AFM202 Lecture Notes - Lecture 3: Financial Statement

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

Part 1

You have been assigned as audit senior to the audit of Universal Magazines Pty Ltd (Universal).Your firm has recently been appointed as auditors and this is the first time you have been on the audit.
Your engagement partner and the assistant auditor conducted an interim audit five months before this year end. There were no major issues at the interim audit and the assistant informs you that she thinks that the results of the audit are applicable for the full year.

The owners (i.e. shareholders) of the magazine are a private equity firm and have specified that audits should be undertaken. The company commenced business on day one of the current financial year when it purchased the business from its former owners. They have plans to merge the company with other publishing interests and list the merged entity on the Australian Stock Exchange in two or three years time. As an incentive to perform, the editor and senior staff have been given the right to take up shares in the new entity at a highly discounted price when it is listed subject to meeting their KPIs (key performance indicators) each year until the listing.

The magazine is a monthly giveaway and it is distributed in six areas of Melbourne. Its revenueconsists of advertising by local businesses. The sales director and her staff actively pursue sales
opportunities in each area.

Articles written by locals largely consist of reports on upcoming community events.

The Managing Director (MD) generally attempts to convince the local writers that the resultant publicity for their community event means that the article should be written for free. Most of the time he
is successful, and only about half the magazines’ articles are paid for. Prior to the equity partners taking over the magazine, any paid articles or photographs were treated as expenses to be written off as they were accrued or paid.

After the private equity firm took over the magazine, the firm insisted that all paid articles provided by external writers for upcoming issues would be considered as inventory until used in the
magazine and that they be valued at cost. If an article cannot be used after purchase (i.e. the restaurant for which a review was written has closed), then it is considered to be impaired and its value is written down.

The MD accumulates articles so that he always has a ‘bank’ of articles available for the next edition.

Advertising is mostly sold in three or six edition bundles. Occasionally there are a few one-off monthly advertisements, especially from seasonal businesses.

The magazine offers a discount to advertisers if they place orders early and the discount increases the earlier the order is placed (i.e. a bigger discount is offered if an advertiser wants an ad in next year’s magazine than if they want an ad in next month’s magazine).

Responsibility for invoicing the advertiser and recording the details lies with whichever member of the sales team lands the advertiser.

The company has an experienced bookkeeper who has been with the company for five years.

The financial director of the private equity firm, who is also a director of the company, regularly visits the company and conducts a few compliance procedures of his own. He has no formal audit
programs for this work but he has made his reports available to your audit team. He has told your engagement partner that he expects your firm to ensure that the year-end closing is accurate and
complete.

Required:
(a) Provide two (2) account balances and assertions at risk in this scenario.
(b) Explain whether you should accept the advice of your assistant auditor to accept the results of the
interim audit as applicable for the whole year

Background
You are a junior auditor working for Forrest Gump & Co. (theFirm), an international chartered
accounting firm.
Your client, Wellness Pty Ltd (Wellness) operates the world-famousWellness Health Resort,
located in the Whitsunday Islands of northern Queensland.
While revenue from accommodation is an important factor in thefinancial success of Wellness
Health Resort, its profits are predominantly driven by the uptakeof additional services and
facilities by guests during their stay (e.g. use of the spa andwholistic health facilities, patronage
of the five restaurants and bars within the resort, and partakingin other fee-paying activities).
Wellness maintains its own website which allows guests to bookaccommodation at the resort
directly. This online booking system is monitored by thereservations team at Wellness which
consists of two full-time and three casual staff.
When a booking is made over the internet, an email is sent to thereservations team informing
them that a booking has been made. The resort’s booking system isautomatically updated at this
time. The reservations team is responsible for manually confirmingthe availability of the
accommodation, verifying the guest’s credit card details, issuingthe guest with an invoice, and
passing on the payment receipts to the accounts department. Theaccounts department then
processes the sale into the general ledger.
On a weekly basis, the junior accounts clerk in the accountsdepartment reconciles the payment
receipts, sent by the reservations team, to Wellness’s bankstatements. The bank statements are
emailed to Wellness in PDF form each week.
Any cancellations received by the reservations team are referred tothe accounts department
which organises for the guest’s payment to be refunded in full (or50% for cancellations made
within seven days of the guest’s anticipated arrival date).

Since the internet booking system is not technically up to date,Wellness intends to engage an IT
specialist to completely upgrade the system and eliminate the needfor manual checking of
details by the reservations staff.
Based on its discussions with the previous auditors, Wellnesschanged its revenue-recognition
policy prior to the current year audit. Previously, all revenuesearned were brought to account
when bookings were made (including internet bookings). Now,Wellness recognises:
 50% of the accommodation at the time of booking (put to the‘Deferred revenue:
accommodation’ account)
 50% of the accommodation seven days prior to the guest arriving(in accordance with
Wellness’s cancellation policy) which is immediately recognised as‘Revenue:
accommodation’ since this portion of the revenue is no longerrefundable to the guest.
You are currently in the planning stage of the 2014 audit.
Based on the review of the previous year’s audit files and theinformation gathered by the
Forrest Gump & Co. audit team during the planning stage, thehead of the audit team tells you
that he intends to adopt a combined audit approach for the 2014Wellness audit.
His expectation is that all controls at Wellness are operatingeffectively. He tells you that he
intends to place a high level of reliance on the controls atWellness as he does not expect there
will be any deviations.
He has now asked you to assist with the review of the internetbooking system at Wellness.

Required:
(a) Identify and explain two (2) key risks to the financial reportassociated with the internet booking system that may lead tomaterial misstatements being undetected and/or uncorrected. Note:For the
purpose of this question, disregard any risks arising from theinterface between the internet booking system and the generalledger system.

(b) For each risk identified in (a) above, identify whether it isan inherent risk or a control risk. Explain your answer.

(c) For each risk identified in (a) above, identify one (1) keyaccount balance at risk of material misstatement as a result of therisk (i.e. two (2) account balances in all).

(d) For each account balance identified in (c) above, identify andexplain one (1) key assertion that may be affected by the risk youidentified in (a) above.

(e) Based on your understanding of the control environmentsurrounding the internet booking system, describe one (1) keycontrol that you would seek to rely on in the conduct of the 2014audit of Wellness.

(f) For the control you identified in (e) above, design anappropriate procedure to test that control.

(g) For the procedure you described in (f) above, outline theresult you would expect if you determined that the control was notreliable.