- 25 Marks
AAA – L3 – Q43 – Internal audit and outsourcing
Question
YUM Supermarkets (YUM) has 200 stores throughout Ghana, with around a further 20 stores across Africa. YUM have been trying to compete with the large out of town supermarkets for the last five years but have recently taken the decision to move into the smaller stores in towns. Their aim is to be specialist in the type of value for money ‘quality’ products that cannot normally be obtained in local shops. YUM has also moved into sales via the internet. They receive orders through the internet and arrange for the closest local store to distribute the shopping to the customer.
You have been assigned to the audit of YUM this year. You have obtained the following information:
(1) The internet sales service has proved very successful with a 100% increase in revenue on last year. However, there have been complaints about the quality of deliveries and that customers are failing to receive all items ordered.
(2) There have been interruptions to the internet sales service caused by the higher than expected levels of revenue. There have also been concerns over the confidentiality and security of information accessed via the internet.
(3) Problems have arisen with two of the new sites selected by YUM for expansion.
In respect of Site A, there has been substantial local opposition accompanied by environmental concerns over potential contamination of the site.
In respect of Site B, planning permission has not yet been obtained and has been deferred due to an alternative application in the locality by a major competitor. This looks likely to delay planning decisions for a significant period of time.
(4) YUM acquired Ripe Supermarkets last year as part of their business strategy. Initially, the decision was taken to continue to operate Ripe separately and integrate the stores on a phased basis over a two year period. This would involve rebranding Ripe, investing and upgrading stores and ensuring the same quality of staff as YUM. Ripe managers were retained to continue managing stores and to ensure continuity. As the integration has commenced, a number of problems have now become apparent with Ripe operations. These include the following:
- Ripe employees have not been receiving the legal minimum wage.
- No records have been maintained of the number of hours worked by employees, although anecdotal evidence has been received that in some areas they have been regularly working 60 hour weeks.
- There are three ongoing complaints for unfair dismissal.
- Staff retention has been a major difficulty.
- Investigations are underway by the authorities over allegations of false labelling of sales items.
- An investigation is underway over the sale of meat products in one store that appear to have resulted in a local outbreak of food poisoning. The most likely cause for this outbreak is the poor refrigeration and maintenance of the products and sales beyond ‘sell by’ dates. Some local press comment has already arisen.
Required
Explain the risks facing YUM Supermarkets in respect of the above, the controls you would expect to operate in the scenario, the further work you would undertake and the potential impact on the financial statements and the audit.
Answer
Risks Facing YUM Supermarkets
- Internet Sales Service (Point 1)
- Risk: The 100% revenue increase indicates materiality, but complaints about delivery quality and missing items suggest control weaknesses in order fulfillment, risking customer dissatisfaction, reputational damage, and potential revenue loss from returns or refunds.
- Controls Expected: Robust order verification systems, delivery tracking, quality checks before dispatch, and customer feedback mechanisms.
- Further Work: Review customer complaint logs, test order-to-delivery processes, and perform analytical procedures on revenue and returns.
- Financial Statement Impact: Potential provisions for refunds or returns, overstated revenue if incomplete deliveries are recognized, and possible impairment of goodwill due to reputational damage.
- Internet Service Interruptions and Security (Point 2)
- Risk: Service interruptions due to high demand indicate inadequate IT infrastructure, risking revenue loss. Confidentiality and security breaches could lead to legal penalties, customer loss, and reputational harm.
- Controls Expected: Scalable IT systems, regular stress testing, encryption, and compliance with data protection regulations.
- Further Work: Test IT system reliability, review security protocols, and obtain expert IT audit reports.
- Financial Statement Impact: Potential contingent liabilities for data breach fines, understated expenses for IT upgrades, and revenue adjustments for lost sales.
- New Site Issues (Point 3)
- Risk (Site A): Local opposition and environmental concerns may delay or halt development, risking sunk costs and reputational damage.
- Risk (Site B): Delayed planning permission increases project costs and delays revenue generation.
- Controls Expected: Due diligence on site selection, environmental impact assessments, and contingency plans for delays.
- Further Work: Review contracts, environmental reports, and planning correspondence; assess capitalization of costs under IAS 16.
- Financial Statement Impact: Potential impairment of capitalized costs, provisions for legal or remediation costs, and disclosure of non-adjusting events per IAS 10.
- Ripe Supermarkets Acquisition Issues (Point 4)
- Risk: Non-compliance with minimum wage laws, unrecorded overtime, unfair dismissal claims, and staff retention issues increase legal and financial exposure. False labeling and food poisoning allegations risk fines, reputational damage, and revenue loss.
- Controls Expected: Payroll compliance checks, hour tracking systems, fair dismissal procedures, inventory quality controls, and refrigeration maintenance logs.
- Further Work: Review payroll records, inspect employment contracts, test inventory controls, and obtain legal correspondence on investigations.
- Financial Statement Impact: Provisions for wage back-payments, fines, or legal settlements (IAS 37); potential impairment of goodwill from acquisition; and revenue adjustments for returns or lost sales.
Audit Implications
- Materiality: Issues like internet sales, acquisition problems, and site delays are likely material due to their financial and reputational impact.
- Audit Risk: High inherent risk due to new systems (internet sales), acquisition integration, and regulatory non-compliance. Control risk is elevated due to weak controls in Ripe and IT systems.
- Audit Procedures:
- Perform substantive testing on revenue recognition (IFRS 15) for internet sales.
- Test provisions and contingent liabilities (IAS 37) for legal claims and fines.
- Review goodwill impairment testing (IAS 36) for Ripe acquisition.
- Assess going concern if significant losses or penalties arise.
- Audit Opinion: Potential qualification if material misstatements (e.g., unrecorded liabilities) are not corrected or if scope limitations arise (e.g., inability to verify Ripe’s payroll).
- Uploader: Salamat Hamid