Star Studios Inc. (SS) has been a small family-run business. SS has a studio space that is set up to be used for music practice and collaboration. Musical instructors also use the space to provide music lessons to school going children. In the winter of 2020, SS announced it was shutting down. Despite appearing to be a busy operation, SS was unable to turn a significant profit, and the owners wanted out.

Blake, her sister-in-law Lexi, and their friend Stevie have used the studios for years and were determined to keep SS open. They pooled their resources and acquired the shares of SS on April 1, 2020. The purchase was impulsive, but the friends were sure they could make the business a success. Information on the new owners and notes from discussions with them are provided in Exhibit I.

Because SS is under new ownership, the bank has requested audited financial statements. The owners have approached your firm to conduct a first-time year-end financial statement audit.

It is now May 2, 2021, and you, CA, have just been assigned as the senior on the audit. You have obtained draft financial statements for the year ended March 31, 2021 (Exhibit II) and have gathered other information from SS's administrator and bookkeeper, Mrs. Rose, as well as from the receptionist (Exhibit III).

Required:

1.Based on your calculations and case facts, identify the income statement and balance sheet accounts that could be misstated. Calculate the potential errors in the accounts identified and create the adjusted financial statements. Hint: Discuss each error from a double entry perspective and where necessary, add accounts/lines in the financial statements. (12 marks)

2.Identify THREE internal control weaknesses and discuss its impact and provide a control recommendation to improve the process. (9 marks)

3.Based on the adjusted financial statements, calculate a materiality level using an appropriate benchmark. Briefly explain why this benchmark was chosen. Also calculate a performance materiality level. (3 marks)

4.Plan the nature, timing and extent of substantive procedures for the significant accounts/transactions listed below. Note provide procedures for only the listed assertion. Tailor the procedures to the case fats given and avoid repetition of the same procedure (12 marks)

a.Revenue - music sessions (Occurrence, Accuracy and Completeness)

b.Revenue - concerts (Occurrence)

c.Money lent to 3D Inc. (Accuracy, Rights and Obligations)

d.Depreciation Expense (Accuracy)

e.Cash receipts (Completeness)

f.Cash disbursements (Occurrence)

g.Selling, general, and administrative expenses (Occurrence)

h.Maintenance Expense (Accuracy)

i.Unearned Revenue (Completeness)

5.The engagement partner has asked whether, based on your initial findings, there is any matter to discuss with those charged with governance. (4 marks)

EXHIBIT I: INFORMATION ON NEW OWNERS AND NOTES FROM DISCUSSIONS WITH THEM

Stevie owns a small bookshop in the same city and runs her own business.

Blake manages an art gallery called Art360 Inc. (Art360), which specializes in displaying local artists paintings and other art pieces. She has a 20% stake in Art360, with the remainder split equally between her brother and her sister-in-law, Lexi.

Although Lexi is a co-owner in Art360, she is not involved in its operations. She is a school teacher and teaches music lessons in her free time.

Stevie, Blake, and Lexi have each purchased an equal number of common shares in SS. Things have been hectic so far, and the new owners have not had a lot of time to focus on the operations. However, all three have faith in Mrs. Rose, whom they have known for years. Blake noted that there seem to be fewer controls at SS than she is used to at Art360. When Blake inquired, Mrs.

Rose said she did not think it was a problem because, as the administrator of SS, she is always there and never takes a vacation.

The three owners think things are going well so far, but had a few concerns when you met with them.

"There seems to be some confusion about music lesson rates," says Lexi. "Music lessons are $30 an hour for all instructors, but one of the clients mentioned that she has been paying the office

$40 an hour. I'm not sure if that's an issue, since that money belongs to the outside instructors and we're just collecting it on their behalf."

"SS is bringing in a lot of cash, but it seems to go right back out again!" notes Blake. "Mrs. Rose is always getting me to sign cheques. Sometimes I don't see the related invoice, but I know Mrs. Rose will have it. I know there are a lot of expenses in running a business, but there are so many that it is hard to keep up. All three of us are able to sign cheques and only one signature is

required, which sometimes gets confusing. Once, Lexi and I both signed different cheques to pay the same computer supplier. When we called the supplier to ask for a refund, he told us he had sold us two computers, although we have only one in the office.

"These issues would not have happened at Art360, and I'm wondering if improvements could be made at SS."

EXHIBIT II: STAR STUDIOS INC. DRAFT BALANCE SHEET AS AT MARCH 31

2021

2020

(unaudited)

(unaudited)

Assets

Cash

80,407

100,820

Accounts receivable

15,563

17,445

Income taxes receivable

2,687

955

Sheet music supplies

12,270

15,480

110,927

134,700

Investment in 3D Inc.

10,000

0

Property, plant and equipment (Note 2)

480,700

497,810

Total Assets

601,627

632,510

Liabilities

Accounts payable

58,580

60,300

Current portion of long-term debt

24,000

24,000

82,580

84,300

Long-term debt

252,000

276,000

334,580

360,300

Shareholders' equity

Share capital

100

100

Retained earnings

266,947

272,110

267,047

272,210

Liabilities and Equity

601,627

632,510

STAR STUDIOS INC. DRAFT INCOME STATEMENT For the year ended March 31

2021

2020

(unaudited)

(unaudited)

Revenue music sessions

267,240

274,960

Revenue concerts

24,500

22,000

Expenses

Selling, general, and administrative expenses

184,118

190,934

Salaries and wages

95,000

89,000

Depreciation Expense

17,110

17,764

296,228

297,698

Earnings before income tax

(4,488)

(738)

Income tax recovery (18.9%)

848

139

Net loss

(3,640)

(599)

STAR STUDIOS INC.

EXCERPTS FROM THE NOTES TO THE DRAFT FINANCIAL STATEMENTS

For the year ended March 31, 2021

1.Accounting Policies: Financial statements are prepared in accordance with IFRS.

2.Property, Plant and Equipment

Cost

Accumulated Amortization

2021

Net Book

Value

2020

Net Book

Value

Land

200,000

200,000

200,000

Building

151,576

41,099

110,477

114,123

Fencing

17,122

2,671

14,451

15,306

Musical Equipment

89,842

7,811

82,031

81,502

Fixtures and lighting

94,155

22,750

71,405

83,125

Office equipment

12,303

9,967

2,336

3,754

564,998

84,298

480,700

497,810

EXHIBIT III: NOTES FROM DISCUSSIONS WITH MRS. ROSE AND THE RECEPTIONIST

1.Musical Session Revenue SS makes each of its musical equipment available to its clients for one two hours session per day, at a cost of $75 per session. To comply with local laws, the last musical equipment rental is at 4pm, so the session can be finished by 6pm.

Lexi noted that some neighbors had complained of loud music from the studio past 6pm. Lexi checked the schedule, and noted that no sessions were booked beyond 4pm, so she concluded it must have been an anomaly.

2.Music Lessons Lessons are not a source of revenue for SS because outside instructors provide them directly to learners. Lesson fees are paid to SS's office and are handed over to the instructors.

3.Music Concerts - SS rents space for music concerts. The fee for each concert is $500. The payment for concerts is collected a month in advance. As of year-end 2021 there were 5 concerts that were to be held within the next month. Last year the number of concerts to be held within the next month was 4.

4.Payments from Customers All payments are accepted in cash or cheque only.

5.Maintenance Expense Musical instruments require regular acoustic maintenance and cleaning. David, a local college student daily cleans all instruments and weekly he checks for signs of maintenance. There is a small boarding room on top of the studio, where David boards. In exchange for his services, he is not charged a boarding fee. Previously when SS hired an outside individual to perform the weekly acoustic maintenance and cleaning tasks, typically, it costed $100 a week to do so. Maintenance Expense is included as part of selling, general, and administrative expenses.

6.3D Inc. (3D) During the year, SS was approached by 3D, which was experiencing financial difficulty. Because of a long-standing relationship, SS agreed to lend 3D $10,000, interest-free, under the following terms:

The loan matures in five years and requires fixed annual principal payments of $2,000.

In the event 3D misses a payment, SS is entitled to recall the entire amount.

Mrs. Rose mentioned that she's confused by this transaction since there is no interest payment involved, and therefore, she has classified it as an investment.

7.On January 1, 2021 SS purchased office equipment costing $8,000 on credit, however, Mrs. Rose neglected to make the necessary entries for this transaction. Office equipment depreciates at 11.5% annually.

8.Staff Mrs. Rose is the main employee on site. A part-time receptionist works afternoons and weekends, and there are part-time cleaners who clean the studio daily.

9. Administrator and Bookkeeper Mrs. Rose opens the mail, prepares deposits for monies received, and updates the accounting records. She makes deposits daily. She prepares bank reconciliations on a monthly basis but notes that she may stop doing them because the owners don't review them anyway.

10. Receptionist The receptionist collects all payments made on site and hands them over to Mrs. Rose for deposit and updating of the records. Since to comply with local laws, the last musical equipment rental is at 4pm, a calendar is maintained that shows the rental schedule for each day. Occasionally, Mrs. Rose asks the receptionist to collect money from a customer who is not listed on the schedule. When this occurs, the money is collected, and a note is made for Mrs. Rose. The receptionist has been instructed to not make the note directly on the schedule "so as not to confuse things."