As the engagement partner for Big Boldov and Best (B3) it is your responsibility to write the audit report for Oreco Mining Corporation, a publicly listed iron miner. A new CEO and new CFO were brought in in 2021. They brought in a lot of changes to operations, but most of the accounting policies remained the same as prior years. They want to show the Board of Directors good results for their hard work. The new management is sensitive to showing losses. They have said they don't mind writing off the mistakes of previous management but need to show progress to investors. Sales increased from $141 million in 2020 to $162 million in 2021 despite a downturn in commodity prices.

Oreco's auditors last year, Shan, Shaw and Shah, LLP (3S) are a reputable mid-size firm. Their opinion last year was unqualified. You were brought in to replace 3S just before year end which made planning and staffing a challenge but possible. While reviewing their 2020 working papers, you note that there was discussion over the client's booking maintenance expenses as capital improvements. The amount booked as maintenance expenses was $1,831,450.

Your field manager has recommended an adjustment to maintenance expense of $2,380,000 with the credit to fixed assets. She has also recommended accelerating depreciation to reflect greater than expected wear and tear, resulting in an adjustment of about twice materiality. Oreco's new management has said they will book the accelerated depreciation if you agree to ignore the adjustment to maintenance expense since it followed previous accounting practices.

The field manager also noted that the count of inventory on hand at the end of the year went well. The count occurred on January 1 and consisted of a count of finished goods, which is a crushed, high-grade ore. This is ore which has been extracted from the mine, crushed into centimeter or less sized nuggets, and run through a powerful magnet to pull out nuggets with high concentrations of iron. This high-grade ore is piled. The count consisted of measuring the height of the pile and using formulas to estimate the volume and the weight of the ore.

Lastly, there was a note that read as follows:

"I'm not sure how to deal with this but while on site I visited the tailings pond. I'm no expert but this is an environmental disaster waiting to happen. The sides are overgrown with willow trees and you can see cracks in the cement wall. It doesn't look like anything has been done to fix it in years. If the wall goes, there will be spillage into the French River and the entire watershed will be poisoned. I have no idea the cost to fix it, but the clean up and liability cost would be many many millions. I am purposefully not putting this in the evidence file but thought you should know."

An accrual to fix the pond would be a super material adjustment. Your firm is also the auditor for a large institutional investor in Oreco and they would not be happy if your report caused them to take a big loss on their investment in Oreco. Maybe you could just point out the problem to management and ask them to fix it next year? And after all, you really don't know what the numbers are. Is it your job to be the environmental watchdog?

a) What do you think planning materiality was for the 2021 audit? Why did you choose that amount?

b) List four areas of above average inherent risk and control risk for this audit. Be specific as to the possible effects on the financial statements of the identified risk,

c) Prior to writing your report, you hear a news report that commodity prices have continued to fall. Iron ore with 63.5% iron content for delivery in Tianjin, China has fallen to $73.70. Iron ore reserves at year end include 4,320,000 tones of iron at $83.25 a tonne.

d) Are there any issues regarding the rules of professional conduct that you note in this case?

Answer rating: 100% (QA)

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