Electronics Parts Corporation (EPC) is a new audit client of Zayn & Malik, CPAs. You have been assigned to the team performing the financial statement audit of EPC for the year ended December 31, 2014.

EPC was incorporated in 1999 and is owned by Sunny Kwong, Samuel Kwong, and George Brown. Sunny and Samuel Kwong are brothers. Both play an active role in the company's operations and each brother holds a 40% ownership stake in EPC. George Brown owns the remaining 20% share of the company. George does not actively partake in the company's activities. He became a silent shareholder approximately three years ago, when EPC needed additional resources to fund its expansion. As a condition of Brown's 20% share investment, he insisted that audited financial statements are to be provided to him annually.

EPC manufactures and sells a wide range of electronic parts used in the assembly of laptop and desktop computers. The industry is very dynamic and fast paced. As technological advances relating to computers are rapid, EPC has to ensure that they keep pace with these advances within the industry to remain competitive and profitable. Sunny Kwong is the CEO and is charged with overseeing the manufacturing and sales processes. Samuel Kwong takes on the role of the CFO and oversees the accounting functions of the business.

Frank Dawson has been a long time employee of Zayn & Malik since 2000. In January 2013, he decided to make a change in his career after being offered the role of controller at EPC by Samuel Kwong (Chief Financial Officer of EPC). Frank has known Samuel for the last ten years and has developed a very close friendship with him. Samuel considers Frank as his brother and their families often meet socially. In June 2013 Samuel approved a no-interest personal loan to Frank for $50,000 from EPC, to help him with his home renovations. Frank has promised Samuel that he will repay the loan to EPC as soon as he can. Frank enjoyed the controller role at EPC, but by April 2014, he realized that the role was not for him and therefore rejoined Zayn & Malik. Frank was welcomed back by Zayn & Malik as he was always an exemplary employee and he had developed good working relationships with all of Zayn & Malik's clients. Frank has yet to repay the loan to EPC and expects to repay by end of 2015. Frank was appointed as the audit supervisor for the EPC audit by Zayn & Malik and has been giving you guidance as you start working on the EPC engagement.

In May 2014 there were disputes between EPC and two of its customers. Samuel reached out to Frank to help resolve the issues, as Frank is a good mediator. Frank had a few meetings with the customers where he made it apparent that he was the financial statement auditor of EPC. His meetings with the customers were successful as the customer's issues with EPC were able to be resolved.

As EPC is a part of a very competitive industry and the company was experiencing significant growth, both Sunny and Samuel agreed to hire a vice president of sales, Richard Lowden. Richard was hired in March 2014 and his compensation is mainly performance driven, driven primarily by the ability to meet specific sales targets. One specific change Richard implemented was that EPC began including a one-year warranty on all equipment they sold. In the past, EPC only provided customers with a limited two-week return period. In the rare situation when a customer received a defective product, they were obligated to send it back within a two-week period. Sunny and Samuel are quite pleased with this new initiative. They believe that it was the primary driver for the increase in sales of 30% in 2014 over the prior year.

In 2014, EPC began ordering a significant amount of raw materials that it uses to manufacture electronic parts from One Direction Inc. EPC was able to save approximately 10% on raw material costs as a result of the switch to One Direction Inc. The majority of the raw materials purchased from One Direction remained unused and are part of EPC's closing inventory as of December 31, 2014. One Direction Inc. is 80% owned by Paula Kwong, Sunny and Samuel's sister, and the remaining 20% is equally owned by Samuel Kwong and Richard Lowden. Richard is married to Paula Kwong.

You have reviewed the 2013 fiscal year audit file and met with EPC personnel to gain some additional knowledge about EPC and the industry in which it competes. EPC's financial condition appears to be strengthening, as assessed from a comparison of the firm's financial ratios with those of other companies in its industry.

During your initial meeting with Sunny and Samuel Kwong, you inquired about EPC's transactions with One Direction. Samuel informed you that for the audit, One Direction should be considered by you as any other vendor of EPC and nobody needs to know about the relationship between the owners of EPC and One Direction. Samuel added that it was in the best interest of Zayn & Malik to issue an unqualified audit report for EPC, especially considering that EPC awarded the audit to Zayn & Malik despite strong interest from other competing firms. Samuel concluded the meeting by stating that he was approached by several audit firms this year before deciding to assign the audit to Zayn & Malik. All the firms were very eager to accept the audit of EPC and some had even promised EPC an unqualified audit report. EPC ultimately decided to go with Zayn & Malik due to their relationship with Frank. You thanked Sunny and Samuel for their insight and informed them that you were very pleased that the confusion was now cleared and you were glad that EPC had chosen Zayn & Malik. You concluded by stating that you were certain, Frank would a good job on the audit and that you were looking forward to completing the audit of EPC in a timely manner. After the meeting, you reviewed a summary of key financial information relating to EPC as of December 31, 2014. Revenues 7,248,300 Total Assets 27,350,000 Cost of Goods Sold 4,110,200 Total Liabilities 22,350,000 Gross Profit 3,138,100 Shareholders Capital 4,000,000 Selling and Admin Expenses 2,600,050 Retained Earnings 1,000,000 Earnings Before Income Taxes 538.050 Income Tax Expense 114,000 Net Income 424,050

Required:

A. Assess five inherent risk factors as part of the financial statement audit of EPC. For each factor identified, indicate why the factor increases or decreases inherent risk and if inherent risk is impacted at the account or financial statement level.

B. Calculate and decide on preliminary materiality and performance materiality for the EPC financial statement audit.C.1. A change in the amount considered material is not an explicit component of the audit risk model. Outline how then (if at all) a change in the amount considered material can result in a change in detection risk if there is no change in audit risk and no change in the client's operations or controls?

C.2. Assume the audit partner suggests that materiality for the audit should be reduced by $50,000 compared to what you had calculated. What effect will this decrease have on detection risk?

D. Assess and conclude on Audit Risk for the EPC audit.

E. Assess independence threats relating to the financial statement audit of EPC. For each independence threat identified, explain why it is a threat to the audit and identify the type of independence threat that exists.