You are a partner in the firm of Segal and Associates Professional Corporation (Segal), a firm of Chartered Professional Accountants and you are responsible for conducting the final independent review of audits completed by the firm.Segal is a full-service medium-sized public accounting firm that specializes in the audits of moderate-sized high-technology companies.

You are currently reviewing the audit working papers and a draft of the audited financial statements of Power Technologies Inc. (PTI) for the year ended December 31, 2017, together with the draft audit report (an unqualified opinion dated February 19, 2018) prepared by the engagement partner. The company has developed a line of power supplies for electronic equipment, and sells them to manufacturers of such equipment. Although some power supplies are manufactured to the specific requirements of individual customers, most of the company's sales are of standardized products.

PTI was formed five years ago by two brothers who own all the shares and work in the business as president and vice-president, manufacturing. Financing was obtained from a venture capital company which has an option of acquiring shares in the company. The venture capital company requires that the annual financial statements be audited.

PTI has had a steady growth in revenue since its formation, with revenues of $50,000,000 reported in the draft audited financial statements for 2017, which was almost exactly the level budgeted for the year. Income before taxes has been increasing but is somewhat volatile, with income before taxes of $100,000 reported in 2015, a loss before taxes of $500,000 in 2016, and income before taxes of $1,000,000 in 2017.

Segal have been auditors since the company's inception. The 2017 audit fieldwork was performed by a senior auditor (who had not previously worked on the audit of this particular client) and two junior auditors, and the working papers were reviewed by a manager and the engagement partner.

Based on your review of the working papers, the draft financial statements, and the audit report, you have noted the following:

1. Before beginning the audit, the engagement partner met with the two shareholders and the company's vice-president, finance to discuss changes in the company in the past year. The vice-president, finance stated that the company was under some pressure from the venture capital company to report a reasonable profit this year, especially after the loss in 2016.

2. The only change in the company during 2017 was the implementation of a new inventory system. The vice-president, manufacturing also said that there had been a small problem with the quality of some of the power supply units shipped in the last quarter of 2017, but the problem had been identified and addressed.

3. The engagement partner then met with the senior auditor and stated that there had been no audit adjustments in the past two years. The main concern was with the collectability of accounts receivable and the valuation of inventory, particularly regarding possible obsolescence of some of the standardized power supply units. The partner stated that she was not aware of any changes in the client or its industry in the past year and that the inherent risks could be considered to be low, as they were in past years. The partner documented both her meeting with the client and with the senior auditor, which were the only meetings held prior to beginning the audit work.

4. The materiality level for the audit was set at 0.5% of budgeted sales ($250,000) because the net income levels for the past several years were so variable. Consideration was given to the need for setting performance materiality levels, but no areas were identified where that was considered necessary.

5. The audit working papers documented that based on prior year audits, inherent risk was low and controls were excellent in all areas. The firm tested the operating effectiveness of the controls in each transaction cycle over a three-year period. Controls over purchases, payments, and inventories had been tested in 2015 and controls over sales and receivables in 2016, so in 2017 testing of controls was performed only on the payroll and personnel cycle. Controls in that cycle were found to be operating effectively.

6. The analytical review performed during planning consisted of the senior auditor comparing the current year's financial statement to 2016 financials. Her conclusion was that since no significant changes were noted the account balances appeared reasonable; therefore, the planned audit strategy was appropriate.

7. Balances for confirmation of accounts receivable were selected using judgmental sampling. A total of 40 confirmations were prepared and mailed out by the controller of PTI to those accounts selected by the auditors. Of these, 36 were eventually returned directly to the auditors with no differences. The remaining four accounts were verified by vouching the balances reported as due to the sales invoices issued during 2017. No exceptions were found.

The junior auditor responsible for auditing the accounts receivable balances then discussed the provision for doubtful accounts with the controller and concluded that it was adequate, and included a note in the working papers of their discussion. No additional work was performed on accounts receivable or the allowance for doubtful accounts.

8.The senior auditor recalculated the returns and allowance using the historical rate of returns which was noted in the previous year's audit file.She calculated an appropriate year-end provision for returns and allowances to be in the range of $300,000 to $400,000. The client had booked a returns provision in the amount of $350,000 therefore she determined that no error was required to carry forward to the unadjusted error summary.

9.The audit senior conducted the inventory count procedures.The following is an excerpt of the work performed at the count:

Inventory during the count was well organized and all items in the warehouse were appropriately tagged.Per the warehouse manager, all products with the inventory product quality issue had been set aside in a separate area of the warehouse.Inventory counters were working in pairs to ensure the accuracy of the count.

Inventory Test Counting

Selected a sample of 40 items from the inventory listing and performed a test count on each of these items. The following discrepancies were noted:

Product

Description

# of boxes per auditor

# of boxes per count

Product # 5267XYB

Electrical Wire (40 cm length, 100 per box)

30 boxes

34 boxes

Product # 645XMHN

5 mm screws (1000 screws per box)

10 boxes

9 boxes

Upon discussion with the warehouse manager these discrepancies are a result of one particular counter who was continuously making errors.The warehouse manager has since replaced this particular counter.No further audit work is required.

Selected a sample of 40 items from the inventory floor and performed a test count on each of these items.All items tested agreed to the count conducted by the counter.

10.The following is an excerpt of the work performed on the salaries and benefit's account:

Dec 31, 2016

Dec, 31, 2015

$ change

% change

Salaries & Benefits account

$6,900,000

$4,950,000

1,950,000

40%

Per discussions with controller, the increase in salaries is a result of the hiring of 12 new sales representatives.This explanation appears reasonable.Obtained a listing which summarized the total annual salary for 2016 by employee. Re-added the schedule to verify the mathematical accuracy of the listing and agreed the total of $6,900,000 to the general ledger.

11.The management representation letter obtained by the audit senior on the last date of field work, February 10^th, 2018.The letter was signed by both the CEO and CFO.

After considering these various issues, you decide to memo to the engagement partner, with a copy to the managing partner of the firm, expressing your views on these matters and what needs to be done before you are prepared to "sign off" on the engagement.

Required

Explain eight deficiencies that are in violation with generally accepted auditing standards (GAAS) and provide a recommendation to address each deficiency.