The following information related to Success Ltd, one of your audit clients.

The Company

The company was incorporated in 2010 and is owned by Jason Last who is actively involved in all aspects of the business.

Success Ltd. reports its financial statements in Canadian dollars; however, they have some US vendors who insist on payment in US dollars.

Many of the Success Ltd customers are well-established retail outlet.

The Product

Success is a distributor of a unique sports energy drink. What differentiates this product is the fact that it contains 20 grams of protein, a significant higher amount than any of the competitors in the market.

The drink has a 2-year shelf life.

There are a number of distribution centres across Canada and the U.S.

Current Situation

Jason is current planning to sell his shares to Mike Owens, an unrelated party.

2022 was a challenging year for Success Ltd as a very successful multinational corporation entered the marketplace and has rapidly started to increase its shares of the North American market for protein drinks.

In response to this, Jason changed the Companys compensation policy this year and increased commissions paid to sales staff by approximately 5% of sales.

Department managers now receive a bonus based on net income.

Also, with a plan to increase sales, for the first time, Success Ltd entered into an agreement with one of its suppliers whereby Success Ltd would sell one of their products on a consignment basis.

The bank loans are nearing renewal. Under the existing loan agreement, they must maintain a minimum current ratio of 1.5:1. The company is very close to breaching this covenant.

The bank requires audited annual financial statements as the accounts receivable and inventory are used as collateral for the bank loan.

Success Ltd hired a new controller this year, with the previous controller resigning after 10 years.

There was also significant turnover of staff in the accounting department. This turnover was due to the stress of being understaffed and unable to keep up with the daily work load. As a result, staff were falling behind with many important duties, such as following up with on account receivable.

It is now February 2023. The previous external auditors have recently resigned and Janson has approached your firm to take over the audit engagement for the fiscal year end December 31, 2022.

Income Statement (unaudited)

Year Ended December 31, 2022

Net sales $4,358,100

Cost of sales 2,738,714

Gross profit 1,619,386

Selling and operating expenses 884,783

General and admin expenses 496,333

Total operating expenses 1,381,116

Income before income taxes 238,370

Income taxes 58,000

Net income 180,370

Balance Sheet (unaudited)

December 31, 2022

Assets

Current

Accounts receivable $232,750

Inventory 237,254

Prepaid expenses 99,555

569,559

Property, plant & equipment 481,835

Total assets 1,051,394

Liabilities & Equity

Current

Bank overdraft $60,897

Accounts payable 197,787

Income taxes payable 58,000

Current portion of LT debt 55,270

371,954

Long-term debt 216,454

588,408

Shareholders Equity

Share capital $10

Retained earnings 462,976

462,986

Total liabilities & Equity 1,051,394

Required:

Assuming that your firm has accepted the audit engagement:

1. Identify the factors that impact the risk of material misstatement (RMM) in this engagement. For each factor identified, explain, and indicate whether it will increase or decrease the RMM. Conclude on the overall RMM in this engagement. (5 marks)

2. Calculate the overall and performance materiality for this engagement. Explain your reasoning. (6 marks)