The Lakeside Company: Case Studies in Auditing

Summary of Introductory Case and Case 1

I. Introductory Case: A look inside a CPA firm
A. Abernethy and Chapman
1. Began operations in 1969
2. 145 employees
3. 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 policies
1. 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 team
1. Partner-in-charge - final decisions, not much of the work
2. 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 audits
and other accounting work.
2. Revenues over $2.5 million
3. 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. Clientele
1. Largest clients
- Small hotel chain
- 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 client
A. Lakeside Company
1. Benjamin Rogers, president.
2. Consumer electronics (mainly audio and video equipment), retailer and
distributor.
3. Prior auditor: King and Company CPA's
4. A and C audit bank that Lakeside does most of business with.
5. March 1997 first contact made between Lakeside and A & C.
6. J une 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.
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 qualified
opinion. 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 a
shipping center that had proven to be very unsuccessful. To date, the
shopping center had leased less than 40% of its available space. The
Lakeside sore had, consequently, never been able to generate the
customer traffic necessary to even come close to a break-even point.
The continuing failure of the shopping center made the fate of the
Lakeside store appear quite uncertain to King and Company, and they
felt 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 J anuary based on the
income earned (% of gross profit - any directly allocable expenses) by
their 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 of
building.
Rogers is growth oriented. Lakeside is considering adding computers
to product line.
Introductory Case and Case 1

Introduction: Introductory case and case 1 introduce us to the CPA firm and the
potential 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 todays
meeting 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