The year under audit is Year 2.
Company
Scott, Inc. (Scott) is a manufacturer of handmade glycerine soap and candles. The company has been in business for 15 years and has its headquarters in Yorba Linda, California. Historically, Scott’s revenues arose predominantly from sales within North America, where its products have an excellent reputation.
Marketing
Scott is divided into two divisions, which serve the major markets for the company’s products. One division focuses on sales to department stores. The other division focuses on placing company products in small specialty shops. Currently, each division generates about half of Scott’s revenues and net income.
Scott experienced record profitability in Year 1 and management anticipated that Year 2 would be another banner year. However, sales declined in Year 2 because of regional economic conditions related to a recent recession, and the financial results for Year 2 did not meet management’s expectations. Sales for Year 2 decreased 5% compared to Year 1 and gross profit also declined due to increases in manufacturing costs. Management, after reviewing its operations for Year 2, recognized that its domestic sales growth had slowed in the past several years and its manufacturing costs had increased. As a result, the company adopted a new business plan with a global focus for marketing its products. During Year 2, Scott opened up new markets in Australia and Japan with production at each of these locations.
Management
Management realized it must strictly control all costs to make its overall operations more efficient. As a result, Scott announced that it would make a series of restructuring changes as of the end of Year 2 as part of its overall business plan. During Year 2, the company issued long-term debt with complex financial covenants. The debt was incurred to purchase property, plant and equipment. The company also issued additional common stock during Year 2.
Senior management at the company experienced significant turnover in recent years. The CEO has been with the company for only one year. The CEO was hired from a major competitor after the previous CEO left to take a position with a large manufacturing company in the Northeast. In another management change, the company’s CFO retired, and the current CFO was hired only six months ago. The new CFO was an audit manager from the predecessor audit firm.
Engagement
Scott switched from a regional audit firm to an international audit firm, because the company added factories and employees overseas. There have been no internal disagreements over accounting issues in any of the prior three years.
Based on the information in Scott’s Company Profile, which of the following is the factor most likely to increase audit risk? Select only one factor.
a- the company has begun to focus on strategic advertasing plan so it may expand its domestic market into other states
b-during year 2, management issues aditional long -term debt with complex financial convenenants
c- Scott is diveded in to two divisions, which serve the major markets of the company products
d-- The new CFO was an audit manager from predecessor audit firm.