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(Accepting the engagement) Sunny Energy Applications Co. sells solar-powered swimming pool heaters. Sunny contracts 100 percent of the work to other companies. As Sunny is a new company, its balance sheet has total assets of $78,000, including $24,000 of â€œstock subscriptions receivable.â€ The largest asset is $42,000 worth of â€œunrecovered development costs.â€ The equity side of the balance sheet is made up of $78,000 of â€œCommon Stock Subscribed.â€
The company is contemplating a public offering to raise $1 million. The shares to be sold to the public for the $1 million will represent 40 percent of the then issued and outstanding stock. There are two officer-employees of the company, Mike Whale and Willie Float, former officers of Canadian Brass Co. Float is being sued by the SEC for misusing funds raised by Canadian Brass in a public offering. The funds were used as compensatory balances for loans to a Physics Inc. Physics Inc. was controlled by Float and is the predecessor for Sunny Energy Applications.
Canadian Brass is being sued by the SEC for reporting improper (exaggerated) income. Float was chief executive at the time. Many organizations are engaged in researching the feasibility of using solar energy. Most of the organizations are considerably larger and financially stronger than Sunny Energy. The company has not been granted any patents that would serve to protect it from competitors.
- a. What potential risks may be present in this engagement?
- b. What specific auditing and accounting problems appear to exist?
- c. What additional information do you feel you need to know about the company?
- d. Do you believe the engagement should be accepted or rejected? Why?
- Prepare common-sized balance sheets and income statements for Just for Feet for the period 1996-1998. Also compute key liquidity, solvency, activity, and profitability ratios for 1997 and 1998. Given these data, comment on what you believe were the high-risk financial statement items for the 1998 Just for Feet audit.
- Just for Feet operated large, high-volume retail stores. Identify internal control risks common to such businesses. How should these risks affect the audit planning decisions for such a client?
- Just for Feet operated in an extremely competitive industry, or sub-industry. Identify inherent risk factors common to businesses facing such competitive conditions. How should these risks affect the audit planning decisions for such a client?