ACCT 107 Lecture Notes - Lecture 30: Analytical Review, Deferral, Gross Margin

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beigewhale811

21 Oct 2020

School

American River College

Department

Accounting

Course

ACCT 107

Professor

Dr.Charles“ Kale” Braden

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Document Summary

Key purpose of preliminary analytical procedures is to help the auditor to better understand the client"s business and the client"s business risk. Also used to identify areas that have high risk of misstatement as well as fraud risk. Preliminary tests can reveal unusual changes in ratios compared with those of prior years, or to industry averages. Look at chapter 5 appendix 5a for ratio calculations! Examines of analytical procedures used during audit planning include: Calculate key ratios for the client"s business and compare them with industry averages. Purpose is to understand the client"s industry and business. Calculate the d/e ratio and compare it with those of previous years and successful companies in the industry. Compare the gross margin with those of prior years, looking for large fluctuations. Purpose is to identify possible misstatements and to plan nature, extent and timing of further audit procedures. Purpose is to identify high-risk audit areas and to aid in the assessment of fraud risk.

Related Questions

The company the team chose is Alphabet formally Google, and competitor is Yahoo

You are a senior manager for the highly successful regional CPA firm of Fine, Dee, Evah, Dense, LLP (Fine). Since its inception nearly 30 years ago, Fine's audit practice has exclusively consisted of auditing private and not-for-profit organizations. Recently, the partners have been considering an opportunity to audit a publically-traded company for the company your team has selected.

The primary reason Fine has not heretofore ventured into auditing public-traded companies is because of the potential risk and legal liability associated with auditing public companies. However, Fine has been a bit stagnant, business-wise, for the past few years, and some of the older and more risk adverse partners are beginning to retire. Consequently, the lure of the often-lucrative and prestigious opportunity to audit a public company has become to hard to resist, so the partners have decided to pursue the chance to audit this company.

On a beautiful early-september morning you are called into the senior partner's office and told you and your team have been selected to lead the first-ever effort to audit a public-traded company for Fine. You are honored, but also know auditing a public company is a bit more tricky and complicated than auditing private and not-for-profit organizations. Fortunately, the senior partner had considerable experience early in his career with another firm in auditing public companies and told you he would be with you all the way. Relieved, you asked him what he wanted you to do. He tossed you the most recent Form 10-K of the company you selected and gave you the following assignments:

Review and discuss the Form 10-K for the company you have selected.
Create a report that will have 4 Sections.

Section 1. Initial Risk Assessment

Hint: The business and risk information is usually found in the first part of the risks, do not simply restate what is in the Form 10-K. Think like a senior manager at a CPA firm-what accounts (cash, A/R, Inventory,etc.) might be the most potentially risky and Why? For example an airline might not have the same inventory considerations found with a retail outlet like Wal-Mart.

Describe the following issues:
Ethics and legal Issues

1. The ETHICS and sophistication of top management and cultures where the company operates.

2. Have there been significant auditing or accounting issues raised in the recent past?

3. Did they have disputes with their previous audit firm?
4. IS this company or industry particularly susceptible to lawsuits or other legal proceedings?

Evaluate the regulatory and compliance and requirements of this company.
1. The compliance requirements of this company.

2. is it subject to a high-level of governmental regulation?

3. Are employees unionized? Are they generally compliant with Sarbanes-Oxley and other regulatory rules?

Section 2. Analytical Procedures

Based on Table 8-1 Examples of Planning Analytical Procedures and the sections on Analytical Procedures, select three ratios ( current, ratio, Inventory turnover, debt to equity, return on assets). calculate these ratios for the most recent year and compare the results.

Write a 350 to 525 word analysis of your findings

Section 3. Materiality and Risk

The senior partner wants to confirm your understanding of key concept.
Summarize each concept 90 to 175 words each.

materiality
misstatement
audit risk
audit risk model
inherent risk.
relationship of risk to audit evidence

2â31. Simulation
Casa Royale, Inc., a nonpublic company, retained Ying and Company CPA to perform an
audit of the fi nancial statements for the current year. Howard Smythe, the partner in charge of
the audit, drafted the following unmodifi ed report:

To the Management of Casa Royale, Inc.:
We have examined the accompanying consolidated balance sheet of Casa Royale, Inc., and
its subsidiaries, as of December 31, 20X1, and the related consolidated statements of income,
retained earnings, and cash fl ows for the years then ended.
Managementâs Responsibility for the Financial Statements
Management is responsible for the preparation and fair presentation of these consolidated
fi nancial statements in accordance with accounting principles generally accepted in the United
States of America; this includes the design, implementation, and maintenance of internal control
relevant to the preparation and fair presentation of consolidated fi nancial statements that are
free from material misstatement, whether due to fraud or error.
Auditorâs Responsibility
Our responsibility is to express an opinion on these fi nancial statements based on our audit. We
conducted our audit in accordance with auditing standards generally accepted in the United
States of America. Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the consolidated fi nancial statements are free of material
misstatement.
An audit involves performing procedures to obtain audit evidence about the amounts and disclosures
in the consolidated fi nancial statements. The procedures selected depend on the auditorâs
judgment, including the assessment of the risks of material misstatement of the consolidated
fi nancial statements, whether due to fraud or illegal acts. In making those risk assessments, the
auditor considers internal control relevant to the entityâs preparation and fair presentation of
the consolidated fi nancial statements in order to design audit procedures that are appropriate
in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of
the entityâs internal control. An audit also includes evaluating the appropriateness of accounting
policies used and the reasonableness of signifi cant accounting estimates made by management,
as well as evaluating the overall presentation of the consolidated fi nancial statements.
We believe that the audit evidence we have obtained is adequate to provide a basis for our audit
opinion.
Opinion
In our opinion, the consolidated fi nancial statements referred to above present fairly, in all material
respects, the fi nancial position of Casa Royale, Inc., and its subsidiaries as of December 31,
20X1, and the results of their operations and their cash fl ows for the years then ended in accordance
with auditing standards generally accepted in the United States of America.
Howard Smythe , Partner
Phoenix, Arizona
February 12, 20X2
Reviewerâs Comments
Comment Is
Correct (yes or no)
a. The report should not be addressed to management.
b. The report should indicate that we have âaudited,â rather than âexamined,â
the fi nancial statements (fi rst paragraph after introduction).
c. The report should not indicate anything concerning managementâs
responsibility for internal control.
d. The report should state that the auditorsâ responsibility is to express
âreasonable assurance,â not an opinion (fi rst paragraph under âauditorâsâ
responsibility).
e. The audit is designed to assess risks of material misstatements due to
errors or fraud; the term âillegal actsâ is incorrect (second paragraph
under auditorâs responsibility).
f. The report should not refer to the auditors âevaluating the appropriateness
of accounting policies,â since those are the responsibility of management.
g. The evidence should be suffi cient and appropriate rather than âadequateâ
(third paragraph under auditorâs responsibility).

Reviewerâs Comments
Comment Is
Correct (yes or no)
h. The opinion should not include âin all material respectsâ since the auditors
are providing an opinion on the accuracy of the fi nancial statements
(opinion paragraph).
i. The opinion should be on âaccounting principles generally accepted in the
United States of America,â not on auditing standards (opinion paragraph).
j. The signature on the report should be that of the CPA fi rm, not that of
the partner.

blushcrocodile696

Question 1 (40 marks)

You are the audit manager of a medium-sized firm and have just received a package from Rachel Jones, the financial controller of KidSpace Ltd., an electronic toy manufacturer. This is your firmâs first year as auditor of KidSpace Ltd. The information below was prepared for a board meeting and Rachel, the acting Chief Financial Officer, felt it might be useful to you in preparation of the forthcoming audit for the year ended 30 June 2017.


KidSpace Ltd.
Statement of Financial Position $'000s

Current assets	2017	2016	2015
Cash	1,586	1,743	830
Accounts receivable and other receivables	13,734	11,200	9,623
Inventory	16,498	11,731	7,197
Total current assets	31,818	24,674	17,650
Non-current assets
Property, plant and equipment	14,606	12,840	9,572
Long-term loan receivable	5,200	3,600	3,300
Intangible assets	1,400
Total non-current assets	21,206	16,440	12,872
Total assets	53,024	41,114	30,222
Current liabilities
Trade payables and other payables	9,012	6,288	2,021
Provisions	4,875	3821	4577
Total current liabilities	13,887	10,109	6,598
Non-current liabilities
Long-term loan	20,000	16,000	12,000
Total liabilities	33,887	26,109	18,598
Net assets	19,137	15,505	11,624
Shareholder's equity
Share capital	2,000	2,000	2,000
Retained earnings	17,137	12,505	9,624
Total shareholder's equity	19,137	14,505	11,624

KidSpace Ltd.
Income Statement $'000s
	2017	2016	2015
Sales revenue	76,945	74,927	89,735
Cost of sales	51,840	51,765	63,066
Gross profit	25,105	23,162	26,669
Depreciation	5,595	4,332	2,796
Inventory obsolescence	990	1,173	670
Selling expenses	2,405	3,153	3,317
Administrative expenses	8,925	8,727	11,516
Finance costs	1,040	1,275	1,140
Total expenses	18,955	18,660	19,439
Profit before tax	6,150	4,502	7,230
Tax expense	1,518	1,621	2,386
Profit after tax	4,632	2,881	4,844

Notes:
Trade Receivables	12,034	10,655	9,300
Pre-paids	1,600	500	300
Other receivables	100	45	23
Total Trade & other receivables	13,734	11,200	9,623

Inventory
Raw Materials	6,599	5,866	3,845
WIP	4,333	2,588	1,550
Inventory held for sale	6,699	3,520	1,972
	17,631	11,974	7,367
Provision for Inventory obsolescence	(1,133)	(243)	(270)
Total inventory	16,498	11,731	7,197

Ratios	2017	2016	2015
Profit ratio	7.99%	6.01%	8.06%
Return on shareholder equity	24.20%	19.86%	41.67%
Quick Ratio	0.99	1.18	1.54
Times Interest Earned	6.91	4.53	7.34
Accounts Receivable Turnover (times)	6.78	7.51	9.33
Asset Turnover	1.45	1.84	2.94
Inventory Turnover (times)	3.50	5.35	8.76

During a brief telephone call with Rachel, you made the following notes:

1. One of the conditions of the long-term loan is that the company is not to exceed a debt-to equity ratio of 2:1 at any time and they must maintain a current ratio of 2:1. The loan is reviewed each year on 31 July.
2. Provision for obsolescence of finished inventory held for sale and work-in-progress is provided for at a flat rate of 10%. The amount provided in previous years was 20%. Rachel said that the company believes it has been overly conservative in previous years and 10% is a more realistic level, given the nature of its products.
3. To combat declining sales a senior management incentive scheme based on sales and profit levels was introduced in July 2016.
4. The long-term loan receivable is from a company involved in the development and production of computer software. It is owned by one of the directors.

Required:

a) Identify and explain what the inherent risks for KidSpace Ltd. that you will need to consider. (6 marks)
b) From the information provided, perform additional preliminary analytical procedures:
i) Simple comparison (3 marks)
ii) Current ratio (1 mark)
iii) Return on assets (1 mark)
iv) Gross profit ratio (1 mark)
v) Debt-to-equity ratio. (1 mark)

c) Drawing on information from a) & b), identify and justify:

i) Three key account areas that would require special attention during the audit of the 30 June 2017 financial statements. Also, indicate if those accounts are likely to be over or understated. (12 marks)
ii) Two key assertions at risk for each of those account areas. (12 marks)

d) Identify and discuss any going concern issues to be considered at this stage?. (3 marks)

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ACCT 107 Lecture Notes - Lecture 30: Analytical Review, Deferral, Gross Margin

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