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The Lakeside Company: Case Studies in AuditingSummary of Introductory Case and Case 1

I. Introductory Case: A look inside a CPA firmA. Abernethy and Chapman

1. Began operations in 19692. 145 employees3. Main office in Richmond, Virginia with 3 branches elsewhere in Virginia.4. In Richmond: 10 partners, 14 managers, 21 seniors, and 42 staff auditors.5. Tax = 11; advisory services 7; remainder usually focus on accounting and

auditing services.6. During busy times - may work in other areas.7. 18 secretaries and other clerical staff.

B. Hiring policies1. College graduates with major in accounting.2. Must sit for CPA exam within one year of hire date.

3. Complete 40 hours of CPE per year.4. Promote based on seniority and technical competence.5. Must be with firm at least two years, pass CPA exam before promotion to

senior.C. Quality control standards

1. Responsibility of DeAnna Malott.2. Training seminars on company policies.3. Policy to sever all financial ties to clients.4. Assigns personnel to audit and other engagements.5. Considers experience with client's business and technical training.6. Audits require both a consulting partner and a partner-in-charge.

7. Supervision, objectivity, and competence.D. Engagement team1. Partner-in-charge - final decisions, not much of the work2. Manager - on site decision-maker.3. Senior - completes majority of work.4. One or more staff auditors - completes majority of work.5. Consulting partner - advises and reviews the final work to assure

applicable professional standards and regulatory requirements followed.E. General

1. Much growth in last five years - marketing strategy and high-quality auditsand other accounting work.

2. Revenues over $2.5 million3. Profits to partners ranged from $65,000 to $200,000.4. Revenues: 60% audit, 25% tax, 15% other accounting, attestation and

consulting services.5. Strategy to encourage growth of auditing services.

F. Clientele1. Largest clients

- Small hotel chain

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- Group of furniture stores- Several large car dealerships- Three local banks

2. Advertising- Local newspapers-

Several Virginia periodicals- Monthly newsletters to clients and local business leaders- "We are here to help your business" - cost of $53,000.

II. Case 1: Analysis of potential audit clientA. Lakeside Company

1. Benjamin Rogers, president.2. Consumer electronics (mainly audio and video equipment), retailer and

distributor.3. Prior auditor: King and Company CPA's4. A and C audit bank that Lakeside does most of business with.

5. March 1997 first contact made between Lakeside and A & C.6. June 1, meeting to discuss Lakeside's 1997 audit.B. Information gathered by Abernethy and Wallace Andrews, audit manager

1. Never had a client in this field.2. Began 1980 with single store, sold bargain-priced television and stereo

equipment.3. Presently have six stores; 3 in Richmond, one each in Charlottesville,

Fredericksburg, and Petersburg.4. Five stores rented in small shopping centers.5. Sixth stores built by Lakeside located adjacent to new shopping mall.6. Also own warehouse with office space.7. 1990

Began concentrating on sale of high-end audio and video equipment. Sole distributor of Cypress Products for Virginia and N. Carolina.

8. Currently Carry Cypress products almost exclusively in stores. Cypress not known in Richmond, sales declined initially, but

rebounded in 1995 and 1996. All stores suffer from intense competition, some stores failing.

9. Sales Six sales representatives visit other audio, electronic, and appliance

stores

Order can be phoned into Richmond headquarters. After credit check, inventory sent and billed, 2/10, n/45. Up to 20% of merchandise can be returned within four month as long

as not damaged. Historically, returns have been low. Distributorship types sales have risen materially in last two years.

10. Inventory Purchased weekly from Cypress.

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90-day terms, but offer large cash discounts for early payment. Lakeside policy to take all available discounts. Cover cash needs with lines of credit with two banks - total $750,000,

interest rates floats with an average of 7% to 9% over last few years.Both banks require a minimum cash balance of 5% of loan balance.

11. Building construction Loans with National Insurance Company of Virginia. With 9 1/4% interest and 10% interest respectively.

12. Reasons for changing CPA firms. Unhappy with services. Need help updating accounting system. Outgrowing control features of

current system. Charging an excessive fee. Audit opinion for 1996. The auditors to draw attention to an uncertainty

that was not disclosed by the Lakeside Company rendered a qualifiedopinion. King was not satisfied that the company would be able to

recover the $186,000 investment in its latest store. This sixth store,which opened in November of 1995, was constructed adjacent to ashipping center that had proven to be very unsuccessful. To date, theshopping center had leased less than 40% of its available space. TheLakeside sore had, consequently, never been able to generate thecustomer traffic necessary to even come close to a break-even point.The continuing failure of the shopping center made the fate of theLakeside store appear quite uncertain to King and Company, and theyfelt that the uncertainty should be disclosed by Lakeside.

13. Ownership Eight investors Rogers, age 46, owns 30% of Lakeside. Other 7 own 6% to 22%. Rogers only one involved in day-to-day activities. Board of Directors: Rogers, two other owners, local lawyer. All eight shareholders want an audit conducted annually, so do banks.

14. Stores Each store has a manager and assistant manager. Three to six sales clerks. Bonus system started in 1996 to increase sales. Manager and

assistant manager receive cash bonus each January based on theincome earned (% of gross profit - any directly allocable expenses) bytheir stores during the previous year.

15. Other stuff Seventh store opening in December 1997. Owned by a separate

corporation owned by Rogers. Leased to Lakeside for entire life ofbuilding.

Rogers is growth oriented. Lakeside is considering adding computersto product line.

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Introductory Case and Case 1

Introduction: Introductory case and case 1 introduce us to the CPA firm and thepotential client.

Memo

Date: August 26, 1999

To: Members of Abernethy and Chapman (A439 students)

From: Kathy Pollock, CPA

Re: Potential new audit client, Lakeside Company

Hopefully, you have all had a chance to review the preliminary information we have

gathered on our potential new client, Lakeside Company. The agenda for todaysmeeting is as follows:

Introductory case

Discuss our organization structure. Discuss our objectives as an organization and decide if Lakeside will help us in

fulfilling those objectives. Discuss the effectiveness of the marketing plan. Review Quality Control Standards

Case 1 Discuss issues involved with accepting Lakeside as a client

Staffing problems, if any Prior auditor issues Rogers reason for changing firms:

Lack of advisory services Excessive fee Qualified report

Environmental concerns Potential audit problems

Reasons for the audit Information needed to estimate time needed to do the audit Other

Summary:

Know Abernathy and Chapman Know Lakeside and Rogers