You are an audit senior in the firm of Miller and King LLP and are currently reviewing the audit working papers and a draft of the audited financial statements of a new client for you, Superior Inc. for the year ended December 31, 2018 year. The draft audit report is an unqualified opinion dated March 15, 2019. Your firm has audited Superior Inc. for the past 4 years and the management letter each year has revealed a number of control deficiencies. While your firm has identified a number of errors in the financial statements in the past, management has always agreed to make all the adjustments your firm identified as material and accordingly have always received an unqualified opinion.

This year the audit was done by 2 audit trainees who reported to an audit senior. Unfortunately, the audit senior had to leave the job about half way through the audit in order to visit his mother in another country who became deathly ill.The audit senior has not returned as yet and did not have a chance to review the work done by the audit trainees. Accordingly, you were assigned to this engagement and were asked by the audit partner to review the audit work completed and make any necessary changes to make it ready for her review.

You initially reviewed the information on Superior operations (Exhibit 1) and the draft financial results for the company for the year ended December 31, 2018 (Exhibit 2). You then reviewed the work done by the audit trainees on substantive audit work related to inventory, sales, and accounts receivable. (See Exhibit 3).

Exhibit 1

Description of Superior's Operations

Superior is a privately-held company that was founded in 2005 by Andrew Winter, CEO.In 2007 Andrew sold 25% of his company to a group of private investors. The investors receive quarterly dividends that are calculated based upon a combination of sales and net income. The investors, all experienced business people, serve as Andrew's board of directors and give him advice on the strategic direction of the company. The Board relies on the external audit to provide them with assurance that their dividends are based on reliable figures.

Superior buys computers and related equipment in bulk at wholesale prices and resells these items at a markup to a loyal base of corporate customers. While this is a competitive industry, demand is growing and Superior stands out with its excellent customer service, giving it a competitive advantage.Andrew is very involved in most of the operating decisions.To ensure staff continue to provide excellent customer service and act with integrity, he plans to implement a code of ethics at some point.

Superior operates five warehouses, each carrying a mix of inventory items. In total there are three main categories of inventory, including: (1) computer hardware ; (2) standard computer parts and peripherals and (3) computer software.

The first type of inventory, computer hardware, consists of specialized computer hardware, desktop computers, and laptop computers.This inventory is more costly than other items and while it generates a higher profit margin, new technology is always emerging that customers are asking for. Because the company makes inventory orders months in advance, Superior occasionally overestimates demand. After three or four months products are difficult to sell, but they are kept because most can be returned to the supplier.

The second type of inventory relates to standard computer parts and peripherals, such as monitor and printers. This type of inventory generates a significant portion of Superior's sales. The third type of inventory is software, ranging from operating systems to business applications (such as financial reporting software).

This year, Superior implemented an integrated computer system to manage the general ledger as well as inventory, purchases, and sales. The system was developed by external consultants and is maintained by Superior's IT department. Superior is confident that this new system will result in more accurate financial statements.

The amount of damaged inventory has been gradually increasing over the past eight months. Damaged inventory has been piling up in a corner of the warehouse. The CEO suggested holding a liquidation sale to get rid of this inventory to free up space in the warehouse.

Exhibit 2 - Extracts from DRAFT Financial Results

Superior inc

Extracts from statement of profit and loss - stated in 000's

for the year ended Dec 31

2018 2019

(unaudited) (audited)

Sales 100,011 50,006

Cost of sales 60,007 30,003

Gross margin 40,004 20,003

Operating expenses 28,483 14,682

Operating income 11,521 5,321

Other expenses (income)

interest expenses 650 650

Net income before income taxes 10,871 4,671

income taxes 1,631 701

Net income after taxes 9,240 3,970

Superior inc

Extracts from balance sheet - stated in 000's

as at Dec 31

2018 2017

(unaudited) (audited)

Receivables less allowance 16,669 4,167

inventories 13,335 6,251

Total current assets 43,271 24,695

total assets 61,738 49,390

total current liabilities 38,895 14,817

total liabilities 30,869 34,573

EXHIBIT 3

SECTIONS FROM THE AUDIT TRAINEE's AUDIT FILE CONT'd

Part A

The audit procedures relating to inventory from an audit trainees' audit files were as follows:

Inventory

At the main warehouse a full count was undertaken on December 31, 2018 by 15 teams of two counters from the warehouse department with Superior's controller providing overall supervision. Each team of two is allocated a number of bays within the warehouse to count and they were provided with sequentially numbered inventory sheets which contain product codes and quantities extracted from the inventory records. The counters move through each allocated bay counting the inventory and confirming that it agrees with the inventory sheets. Where a discrepancy was found, they noted this on the sheet. The warehouse is large and approximately 10% of the bays have been rented out to third parties with similar operations; these are scattered throughout the warehouse. For completeness, the counters were asked to count the inventory for all bays noting that the third party inventories were recorded on separate blank inventory sheets.

Some of Superior's goods are high in value and are stored in a locked area of the warehouse. All counting teams were given the code to access this area. There were no despatches of inventory during the count and there were no deliveries from suppliers. Each area is counted once by the allocated team; the sheets are completed in ink, signed by the team and returned after each bay is counted. As no two teams are allocated the same bays, there will be no need to flag that an area has been counted. On completion of the count, the controller will confirm with each team that they have returned their inventory sheets.

Required

In respect of the inventory count procedures performed by Superior Inc identify and explain three deficiencies that could result inaccuracies in the count performed. Provide three additional count procedures/controls to address each of these deficiencies;

Deficiency Count Procedure/Control to address deficiency

EXHIBIT 3

SECTIONS FROM THE AUDIT TRAINEE's AUDIT FILE CONT'd

On the day of the count, the audit trainee counted the quantities for a random sample of 10 different products numbers from the first category of inventory (2 desktop computers, 7 laptops and 1 specialized hardware) and compared the inventory count to the quantities on the inventory listing. The audit trainee found 7 minor discrepancies and concluded the amounts involved were immaterial and no further work was deemed necessary.

The audit trainee traced cost for the 10 products sampled in the previous test. Costs matched those on the invoice, except for two models. The controller explained that employees manually change inventory costs to adjust for errors made when recording purchases. She provided a second listing with handwritten corrections.However, no backup documents were available to substantiate the changes.

Required

ii) For the inventory work performed, using concepts from audit sampling theory explain two deficiencies related to the audit trainee's selected sample and the conclusions reached by the audit trainee on the samples selected (minor variances, immaterial).Provide the correct audit procedure you would recommend to address these deficiencies.

Deficiency Recommendation (Correct Procedure)

Part B

The audit procedures relating to sales/accounts receivable from an audit trainees' audit files were as follows:

Sales

The only work completed on sales was as follows.No testing of the internal controls over sales done as a substantive audit approach was taken. The total sales for computers, parts & peripherals and software in 2017 was compared to 2018 and the audit trainee concluded the change in sales from 2017 to 2018 was a minor variance and as such the sales were fairly presented in the financial statements for 2018. The company had excellent controls at year end to ensure revenue was recorded in the correct period. Accordingly, no testing was done to ensure that revenue earned in 2018 was not recorded in 2019.

EXHIBIT 3

SECTIONS FROM THE AUDIT TRAINEE's AUDIT FILE CONT"D

Accounts receivable

Fifty negative confirmations were sent to the largest accounts.As none of the confirmations were returned no further work was done.

Customers have 30 days to pay invoices, but most take advantage of the 2% discount offered for payment within 10 days. A sample of five year-end balances were tested, and all payments were received subsequent to year-end, so accounts receivable were deemed reasonable at year-end.

Three of the samples tested for payments subsequent to year-end received discounts for being paid within 10 days. However, when the receipts were traced to the bank deposits, it was noted that the customers had made full payments and were received within the 10 day discount period. The discounts appeared to be reimbursed later by system-generated cheques, but the cheques could not be traced to any backup documentation. As a result of this lack of documentation, no additional work was done in this area. Since the customers had earned the discount, it was correct for them to be reimbursed.

Historically, the amount of uncollectible accounts ranged from 3% to 4%. In order to save time, Superior applied a blanket provision of 5% for uncollectible accounts. Credit procedures were tightened two years ago, and since then, the rate has been at the lower end of the historic range. Accordingly, 5% is quite conservative, allowing for potential understatement of receivables.

Required

For the accounts receivable work performed, using concepts from audit sampling theory explain two deficiencies related to the audit trainee's selected sample and the conclusions reached by the audit trainee on the samples selected (minor variances, immaterial).Provide the correct audit procedure you would recommend to address these deficiencies.

Deficiency Recommendation (Correct Procedure)

ii) Using case specific facts identify three deficiencies in the work performed on sales and accounts receivable (omitted procedure, incorrect evaluation of the evidence, weakness in the procedure performed) provide the risk and assertion not addressed as a result of the deficiency and an audit procedure that should be performed to address the deficiency. (Do not repeat any of the points mentioned in Part B i) above).

Deficiency Risk and Assertion Audit Procedure