Answers to December 2010 Exam

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Professional Level – Options Module, Paper P7 (INT) Advanced Audit and Assurance (International) 1 (a) Briefing notes Subject: Business risks facing Jolie Co Introduction

December 2010 Answers

These briefing notes evaluate the business risks facing our firm’s new audit client, Jolie Co, which operates in the retail industry, and has a year ended 30 November 2010. Ability to produce fashion items The company is reliant on staff with the skill to produce high fashion clothes ranges, and also with the ability to respond quickly to changes in fashion. If Jolie Co fails to attract and retain skilled designers then the clothing ranges may not be desirable enough to attract customers in the competitive retail market. The high staff turnover in the design team indicates that Jolie Co struggles to maintain consistency in the design team. This could result in deterioration of the brand name and, ultimately, reduced sales. There would be a high cost associated with frequently recruiting – this would have an impact on operating margins. Inventory obsolescence and margins There is a high operational risk that product lines will go out of fashion quickly, because new ranges are introduced so quickly to the stores (every eight weeks), leading to potentially large volumes of obsolete inventory. These product lines may be marked down to sell at a reduced margin. The draft results show that operating margins have already reduced from 17·9% in 2009 to 16·8% in 2010. Any significant mark down of product lines will cause further reductions in margins. Wide geographical spread of business operations Jolie Co operates a large number of stores, many distribution centres, and has an outsourced function which is located overseas. This type of business model could be hard to control, increasing the likelihood of inefficiencies, systems deficiencies, and theft of inventories or cash. E-commerce – volume of sales On-line sales now account for $255 million ($250 per order x 1,020,000 orders). In the previous year, on-line sales accounted for $158 million ($300 per order x 526,667 orders). This represents an increase of 61·4% (255 – 158/158 x 100%). One of the risks associated with the on-line sales is the scale of the increase in the volume of transactions, especially when combined with a new system introduced recently. There is a risk that the system will be unable to cope with the volume of transactions, leading possibly to unfilled orders and dissatisfied customers. This would harm the reputation of the company and the JLC brand. The company has recently upgraded its computer system to integrate sales into the general ledger. A disaster plan should have been put into place, for use in the event of a system shutdown or failure. The risk is that no plan is in place and the business could lose a substantial amount of revenue in the event of the system failure. E-commerce – security of systems It is crucial that the on-line sales system is secure as customers are providing their credit card details to the site. Any breach of security could result in credit card details being stolen, and Jolie Co may be liable for losses suffered by customers if their credit card details were used fraudulently. There would clearly be severe reputational issues in this case. Additionally, the system must be secure from virus infiltration, which could cause system failure, interrupted sales, and loss of customer goodwill. E-commerce – tax and regulatory issues There are several compliance risks, which arise due to on-line sales. Overseas sales expose Jolie Co to potential sales tax complications, such as extra tax to be paid on the export of goods to abroad, and additional documentation on overseas sales that may be needed to comply with regulations. Another important regulatory issue is that of data protection. Jolie Co faces the risk of non-compliance with any data protection regulation relevant to customers providing personal details to the on-line sales system....
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