AutoCare Ltd. (ACL) is a federally incorporated public company formed in 2010 to manufacture and sell specialty auto products such as paint protection and rust proofing. By 2014, ACL’s board of directors felt that the company’s products had fully matured and that it needed to diversify. ACL aggressively sought out new “concepts,” and in November 2015, it acquired the formula and patent for a new product synthetic motor lubricant (Synlube). Synlube is unlike the synthetic motor oils currently on the market. Its innovative molecular structure accounts for what management believes is its superior performance. Although Synlube is more expensive to produce and, therefore, has a higher selling price than its conventional competitors, management believes that its use will reduce maintenance costs and extend the life of the equipment in which it is used. ACL’s main competitor is a very successful multinational conglomerate that has excellent customer recognition of its products and a large distribution network. To create a market niche for Synlube, management is targeting commercial businesses in western Canada that service vehicle fleets and industrial equipment. ACL’s existing facilities were not adequate to produce Synlube in commercial quantities, so in June 2016 ACL began construction of a new blending plant in a western province. The new facilities became operational on December 1, 2016. ACL has financed its recent expansion with a term bank loan. Management is considering a share issue later in 2017 to solve the company’s cash flow problems. ACL’s March 31, 2016, the draft balance sheet is provided in Exhibit I. 

Although they had been with the company since its inception, ACL’s auditors have just resigned. It is now April 22, 2016. You and a partner meet with the CEO to discuss the services your firm can provide to ACL for the year ended March 31, 2016. During your meeting, you collect the following information: 

• ACL has started a lawsuit against its major competitor for patent infringement and industrial espionage. Management has evidence that it believes will result in a successful action and wishes to record the estimated gain on settlement of $4 million. Although no court date has been set, legal correspondence shows that the competitor intends “to fight this action to the highest court in the land.” 

• The CEO, Arif Saleh, contacted your firm after ACL’s former auditors resigned. The previous auditors informed Mr. Saleh that they disagreed with ACL’s valuation of deferred development costs and believed that the balance should be reduced to a nominal amount of $1. ACL has incurred substantial losses during the past three fiscal years, but revenue for 2016 was $6.2 million. 

Required 

(a) List five procedures that the auditor should perform before deciding to accept ACL as a client. 

(b) Evaluate four factors that impact the audit risk assessment for the current year and indicate how these factors influence audit risk (that is, increase or decrease audit risk). 

(c) Conclude on overall audit risk and indicate how this will impact the audit planning. 

(d) Using at least three of your calculations of materiality, calculate the range of materiality for the current year. Conclude on the most appropriate materiality and include a detailed explanation supporting your decision. 

(e) Perform planning analytic procedures and identify at least three accounts with unusual fluctuations. For each of the “risky” accounts, you identify, indicate a possible client error that may have caused this significant fluctuation as well as a possible business reason for the change.

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EXHIBIT I AutoCare Ltd. DRAFT BALANCE SHEET as at March 31 (in thousands of dollars) Assets 2016 (Unaudited) 2015 (Audited) Current $ 213 1,650 $ 195 615 Accounts receivable Inventories Prepaid expenses 45 1,908 30 840 Capital assets 2,120 716 Investment in JDP Ltd. Deferred development costs Patent 1,979 835 $6,843 686 835 $3,078 Liabilities Current $ 462 476 98 Bank indebtedness $1,225 607 Accounts payable Current portion of long-term debt Advances from shareholders 400 253 2,485 1,036 3,114 650 Long-term debt 5,599 1,686 Shareholders' Equity Capital stock 2,766 2,766 (1,522) 1,244 Deficit (1,374) 1,392 $6,843 $3,078