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Question

Mugsy Brights Limited (MBL) is a private company in Winnipeg that sells mugs, jars and bottles in a variety of colours, sizes and materials. MBL is owned by four equal owners since inception. The owners have different skills - creative design, marketing, finance and information systems. The company attributes much of its success to the use of materials that can be easily shipped without breaking, and unique designs that appeal to a variety of buyers, particularly commercial buyers who purchase for restaurants, or for businesses who choose to advertise their business by giving away or selling regular or travel mugs.

The owners meet formally every month, and have informal meetings two or three times per week to discuss particular clients or new approaches. About a quarter of the sales are via the company's secure web site, while the remainder are by telephone or purchase order. MBL works with distributors of kitchenware, selling wholesale to hundreds of outlets in Canada. Most of these sales are done via the telephone, although a salesperson does spend some time in major cities across the country visiting some of the large customers, helping with shelf layout and marketing to the ultimate consumers for larger distributors. These efforts have resulted in gradually increasing market share for the company.

All sales are recorded in the accounting software package used by the company. The accounting manager reports directly to one of the owners, and there are two other employees in the accounting department. Password controls are used to limit functions that are accessible by employees. For example, only the controller can implement wage rate increases or product price increases (which are reviewed and approved by the owner responsible for marketing). Two owners are required to sign cheques, and do so with source documents attached. Similarly, two owners are required to approve new employees.

All manufacturing is outsourced to local producers who work with different materials. For example, a different supplier handles steel mugs versus plastics or glass. Ceramics is rarely used as it is quite breakable, whereas some forms of glass are very durable. MBL does not hold any inventory, as manufacturing is all done to order. However, as there have been some collection problems from customers, the company has had to go to the maximum of its line of credit, and has no additional borrowing capacity available. It is waiting for the results of the audited financial statements to approach the bank for an increase in its line of credit.

Internet sales are prepared (via credit card), while sales to distributors are net thirty. The company has an April year end.

Following are extracts from the annual financial statements:

Required:

A) What audit risk would you assign to the company? Why? [Tip: Do some calculations and consider client business risk.]

B) Calculate preliminary materiality. Justify your decision of materiality base and choice of materiality.