Wheels Avionics Ltd. has contacted your CPA firm to enquire about the cost of an external audit. The companys president explained that he feels that the previous auditor charged too much and only issued a modified opinion. Your firm was recommended to Wheels by your bank manager.

Wheels has a large loan request at that bank, and the interest rate of the new loan will depend on the audit opinion. As the partner in charge of this file, you interviewed the president and controller of the company as part of your decision to accept or reject Wheels as a client. You

have found that the company has a new design for an aircraft and plans to borrow funds from the bank and to issue common shares to finance a prototype plane to test the design. The new funds will also greatly improve the companys balance sheet by providing the funds to bring the companys existing bank loan up-to-date. If the design is successful, more common shares will be issued for more capital.

The controller was very helpful in your discussions, and you note his high level of enthusiasm for the project as this is his first job at this level. However, the president was not so helpful, and seemed annoyed with your questions.

Required:

a. Indicate 5 factors in the above situation that indicate high inherent risk. Explain your answer.

b. Assume that you have accepted the audit engagement. The companys draft financial statements contained the following note: Note 45: Wheels received a $750,000 loan from the provincial governments labour incentives program. This loan is not recorded as it will be 100% forgiven if the company maintains current employment levels. The company is confident that the required employment levels will be maintained if the new aircraft prototype is successful.

Explain 2 concerns you would have regarding the loan and Wheels accounting treatment of the loan.

c. Assume that you have accepted the audit engagement. You discover that Wheels received a $500,000 loan from Wings Ltd., a wholly-owned subsidiary, but the loan was not forgivable.

Because it was from a subsidiary company, Wheels treated it as an off-balance sheet item, and only provided note disclosure. You requested the previous auditors working papers, and specifically reviewed them to identify related parties. What 2 other audit procedures could you take to identify the existence of other transactions with related parties?