ACC 521 Lecture Notes - Lecture 5: Bes, Windows Management Instrumentation, Liberation Tigers Of Tamil Eelam

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2 Oct 2014

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Ep6-2 as royal health is a public company, the auditor would likely accept only a low level of audit risk. Three audit issues that affect audit risk and risk of material misstatement include: Inventory: the company is growing its own inventory, so cost accumulation and determination of quantities may increase risk of misstatements in the existence and valuation assertions. The product is a commodity, and the auditor may require expert assistance to obtain appropriate evidence. Related party transactions: the company has significant marketing expenditures that not at arms" length. This increases risk of misstatement since valuation may not be at fair value, and evidence will need to be obtained regarding fair value of the marketing services used. The auditor will also need to ensure that related parties, and the transactions and balances with them, are accounted for and disclosed in accordance with the financial reporting framework.

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A424

Homework #3

Due Tuesday, February 28

Worth 100 Points

Note: Students are expected to work independently (i.e., on your own) on all homework assignments. Please type and post to Canvas.

Part I. Risk Assessments

1. For each illustration, select the component of audit risk that is most directly illustrated. The components of audit risk may be used once, more than once, or not at all. (10 points, 1 point each).

Components: Inherent Risk (IR), Control risk (CR), or Detection Risk (DR)

a. A client fails to discover employee fraud on a timely basis because bank accounts are not reconciled monthly.

b. Cash is more susceptible to theft than an inventory of coal.

c. Confirmation of receivables by an auditor fails to detect a material misstatement.

d. Disbursements have occurred without proper approval.

e. There is inadequate segregation of duties.

f. A necessary substantive audit procedure is omitted.

g. Notes receivable are susceptible to material misstatement, assuming there are no related internal controls.

h. Technological developments make a major product obsolete.

i. The client is very close to violating debt covenants.

j. XYZ Company, a client, lacks sufficient working capital to continue operations.

2. Read Case 1.6, Nextcard, Inc. from our Casebook. Pretend you are the auditor for Nexcard, Inc. in the planning phase of the audit for FY 2000 and perform the following risk assessment procedures. That is, just focus on the information in the case prior to the discovery of the fraud (pages 83-86). (50 points total)

a. Perform a risk assessment as part of your audit plan for fiscal year 2000. Set or assess each component/factor of the audit risk model. Describe in detail how you set or assessed each factor (i.e., include specific risk factors from the case and explain how they influenced your assessment). (25 points)

b. Perform a fraud risk assessment for the risk of material misstatement due to fraudulent financial reporting. That is, identify and briefly describe specific fraud risk factors (i.e., more than 1) for each of the three components of the fraud risk triangle, specific to fraudulent financial reporting. (15 points)

c. Identify and describe one significant pervasive risk present during the Nextcard audit. In doing so, explain how the pervasive risk affects the risk of material misstatement. Then, describe how the auditor could respond to that pervasive risk (how could they change the audit plan to address that risk). (5 points)

d. Identify and describe one significant specific risk present during the Nextcard audit. In doing so, explain how the specific risk affects the risk of material misstatement. Then, describe how the auditor could respond to that specific risk (how could they change the audit plan to address that risk). (5 points)

Part II. Evidence and Management Assertions

1. For each of the following specific audit procedures, indicate the type of audit procedure it represents: (1) inspection of records or documents, (2) inspection of tangible assets, (3) observation, (4) inquiry, (5) confirmation, (6) recalculation, (7) reperformance, (8) analytical procedures, and (9) scanning. (10 points, 1 point each)

a. sending a written request to the entityâs customers requesting that they report the amount owed to the entity

b. examining large sales invoices for a period of two days before and after year-end to determine if sales are recorded in the proper period.

c. agreeing the total of the accounts receivable subsidiary ledger to the accounts receivable general ledger account.

d. discussing the adequacy of the allowance for doubtful accounts with the credit manager.

e. comparing the current-year gross profit percentage with the gross profit percentage for the last four years.

f. examining a new plastic extrusion machine to ensure that this major acquisition was received.

g. watching the entityâs warehouse personnel count the raw materials inventory.

h. performing test counts of the warehouse personnelâs count of the raw material.

i. obtaining a letter from the entityâs attorney indicating that there were no lawsuits in progress against the entity.

j. tracing the prices used by the entityâs billing program for pricing sales invoices to the entityâs approved price list.

2. For each of the audit procedures listed above in Part II. 1. (a-j), identify the category (assertions about classes of transactions and events, or assertions about account balances) and identify the primary management assertion being tested. (30 points, 3 points each)

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Part A

(a) How does the materiality of a condition that might lead to a departure affect the auditorâs choice of audit opinions? Discuss in detail naming the various types of audit opinions that may be issued given the different amounts of misstatements detected. (10 marks)

(b) For each of the following independent situations, indicate the type of audit report you would issue and provide your reasons. You may assume that each item is material. (10 marks)

(i) On 2 January 2017, the Hot Wheels Auto Parts Limited received a notice from its primary supplier that, effective immediately, all wholesale prices would be increased by 10%. On the basis of this notice, Hot Wheels Auto Parts revalued its 31 December 2016 inventory to reflect the higher costs. The inventory constituted a material proportion of total assets; the effect of the revaluation was material to current assets but not to total assets. The increase in valuation is adequately disclosed in the notes to the financial statements.

(ii) Your client holds a significant investment in Iraq. Due to recent political instability sparked off by a series of terrorist acts by the militants, Iraqâs communication with the outside world has been completely cut-off. You are thus unable to obtain sufficient and appropriate evidence regarding your clientâs investment in Iraq.

Part B

During an examination of financial statements, an auditor needs to verify managementâs assertions that are part of the financial statements. In doing so, the auditor must choose the quality and quantity of evidence, and the timing of the tests to be performed.

(a) Describe five factors that influence the quality or appropriateness of audit evidence. (5 marks)

(b) Why is it necessary to obtain corroborating evidence for inquiry and for observation? (5 marks)

(c) Describe the highest quality form(s) of evidence an auditor would normally obtain to verify each of the following assertions. Be sure to state the type of audit evidence/audit procedure technique being used, e.g. inquiry. (10 marks)

(i) ownership of share certificates held in a safe deposit box

(ii) valuation of gross trade accounts receivable

(iii) completeness of additions of fixed assets

(iv) validity of trade accounts payable

(v) valuation of finished goods inventory

Part C

An auditor is required to obtain sufficient understanding of each element of a companyâs internal control system in order to properly plan the audit of the companyâs financial statements and to assess control risk for the assertions included in the account balances.

How does the quantity of evidence differ between procedures to obtain an understanding of internal control and tests of internal controls? (4 marks)

(b) Distinguish between a compliance/reliance strategy and a substantive strategy. (6 marks)

(c) For each of the following, give an example of a physical control the client can use to protect the asset or record: (5 marks)

(i) cash received by retail clerks

(ii) accounts receivable records

(iii) raw material inventory

(iv) manufacturing equipment

(v) marketable securities

(d) Explain what is meant by independent checks on performance! (5 marks)

performance review and give two specific examples.

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1 - The most appropriate procedure an auditor can use toensure integrity of the sales and collection cycle isto:

a) Confirm accounts receivables balances.

b)Ensure the bank reconciliations are preparedby one who also handles sales returns so missing items can beaccounted for timely.

c)Recalculate the sales list price of allproducts in the computer files that are accessed by salepersonnel.

2 - When performing audit procedures, which of thefollow must be set prior to testing a sample?

a)Achieved upper precision limit

b) Computed error rate

c) Tolerable error rate

3 - When auditing the inventory cycle the auditor shoulddo all of the following EXCEPT:

a)Adjust the balance in the inventory accountto reflect the perpetual inventory counts

b)Assess the value of obsolete or damagedinventory

c)Review the procedures for the count ofphysical inventory.

4 - Tests of controls for the acquisition and paymentcycle are usually done by:

a)Inquires and documentation of management'srepresentation.

b)Recalculating sales tax amounts

c)Sending out confirmations for amounts under$10,000

5 - Cash is the most desirable asset for people tomisappropriate, when determining risk as part of the audit process,cash would have a higher:

a) Control risk

b)Detection risk

c) Inherent risk

6 - When an auditor looks at a report with over 500purchases and decides to review all of the purchase over $1,000,000this is an example of what type of sampling:

a)Judgmental sampling

b)Statistical sampling

c)This is not sampling

7 - Upon review of your audit findings your discovercash receipts from sales on account have been misappropriate. Whichof the following internal controls may have preventedthis:

a)Ensuring the same person that receives thepayments from customers does not enter transactions into thejournal and post to the ledger

b) Do a background check on all accountspayable personnel before they are hired

c)Verify that the person who receives thepayments does not also write the checks

8 - Upon review of your audit findings you not weakinternal control system that allows a department supervisor to"clock in" for a fictitious employee and then approve theemployee's time card at the end of the pay period. This fraud wouldbe detected if other controls were in place, such as having anindependent party:

a)Compare the date of the recorded check in thepayroll journal with the date on the canceled checks and timecards

b)Distribute paychecks

c)Recompute hours worked from time cards

9 - Different professional standards apply to differenttypes of services offered by a CPA. Assurance services performed bya CPA would include:

a)Audits of financial statements

b)Bookkeeping and accounting system consultingservices

c)Tax service

10 - A CPA may perform all of the following services fordifferent clients EXCEPT:

a)Audits

b)Legal advice relating to accounting ethicsviolations

c)Tax preparation

11 - If an auditor discovers material misstatement afterthe audit report is issued the auditor's first step should benotify

a)The audit firm's legal council

b)The audit committee of the client

c) The client

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ACC 521 Lecture Notes - Lecture 5: Bes, Windows Management Instrumentation, Liberation Tigers Of Tamil Eelam

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