King Companies, Inc. (KCI) is a private company that owns five auto
parts stores in urban Los Angeles, California. KCI has gone from two auto parts stores to five stores in the last three years, and it plans continued growth. Eric and Patricia King own the majority of the shares in KCI. Eric is the chairman of the board of directors of KCI and CEO, and Patricia is a director as well as the CFO. Shares not owned by Eric and Patricia are owned by friends and family who helped the Kings get started. Eric started the company with one store after working in an auto parts store. To date, he has funded growth from an inheritance and investments from a few friends. Eric and Patricia are thinking about expanding by opening three to five additional stores in the next few years.
In October 2021, Eric approached your accounting firm, Thornson & Danforth LLP, to conduct an annual audit of KCI for the year ended December 31, 2022. KCI has not been audited before, but this year the audit has been requested by the company's bank because of anticipated bank loans and by a new private equity investor that has just acquired a 20% share of KCI.
KCI employs 20 full-time staff. These workers are employed in store management, sales, parts delivery, and accounting. About 40% of KCI's business is retail walk-in business, and the other 60% is regular customers where KCI delivers parts to their locations and bills these customers on account. During peak periods, KCI also uses part-time workers.
Eric is focused on growing revenues. Patricia trusts the company's workers to work hard for the company and she feels they should be rewarded well. The accounting staff, in particular, is very loyal to the company. Eric tells you that accounting staff enjoy their jobs so much they have never taken any annual vacations, and hardly any workers ever take sick leave.
There are two people currently employed as accounting staff, the most senior of whom is Jonathan Jung. Jonathan heads the accounting department and reports directly to Patricia. He is in his late fifties and hopes to retire in two or three years and move away from Los Angeles. Jonathan keeps a close watch on accounting and does many activities himself, including opening mail, cash receipts and vendor payments, depositing funds received, performing reconciliations, posting journals, and performing the payroll function. His second employee, Abby Owens, is a recent college graduate who just passed the CPA exam. Abby is responsible for the payroll functions and posting all journal entries into the accounting system. Jonathan and Abby often help each other out in busy periods.
A. Identify and explain any significant fraud risk factors for KCI.
B. For each fraud risk factor you identify, analyze how the risk will affect your approach to the audit of KCI.
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