Prefab Sprout Company
The Prefab Sprout Company is a construction company which develops and constructs modular home enclosures in South Florida. Though being listed on the New York Stock Exchange (NYSE), it is still a family-run business with about 40% of the shares resting with the Warner family. This working paper provides a thorough analysis of Prefab’s internal structure and its external business relations from an auditor’s viewpoint. In particular, the potential business and audit risks that could possibly evolve from an audit engagement are central to this study.
Before coming to a decision whether or not accepting an audit engagement at Prefab Sprout Company, the auditor should obtain business-related background information and evaluate the risk factors associated with the potential client on which a well-grounded judgment can be made (Knechel et al., 2007).
In this respect, the auditor especially needs to become aware of the wide-ranging family ties between executives of Prefab and closely related business partners. With the president, the vice president and the treasurer being members of the Warner family, it is doubtful whether the objectivity and the reliability of Prefab’s internal control system can be guaranteed. Moreover, family members are financially involved in the Sun Atlantic Bank which provides Prefab with loans, as well as in JRW Realty, Prefab’s most important purchaser of modular home developments. Consequently, there is a risk that transactions between these more or less affiliated parties are not carried out at arm’s length (Knechel et al., 2007).
A further problem that should already be detected in the pre-engagement risk evaluation process is the composition of the audit committee. The Sarbanes-Oxley Act of 2002 and the accompanying SEC standards prescribe that publicly-traded companies in the United States establish an audit committee that consists of at least three members, with all of them being outsiders to the company (SEC, 2003). At Prefab
Before coming to a decision whether or not accepting an audit engagement at Prefab Sprout Company, the auditor should obtain business-related background information and evaluate the risk factors associated with the potential client on which a well-grounded judgment can be made (Knechel et al., 2007).
In this respect, the auditor especially needs to become aware of the wide-ranging family ties between executives of Prefab and closely related business partners. With the president, the vice president and the treasurer being members of the Warner family, it is doubtful whether the objectivity and the reliability of Prefab’s internal control system can be guaranteed. Moreover, family members are financially involved in the Sun Atlantic Bank which provides Prefab with loans, as well as in JRW Realty, Prefab’s most important purchaser of modular home developments. Consequently, there is a risk that transactions between these more or less affiliated parties are not carried out at arm’s length (Knechel et al., 2007).
A further problem that should already be detected in the pre-engagement risk evaluation process is the composition of the audit committee. The Sarbanes-Oxley Act of 2002 and the accompanying SEC standards prescribe that publicly-traded companies in the United States establish an audit committee that consists of at least three members, with all of them being outsiders to the company (SEC, 2003). At Prefab
References: Knechel, W. R., Salterio, S. E., & Ballou, B. (2007). Auditing. Assurance & Risk. (Third Edition). Mason: Thomson Higher Education. Securities and Exchange Commission (2003). Final Rule: Standars Relating to Listed Company Audit Committees. October 4, 2003. Retrieved 14 September 2008 from: http://www.sec.gov/rules/final/33-8220.htm