REPLYOVERVIEWThe student will post one reply for this discussion. Your one reply must be a critique of the other student’s Discussion: Client Acceptance and Retention Analysis in this course. INSTRUCTIONSThe critique should be between 1000 and 2500 words, twelve-point type. The student will organize the critique by listing each item on the grading rubric in order, stating whether the other student’s posted work appears adequate.Please see the Discussion: Client Acceptance and Retention Analysis Grading Rubric for complete details of how this assignment will be graded.

Client Acceptance & Retention Analysis: Smith & Wesson Brands, Inc

Aaron Penney

Liberty University

ACCT 622-B03: Advanced Auditing

Prof. James Shelton

February 26, 2022

Introduction:

Client acceptance procedures are a must for auditing firms, as “Ineffective or nonexistent client acceptance procedures are often an underlying cause of many lawsuits against CPAs, either directly or indirectly” (Wolfe & Sterna, 2020).  In considering whether Smith & Wesson Brands, Inc. should be accepted as an audit client, there are several factors that should be evaluated, including the company history, board of directors and audit committee including their independence, ratio analysis including competitor and industry comparison, and audit risk evaluation.

Company History:

Smith & Wesson is one of the leading manufacturers of firearms in the world, offering three categories of long-guns and two categories of handguns to a wide variety of customers, ranging from military and law enforcement to gun enthusiasts and sportsmen.  Founded in 1852 by Horace Smith and Daniel B. Wesson, the family business was eventual sold to Bangor Punta Corp in 1956, Lear Siegler Corp in 1984, Forstmann Little & Co. and Tomkins PLC in 1986, and finally to the current owners, Smith & Wesson Holding Corporation in 2001. In 2020, American Outdoor Brands Corporation split off to focus on the outdoor products and accessories, and Smith & Wesson Holding Corporation changed its name to Smith & Wesson Brands, Inc. following the split.  Their firearms are sold under the names Smith & Wesson, M&P, Thompson/Center Arms, and Gamtech.  Each year, they continue to introduce new products and product enhancements for their long-guns and handguns, and they own numerous patents on their products and technology.  The current President and CEO is Mark P. Smith (45), and the Executive VP, CFO, Treasure, and Assistance Secretary is Deana L. McPherson (50).  Robert J. Cicero (54) is the Senior VP, General Counsel, Chief Compliance Officer, and Secretary, while Susan J. Cupero (61) is the VP and Sales Executive.  In 2021, Smith & Wesson generated 317.3 million in cash from continuing operations, and reportedly paid off all existing notes and loans, invested in equipment and declared the first ever dividend in the company’s history (S&W Form 10-K, 2021).  While the firearm industry has significant inherent risks associated with it, the lengthy company history, significant growth, and recent positive financial performance help reduce the audit risk of S&W.

Acceptance/Non-Acceptance Statement:

Smith & Wesson has a long history of being a leader in the firearm industry and has a Board of Directors with a vast experience in business.  There do not appear to be any ethical or independence issues, or any other red flags significant enough to lead to non-acceptance. Provided the audit firm has the expertise and experience to understand the firearm industry and manage the inherent risks, the audit engagement should be accepted.  However, if additional legal and regulatory issues materialize for the firearm industry, this decision may need to be reevaluated. For the financial year 2021, the financial statements and internal controls were audited by Deloitte & Touche, LLP (S&W Form 10-K, 2021).

Independent Status of the Board

The Board of Directors of S&W are as follows:

• Robert L. Scott – Independent
• Michael F. Golden – Independent
• Anita D. Britt – Independent
• Fred M. Diaz – Independent
• John B. Furman- Independent
• Barry M. Monheit – Independent
• Mark P. Smith – Not Independent
• Denis G. Suggs – Independent

According to a recent Proxy Statement 14A, all but one of the board members meet the requirements for independence as defined by the listing standards of the Nasdaq Stock Market, and do not have any relationships that would compromise their independent judgement. Mark P. Smith, the only one considered to be not independent, is an employee director and holds no committee positions.  Additionally, S&W claims that there are no family relationships among their executives (S&W Schedule 14A, 2021).

Audit Committee

The purpose of the Audit Committee is to oversee the financial reporting process and assist the board of directors in their oversight of the integrity of the financial statements, the compliance with regulations, practices of information security, and CPA qualification, independence, and performance (S&W Schedule 14A, 2021).  The Audit Committee is made up of Chair and Independent Director Anita D. Britt, and members John B. Furman, Robert L. Scott, and Denis G. Suggs.  Anita Britt also serves on the board for Urban-Gro Inc and Delta Apparel Inc, and was formerly the CFO of Perry Ellis Intl Inc from 2009 – 2017.  John B. Furman has held many executive positions with the most recent being the CEO of GameTech International.  Robert L. Scott also serves on the board of the National Shooting Sports Foundation, Inc. Denis Suggs serves on the board of Education Corp. of America and Patrick Industries, Inc. Each of the members qualifies as an “audit committee financial expert” (S&W Schedule 14A, 2021).

SEC 8-K Filing

The most recent S&W 8-K was filed on December 2, 2021, and provided the second quarter 2022 Financial Results.  The reported net sales of 230.5 million was as decrease of 7.3% from the comparable quarter in the previous year.  They also reported a gross margin of 44.3%, an increase of 3.7%.  According to the CEO, their sales decreased from previous record highs, commenting that despite this, they still managed to deliver higher gross profit and have seen a two-year compounded growth rate of 140%.  Accordingly, the board authorized a $0.08 per share quarterly dividend.  He also announced relocation plans for their headquarters to Maryville, TN in 2023.  The 8-K shows a positive financial performance indicating less audit risk (S&W Form 8-K, 2021).

Ratio Analysis

Ratio Analysis

S&W 2021 (S&W Form 10-K, 2021)

Ruger 2021 (Sturm, Ruger, & Company Form 10-K, 2022)

Net Profit Margin

23.8%

21.4%

Gross Profit Ratio

42.3%

33.7%

Current Ratio

2.13:1

4.26:1

Debt-to-Equity

67.6%

21.6%

Times-Interest-Earned

82.1:1

1,260.7:1

In 2021 S&W reported a net profit margin of 23.8% and gross profit ratio of 42.3%, showing S&W was very successful in turning sales into net income in 2021 (Griffin, 2015).  Ruger, a major competitor for S&W, had a profit margin of 21.4% and a gross profit ratio of 33.7%.  The gun industry had a very big year in 2021 with almost 20 million firearms sold, making it the second highest year ever recorded (Walsh, 2022).  Comparatively, the industry average in 2012 was only 8.5% (Cardello, 2012).  With this in mind, we should not expect these profit margins to continue indefinitely.  S&W’s current ratio, which shows their ability to pay their current liabilities with their current assets, is 2.13 compared to Ruger’s 4.26.  The reason for the difference is that S&W has fewer current assets while also having over double the current liabilities of Ruger.  Likewise, S&W also has significantly higher Debt-to-equity ratio, with S&W coming in at 67.6% compared to Ruger’s 21.6%. This means that S&W is relying heavily on leverage, with a significant amount of its total assets coming from creditors.  Additionally, S&W’s times-interest-earned ratio shows they can pay their interest charges 82 times over, while Ruger shows a much greater ability to meet interest payments at over 1,260 times, its interest payments being significantly less than S&W (Griffin, 2015).  Despite S&W’s higher net profit margin in 2021, their higher leverage makes them a riskier option than Ruger.  However, a positive sign is that S&W recently cut their liabilities nearly in half, thanks significant earnings in 2021 (S&W Form 10-K, 2021).

Audit Risk

S&W faces significant risks from the firearm industry, including political, regulatory, and legal risks, as well as manufacturing risks related to raw materials and components (S&W Form 10-K, 2021).  These risk factors in turn contribute to a higher inherent audit risk for auditors of the firearm industry.  The audit firm will need to feel confident in their ability to manage the inherent risks before accepting an audit engagement (Johnson-Snyder & Chandrasekran, 2017).  The firm will need to evaluate their staff to determine if they have enough experience and expertise in the firearm industry to complete the audit successfully. The biggest risk factor for S&W comes from legal and regulatory risk, with lawsuits and liability often being threatened for mass shooting events (Pierson, 2021).

Background checks will also need to be run on the executives and board members to evaluate the “tone-at-the-top,” looking for ethical, legal, or independence issues that could increase audit risk.  According to the recent filings, no such issues are apparent from the current leadership. The firm will also want to evaluate the company’s history to identify any risk events or red flags that could raise the level of audit risk.  In this case, once again the biggest concern is the ongoing threat of liability for gun violence (Pierson, 2021). They should also evaluate the relationship with past audit firms and accountants, looking at the frequency with which they change firms or complain about accountants. (Wolfe & Sterna, 2020).  S&W changed to Deloitte & Touche LLP from BDO USA, LLP, whom they had engaged since 2005, citing no disagreements with BDO (S&W Form 8-K, 2014). The upcoming relocation of the company headquarters may present some additional challenges and complexities for auditors in the years ahead (S&W Form 8-K, 2021).  Due to the elevated inherent risk associated with the firearm industry, S&W could be considered a higher risk audit.  Despite this, with no additional risk factors discovered, the risks do not exceed what can be managed by a professional and experienced audit firm.

Statement of Christian World View

As Christians, we know that all mankind is corrupted by sin, and “are by nature children of wrath” (Ephesians 2:3, ESV).  As Jeremiah says in Jeremiah 17:9, “The heart is deceitful above all things, and desperately sick; who can understand it?”  Knowing this, that mankind has a natural disposition toward sin and is extraordinarily prone to fraud and corruption, accountants should carefully evaluate each audit client before accepting an engagement.  While many clients may resist the temptation to behave unethically or illegally, some will not, and auditors want to avoid partnering with the latter.

Even Christians are not yet freed from the sinful nature that dwells within them, as the Apostle Paul laments in Romans 7:18 (ESV), “For I know that nothing good dwells in me, that is, in my flesh. For I have the desire to do what is right, but not the ability to carry it out.” Yet, he still concludes that “Thanks be to God through Jesus Christ our Lord” (Romans 7:25, ESV), for God does not deal with us according to our sins, but according to grace (Romans 6:14), having forgiven and redeemed us by the blood of Christ (Ephesians 1:7).  So, while we still must account for the sin in the world and act accordingly, we must not despair or give ourselves over to sin, but should put on the righteousness and holiness of Christ as He empowers and renews us by His Spirit (Eph 4:22-24).

References:

Cardello, H. (2013, January 14). The gun industry needs to reinvent itself before it’s too late. Forbes. Retrieved February 26, 2022, from h