1.

a) Observations from the data provided:

1. Misclassification of Transactions:
o Revenue entries have been misclassified and posted under the "Travel and
Entertainment" account. For example, Transaction ID 1469 shows a cash debit
and a travel and entertainment credit of $8,138, which is unusually high and likely
incorrect.
2. High Travel and Entertainment Expenses:
o The travel and entertainment expenses (Account 70512) seem excessively high,
particularly given the context of Marvin's trip to Europe. This is unusual for a
self-financing workshop program that should have limited expenses.
3. Revenue Discrepancies:
o There are significant discrepancies between the expected ticket revenue and the
actual amounts reported. Given the high attendance reported by Harvey’s family
members, the actual revenue should have been higher.
4. Frequent Posting Errors:
o The pattern of frequent postings to the travel and entertainment account suggests
either consistent errors or intentional misclassification.
5. Suspicious Timing of Transactions:
o The timing and amounts of transactions related to travel and entertainment are
suspect, particularly those closely following high-ticket revenue entries.
6. Potential Fraud Indicators:
o The repeated misclassification of substantial amounts hints at potential fraud. This
is further supported by the lack of scrutiny from Harvey and the operational
deficits covered by shifting funds from the operating budget.

b) Internal Control Weaknesses:

1. Lack of Segregation of Duties:

o Implication: Marvin handles multiple roles, including transaction entry, fee
collection, and deposit handling, increasing the risk of errors and fraudulent
activities.
o Recommendation: Implement segregation of duties. Different individuals should
handle fee collection, transaction entry, and deposit reconciliation to reduce the
risk of fraud. This is appropriate as it introduces checks and balances in financial
operations.
2. Insufficient Oversight and Review:
o Implication: Harvey's lack of oversight and reliance on annual audits means
operational discrepancies can go unnoticed for extended periods.
o Recommendation: Establish regular internal reviews and random checks of
financial records. Increased oversight ensures early detection of irregularities,
maintaining financial integrity.
3. Inadequate Documentation and Approval Processes:
o Implication: Absence of detailed documentation and approvals for significant
expenses like travel leads to mismanagement and potential misuse of funds.
 o Recommendation: Implement a robust approval process for all expenses,
especially high-value ones. Require detailed documentation for travel and
entertainment expenses. This ensures accountability and transparency.
4. Inappropriate Transaction Posting:
o Implication: Misclassification of transactions undermines the accuracy of
financial reports, leading to incorrect budget reconciliations and potential audit
issues.
o Recommendation: Provide additional training for staff on correct transaction
posting and classification. Regularly audit financial entries to ensure accuracy.
This enhances the reliability of financial reporting.

c) Addressing Harvey’s Concerns about Potential Fraud and Past Audits:

 Scope of Annual Audits:

o Annual audits are typically designed to provide reasonable assurance that
financial statements are free from material misstatement, whether due to fraud or
error. They are not forensic audits aimed specifically at detecting fraud.
 Potential for Past Audit Oversights:
o Clean audit reports in past years do not guarantee the absence of errors or fraud.
Audits involve sampling and professional judgment, which means some issues
may go undetected.
 Addressing Possible Fraud:
o Given the identified discrepancies and weaknesses, a forensic audit focused on
detecting fraud should be considered. This would involve a more detailed
examination of transactions and controls.
 Ensuring Future Audit Effectiveness:
o Strengthen internal controls, implement regular internal audits, and consider
hiring a fraud examiner periodically. This will complement the annual audits and
enhance the overall financial oversight.

d) Responding to Harvey’s Consideration of Hiring an Internal Auditor:

 Cost-Benefit Analysis:
o While internal auditors can provide continuous monitoring and may seem cost-
effective, they require salaries, benefits, and ongoing training, which might not
necessarily reduce overall costs significantly.
 Advantages of External Auditors:
o External auditors provide an independent perspective, crucial for stakeholders,
especially for maintaining funding eligibility. Their independence enhances
credibility and impartiality.
 Hybrid Approach:
o Consider a hybrid approach: hire an internal auditor for routine checks and
controls while retaining external auditors for annual audits. This combination
leverages the strengths of both internal and external audits, ensuring thorough
oversight.
 Long-Term Financial Health:
 o Investing in robust audit mechanisms is essential for the long-term financial
health of CAG. Effective audits, whether internal or external, help prevent fraud,
ensure compliance, and maintain the organization’s integrity and funding

2. Memorandum: Planning the Audit of AFC’s Financial Statements for the Year Ended
December 31, 20X8

To: David Kwok, CPA

From: [Your Name], Audit Senior
Date: [Current Date]
Subject: Accounting and Audit Areas of Concern for AFC Audit

Introduction

This memorandum outlines key areas of concern identified during the planning stage of the audit
of Auto Financing Company (AFC) for the year ended December 31, 20X8. It includes
accounting and audit-related issues, as well as management and business advice for AFC.

Accounting and Audit Areas of Concern

1. Segregation of Business Lines

o Issue: The draft financial statements do not provide separate details for the loan
financing and equipment manufacturing business lines.
o Risk: Lack of segmentation may obscure performance metrics and financial
health of individual business lines, affecting the accuracy of financial statements.
o Audit Procedure: Ensure the financial statements provide segmented reporting
for each business line as required by ASPE Section 1701.
2. Bank Reconciliations and Cheques
o Issue: Unusual cheques made payable to Penn & Keaton with dual endorsements
and marked as "refund cheques."
o Risk: Potential for misappropriation of funds or fraudulent transactions.
o Audit Procedure: Perform detailed testing of bank reconciliations and cheque
transactions, investigate the nature and purpose of the refunds, and confirm with
Penn & Keaton.
3. Inventory Write-Down
o Issue: John Layman instructed a $575,000 write-down of inventory manufactured
in the last two years.
o Risk: Possible overstatement of inventory write-downs to manipulate net income.
o Audit Procedure: Verify the appropriateness of the write-down by examining
inventory records, assessing market conditions, and reviewing inventory turnover
rates.
4. Allowance for Doubtful Accounts and Warranty Expense
o Issue: Significant increases in the allowance for doubtful accounts (20%) and a
large accrual for warranty expenses.
o Risk: Potential understatement of revenue and overstatement of expenses to
manage net income.
 o Audit Procedure: Review the basis for allowance estimates and warranty
provisions, evaluate historical trends, and perform substantive testing on accounts
receivable and warranty liabilities.
5. Profit-Sharing Plan
o Issue: AFC has implemented a profit-sharing plan for unionized workers based
on audited net income.
o Risk: Potential bias in financial reporting to influence profit-sharing calculations.
o Audit Procedure: Ensure accurate calculation and reporting of net income, verify
profit-sharing plan terms, and confirm compliance with the agreement.
6. Potential Conflict of Interest
o Issue: John Layman offered auditors participation in the profit-sharing plan.
o Risk: Independence and objectivity of the audit team could be compromised.
o Audit Procedure: Decline the profit-sharing offer and document the refusal to
maintain audit independence and integrity.

Management and Business-Related Advice

1. Enhance Internal Controls

o Recommendation: AFC should strengthen internal controls, especially in the
areas of bank reconciliations, cheque issuance, and inventory management.
o Benefit: Improved internal controls will enhance accuracy in financial reporting
and reduce the risk of fraud.
2. Segmentation Reporting
o Recommendation: AFC should adopt segmented reporting for its financial
statements to provide clearer insights into the performance of its loan financing
and manufacturing operations.
o Benefit: Segmented reporting will enable better decision-making and facilitate
more transparent communication with stakeholders.
3. Employee Profit-Sharing Education
o Recommendation: Educate unionized employees on how the profit-sharing plan
works and the factors influencing net income.
o Benefit: Increased understanding will motivate employees to contribute to the
company’s profitability and enhance overall performance.
4. Regular Communication with Legal Counsel
o Recommendation: Maintain regular communication with Penn & Keaton to
clarify any unusual transactions and ensure proper documentation.
o Benefit: Proactive communication will prevent misunderstandings and ensure all
financial transactions are accurately recorded.
5. Inventory Management Strategy
o Recommendation: Develop a strategy to manage and liquidate slow-moving or
obsolete inventory.
o Benefit: Effective inventory management will improve cash flow and reduce the
need for significant write-downs in the future.

Conclusion
The outlined accounting and audit areas of concern, along with the proposed audit procedures
and management advice, should be considered during the planning and execution of the audit.
Addressing these issues will ensure the accuracy and reliability of AFC’s financial statements
and support the company’s strategic goals.

Please let me know if you need any further information or clarification.

Ali Mehrassa
Audit Senior

3. SEE ATTACHED EXCEL SHEET FOR PART OF THE ANSWER. Here is a summary
of the findings based on the sales data for JA Tire Manufacturing for the year ended December
31, 2019:

Sales by Month and Division

The first chart illustrates the sales amount by month for each sales division (MW, NE, SE, SW).
Key observations include:

 Sales exhibit seasonality with noticeable peaks and troughs.

 The Southwest (SW) division consistently shows higher sales throughout the year
compared to other divisions.
 The Northeast (NE) division also shows strong performance but with significant
fluctuations.
 The Midwest (MW) and Southeast (SE) divisions have relatively lower sales compared to
the SW and NE divisions.

Sales by Customer

The second chart shows the total sales amount for each customer. Key observations include:

 A few customers contribute to a significant portion of the total sales.

 Customer Number 1015 and Customer Number 1024 are the top customers with the
highest sales amounts.
 Sales distribution is uneven, with a substantial portion of revenue coming from a small
number of customers.

Recommendations for Audit Procedures

Based on these observations, I recommend the following audit procedures to address the
identified risks:

1. Commission Calculation Review:

o Verify the accuracy of commission calculations for salespersons by recalculating
commissions based on sales data and ensuring they match the recorded amounts.
 2. Revenue Recognition Testing:
o Perform detailed testing of revenue recognition to ensure sales are recorded in the
correct period and in compliance with accounting standards.
o Focus on periods with significant sales fluctuations to ensure proper cut-off
procedures are followed.

3. Customer Confirmation:
o Send confirmations to the top customers (e.g., Customer Number 1015 and
Customer Number 1024) to verify the accuracy of recorded sales and receivables.

4. Sales Trend Analysis:

o Conduct a trend analysis of monthly sales to identify any unusual patterns or
discrepancies that may indicate potential misstatements or irregularities.
o Investigate any significant variances between expected and actual sales trends.

5. Division Performance Analysis:

o Perform a detailed analysis of each sales division's performance to identify any
outliers or anomalies.
o Investigate the reasons behind significant fluctuations in sales within the NE
division and consistently high sales in the SW division.

6. Cut-off Testing:
o Conduct cut-off testing at year-end to ensure that sales transactions are recorded
in the correct accounting period.
o Focus on transactions around the year-end to verify proper cut-off procedures.

By implementing these audit procedures, we can address the identified risks related to revenue
and commission calculations and ensure the accuracy and completeness of JA Tire
Manufacturing's financial statements for the year ended December 31, 2019.

Let me know if you need any further analysis or details.

Best regards,

Ali Mehrassa
Senior Auditor