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Identify six deficiencies with the sample selection process in the accounts receivable and inventory work performed by the recruit. Your response should describe any deficiency (insufficiency) in the samples selected and provide an appropriate recommendation to correct each deficiency.

Question 2 (12 marks) As part of your firm's training program, newly hired PA recruits must audit a fictitious audit client, Merlon Intercom Inc. (MII). The recruits complete various sections of the audit file for the year ended December 31, 2015. The files are then reviewed by more experienced co-workers. The partner in charge of the training program asks you, an experienced public accountant, to review a file prepared by a recruit and comment on each section. Below is a description of MII, followed by the work on the file completed by the recruit. DESCRIPTION OF MII OPERATIONS MII is a privately held, medium-sized company that is managed by the sole owner who is actively involved. MII buys intercom equipment, telephone equipment, parts and related equipment and resells them at a mark-up to a loyal base of corporate customers (approximately 250 customers). Approximately 60 of MII's 250 customers make up 75% of MII's total sales. Competition is growing, but the market is favourable, and MII offers excellent customer service, giving it a competitive advantage. The owner is very involved in most of the operating decisions. His capable assistant steps in when necessary. The owner wishes to implement a code of ethics at some point and also wishes to improve certain controls. MII operates multiple (six in total) warehouses, each carrying a mix of inventory items approximately 1,500 different products. The first type of inventory, that can be quite costly, consists of specialized telecom equipment hardware, high end intercom equipment and parts. The turnover rate of this inventory is high since new technology is always emerging. Because the company orders months in advance, MII occasionally overestimates demand. After three or four months, products are difficult to sell but they are kept because most cannot be returned to the supplier, and MII is reluctant to hold liquidation sales for fear they would negatively affect the sales of the regular products. The second type of inventory, parts and peripherals, generates a significant portion of MII's sales. This category includes items such as cables, headphones and replacement parts. The third type of inventory includes batteries and chargers for cordless phones. This inventory can be returned to suppliers if unsold after a certain period. The sales mix has not changed significantly from previous years. Ten new accounts were opened during the year, with average monthly sales of $5,000 each. Sales also increased because a new sales representative was hired at the beginning of the fiscal year. Average monthly sales for the 10 experienced representatives are $500,000 each. Rookie representatives normally perform at 50% of an experienced representative's level in their first year. MII also lost a customer, who had averaged $90,000 a year in sales, to the 1 competition. Purchases of products increased in the current year and were distributed across the inventory types in amounts similar to the overall sales mix. Sales representatives enter orders into the sales database, and can modify the information, including quantities and selling prices. Any changes are usually made to orders before shipping. Problems result if representatives make changes after shipping, since they should issue credits instead. The timing differences create reconciliation problems for both customers and MII when settling invoices. Also, sometimes credits have been issued in error. Sales representatives are compensated based on a combination of a basic salary and commissions on sales. The owner noted he just received a memo from a clerk at one of the warehouses. It says the amount of damaged inventory has been gradually increasing over the past eight months. The clerk suggests this is because the forklift is not operating properly and items are being dropped as they are loaded for shipment. He wants the forklift replaced. He asks what he should do with the damaged inventory that has been piling up in a corner of the warehouse. He suggests holding a liquidation sale to get rid of it, since it needs space. The owner's assistant has a vital role in the day to day operations of the business. He is responsible for developing relationships with the various vendors and finding new vendors. He adds new vendors in the system and also places orders when inventory items are low. Lastly the assistant assumes all of the owner's responsibilities when the owner is on vacation or on a business trip. SECTIONS FROM THE RECRUIT'S AUDIT FILE INVENTORY WORK PERFORMED 1. Matched totals on inventory listing to sub-ledger and general ledger. 2. Went to one of the six warehouse locations. Traced quantities from MII's inventory listing to the warehouse floor for a random sample of 10 cordless phones. My inventory count matched quantities on the inventory listing. 3. Traced prices for the 10 cordless phones sampled in the previous test. Prices matched those on the price listing, except for two models. The owner explained that employees sometimes manually change inventory prices to adjust for errors made when recording purchases. He provided a second listing with handwritten corrections. However, no backup documents were available to substantiate the changes. 4. Recalculated quantity and price extensions for the same 10 cordless phones and they were accurate. 2 5. One customer placed an order of more than $800,000 for specialized telephone equipment. Unfortunately, the customer went bankrupt and, 10 months later, the specialized telephone equipment was still in inventory. MII never posted the sale because the equipment was never shipped. The company is certain it can resell the equipment to another customer, so no provision has been booked. EXCERT FROM SALES WORK PERFORMED Sales variance analysis: 2014 2015 Telephone Devices Parts & peripherals Cordless Phones Variance ($) Variance % $20,000,000 $22,000,000 $2,000,000 10% 35,000,000 37,500,000 2,500,000 7% 5,000,000 5,500,000 500,000 10% Total $60,000,000 $65,000,000 $5,000,000 8% Explanation for variance: Sales increased because a new sales representative was hired. ACCOUNTS RECEIVABLE WORK PERFORMED 1. Customers have 30 days to pay invoices, but most take advantage of the 2% discount offered for payment within 10 days. A sample of five year-end balances was tested, and all payments were received subsequent to year-end, so accounts receivable were reasonable at year-end. 2. On January 2, 2016, goods related to a sale made on December 29, 2015 were destroyed in a transport accident. The goods were sold FOB shipping point and the customer is refusing to pay for the goods. The goods were valued at $200,000. 3. In order to save time, MII applied a blanket provision of 5% for uncollectible accounts. Historically, the amount of uncollectible accounts ranges from 4% to 5%. Credit procedures were tightened two years ago, and since then, the rate has been at the lower end. Therefore, 5% is quite conservative, allowing for potential overstatement of receivables. Required: a) Identify six deficiencies with the sample selection process in the accounts receivable and inventory work performed by the recruit. Your response should describe any 3 deficiency (insufficiency) in the samples selected and provide an appropriate recommendation to correct each deficiency. (12 marks) Sampling - Description of Deficiencies Recommendation Sampling - Description of Deficiencies Recommendation Sampling - Description of Deficiencies Recommendation Sampling - Description of Deficiencies Recommendation 4 Sampling - Description of Deficiencies Recommendation Sampling - Description of Deficiencies Recommendation 5