers, primarily by stocking shelves

    and displays. Household and builder hardware product merchandisers occupy an intermediate market between

    the manufacturers and the end users. The manufacturers typically focus on producing high volumes of their

    product. The merchandisers purchase these finished products from the manufacturers. They distribute these

    products through retail. This is very common because it somehow eliminates the manufacturers burden to

    further market their product.

    The Companys main line of business is purchasing and selling household and builder hardware like keys,

    locks, hinges, chains, tools, machine parts, doors, windows, bathrooms, etc. These are used by homeowners

    and builders for residential and commercial purposes. The entity has several suppliers for the merchandise

    within and outside Cebu and they are normally sold to walk-in customers, to the City Government of Cebu and

    Mandaue, and to regular customers who are usually construction companies.

    The registered business address of the Company is Ground Floor, The Columbia Tower, A.S. Fortuna Street

    Mandaue City, Cebu (see attachment 1). The Company is situated near the national road which is very

    accessible to the public. The Company location is also accessible to trucks and public utility vehicles. The

    Company is under a lease agreement with The Columbia Tower Real Estate, Inc. for the space used by the

    Company.

    The Company is controlled by Ms. Cynthia D. Chungunco, who owns 78.21% of the Companys outstanding

    shares. The remaining 21.79% of the shares are publicly held. The Company has its primary listing on the

    Philippine Stock Exchange. As of December 31, 2012 and 2013, the Company has 24 and 26 equity holders,

    respectively (see attachment 2 for the organizational structure).

    The Company has an internally-generated accounting system but manually processes pre-numbered source

    documents. According to a survey, companies that do better than industry averages tend to use and

  • understand specialized computer software tools to manage specific aspects of merchandising. It has identified

    forecasting as the most important tool. The system helps predict what goods customers might want and

    stocking patterns to satisfy customer demand while minimizing the amount of capital invested in excess

    inventory. Seventy-five percent of the retailers surveyed said that retail forecasting is extremely important to

    financial success. In the past, forecasting systems were largely seen as supply chain management tools,

    where the focus was on reducing operational costs. Now such systems and techniques have become

    important to expand sales opportunities, moving from a strictly bottom-line focus to a top-line one. Almost

    equally as important as demand forecasting is customer analytics. One cannot create a good demand forecast

    without understanding the customers and what they might want.

    The Company approximately has 43 regular customers, an average of 300 walk-in customers per day, and the

    City Government of Cebu and Mandaue. The Company negotiates sales orders with the majority of their

    customers. The Company does not have any long-term contract with any customer. Because of the nature the

    Companys products and the short lead time order cycle, backlog is not a significant factor of the business. The

    Company believes that substantially all of the orders existing as of December 31 will be shipped prior to the

    end of the first quarter of the next year. In general, the Company competes in the home and builder hardware

    products with the other companies in within Cebu and Mandaue City. A few of the Companys competitors may

    be larger, have greater financial resources or have less financial leverage than the Company does. As a result,

    the competitors may be better positioned to respond to any downward pricing pressure or other adverse

    economic or industry conditions or to identify and acquire companies or product lines compatible with their

    business.

    The primary goal of the company is to sustain itself in the long run of competition and to increase its market

    share in the future. The management continuously gives good service to its customers by availing quality

    products from its suppliers. It hopes that by putting up branches on strategic locations, it will be able to

    increase profitability and at the same time satisfying the needs of the customers. It is currently advertising on

    media, specifically on radio stations and print, to make the business known to the public. As a corporate social

    responsibility, it actively participates on the preservation of the natural environment. The management says

    that their strategies do not contribute much to the overall success of the Company and they admit that they are

    not that aggressive in terms of promotion.

    The Company sees itself as a growing entity. The management believes that it will be able to expand its

    operations especially because they are yet starting. Ms. Chungunco is pressuring the management to expand

    sooner in order to also get fully the market share for the City Government of Cebu and because the opportunity

    revenue is high.

    As of the date, the company has no investments in associate, subsidiary or joint venture. For now, the

    management has no plans of entering into acquisition of companies under its name or disposing its equity

    interest. However, the company has planned initially in 2013 to open a branch in Cebu City in order to get a

  • wider share in the market. The Company has also planned to obtain loans from the bank to finance its

    expansion plans.

    The preparation of the financial statements in conformity with accounting principles generally accepted in the

    Philippines requires the management of the Company to make decisions based upon estimates, assumptions,

    and factors it considers relevant to the circumstances. Such decisions include the selection of applicable

    principles and the use of judgment in their application, the results of which could differ from those anticipated.

    The Company has considered the following as their most critical accounting policies:

    1. Accounts receivable valuation

    2. Inventory Valuation

    3. Revenue recognition

    The management reviews the estimates on a regular basis but believes that these estimates are reasonable,

    but actual results could differ from these estimates.

    Valuation of accounts receivable

    The accounts receivable of the Company represent those amounts that have been billed to the Companys

    regular customers and to the City Government of Cebu and Mandaue but not yet collected. The Company

    records an allowance for doubtful accounts based on the portion of those accounts receivable that the

    Company believes are potentially uncollectible based on various factors, including historical experience and

    creditworthiness of customers. If the financial condition of customers were to deteriorate, resulting in

    impairment of their ability to make payments, additional allowances may be required. Changes in judgments on

    these factors could impact the timing of costs recognized.

    Valuation of inventories

    The company states their inventories at the lower of cost or market. The Company determines the cost basis

    their inventory on a first-in-first-out basis using actual costs. Changes in product demand and their customer

    base may affect the value of inventory on hand, which may require provisions for obsolescence.

    Revenue recognition

    The Company recognizes revenue at the point of sale. The Company treats sales returns and allowances as

    reductions to sales.

  • ORGANIZATIONAL CHART

    BOARD OF DIRECTORS

    CYNTHIA D. CHUNGUNCO

    President

    JOHN F. GOGeneral Manager

    MANOLO F. CHUA

    Purchaser

    GERRY S. VELORA

    Inventory Clerk

    MIMI L. GARCIA

    Sales Manager

    CHARLOTE R. AGUILARChief Accountant

    CHRISTINE D. LAPINID

    Cashier

    MARLON S. YUAccountant 1

    ANNIE T. DALON

    Accountant 2

    ARMANDO G. SUICOSupport Head

  • GEOGRAPHICAL LOCATION

  • Prior to the end of November 2014, you went back to the Global Home Depot, Inc. to examine their

    control manual in order for you to document your understanding of the design of the internal control

    and assess the control risk.

    Purchasing / Disbursement Cycle

    Whenever a certain inventory level goes below the reorder point, the Inventory Clerk will report to the

    Purchaser for requisitioning. The Purchaser will determine the supplier and will send copy of the purchase

    order to the supplier (via e-mail or by fax), to t