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Question 3 (15 marks)

You are the Engagement Quality Control Reviewer in the firm Hartley & King (HK) LLP and you are responsible for the independent review of all audits.It is March 1st, 2017, you are reviewing the audit working papers and draft audited financial statements of Touchwood Tires (TT), a private company, for the year-end December 31, 2016, and the recommended auditors report (an unqualified opinion) dated February 28, 2017.

Your firm has audited TT for several years.The 2016 year-end audit was conducted in the two-month period from mid-December 2016 to mid-February 2017. The audit team consisted of the partner, an audit manager and two staff members, a senior auditor, who has been involved with the audit of TT for several years, and a newly hired junior auditor.

The following is some key information from TTs draft audited financial statements:

Sales

$50,000,000

Net income

500,000

Inventory

10,000,000

Total Assets

60,000,000

Total Liabilities

40,000,000

After reviewing the audit file, you decide to write a memo to the engagement partner, with a copy to the managing partner of the firm, expressing your concerns and what needs to be done before you are prepared to sign off on the engagement Below are the relevant excerpts from the audit files used to draft your memo:

Excerpts from Audit Working Papers

Accounts Receivable

Accounts receivable confirmations were sent to 30 customers, which represented 75% of the accounts receivable balance. The following discrepancies were noted in the audit file:

Trans Auto Inc. indicated that they are disputing the $40,000 owing to TT as the tires they received were defective.The audit senior agreed the amounts owing to the invoices, shipping documents, and customer orders and found no discrepancies.The audit senior concluded that no adjustment was required.

Automotive Parts Inc. indicated that they are in a state of financial difficulty and they would like to re-negotiate the terms for the payment of their $35,000 balance.Based upon this reply, the audit senior concluded that this amount was likely uncollectable and should be provided for in the allowance for doubtful accounts.The proposed adjustment of $35,000 was included in the summary of possible misstatements.

Inventory

The inventory count was performed at the main warehouse in Ontario, where 75% of the inventory is held. Inventory during the count was well organized and all items in the warehouse were appropriately tagged. Inventory counters were working in pairs to ensure the accuracy of the count.

Inventory Test Counts

We selected a random sample of 40 different products from the inventory listing and performed a test count on each of those items. All of the test counts agreed to the count sheets except for the following two discrepancies:

Product

Description

# of items per auditor

# of Items per count

Model # 5267XYB

Winter Tires

44

45

Model # 645XMHN

All Season Tires

33

36

Upon discussion with the warehouse manager these discrepancies are a result of one particular counter who had been assigned to count the tire inventory and was continuously making errors. Tires are organized by model and are stored in five-tiered shelving racks that hold 9 tires per row. The warehouse manager has since replaced this particular counter.No further audit work is required.

Selected a sample of 40 items from the inventory floor and performed a test count on each of these items.All items tested agreed to the count conducted by the counter.

Pricing and Compilation Testing

Price tests were performed on the items selected during the count. Each item was agreed to the supplier invoice and no discrepancies were noted. As tires do not have an expiration date, obsolescence is not an issue; therefore, net realizable value testing was not necessary. Based upon the work perform, we conclude inventory is fairly stated.

REQUIRED

a) (6 marks) Accounts Receivable.In the table below identify and explain two major deficiencies in the work performed in the accounts receivable testing.Provide recommendations regarding further actions and/or audit procedures.

Deficiency

(Case Fact)

Explanation of the nature of the deficiency Use GAAS requirements and/orassertions as a basis for your explanation)

Recommendation Auditor action or further procedure(s)to be performed prior to the issuance of the unqualified audit report

b)(9 marks) Inventory -In the table belowidentify and explain three major deficiencies in the work performed in the testing of inventory.Provide recommendations regarding further actions and/or audit procedures.

Deficiency

(Case Fact)

Explanation of the nature of the deficiency Use GAAS requirements and/orassertions as a basis for your explanation)

Recommendation Auditor action or further procedure(s)to be performed prior to the issuance of the unqualified audit report