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ACCT 107 Chapter Notes - Chapter 7: Internal Audit, Internal Control, Flight Controller

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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

When auditors assess risks, they use a considerable amount of the info acquired and documented during client acceptance and audit planning: assess risk at fs level and assertion level to develop an appropriate risk response. Auditing standards require the auditor to obtain an understanding of the entity and its environment, including its internal controls, to assess the risk of material misstatements in the client"s fs. Auditors accept some level or risk, or uncertainty, in performing the audit function. Since assessment of risk is a matter of professional judgement as opposed to precise measurement, responding to these risks properly is critical to achieving a high-quality audit. Assess risk of material misstatement at the overall fs level. Overarching factors that increase the romm at the overall fs level include: declining economic conditions, significant changes in the industry. Assess risk of material misstatement at the assertion level.

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Related Questions

Question 2

You, a recent auditor with a local auditing firm, are responsible for the audit of a new client, PresentShop, a retailer of electronic home and office equipment in Western Canada.

PresentShop has 14 locations across Western Canada. It specializes in providing customers with the latest technology in home entertainment electronics such as televisions and DVD players as well as top of the line office technology such as computers.

The business was started 15 years ago in Alberta by two brothers who are still the only owners of the company. The brothers paid themselves a management bonus in 2017 of $60,000. The business has grown as a result of excellent advertising, good locations, and reasonable prices based on the ability of the company to buy in volume. Each store has a high degree of security such as electronic bars and video surveillance.

The accounting for the stores is all electronically performed. The sales tills are downloaded every day to the main office in Calgary which performs the accounting for all of the stores. The main office also has the warehouse from which all inventory is shipped to the stores.

Business has been relatively stable but the company does have pressure from American competitors moving into Canada as well as another Western Canadian competitor, B&C Sound. As well, the business tends to fluctuate with the economic cycles so recent government cutbacks in B.C. have resulted in lower sales. As a result of a decrease in profits, the company requires a significant loan from a bank and the bank has requested audited financial statements. It is the first year that the financial statements have been audited. The bank intends to use the inventory as collateral for the loan.

PresentShop has provided you with the following financial information for the years ending December 31, 2017:

December 31, 2017

(‘000s)

Total assets

$48,900

Total revenues

$124,900

Total net income before tax

$23,500

Total net income after tax

$15,400

Required:

Assess inherent risk at the overall financial statement level. Conclude on inherent risk. Is it low, medium or high?

Assess control risk at the overall financial statement level. Conclude on control risk. Is it low, medium or high?

Conclude on detection risk and the level of substantive testing required.

Assess overall (planning) materiality

Question 3

Explain the approach adopted by auditors of identifying accounts and related assertions at risk of material misstatement. How does this approach help auditors to reduce audit risk to an acceptably low level?

Question 4

What is the relationship between materiality and audit risk?

2–31. 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.
Management’s 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.
Auditor’s 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 auditor’s
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 entity’s 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 entity’s 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
Reviewer’s Comments
Comment Is
Correct (yes or no)
a. The report should not be addressed to management.
b. The report should indicate that we have “audited,” rather than “examined,”
the fi nancial statements (fi rst paragraph after introduction).
c. The report should not indicate anything concerning management’s
responsibility for internal control.
d. The report should state that the auditors’ responsibility is to express
“reasonable assurance,” not an opinion (fi rst paragraph under “auditor’s”
responsibility).
e. The audit is designed to assess risks of material misstatements due to
errors or fraud; the term “illegal acts” is incorrect (second paragraph
under auditor’s responsibility).
f. The report should not refer to the auditors “evaluating the appropriateness
of accounting policies,” since those are the responsibility of management.
g. The evidence should be suffi cient and appropriate rather than “adequate”
(third paragraph under auditor’s responsibility).

Reviewer’s Comments
Comment Is
Correct (yes or no)
h. The opinion should not include “in all material respects” since the auditors
are providing an opinion on the accuracy of the fi nancial statements
(opinion paragraph).
i. The opinion should be on “accounting principles generally accepted in the
United States of America,” 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.

General Practice (GP) is a not-for-profit organization thatoperates a nursing home in Toronto, Ontario. You are auditing therevenue and receivables at GP. The nursing home has a reputationfor delivering excellent patient services, but its accountingdepartment is understaffed and does not have time for internalverification or other accuracy checks. Your assessment of controlsover cash receipts indicates that there are effective managementsupervision and monitoring procedures in place, and you have foundno indication of fraud risk, but past audits have foundmisstatements in recording the patient invoices and accountsreceivable. In confirming the accounts receivable from patients inpast audits, you have had a very low response rate. Furthermore,those patients who did respond did not appear to know whatinformation they were being asked to provide or what their correctoutstanding balance actually was. You have had the same experiencein confirming receivables at other nursing homes. The nursing homehas a large bank loan payable, which is up for renewal two monthsafter year-end. The bank’s loan officer has told management thebank’s head office may not approve a renewal. The bank is concernedabout its exposure to not-for-profit nursing homes because many newgovernment- funded nursing homes are expected to open over the newfew years. These new long-term care facilities will be more modernand will be located closer to many large hospitals than GP.

Required:

1. Identify the business risks in GP.

2. Assess the risk of material misstatement at the overallfinancial statement level. Identify the inherent and control riskfactors in the organization to support your assessment.

3. In the audit of the revenues, explain the overall auditapproach you would use to obtain sufficient appropriate evidence inthis situation. Give clear reasons for the mix of control andsubstantive work you would plan to do. Describe the substantivetests you would perform to audit the revenue transactions in thisorganization. Be specific and show how the tests tie in to therelevant assertions.