Take a look at Case 8.1 and answer the following questions:
Case 8.1 Audit Adjustments:
You are a CPA on the audit staff of a multinational publicaccounting firm. You are the senior auditor on an annual audit of amanufacturing company that is a small subsidiary of a largercompany that is a significant client of your firm. In addition to asizable fee for the annual audit, the parent company pays your firmadditional fees each year for tax consultation and returnpreparation as well as other management consulting services. Withthis particular audit, as with many parent-subsidiaryrelationships, you are aware that there is a tremendous amount ofpressure on the subsidiary companyâs management to reach certainprojected sales goals for the year. Because of this, the climate atthe subsidiary is tense as you begin your annual examination of theyear-end financial statements. During the course of the audit, youperform a sales cutoff test to ensure that all sales transactionsat year-end were recorded in the proper period. Since title to thecompanyâs products passes when they are shipped to customers,shipments are required in order for a sale to be properly recorded.Accordingly, a standard audit procedure is to cross-reference salesrecorded prior to year-end to related shipping records to salesjournals. The sales cutoff test revealed that numerous shipmentsmade after the companyâs year-end were recorded as sales prior toyear-end, which resulted in significantly higher revenue during theyear you are auditing. You are aware that as an independentauditor, you have a responsibility to your clients and to those whomight make decisions based on the companyâs financial statement,such as investors and lenders. When you inform the subsidiaryâscontroller of the results of your sales cutoff test and that anadjustment to annual revenues and profits would likely bewarranted, he takes the matter to the president of the subsidiary.During a follow-up meeting with the controller and president, thepresident attempts to get you to reconsider your proposedadjustment with the following arguments.
1) The amount of the adjustment you were proposing was notmaterial to the parent companyâs financial statement.
2) All of the subsidiaryâs competitors did the same thing inrecording shipments just after year-end as sales in the previousyear.
3) It really didnât matter in the long run if sales were movedfrom the current year to the next year, since sales and profits forthe next year would be greater> At the end of the meeting, thepresident drops a not-so-subtle reminder that his company is asubstantial client of the firm. You call the partner from your firmwho is in charge of the audit for advice, and he tells you tohandle the situation on your own. After considering all factors,you continue to feel that an adjustment to the companyâs financialstatements is warranted, but after a meeting with the clientattended by your senior partner on the audit (and not attended byyou) you are instructed by the senior partner not to make theadjustment.
How should you react?
Question answer should address these issues â This calls for ananalysis that appreciates the complexity of the auditorâs role.
The well written answer will address the following points: Theauditor and the auditorâs firm has to recognize that its ownfinancial survival may be dependent in part on continuedsatisfactory work in the eyes of the client/subsidiary as well asthat of the subsidiaryâs parent corporation.
The auditor will have to reconcile professional and satisfactoryservice with the responsibility of the auditor to report accuratelyand to attest to proper accounting standards within the reportingsystem of the subsidiary.
The auditor will be subject to professional discipline and civilliability if the auditor fails to honor professional standards ofconduct and of fiduciary duties.
As a practical matter, and as an interpretive artist, theauditor need not either comply with the senior partner or quitâ¦
Information can be honestly presented in a fashion that iscandid, such as through footnoting, while still presenting apicture that might me closer to the expectations of the client. Ofcourse, there is a large potential for disingenuousness in such anapproach.
Take a look at Case 8.1 and answer the following questions:
Case 8.1 Audit Adjustments:
You are a CPA on the audit staff of a multinational publicaccounting firm. You are the senior auditor on an annual audit of amanufacturing company that is a small subsidiary of a largercompany that is a significant client of your firm. In addition to asizable fee for the annual audit, the parent company pays your firmadditional fees each year for tax consultation and returnpreparation as well as other management consulting services. Withthis particular audit, as with many parent-subsidiaryrelationships, you are aware that there is a tremendous amount ofpressure on the subsidiary companyâs management to reach certainprojected sales goals for the year. Because of this, the climate atthe subsidiary is tense as you begin your annual examination of theyear-end financial statements. During the course of the audit, youperform a sales cutoff test to ensure that all sales transactionsat year-end were recorded in the proper period. Since title to thecompanyâs products passes when they are shipped to customers,shipments are required in order for a sale to be properly recorded.Accordingly, a standard audit procedure is to cross-reference salesrecorded prior to year-end to related shipping records to salesjournals. The sales cutoff test revealed that numerous shipmentsmade after the companyâs year-end were recorded as sales prior toyear-end, which resulted in significantly higher revenue during theyear you are auditing. You are aware that as an independentauditor, you have a responsibility to your clients and to those whomight make decisions based on the companyâs financial statement,such as investors and lenders. When you inform the subsidiaryâscontroller of the results of your sales cutoff test and that anadjustment to annual revenues and profits would likely bewarranted, he takes the matter to the president of the subsidiary.During a follow-up meeting with the controller and president, thepresident attempts to get you to reconsider your proposedadjustment with the following arguments.
1) The amount of the adjustment you were proposing was notmaterial to the parent companyâs financial statement.
2) All of the subsidiaryâs competitors did the same thing inrecording shipments just after year-end as sales in the previousyear.
3) It really didnât matter in the long run if sales were movedfrom the current year to the next year, since sales and profits forthe next year would be greater> At the end of the meeting, thepresident drops a not-so-subtle reminder that his company is asubstantial client of the firm. You call the partner from your firmwho is in charge of the audit for advice, and he tells you tohandle the situation on your own. After considering all factors,you continue to feel that an adjustment to the companyâs financialstatements is warranted, but after a meeting with the clientattended by your senior partner on the audit (and not attended byyou) you are instructed by the senior partner not to make theadjustment.
How should you react?
Question answer should address these issues â This calls for ananalysis that appreciates the complexity of the auditorâs role.
The well written answer will address the following points: Theauditor and the auditorâs firm has to recognize that its ownfinancial survival may be dependent in part on continuedsatisfactory work in the eyes of the client/subsidiary as well asthat of the subsidiaryâs parent corporation.
The auditor will have to reconcile professional and satisfactoryservice with the responsibility of the auditor to report accuratelyand to attest to proper accounting standards within the reportingsystem of the subsidiary.
The auditor will be subject to professional discipline and civilliability if the auditor fails to honor professional standards ofconduct and of fiduciary duties.
As a practical matter, and as an interpretive artist, theauditor need not either comply with the senior partner or quitâ¦
Information can be honestly presented in a fashion that iscandid, such as through footnoting, while still presenting apicture that might me closer to the expectations of the client. Ofcourse, there is a large potential for disingenuousness in such anapproach.
Related questions
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)
Assessment item 3
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Case B - Report
Value: 20%
Due Date: 16-Sep-2018
Return Date: 05-Oct-2018
Length: 3000 words
Submission method options: Alternativesubmission method
Task
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Background
You are a manager in the audit division at Miller Yates Howarth(MYH), an accounting firm with offices throughout the majorregional centres of NSW and Queensland. Although a medium sizedfirm by national standards, MYH is the second largest regionalaccounting firm in Australia. Most of MYHâs audit clients are inthe agriculture, mining, manufacturing and property industries. Allthose industries are currently under pressure, either from adownturn in commodity prices or fierce competition from overseascompetitors. Ratios extracted from an unaudited set of financialreports at 30 June 2018 together with audited comparatives for theyear ended 30 June 2017 and 2016 are set out below for yourreview.
You are gatheringinformation to prepare the audit plan of Trunkey Creek WinesLimited for the year ended 30 June 2018. Trunkey Creek Wines (TCW)is one of MYHâs most significant and longstanding clients. Thefollowing information has been gathered to date.
Principal activitiesof TCW
⢠growing grapes for wine production;
⢠production and distribution of red, white and sparklingwines;
⢠beef cattle production on land surplus to grape production;and
⢠investment of surplus funds.
TCW was originally afamily company incorporated in 1968 and has operated successfullyand profitably since that date. In the 1990âs shares were sold to asmall number of investors to increase funds for the development andupgrading of the winery and the purchase of additional land for thevineyards. Insufficient rainfall had meant that some land was nolonger suitable for wine grape production, as a result, TWC movedinto Wagyu beef cattle production on this surplus land. The Wagyuoperation is now starting to return a profit.
TWC now find that the2 degrees increase in temperature at some vineyards is affectingthe production of sparkling wine and are now looking at purchasingland in cooler climates. TWC has built up a strong following fortheir sparkling wine which earns significant profits in bothdomestic and overseas markets. TWC are currently negotiating theland purchase and part funding in part from medium term bank loans.The remaining purchase price will be sourced from surplusfunds.
The Wagyu beef is soldthrough the Wagyu Selling Group (WSG) in which TWC has shares.These shares form a material part of TWCâs investment portfolio.WSG buys, butchers and sells the Wagyu beef to high end domesticrestaurants and regularly sends frozen shipments to Japan andChina. TWC are heavily marketing their pinot, both domestically andoverseas, as a perfect accompaniment to the Wagyu beef.
The directors of TCWare:
Mrs Claire Harewood, Chairman. Mrs Harewood has significantexperience in the industry and replaced her husband as chair whenhe died 10 years ago.
Mr Phillip Strange, Chief Executive Officer
Mr. Joe Quade
Mr Steven Harewood, son of Claire Harewood and has oversight ofthe Wagyu beef operation
Dr Mary Owens
Ms Hilary Jones
Mr Geoffrey Owens
Your audit partner,John Richards, has approached you and advised that there areseveral areas he is concerned about and he wants to you to reportback to him about these areas before you complete your auditprogram. These areas and accounts are:
⢠Accounts receivable
⢠Investments
⢠Property assets
⢠Marketing expense
Ratio | 2018 (Unaudited) | 2017 (Audited) | 2016 (Audited) |
Return on equity % | 10.80 | 17.5 | 15.2 |
Return on beef production assets % | 1.67 | -0.82 | -3.45 |
Return on grape and wine production assets % | 12.2 | 14.5 | 16.2 |
Gross margin % | 24.5 | 30.00 | 31.76 |
Net profit margin % | 14.38 | 20.27 | 17.85 |
Marketing expense % of total S & A expenses | 23.67 | 17.89 | 15.2 |
Times interest earned | 6.67 | 7.51 | 8.10 |
Days in inventory - wine | 367 | 423 | 460 |
Days in accounts receivable - wine | 50.2 | 60.65 | 53.24 |
Days in accounts receivable - beef | 57 | 36 | 24 |
Current ratio:1 | 2.80 | 2.54 | 2.66 |
Quick asset ratio:1 | 1.18 | 1.15 | 1.20 |
Debt to equity ratio:1 | 0.54 | 0.63 | 0.67 |
Internal control
The financialcontroller at TCW has been refining the system of internal controlsand informs you, at the planning stage of the current year's audit,that he has put together an internal control manual for thecompany. He has stated that this manual will create greaterawareness of controls in the company, particularly with managementwhich, in the past, has not been overly conscious of the need toimplement and enforce effective internal controls.
Management staffreceive bonuses based on certain agreed-upon target ratios whichinclude measures such as targeted monthly sales volumes, varianceof actual to budget departmental overheads and profit beforeinterest and tax. The Board takes an active interest in theperformance of the company and is quick to request explanations onvariances from the agreed-upon monthly budgets.
Two years ago, thecompany devoted significant time and resources to the developmentand implementation of a new IT system. All teething problemsassociated with the implementation phase have now been resolved,and the financial controller is satisfied that the automatedcontrols in place are assisting in producing accurate and completeaccounting records. The management accountant also looks after theIT function as the position is not regarded by management as beinga full-time job. Once application programs have been tested, strictpassword control exists over access to the programs. Passwords arenot required for access to databases.
To assist in theplanning for the current year's audit engagement, you extracted thefollowing information from a review of the systems notes in thepermanent file and a perusal of the new internal controlmanual:
There are three section managers, one each for grape production,wine production and beef production. Each can order supplies fortheir respective operations up to a limit of $10,000 for eachorder. Orders between $10,000 and $30,000 must be approved by themanagement accountant. Orders over $30,000 must be approved by theCEO. Orders over $50,000 must be approved by the Board.
Orders must be made through the computer ordering system whichhas direct links to the approved suppliers.
Supplier information is contained in a supplier master file.Each supplier has a unique supplier code. If a section managerorders from an unapproved supplier, the order is rejected and sentto the management accountant for approval.
The supplier information file is maintained by the accountsclerk. Changes to the file are approved manually by the managementaccountant.
When supplies are received at the winery, the storeman checksthe supplies received to the online copy of the order and thedelivery docket provided by the supplier. Any discrepancies arenoted on the online copy of the order.
The delivery docket is filed by the storeman in a folder that iskept at the winery.
The invoice is received electronically from the supplier andmatched to the order by the accounts clerk. If the order and theinvoice match the invoice is included in a payments file.
The payments file is approved online by the managementaccountant once a week and used to generate an ABA file which isthen uploaded to the bank by the management accountant.
When the payments file is approved by the management accountant,the invoice is automatically recorded as being paid in theaccounting system.
When services such as repairs are ordered for the winery by thewine production manager, a service order is generated within thecomputer system and automatically sent to the service provider.
When the service has been delivered, the wine production manageror the storeman signs the service delivery docket on the servicemanâs tablet.
The invoice from the service company, with a copy of the signedservice delivery docket, is received online by the accountsclerk.
The accounts clerk checks the signed service delivery docket tothe invoice and the order and adds the invoice to the payments filefor final approval by the management accountant.
In the case of discrepancies, the accounts clerk contacts thesupplier and the wine production manager to resolve the issue.Payments are not made until the issue has been resolved.
Required
Write a report,including a brief executive summary, to your managing partner thataddresses the questions below. Where indicated, use the requiredformat to answer that question.
Question 1A8%
Analyse the ratios and additional information associated with thefour accounts listed by your audit partner, John Richards. Identifythe potential audit risks and any audit steps that need to beundertaken to reduce audit risk.
Answer this question using the following table:
Account | Analysis | Audit Risk | Audit Steps to reducerisk |
Question 1B2%
Analyse the ratios and additional information to outline businessrisks that TWC faces.
Question 2A 7%
Identify the internal controls in the system that are potentiallyeffective, the risk that the control could alleviate and one testof control for each of the identified potentially effectivecontrols.
Answer this question using the following headings:
Effective control | Risk alleviated | Test of control |
Question 2B 2%
List and justify the weaknesses in internal control for purchasesand accounts payable.
Weakness | Justification |
Rationale
