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11e Ch3 Mini Case Client Cont
11e Ch3 Mini Case Client Cont
In this mini-case you will use Willis and Adams' client acceptance/continuance forms to evaluate the
continuance decision for EarthWear as an audit client. One of the most important ways accounting firms
manage their risk is by being very careful about which companies they decide to associate with as clients.
In the first year, that decision is referred to as the client acceptance decision. In each subsequent year,
firms decide whether to continue their association with each client. This subsequent decision process is
referred to as the continuance decision. The factors that firms consider for the continuance decision are
usually very similar to those considered for the initial acceptance decision.
INSTRUCTIONS
1 Read the background information on EarthWear to prepare to evaluate the company as a continuing audit
client.
To open the background document please double-click on the following icon (a document will open in
Microsoft Word).
2 Review EarthWear's unaudited 2019 financial statements including the "Balance Sheet", "Income
Statement", and "Cash Flow" worksheets to obtain a better understanding of the client and to assess its
current financial condition. A senior auditor from your firm has already calculated some financial and
industry ratios to help with the continuance decision. Compare EarthWear's ratios to the industry ratios
provided on the "Ratios" worksheet. Pay particular attention to items that might be helpful in determining
whether or not to continue with EarthWear as an audit client.
3 Review the Willis and Adams' client acceptance/continuance forms Work Papers 3-1, 3-2, 3-3, and 3-4,
which have already been completed.
4 Complete the remaining questions on Work Paper 3-5 using information from the background and financial
statement information.
Fields you are to complete on the form are colored yellow. The color will disappear as the field is completed.
When you've completed the above steps, enter your initials in the yellow box with title " Initial Here" on Work
5 Paper 3-5.
6 Please input your answers into Connect or print a hard copy of Work Paper 3-5 to submit unless your
instructor requests an electronic submission. The work paper is formatted to fit on one page.
EARTHWEAR CLOTHIERS 3-1
Client Continuance Evaluation SAA
December 31, 2019 1/3/2020
General
Has the institution entered into a memorandum of understanding with a regulatory agency? No
Unregulated casinos? No
Entity that is an agency or subdivision of the Federal government, entity receiving substantial
Federal funding or grants, or one subject to the Single Audit Act (excluding local governmental No
entities)?
Management
Board of Directors
Ownership Background
Title: Name: Home City: Home State: % Verification:
Chairman James G. Williams Boise ID 25 Yes
Audit Comm. Chair Gary Amble Boise ID 0 Yes
Key Management
CEO Calvin J. Rogers Boise ID 0 Yes
CFO James C. ("JC") Watts Boise ID 0 Yes
Accounting Officer Carol McKay Boise ID 0 Yes
Outside Advisors
Primary Law Firm Primary Banking Relationship
Name: Leon, Leon & Dalton Name: First National Bank
Address: 958 S.W. 77th Avenue Address: P.O. Box 1947
Boise, ID 79443 Boise, ID 79443
Service Team
Engagement Partner: Michael J. Willis
Engagement Partner Email: [email protected]
Engagement Partner Telephone: (208) 545-6776
Office: Boise
Senior Manager or Manager: Dianne R. Morris
Engagement Quality Review Partner: Karen Mitchell
Discuss the service team's relevant industry experience:
Michael has been the lead partner on this engagement for the past four years. Michael and Karen both have
extensive experience with manufacturing and retail companies. Dianne has been on the staff of this
engagement since she joined the firm in 2000 and became manager last year.
The Firm requires background investigations for all clients. Subjects of the background
investigations include the clients and key decision makers. Key decision makers are normally the
company's board and audit committee (if applicable) chairs, chief executive officer, chief financial
officer and principal accounting officer, but should also include significant principal investors,
shareholders or others who exercise significant influence over company operations. Significant
company related entities and/or subsidiaries should also be considered as additional subjects.
Background investigations have taken place for any newly hired key decision makers. Yes
In 1999, EarthWear's vice president of finance, Don Evans, was charged with a misdemeanor
involving illegal gambling on local college basketball games. Charges were later dropped in return
for Mr. Evans agreeing to pay a fine of $750 and perform 50 hours of community service. No other
illegal or ethical problems were found with any other EarthWear executive.
Class:
Are there any concerns about undue reliance being placed on the results
of our work? (i.e. sale of the company, financing) No
Does the client have any associated entities that are not audited or are
being audited by firms outside of Willis and Adams? No
Have any situations been noted that bear on the integrity of management? In 1999, EarthWear's vice president of finance, Don Evans, was charged with a
misdemeanor involving illegal gambling on local college basketball games.
Yes Charges were later dropped in return for Mr. Evans agreeing to pay a fine of
$750 and perform 50 hours of community service. No other illegal or ethical
problems were found with any other EarthWear executive.
Are there any external conditions or trends that may have a significant
impact on the client, such as changes in buyers, changes in suppliers, or No
new competitors?
Are there any internal conditions or trends that may raise concern, such as In late February of 2019, EarthWear’s chief accounting officer/controller Brad
management turnover or new accounting information systems? Norton unexpectedly left the company to take a job with another clothes
Yes manufacturer. The company switched to a new, integrated central accounting
system in early 2015. The transition to the new system was overseen and
implemented by the former controller, Brad Norton.
Are there any other risk concerns arising out of the information gathering Before her promotion, Ms. McKay had been the VP of External Reporting. In her
process? 14 years with EarthWear, Ms. McKay spent the majority of her time in External
Yes
Reporting. As a result, some executives questioned if Ms. McKay had the broad
skill-set needed for such a demanding position.
December 31
ACTIVITY RATIOS:
Receivables Turnover 71.18 77.25 74.34 73.82 75.41 118.00 42.60 N/A N/A
net sales / net ending receivables
Days Outstanding in Accounts Receivable 5.13 4.73 4.91 4.94 4.84 3.09 -1.74 14.10 -11.01
365 days / receivables turnover
Inventory Turnover 3.43 4.27 4.48 4.47 4.99 3.87 -1.12 6.20 -2.33
cost of sales / inventory
Days of Inventory on Hand 106.41 85.51 81.40 81.72 69.22 94.99 25.78 58.70 36.29
365 / (cost of sales / inventory)
COVERAGE RATIOS:
Debt to Equity 0.79 0.88 0.58 0.61 0.51 0.50 -0.01 0.84 -0.34
total liabilities / shareholders' investment
Times Interest Earned 53.88 26.31 26.41 23.92 10.19 50.57 40.38 N/A N/A
(net income + interest expense) / interest expense
* Expected values are obtained by using the forecast function in Excel (using the row of data from 2017 and 2018 to obtain the expected value for 2019).
† Industry Source: Dun & Bradstreet (D&B). The median values of the industry ratios are used for comparison purposes. For ratios not specifically included on D&B, ratios
were calculated from average financial statement data provided.