You are an audit senior with the firm of Mike and Kiwi LLP. You were just informed that you will be taking over as the in charge auditor to a new client for you, Stanley Inc for the year ended December 31, 2021. The previous incharge had to leave the job before the end of the audit to be with his wife who gave birth to their twin boys 6 weeks earlier than expected. The incharge did not have a chance to check the work done by the audit trainees.

Your firm has audited Stanley Inc. for the past 6 years and the management letter each year has revealed several control deficiencies. While your firm has identified several errors in the financial statements in the past, management always agreed to some of the adjustments your firm identified as material and accordingly have always received an unqualified opinion.

The draft audit report is dated March 15, 2022.

Exhibit 1

Description of Stanleys Operations

Stanley Inc. is a privately held company that was founded in 2007 by Andy Summer, who is also Stanleys CEO. In 2007 Andy 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 Andys 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.

Stanley 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 Stanley stands out with its excellent customer service. Andy 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 in the future.

Stanley operates five warehouses, each carrying a mix of inventory items. In total there are three main categories of inventory, including:

1. computer hardware standard
2. 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 types of inventories. 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, Stanley occasionally overestimates demand. After three or four months products are usually 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 Stanleys sales. The third type of inventory is software, ranging from operating systems to business applications (such as financial reporting software).

This year, Stanley 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 Stanleys IT department. Stanley is confident that this new system will result in more accurate financial information and statements.

To help retain the sales team and motivate and retain senior management, in April 2021 the Board approved a bonus scheme for the sales team and senior management based on sales as an added form of compensation.

On May 30, 2021 Monica Fung was hired as the controller and reported to the CEO. Monica replaced the previous controller who had resigned suddenly in early February 2021 as a result of a dispute he had with the CEO. Monica is a CPA who last worked fulltime in an accounting firm in 2016 where she obtained her accounting designation. Since that time Monica has focussed her efforts on staying at home and raising her children. The CEO knew Monica from his school days at the business school at a Canadian University and decided to hire Monica as the controller as she was looking to start working fulltime again and was available immediately to start work at Stanley Inc.

Monica prepares monthly financial statements for the CEO. She also compares budget versus actual results and highlights all large variances. However, to date the CEO has not followed up with her for any explanations for any large variances between actual and budget.

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

Exhibit 3

SECTIONS FROM THE AUDIT TRAINEEs AUDIT FILE

Part B

Audit Strategy

As the internal controls have been poor in the past it was concluded that it would be more efficient to do 100% substantive testing and not worry about updating our understanding or testing the controls. No fraud has been identified in the past so the focus will be on finding errors.

Required

Discuss two major deficiencies/flaws in the conclusions reached related to work performed in the audit strategy. Indicate based on case specific facts what the correct audit strategy should be.

Discuss Major Deficiency/Flaw

Correct audit strategy to address the deficiency/flaw

Exhibit 2 - Extracts from DRAFT Financial Results