It is March 1st, 2023, and you CPA who work for the firm of Richards Stern LLO has been asked to review the audit working papers and draft audited financial statements of Bestyear Tires (BT), a private company, for the year-end December 31, 2022, and the recommended auditor's report (an unqualified opinion) dated February 28, 2023.  BT has several stores and a main warehouse.

 

Your firm has audited BT for several years.  The 2022 year-end audit was conducted in the two-month period from mid-December 2022 to mid-February 2023. 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 BT for several years, and a newly hired junior auditor.

The following is some key information from BT's draft audited financial statements:

After reviewing the audit file, you decide to write the 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 the 30 largest 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 BT 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 60% 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: 

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

Sales Net income Inventory Total Assets Total Liabilities $50,000,000 500,000 10,000,000 60,000,000 40,000,000