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, 2019, you are at the client premises with the audit team and are reviewing the audit working papers relating to accounts receivable, inventory, payroll and concluding the audit ( contingent liabilities and subsequent events) 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

Sale 50,000,000 45,000,000

Net Income 700,000 250,000

Account Receivable 6500,000 4500,000

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 write 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.

Below is somebackground information:

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.

Notes from Audit Working Papers

Payroll - Consistent with audits in prior years, Black & White does not allow RJ to audit the private payroll records, which cover salaries, expense reimbursements, and bonuses paid to the owners and other LeBlanc family members. The CEO of Black & White signs a letter of representation to RJ that says, "All salaries, bonuses, and other payments to the owners and related parties have been approved by me and by the company's board of directors."

To explain this arrangement, the engagement partner noted:

"We don't verify the private payroll records as they are confidential. Since the owners are free to pay themselves any amounts they please, we ask for and receive every year a letter of representation verifying that all payments made are properly approved."

Review for Contingent Liabilities - A legal letter was sent out to the company's lawyers asking them to confirm as at February 15, 2019 whether there were any claims outstanding against Black & White. As of February 28, 2019, no response has been received. Based upon our review of legal expenses and discussion with management, there are no outstanding claims. No further work is necessary.

Review for Subsequent Events - As per discussions held with the CEO and CFO, there were no significant subsequent events. No further work is necessary.

c) -Payroll/ Contingencies/ Subsequent Events List and explain three major deficiencies in the work performed in the testing of payroll, contingencies, and subsequent events.(Use CAS requirements and/or assertions as a basis for your explanation.) Provide recommendations regarding further actions and/or audit procedures.

Deficiency and explanation of why it is a deficiency. (Use CAS requirements and/or assertions as a basis for your explanation)

Provide recommendations regarding further actions and/or audit procedures.