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Excerpts from the document.... Observations Noted in My Review of the Previous Year (year-end 30 November 2017) Audit File (written by you, the new senior auditor...)

In fiscal 2017, CTC exceeded its earnings targets, reporting operating income of $3,026,100 and net income before taxes of $2,572,800. The only large negatives for the year 2017 were the substantial additions to allowances for receivables and inventories, including an extra $300,000 in the allowance for doubtful accounts related to the struggling Toy-Mart chain in the United States. The increase to the allowance for inventory was due to possible obsolete inventory. The increase in the Allowance for Doubtful Accounts was accomplished by a debit to Bad Debt Expense and a credit to the Allowance. CTCs management advised our Firm that retailers dramatically reduced the quantity of toys they were willing to stock on its shelves at any one time in fiscal 2017, and were expected to continue this trend into 2018. This change did not (at least in 2017) reduce the volume of the toys sold through retailers, but it has intensified competition among industry competitors for retail shelf space, and increased operating costs by increasing the frequency of shipments to stores. (In the competitive environment in which CTC operates, shipping costs are usually paid by the manufacturer, not the retailer.) Its possible that the restrictions on shelf-space could result in lower sales in future periods. Ever since 2015, CTC executives have shared in a bonus pool that is created through CTC contributions of 10% of the first $750,000 of operating income, plus 20% on the next $750,000, and an additional 30% of the next $1,500,000. CTCs total contributions to the bonus pool are capped at a yearly maximum of $675,000.

CTC does not have an internal audit group. In addition, they have struggled to implement the COSO Integrated Framework of Internal Control. Excerpts from the document.... Findings from Visit to Client and Interim (before year-end) Audit Procedures Conducted in September 2018 (written by the audit senior that you replaced) In January 2018, the long-time CEO and CFO of CTC retired, and replacements were hired and began work in March 2018. One senior manager told me that the pair are like fire-breathing dragons, and have indicated that their sole number-one focus will be increasing sales and profitability, and those who do not contribute will be given the opportunity to continue their career elsewhere. We developed an understanding of controls over purchases and payable and found that controls in this area were not well designed and were not operating effectively. Therefore, I decided to test the controls over purchases and payables in the interim period and assigned it to one of the staff auditors. Although this testing has not yet been reviewed, one item seemed unusual. It involved a payment of $30,000 to the International Toy Manufacturer Workers Union. The payment was initiated by the CTC VP-Operations and approved by the current CFO, and was properly classified as a non-operating expense. According to the VP-Operations, the payment was a gesture of support for the toy factory workers a gesture we believe is important since workers believe themselves to be underpaid and are discussing the possibility of work stoppages and strikes in the Fall of 2018. We hope this payment will assist in making it possible for union executives to encourage their members to resolve these issues before a work stoppage or strike. In the tests of controls over revenues and receivables, one of the staff auditors that conducted the testing noted that controls were effective. In particular the staff member noted that one thing that was very impressive was that the CFO was active in oversight of the area of bad debts and inventory obsolescence. Indeed, as an example, the current CFO herself approved the reversal/recovery of the $300,000 amount allowed for with respect to Toy-Mart, and had even initiated and approved the journal entry for the transaction, reversing it into income (debit Allowance for Doubtful Accounts, credit Bad Debt Expense) without the involvement of the credit manager. Excerpts from the document.... Audit Partner Memo to Workpaper File CTC had been unable to produce enough Snuggle Pets for the December 2017 year-end holiday season, due to raw material shortages in an unstable stuffing supplier market. The Company was able, however, to increase production in

January 2018, which allowed for increased sales for Valentines Day in February 2018. Soon after, at the insistence of the national retailers, all unsold Snuggle Pets were returned to CTC for a full refund. The retailers insisted that the absence of Snuggle Pets in stores after February 2018 would build demand for the Fall/Winter 2018-2019, as the retailers focused on the end-of-the-year holidays and gift-giving season. CTC has deferred their purchase of new, hi-tech manufacturing equipment due to a shortage of cash and the inability to obtain favorable financing. This is the second year in a row that CTC has deferred this investment. CTC executives entered into an agreement with Cartoon Studios, Inc., who had produced their very first animated movie, called The Bronx Zoo Escape to Manhattan! for release on 30 November 2018. (The movie is billed as Jumanji meets Babe: Pig in the City!) For $900,000, CTC had won the rights to produce a line of soft and plastic toys based on characters from the movie. (CTC plans to amortize this fee over 9 years.) The toys would be sold through CTCs regular retail customers. The toys were on schedule to be in stores on 30 November. The agreement between the Company and Cartoon Studios indicated that Cartoon Studios would compensate CTC for the cost of the unsold toys if sales of the toys failed to reach $1,500,000 during the first two months after the movies release. CTC plans to accrue $1,500,000 of sales revenue on 30 November relating to this provision of the agreement. CTC executives have carefully reviewed the pricing and valuation of inventory during early November 2018, and determined that the inventory valuation reserve established in the previous year is no longer necessary; a journal entry was made by the CFO on 15 November 2018 to reverse the valuation allowance into operating income in a manner similar to the reversal related to the Allowance for Doubtful Accounts described above. In October 2018, CTC announced that it was suspending its partnership with the charitable organization Toys for Kids, an organization that distributes toys to underprivileged children in less-developed countries around the world. In the past, CTC had donated a substantial number of toys to Toys for Kids. On November 1, 2018, the Companys Board of Directors Compensation Committee agreed to double the Companys contribution to the bonus pool, to $1,350,000. This measure will be effective for the year-ending 30 November 2018.

Questions:

1. The senior auditor before you made a error that relates to the implementation of audit strategy. Identify this error and explain why it was an error.
2. Sales revenue is always an audit area where the risk of misstatement is high. Based on your understanding of management assertions, identify one management assertion relating to revenue that, based on the material above, is particularly high-risk at CTC and briefly explain why.
3. Assuming all material misstatements identified by the auditor are corrected, describe the type of audit report that would be issued in this case. Do not draft an audit report. Just describe the report and any explanatory language or modifications (if necessary), that the auditor would issue.