Individual Assignment 1:
The Peninsula Limited: Analysis of a Potential Audit Client
Jimmy Chung is the president of the Peninsula Company, a retailer and distributor of consumer electronics based in Hong Kong. Although Lam & Company, the audit firm had previously audited Peninsula, Jimmy has recently become aware of the CPA firm of Zhou & Company from his friend. His interest in the firm was heightened when he discovered that Zhou & Company audited the primary bank with which he did business. During March of 2015, Jimmy contacted his banker who arranged for Jimmy to have lunch with one of the CPA firm’s partners. At that time, a wide-ranging ...view middle of the document...
This business did well and the company expanded thereafter at the rate of one new store every two or three years. Presently six stores are in operation in Hong Kong. The first five were set up in rented space within small shopping centres. However, the most recent store was located in a building constructed by Peninsula itself, adjacent to a new shopping mall in Shatin. In addition, Peninsula owns a warehouse that also provides office space for the company’s administrative staff.
* In 2002, Peninsula reduced the marketing of bargain-priced electronics in a more to concentrate on the sale of high-end audio and video equipment. Several years later, Peninsula became the sole distributor of Supreme products from the United States. Supreme is the manufacturer of a quality line of audio and video equipment. Shortly thereafter, the Peninsula stores began to carry Supreme products almost exclusively. Despite the quality of Supreme equipment, the brand was not well known in Hong Kong and store revenues (retail sales) began to decline. Sales did rebound somewhat in 2013 and 2014, although Jimmy admitted to Peter that all of the stores had suffered from intense competition within the local market. He even indicated that several small audio equipment companies had gone bankrupt during the past six months. However, he was not certain as to the specific cause of that failure.
* To market the Supreme brand in local market, Peninsula had hired a staff of six sales representatives who visit audio, electronics, and appliance stores in Hong Kong. These other retailers could then order merchandise from Peninsula by telephoning the administrative office/warehouse. After a credit check, requested inventory is shipped to these customers and billed at 2/10; n/45. Up to 20% of the merchandise can be returned to Peninsula within four months as long as the goods have not been damaged. In the past, returns have been low. Jimmy indicated that these “distributorship sales” had initially been disappointing but had risen materially in the last two years as the Supreme reputation began to spread.
* Audio and video equipment inventory is purchased weekly from Supreme. Regional distributors such as Peninsula are allowed 90-day terms but Supreme encourages quick payment by offering large cash discounts. In hopes of maintaining a high profit margin, Jimmy has chosen to take all available discounts. To meet the payment terms, Peninsula holds bank credit lines with two banks totaling $5,000,000. Interest on this debt is based on the floating prime rate of the respective banks and has averaged just 5% - 7% during recent years. Both banks require that cash in an amount equal to 10% of the outstanding credit line remain on deposit.
* The company’s warehouse and the sixth store were constructed with funds provided by loans from the Kowloon Bank. The first of these obligations was obtained at a 5.5% annual interest rate while the second holds...