After careful consideration of all the facts below, compose a memorandum addressed to the engagement partner. A copy of the memo will also be forwarded to the managing partner of the firm to communicate your opinions regarding this audit engagement. In the memo, detail your stance on the issues at hand and what must be done before you are comfortable giving your approval to the engagement. To accomplish this, you will conduct a thorough evaluation of the three audit issues presented, giving credits to some excellent audit team members, and highlighting any flaws or errors. Please do not forget to provide your professional recommendations.

Case

You are a partner of the CPA firm London and Paris LLP. The CPA firm is a prestigious regional firm in Mid-west US. You are required to conduct an independent review of audits completed by the firm, as required by the firm's quality control program.

Now, you are reviewing the audit working papers and a draft of the audited financial statements of Wallis Electronics Inc. for the fiscal year ended September 30, 2018, along with the suggested auditor's report (an unqualified opinion) prepared by the engagement partner. The company designs and manufactures components for radios, televisions, and other consumer electronics. The company is wholly owned by the family of the founder of the business, Frank Wallis, who passed away several years ago. The company sells its components to several large manufacturers of consumer electronic products, but its major customer is a South Korean conglomerate that normally accounts for about 40% of Wallis's annual sales.

Wallis Electronics Inc. has been your firm's audit client for 3 years. The audit fieldwork, which took about 5 weeks, was performed by two senior auditors (one Senior Accountant I, Tony, as the audit team leader, and one Senior Accountant II, Leslie) and 3 junior auditors (Mary, Jack, Tom). The working papers had been reviewed by the engagement partner. The audited financial statements show total assets at year-end of USD $250,000,000, revenues of $300,000,000, and income before taxes at $10,000,000.

Based on your independent review of the working papers (including various memoranda and review notes prepared by the staff and engagement partner) and the proposed financial statements and audit opinion, you have noted the following issues that arose during the audit, along with the manners in which they were resolved by the audit team:

Issue #1. Inventory Audit

In testing the client's finished goods inventories, the junior auditor (Mary) observed a large number of old and dust-covered parts on hand. According to the perpetual inventory records, these parts were manufactured 2 years ago for a South Korean company with which Wallis does a lot of business, but the order was cancelled by the customer. The recorded inventory cost of these units is about $1,500,000. One junior auditor, Mary, asked the production manager about the parts, who explained that the company decided to hold the parts in inventory until they could find another buyer for the goods. The senior auditor, Tony, reviewed the junior auditor's work and wrote: "No adjustment needed amount immaterial," to which the engagement partner later added "I agree."

Issue #2. Cutoff Test

Wallis uses "FOB Shipping Point" as the standard trade term when selling its components to domestic and international customers. Since its products are all standardized industry components, contractual obligations under contracts usually end after Wallis ships out its products.

Leslie, the SA II, conducted FY 2018 revenue cut off test for Wallis Inc. Below is an excerpt from her working papers. She pointed out that Wallis made a small error: Accounting for consignment transaction as a real sale. She proposed to reverse the $80,000 revenue and $46,000 COGs (Transaction #4 below. Her proposed adjustments have been accepted by the client) and concluded her cutoff audit. The engagement partner approved her working paper on cutoff test with two words, "well done". A snapshot of the working paper is provided below,

Sales Sales Cost of Shipping

Invoice Invoice Goods Document

Amount Date Sold Date

Sep

1. $42,000 9/28 $38,000 9/29
2. 18,000 9/29 14,000 9/22
3. 20,000 9/30 12,000 10/2
4. 80,000 9/30 46,000 9/30(shipped to consignee)

Oct

1. $30,000 10/1 $22,000 10/1
2. 20,000 10/2 13,000 10/1
3. 40,000 10/3 29,000 9/30

Issue #3. A/R and A/P Audit

Tony(SA-I) and Jack(junior) were tasked by their audit manager to conduct an audit of the accounts receivable (A/R) and accounts payable (A/P) accounts. During the first two days of the audit, Jack, under Tony's supervision, efficiently completed the A/R audit work, and then moved on to the A/P audit. To Tony's delight, Jack completed all the A/P audit work in just 6 hours and then sat idle for further instructions.

Jack explained to Tony how he performed the A/P audit. First, he classified the A/P accounts into three categories: A, B, and C.

Category A accounts were those with balances over $50,000, and Jack's confirmation procedures covered 100% of those accounts. He obtained the A/P balance for each account from the A/P sub-ledgers and then requested confirmation from the vendor of the audit client.

Category B accounts were those accounts with balances between $3,000 and $50,000, and Jack's confirmation procedures covered 20% of those accounts.

For the remaining A/P accounts with balances under $3,000, they all belonged to Category C, and Jack only took a 5% sample (in terms of the number of sub-ledger accounts) and sent confirmations.

As a star graduate of Catalina State University, Short Colina (CSUSC), Jack proudly reminded Tony that he still remembered the concept of materiality from Prof. Zheng's class. Jack's approach effectively covered 94% of the total dollar value of A/P accounts, impressing Tony again, who is also a CSUSC alumnus.

Tony was pleased to have such an excellent junior on his team.