Identify entity-level and specific account risks that can be identified from the
ID: 2459916 • Letter: I
Question
Identify entity-level and specific account risks that can be identified from the information in the company profile and the industry information below. For each risk you identify briefly describe why it qualifies as risky.
Company Profile
J & M Lumber Corporation (J & M), an audit client, was formed in Ohio in 2000 to provide high quality lumber packages for builders in the central Ohio region. Ed Jensen and Pat Murphy founded the company and serve as chief executive officer and chief financial officer, respectively. Until this year under audit (2014), the company operated out of one location. In the year under audit, it added two locations to better serve customers and to expand the sales area to cover more of Ohio.
J & M has earned a reputation for excellence both in providing customer service and high quality materials. When business is lost by J & M, it is generally due to lower prices offered by competitors.
As a local company, J & M’s products and species of lumber are particularly suited for the central Ohio climate. The company uses a wide base of suppliers which allows it to supply various species of lumber within a short lead time. The company also has a contract to be the exclusive distributor in Ohio for a non-toxic, rot resistent specialty lumber product that has been making up an increasing percentage of the company's sales. The Company’s trucks are cell phone dispatched and equipped with forklifts to deliver material in a timely manner, when and where customers need it delivered. Customers include builders, carpenters, concrete contractors, general contractors, and homeowners.
Ed and Pat were hoping to maintain or improve upon their recent history of 5% growth in net income in anticipation of an initial public offering (IPO) of stock, which would have the potential to be quite lucrative for Ed and Pat. In fact, in prepartion for an IPO, J & M established an audit committee composed of college friends of Ed and Pat, two of whom, Sally Adams and Jody Jengelen, have also invested in the company.
Before the previous year, most of the earnings were distributed through dividends to J & M's 5 shareholders--CEO Ed Jensen, Ed's wife Madonna Jensen, CFO Pat Murphy, Sally Adams, Jody Jengelen.
The company’s operations are dependent on economic conditions which affect the construction industry, and changes in those conditions affect the company's financial results and the company’s continuing operations.
This is your firm's fifth audit of J & M--no audit was performed in its initial years of existence. There have been no disagreements over accounting issues in any of the previous audits.
Industry
Historically, J & M has competed, and continues to compete, primarily against four other suppliers in central Ohio. J & M has proven itself an able competitor over the years.
Within the past three years new competition has begun as organizations and individuals in several eastern European countries have begun to sell European lumber and related products directly to some of J & M’s residential customers. While the European competitors' prices have been lower, the Europeans have had quality issues as well as difficulties in delivering product on a timely basis. A significant portion of this wood is imported from Siberia.
The nature of most of J & M’s products makes them relatively unaffected by changes in technology, or obsolescence, but sales rely heavily upon both the residential and commercial construction markets. At the begining of J & M's history, the construction industry had been relatively profitable. J & M was able to weather the downturns in construction by supplying lumber to residential customers for remodeling and repair projects. Construction, both residential and commerical has been increasingly steadily since the recession and is approaching pre-recession levels.
The housing market in central Ohio has been particularly healthy due to its stable financial base and the availability of land previously used for farming for the construction of residential housing. A significant portion of this land has attracted “high end” residential housing contractors.
The most significant question facing the industry is whether the strong construction will continue as expected. During the economy of the United States has been in a recovery, yet unemployment remains high as compared to previous periods of recovery.
Explanation / Answer
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