You are the Engagement Quality Control Reviewer in the firm Rumyee & Jones (RJ) LLP and you are responsible for the independent review of all audits.It is March 1st, 2018, you are at the client premises with the audit team and are reviewing the audit working papers and draft audited financial statements of Black & White, a private company, for the year-end December 31, 2018, and the recommended auditor's report (an unqualified opinion) dated February 28, 2019.

Your firm has audited Black & White for several years.The 2018 year-end audit was conducted in the two-month period from mid-December 2018 to mid-February 2019. The audit team consisted of the partner, an audit manager, a senior auditor who has been involved with the audit of Black & White for several years, and a newly hired junior auditor.

The following is some key information from Black & White's draft audited financial statements for the year-ended 2018:

2018

2017

Sales

$50,000,000

45,000,000

Net income

700,000

250,000

Accounts Receivable

6,500,000

4,500,000

Inventory

10,000,000

9,500,000

Total Assets

60,000,000

55,000,000

Total Liabilities

40,000,000

38,000,000

You interview the audit senior to get insight into any difficulties encountered in the audit. After reviewing the audit file and your discussion with the audit senior, you decide to prepare a memo to the engagement partner, with a copy to the managing partner of the firm, expressing your concerns and what needs to be done before you are prepared to "sign off" on the engagement. You divide your memo into three parts - the issues that the audit senior brought forward (Part A), issues related to planning and risk assessment (Part B) and evaluation of the audit work performed (Part C).

PART A (6 marks, 15 minutes)

Highlights from Discussion with Audit Senior

The audit senior told you that the engagement partner, Ally Hogan, was very involved with the audit planning. However, there was little other involvement after that. At the end of the audit, Ally and the audit manager came to review the working papers on the same day close to the completion of the audit work. Ally asked the senior if there were any problems and when the audit senior informed her there were none, she signed off after a quick look through them.

The audit senior also informed you that when she was reading the board minutes, she found several references to Ally Hogan (the audit partner). It appears that Ally recommended that Black & White use the services of her brother, Riley Nagan, a management consultant, for advice on business development. Based upon Ally's recommendation, Black & White hired Riley for consulting services. The senior informed you that Ally asked her not to record it in the working papers or discuss it with anyone.

REQUIRED - PART A

Identify and explain three different violations of the rules of professional conduct or the general requirements of a financial statement audit.Explain using case facts and recommend the actions that should have been taken.

You noted that the engagement partner prepared all of the audit planning documentation after a meeting with the CFO. The engagement partner also met with the audit senior to set the work schedule.

Below are the relevant excerpts from the audit files used to draft your memo:

Audit Planning Memo

Understanding the Entity and Its Environment

Nature of Entity

Black & White is one of the largest independent distributors of tires and wheels in Canada. It offers the most complete selection of tires, wheels and related services and provides 24-hour inventory access and order capability to dealers.

Ownership and Governance

Black & White is privately held and is owned and operated by members of LeBlanc family - some who are not actively involved in running the company. The company has a board of directors that consists of active and inactive family members.

Industry Factors

The wholesale tire industry is highly competitive, and distributors have significant pressure on pricing and their margins. In order to remain competitive, Black & White introduced a much more liberal return policy than it had in the past. Under this new policy, customers have up to a year to return the tires. As a result, several dealers switched to Black & White. This appears to be the major reason for increased revenue this year.

The only other significant development during the year was the merger of one of Black & White's key customers, Fountain Tire, a chain located in Western Canada, with another retail chain, Tyre World. Due to its long relationship with Fountain Tire, Black & White always kept a large inventory of farm equipment tires on hand at its warehouse in Alberta. Tyre World uses another distributor.Black & White's management is uncertain as to whether or not it will continue its relationship with Fountain Tire. Very few of Black & White's other customers sell farm equipment tires.

Organizational Structure and Financing

The company has a line of credit with a large bank, which is secured by Black & White's inventory and accounts receivable. The company also obtained financing from a venture capital company that has an option of acquiring shares in the company. Given the poor results last year, Black & White is under pressure from the venture capital company to report a reasonable profit this year. They have threatened to convert the loan to shares.If the conversion takes place it would effectively give them over 60% ownership of the company and the venture capitalists would control the appointments to the board of directors.

The company has an ongoing liquidity problem and the line of credit with the bank has reached its maximum limit.The company is often quite late when paying its bills.The main reason for the ongoing liquidity problem is the active family shareholders draw substantial salaries (about $500,000 each year).

The loan agreement with the venture capitalists and the line of credit agreement with the bank both require that the company provide audited financial statements.The audited financial statements are also provided to the inactive owners.

Overall Materiality

Consistent with previous years, overall materiality is set at $10,000. The rationale for this is that in the previous audits there have been errors relating to important transactions, especially unrecorded liabilities.Overall materiality is used to assess the results of substantive testing.

Preliminary Analytical Procedures

Compared the dollar change between current year's financial statement balances to the 2017 financial statements. No significant changes were noted; therefore the account balances appear reasonable.

Risk of Material Misstatement Due to Fraud

Since there have been no issues related to fraud in the past, fraud risk is low and no further work is necessary.

Risk of Material Misstatement Due to Error

Risk of material misstatement is moderate for revenue (occurrence) and accounts receivable (valuation and existence).

Risk of material misstatement for liabilities (completeness) is high

The risk of material misstatement for inventory (all assertions) is low.

Audit Approach

A substantive approach will be used to conduct this audit.Controls documentation or testing is not necessary given a substantive approach will be utilized.

REQUIRED - PART B (20 marks, 46 minutes)

Part B.1 (6 marks) Explain two key deficiencies of the materiality assessment and explain why.As part of your analysis, prepare a revised assessment of materiality for the audit.

Parrt B.2 (6 marks)Identify three different deficiencies or omissions in the assessment of risk of material misstatement due to error.For each deficiency indicate what the appropriate action should have been and for each omission prepare the risk statement that should have been included in the audit file.

Part B.3 (8 marks) Identity four additional deficiencies in the other areas of the audit planning memo. (Use Canadian Auditing Standard (CAS) requirements to explain why it is a deficiency). For each deficiency, explain what the appropriate assessment should have been. (No marks will be awarded for deficiencies repeated from B.1 or B.2)

(1/2 mark for identification and explanation of the deficiency, 1 mark for each valid point made in your recommendation). Note:Multiple recommendations for one deficiency is acceptable. Use the tables to complete your response.