PART 3, QUESTION 2

[9 total marks]

Maximoff, CPAs, was contacted by Shield Electronics Inc. (SEI), an electronics manufacturing company that operates in three provinces, to become the companys new auditors for the June 30, 2021 financial statements. Wanda, the partner assigned to the file, had to first learn about the clients industry and determine if their audit firm had the necessary expertise to do the audit. They researched the industry, met with the companys directors, and read over the audit reports and the financial statements for the past 3 years. Wanda noted that the largest accounts on the balance sheet were finished goods inventory and accounts receivable.

Initially, Wanda planned to contact the prior auditing firm to obtain a copy of working papers pertaining to interim work done on the inventory account, as Maximoff was being appointed in August 2021, and well after the June 30 inventory count for the 2021 year. Wanda met with SEIs management to explain Maximoffs standard policy of confirming accounts receivable, which Wanda wanted to schedule right away due to the timing of their appointment. SEIs board of directors explained that there would be no problem, except that one of the major customers, Hydra Distributors Ltd. (HDL), would not likely respond. The directors suggested simply reducing the receivable to whatever amount Wanda felt comfortable with, and not to bother contacting HDL.

When Wanda contacted the previous auditors, they were informed that HDL was owned by the brother of a major shareholder of SEI. HDL would not confirm that they owed a substantial (material) sum to SEI, and SEIs supporting records for the accounts receivable were inadequate to support the amount claimed. The board of directors would not agree to adjust the financial statements as the auditors had insisted, and ultimately, the previous auditors resigned.

Required

a. Identify a GAAP departure in the above scenario [1 mark]. Explain briefly why this is a GAAP departure [1 mark], and the possible effect on the financial statements [1 mark]. If the effect cannot be determined, state this in your answer. [3 total marks]

i) GAAP departure:

ii) Why is this a GAAP departure:

iii) Effect on the financial statements:

b. Identify two scope limitations in the above scenario [1 mark each] and explain why these are scope limitations [1 mark each]. [4 total marks]

Scope limitation:

Explanation:

Scope limitation:

Explanation:

c. Assume that the previous auditors were able to obtain sufficient appropriate evidence on all other items in their audit, except for the HDL receivable, which is material. What opinion could the previous auditors have issued, rather than resign? Explain. [2 marks]