Today is January 15, 2020. You, CPA, work for EY LLP, an auditing firm based out of Vancouver. My-Yoga is a new audit client of yours. My-Yoga is a small yoga goods wholesaler that has two warehouses located in Richmond and has never been audited. Fred, the 100% owner, has recently been contacted by Awesome Yoga, a large yoga studio chain that is interested in buying My-Yoga. The directors at Awesome Yoga have asked Fred to supply audited financial statements for My-Yoga's fiscal year ended December 31, 2019, for purposes of valuing the company and settling on a fair purchase price.

My-Yoga offers high quality yoga products, giving it a competitive advantage, which the company has used to develop a loyal and growing customer base. Fred has a lot of industry experience and has done his best to nurture My-Yoga's rapid growth. With that said, competition is strong and has pushed Fred to the idea of selling his business to pursue other ventures.

The overall activities of the business are simple. My-Yoga imports specialized yoga products such as yoga mats, bolsters, and straps from China, applies their branding at their warehouses, and then re-sells the goods at a generous mark-up. With that said, Fred has noticed that recently some of his inventory purchases are getting held up at customs due to issues with his main suppliers' licenses. Fred is hopeful that this issue will be fixed because it would be difficult to secure an alternate supplier who can match My-Yoga's high standards of quality.

Additionally, the heavy rain season in British Columbia led to flooding at one of My-Yoga's warehouses in November. A significant number of yoga mats were damaged, and Fred is unsure of the extent as he hasn't had time to check.

On top of the audit, Awesome Yoga has asked Fred to increase the strength of his control environment to demonstrate that the business is capable of functioning without Fred's presence. Fred admits that the controls 'need to be improved' and therefore he would like you, the CPA to identify any control weaknesses.

An excerpt from your conversation with Fred over the current state of internal controls are as follows:

"We use a specialized inventory system so that we can track our margins on sales and ensure the quality of our goods. The system can be accessed at both warehouses and has one shared login, although I am usually the only one playing around in the system. When we purchase our yoga goods, I use the supplier's invoice to input the cost and amount of each item into the inventory system. There have been occasions where I've noticed manual adjustments to the inventory records without documented backup. This usually occurs when I'm on vacation and one of my employees needs to make an adjustment on my behalf."

"We use electronic purchase orders (PO) that require authorization from either myself or two of my closest employees through the use of a personal identification number (PIN). Each user has a specific PIN. Order's greater than $5,000 require my authorization. However, occasionally I'm not available so I've given one of the accounting clerks that I trust my PIN to be used for emergency situations. This doesn't worry me, although my cost of goods sold has been a bit higher than usual this year."

"I've streamlined our sales process with our sales team so that we can ship our goods to our customers immediately after sale, ensuring customer satisfaction. I think this is a great process and contributes greatly to our customer loyalty. My sales team can: 1) input the details of their customers, 2) input the details of their sales, 3) request and authorize shipment of goods. I have a great sales team that is heavily motivated to do well, as most of their compensation is based on reaching sales targets. With that said, I've noticed customers complaining about receiving shipments for goods that were not ordered. I haven't had time to look into this yet as it really only happened at the end of December"

Other Information:

The long-term debt on the balance sheet was financed by a local credit union, RainCity Trust, who did not require audited statements at the time of financing. However, they were notified of the upcoming audit and have requested copies of the audited statements.

Fred has implemented a code of ethics which is to 'always do the right thing', however, he hasn't found a way to enforce this code.

Select Financial Statement information for year ended December 31, 2019:

Balance Sheet

Income Statement

Inventory: $420,250

Total current assets: $442,560

Total Assets: $664,214

Accounts Payable: $105,102

Long Term Debt Payable: $143,001

Total Liabilities: $350,214

Total Shareholders' Equity: $314,000

Total Revenue: $1,020,030

Gross Profit: $490,500

Wages Expense: $220,500

Income Taxes: $35,000

Net Income after tax: $215,315

Requirement:

(a) Assessandconclude on inherent risk. Be sure to discuss items that both increase and decrease risk for a balanced discussion. Also, ensure to statewhyan item increases or decreases inherent risk. (10 marks)

(b) Assessandconclude on the control risk. Be sure to discuss items that both increase and decrease risk for a balance discussion. (3 marks)

(c) Based on your inherent and control risk assessment, conclude on detection risk.(1 mark)

(d) Based on the risk assessment, what type of audit strategy should be implemented? (Justify your response) (2 marks)

(e) Provide a fullmaterialityassessment and conclude on a finalmaterialitylevel.(8 marks)

(f) Identify two control weaknesses at My-Yoga. For each weakness, indicate an implication and provide a specific recommendation on how to fix it. (6 marks)