Valuation of inventory
High fashion product lines are likely to become out-of-date and obsolete very quickly. Retail Specialist Co. Ltd (RSCL) aims to have new lines in store every eight weeks, so product lines have only a short shelf life. Per IAS 2 Inventories, inventory should be valued at the lower of cost and net realisable value, and could be easily overvalued at the year-end if there is not close monitoring of sales trends, and necessary mark downs to reflect any slow movement of product lines. The decline in revenue could indicate that the RSCL brand is becoming less fashionable, leading to a higher risk of obsolete product lines.
Orders made over the phone or by the internet are prone to higher levels of returns than items purchased in a store, as the customer may find that the item is not the correct size, or they do not like the item when it arrives. The risk is insufficient provision has been made in the financial statements for pre year-end sales being returned post year-end.

Completeness/existence of inventory
Retail Specialist Co. Ltd (RSCL) has 210 stores and numerous distribution centres. It may be hard to ensure that inventory counting is accurate in this situation. There may be large quantities of inventory in-transit at the year-end, which may be missed from counting procedures, meaning that the inventory quantities are incomplete. Equally, it may be difficult for the auditor to verify the existence of inventory if it cannot be physically verified due to being in-transit at the year-end. Inventory could be the subject of fraudulent financial reporting, as it would be relatively easy for management to ‘inflate’ quantities of inventory to increase the amount recognised on the statement of financial position. The clothing items could also be at risk of theft, making inventory records inaccurate.

Unrecorded revenue
The on-line and phone sales systems could contribute to a risk of misstated revenue figures. Firstly, the on-line sales system is integrated with the general ledger, so sales made through the system should automatically be recorded in the accounting system. However, the system is new, and it is possible that the integration is not functioning as expected. The scenario does not state whether the phone sales system is integrated, but it is unlikely given that the function is outsourced, so a similar risk of unrecorded transactions may arise here.
Sales made in store will include a proportion of cash sales. The risk is that the cash could be misappropriated, and the revenue unrecorded.

Over-capitalisation of IT/website costs
The on-line sales system has been upgraded at significant cost. There is a risk that costs have been incorrectly capitalised. SIC 32 Intangible Assets – Website Costs states that only costs relating to the development phase of the project should be capitalised, but costs of planning, and all costs when the website is operational should be expensed. Software development costs follow similar accounting principles. Hence there is a risk of overvalued assets and unrecognised expenses.

Overvaluation of the brand name
The RSCL brand name is recognised as an intangible asset, which is the correct accounting treatment for a purchased brand. The risk is that the asset is overvalued, for two reasons. Firstly, if no amortisation is being charged on the asset, management are assuming that there is no end to the period in which the brand will generate an economic benefit. This may be optimistic, and there is a risk that the brand is overvalued, and operating expenses incomplete if there is no annual write-off. An intangible asset which is not being amortised should be subject to an annual impairment review according to IAS 38 Intangible Assets. If no such review has been conducted, the asset could be overvalued. The falling revenue figures could indicate that the asset is overvalued.
Secondly, a significant amount has been spent on promoting the brand name during the year. This amount should be expensed, and if any has been capitalised, the brand is overvalued, and operating expenses incomplete.

Overvaluation of properties
There are two indications from the scenario that properties may need to be tested for impairment, and so could be overvalued. The first is the potential for distribution centres’ operating licences to be revoked. If this were to occur, the asset would cease to provide economic benefit, triggering the need for an impairment review. Secondly, the average revenue per store has fallen. IAS 36 Impairment of Assets suggests that worse economic performance than expected is an indicator that an asset could be impaired. For these reasons, both stores and distribution centres have the potential to be overvalued.

Unrecognised provision/undisclosed contingency
The revocation of an operating licence could lead to a fine or penalty being paid to the local authority. Two licences have been revoked during the year. The risk is that Retail Specialist Co. Ltd (RSCL) has not either provided for any amount payable, or disclosed the existence of a contingent liability in accordance with IAS 37 Provisions, Contingent Liabilities and Contingent Assets.

Opening balances and comparative figures
As this is our first year auditing Retail Specialist Co. Ltd (RSCL), extra care should be taken with opening balances and comparative figures, as they were not audited by our firm. Additional audit procedures will need to be planned.

In total, Black Gold Ltd’s profit for the year has increased by 88% which appears at odds with the revenue figure, which has only increased by 9% from the previous year. This may indicate that revenue has been inflated or incorrect cut–off applied, especially given the fact that the directors of the company have described the year as ‘challenging’. In response, the auditor should examine the revenue recognition policy of the company and adopt procedures that would certify the revenue figure. The cost of sales and the expenses should be examined.

Revenue has increased by 9% but Cost of Sales has fallen by 7%. It should be expected that an increase in revenue would be matched by a corresponding increase in cost of sales. Again this may indicate incorrect allocation of revenue in order for the bank to look favourably on the company and increase its overdraft facility. It could also be an error in the valuation of closing stock and classification of purchases items. The auditor’s responsibility should be to check on the completeness and accuracy of the revenue amount, the classification of purchases – ensuring proper distinction between capital purchases and purchase of goods, and correct valuation of closing stock.

The gross profit has increased by 28% and this is significant. The auditor should focus on the revenue and cost of sales figures to establish the reasons for the increase.

Administration expenses have fallen in comparison to the previous year (decrease of 16%) which is unusual given that revenue has increased by 9%. An increase in costs to be in line with the increase in the revenue figure should be expected. This could indicate that expenses may be understated through incorrect cut-off or incorrectly capitalising expenditure which should be written off to the statement of profit or loss for the year. The auditor should check the administrative expenses for completeness and correct classification.

A similar issue applies to selling and distribution costs which have fallen by 8% – they have not increased as expected in line with revenue. There could be legitimate reasons for the change but this area needs to be investigated further during the audit fieldwork stage.

Interest payable has stayed in line with the previous year – increase of 2%. This figure can be verified easily during the audit by inspecting bank statements and other relevant documentation from the bank.

WORKINGS: (Amounts are in GH¢’000)
1. Change in Profit: 3,358 / 1,784 – 1 = 88%
2. Change in Revenue: 10,410 / 9,528 – 1 = 9%
3. Change in Cost of Sales: 4,752 / 5,110 – 1 = -7%
4. Change in Gross Profit: 5,658 / 4,418 – 1 = 28%
5. Change in Administration Expenses: 1,334 / 1,596 – 1 = – 16%
6. Change in Selling and Distribution Expenses: 846 / 920 – 1 = -8%
7. Change in Interest Payable: 120 / 118 – 1 = 2%