Subject: Business risks facing Retail Specialist Co. Ltd (RSCL)

Introduction:
These briefing notes evaluate the business risks facing our firm’s new audit client, Retail Specialist Co. Ltd (RSCL), which operates in the retail industry, and its year under review ended 31 December 2018.

1. Ability to produce fashion items:
   The company is reliant on staff with the skill to produce high fashion clothes ranges and quickly respond to changes in fashion. High staff turnover in the design team indicates struggles to maintain consistency. This could result in a deterioration of the brand name and reduced sales.
2. Inventory obsolescence and margins:
   Product lines may become obsolete quickly, leading to potential mark-downs and reduced margins. The operational risk is significant, with inventory possibly being overvalued at the year-end.
3. Wide geographical spread of business operations:
   Operating a large number of stores, distribution centres, and an overseas outsourced function could increase inefficiencies and control difficulties, such as theft or system deficiencies.
4. E-commerce – volume of sales:
   The increase in online sales introduces a risk if the new system is unable to cope with the transaction volume, potentially leading to unfulfilled orders and customer dissatisfaction.
5. Outsourcing of phone ordering system:
   The lowest-cost provider for outsourcing may not maintain quality service, potentially leading to customer dissatisfaction, incorrect orders, and possibly the provider’s business sustainability issues.

Conclusion:
Retail Specialist Co. Ltd (RSCL) faces significant operational and compliance risks, particularly related to inventory obsolescence, e-commerce systems, and the sustainability of outsourcing arrangements.

Risk of material misstatements:

1. 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   High fashion product lines are likely to become out-of-date and obsolete very quickly.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 realizable value, and could be easily overvalued at the year-end if there is not close monitoring of sales trends, and necessary markdowns 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.
2. 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 recognized on the statement of financial position. The clothing items could also be at risk of theft, making inventory records inaccurate.
3. Unrecorded revenue
   The online and phone sales systems could contribute to a risk of misstated revenue figures. Firstly, the online 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.
4. Over-capitalisation of IT/website costs
   The online sales system has been upgraded at significant cost. There is a risk that costs have been incorrectly capitalized. SIC 32 Intangible Assets – Website Costs states that only costs relating to the development phase of the project should be capitalized, 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 unrecognized expenses.
5. Overvaluation of the brand name
   The RSCL brand name is recognized 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 amortization 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 amortized 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 capitalized, the brand is overvalued, and operating expenses incomplete.

Conclusion:
The audit planning should consider these risks of material misstatements, ensuring that appropriate audit procedures are designed to address and mitigate these risks effectively.