Question

Audit risk and revenue. Ajax Finance Inc. (Ajax) provides small and medium-sized personal, car, and business loans to clients. It has been operating for more than 10 years and has always been run by Bill Short. Bill has been the public face of the finance company, appearing in most of its television and radio advertisements, and developing a reputation as a friend of the “little person” who has been mistreated by the large finance companies and banks. Ajax’s major revenue stream is generated by obtaining large amounts on the wholesale money market and lending in small amounts to retail customers. Margins are tight, and the business is run as a “no frills” service. Offices are modestly furnished, and the mobile lenders drive small, basic cars when visiting clients. Ajax prides itself on full disclosure to its clients, and all fees and services are explained in writing to clients before loans are finalized. However, although full disclosure is made, clients who do not read the documents closely can be surprised by the high exit charges when they wish to make early repayments or transfer their business elsewhere. Ajax’s mobile lenders are paid on a commission basis. They earn more when they write more loans. For example, they are encouraged to sell credit cards to any person seeking a personal loan. Ajax receives a commission payment from the credit-card companies when it sells a new card, and Ajax also receives a small percentage of the interest charges paid by clients on the credit card.

Required
Analyze the inherent and control risks for Ajax’s revenue. What type of misstatements would be most
likely for revenue?

Answer 1

Ajax generates one type of revenue by lending to customers. The finance charges paid by the customers (i.e., interest and fees) are Ajaxs revenue. Ajax must pay interest and fees when it raises the funds on the wholesale money market. In addition, Ajax earns revenue through credit card sales. Ajax is paid an amount per credit card and a proportion of the interest charges paid by the customers to the credit card company.

The difference between the revenue earned by lending to the customers and the cost of raising the money paid to the money market participants, plus the credit card commission and interest, pays Ajaxs running costs and contributes to its profit.

The major risks with Ajaxs revenue relate to the style of its business. Loans are made by mobile lending officers who are paid on a commission basis. The lending officers appear to be alone when they visit clients, and we do not know what controls exist over the loan applications when the lending officer returns to the office (or submits the paperwork electronically). These factors suggest control risk will be higher over the validity of the loans and credit card applications. There is also a possibility that some loans or card applications will not be processed at all, or processed in a timely fashion. The facts also suggest that there could be a high risk of selling loans to customers who will not pay their debts. There is the possibility that the little person who is the foundation of Ajaxs business are not likely to pay their obligations as much as the people who have good relationships with their banks. In addition, the selling techniques used by the mobile lending officers could be unscrupulous because of the pressure on the lending officers to make sales. These factors increase the inherent risk surrounding Ajaxs revenue from collecting on their debts and interest payments.