a. They should use the resistance of meeting auditing standards and contributory neglegence. Stuart Supply Company management is responsible for the fraud. The fraud was complicated and difficult to discover, but the steps recommended by Lauren Yost & Co made it possible. The president of Stuart Supply Company ignored the proposal to count the inventory on the same day, and was therefore responsible to breakdown of detecting the fraud due to his decision. Luckily, Lauren Yost & Co can use his signed statement as evidence against him. b. Two defenses are possible: lack of privity of contract, and using auditing standards in the audit of inventory in a suit by First City National Bank. Since the bank was a third party, there is not necessarily any responsibility to the party in this instance. Given this, the defense of lack of privity of contract is unlikely to be successful in most jurisdictions.
The second defense has a higher likelihood of success because it used auditing standards when auditing stock and employment of due care. It is generally a challenge to expect a CPA firm to identify an unusual problem like this during an ordinary audit. Therefore, just because the CPA did not identify it does not mean it shares any responsibility for it. c. Yost will likely be successful in defending against the client using contributory negligence. The company was solely responsible for setting up solid internal controls. The company’s president stated manning made it impossible to count all stock in one day, and customer preference imposed put a burden on the company for its own losses. d. Both issues and the results would probably be mostly the same if the suit were brought under the 1934 Act. If it was brought under Rule 10b-5, it is not likely the plaintiff would be successful as there was no reason for the company to deceive. 19.
The CPA firm would not usually be liable as they relied on the incorrect financial statement, and the firm did not have a contract with the creditor. However, a fraud still exists, whether actual or constructive. As the creditor relied on the illegally prepared financial statements, the CPA firm will still be liable for the fraud. This was a constructive fraud on the part of Small or a firm. The auditor was negligent as he or she had a disregard for the truth and based their report on a faulty basis of judgment. Small turned a blind eye towards the negligence. Thus, the firm is liable to the creditors. Chapter 6
21. a. Purposes of management’s report on internal control over financial reporting: preparation of financial statements, reasonable insurance, and to evaluate effectiveness. Purposes of management’s responsibility for consolidated financial statements: presenting information in an efficient manner and ensuring the information should be reliable and relevant, providing disclosures for proper understanding of transactions, and ensuring consolidated financial statements are reported according to GAAP. 25.
Classification of assertions: Sr. No Management Assertion Category of Management Assertion a. All sales have been recorded Transactions and events b. Receivables are properly classified according to trades and other recievables in financial statements, and are clearly described Account balances c. Accounts recorded in correct amounts Account balances d. Sales are recorded in the appropriate periods Transactions and events e. Sales are recorded in the appropriate accounts Transactions and events f. All required disclosuresfor sales and receivables are made Presentation and disclosure g. All accounts receivable are recorded Account balances h. There are no liens or other restrictions on accounts receivable Account balances i. Disclosures on accounts receivbale are in correct amounts Presentation and disclosure j. Sales transactions that were recorded occured Transactions and events k. Accounts recivables that were recorded occured Account balances l. Sales are recorded in correct amounts Transactions and events m. Sales disclosures and receivables disclosures relate to the entry Presentation and disclosure
Management Assertions: Management assertion about classes of transactions and events – Occurance Completeness Accuracy Classification Cut-off Management assertion about account balances- Existence Completeness Valuation and allocation Rights and obligations Management assertion about presentation and disclosure- Occurrence, rights, and obligation Completeness Accuracy and valuation Classification and understandability
Chapter 7 34. No Audit procedures Type of audit evidence used 1 Test extend unit prices multiplied by quantity on the inventory list, test foot the list, and compare the total to the general ledger Recalculation 2 Trace selected quantities from the inventory list to the physical inventory to make sure that it exists and the quantities are the same Physical examination 3 Question operating personnel about the possibility of obsolete or slow-moving inventory Inquiry of the client 4 Select a sample of quantities of inventory in the factory warehouse and trace each inventory count sheets to determine if it has been included and if the quantity and description are correct Physical examination
5 Compare the quantities on hand and unit prices on this year’s inventory count sheets with those preceding year as a test of large differences Analytical procedures 6 Examines sale invoices and contracts with customer to determine whether any are out on consignment with customers. Similarly, examine vendor’s invoices and contracts with vendors to determine whether any goods on the inventory listing owned by vendors Documentation
7 Send letters directly to third parties who had the client’s inventory and request that they respond directly to the auditors Confirmation
35. a. Six factors that determine reliability of evidence:
Independence of the provider – Evidence is more reliable if it obtained from outside of the organization. Effectiveness of the client’s internal controls – Effective internal controls means higher reliability because the organization has its own means of verifying it is meeting standards Auditor’s direct knowledge- If the auditor knows the evidence is valid, then there is nothing more reliable. Qualifications of individuals providing the evidence- Evidence and information from rpofessionals in their field of knowledge can always be relied upon due to standards of professionalism. Degree of objectivity- Information withou undue influence is more reliable. Timeliness – Evidence obtained closest to the balance sheet date will be more reliable. Situation
Types of evidence that are more reliable 1 Confirmation of accounts receivable with a business organization 2 Physical examination of three inch plates 3 Examination of documents when many competent employees check evaluate each other’s work 4 Physical examination of parts inventory of on hand quantity 5 Discussing potential suits with CPA firm’s legal counsel 6 Confirmation of a bank balance 7 Confirm the bank balance 8 Physical count of a client’s inventory 9 Physical count of the inventory
Situation Types of evidence that are more reliable Factors affecting reliability 1 Confirmation of accounts receivable with a business organization Qualification of the provider of the information 2 Physical examination of three inch plates Auditor’s qualification 3 Examination of documents when many competent employees check evaluate each other’s work Effectiveness of internal controls 4 Physical examination of parts inventory of on hand quantity Degree of objectivity 5 Discussing potential suits with CPA firm’s legal counsel Independence of provider 6 Confirmation of a bank balance Degree of objectivity 7 Confirm the bank balance Independence of provider 8 Physical count of a client’s inventory Auditor’s direct knowledge 9 Physical count of the inventory Independence of provider 36. a. Compute the unit selling price multiplied by quantity on duplicate sales invoice and comparing the total to the amount on the duplicate sales invoice. b. Observe whether the accounts receivable bookkeeper is not allowed to handle cash. c. Scan the ratio of cost of goods sold to sales and compare the ratio to previous years. d. Foot the sales journal and trace the general ledger total. e. Inquire the sales journal, looking for large and unusual transactions requiring investigation. f. Confirmation of management whether all accounting employees are required to take annual vacations. g. Count all marketable securities as of the balance sheet date to determine whether they equal the total on the client’s list. h. Re-compute the balance of the bank account directly with the East State Bank. i. Examine a sample of duplicate sales invoice if the controller’s approval includes it and compare each duplicate sale invoice to the sales journal for agreement of name and amount. j. Read the agreement between Johnson Wholesale Company and client to determine whether the shipment is sale or a consignment. Types of evidence used for each audit procedure:
No Audit procedure Type of evidence 1 Compute the unit selling price multiplied by quantity on duplicate sales invoice and comparing the total to the amount on the duplicate sales invoice Observation 2 Observe whether the accounts receivable bookkeeper is not allowed to handle cash Analytical procedure 3 Scan the ratio of cost of goods sold to sales and compare the ratio to previous years Recalculation and re-performance 4 Foot the sales journal and trace the general ledger total Analytical procedure 5 Inquire the sales journal, looking for large and unusual transactions requiring investigation Inquiry of client 6 Confirmation of management whether all accounting employees are required to take annual vacations Confirmation 7 Count all marketable securities as of the balance sheet date to determine whether they equal the total on the client’s list Physical examination 8 Re-compute the balance of the bank account directly with the East State Bank Documentation 9 Examine a sample of duplicate sales invoice if the controller’s approval includes it and compare each duplicate sale invoice to the sales journal for agreement of name and amount Recalculation 10 Read the agreement between Johnson Wholesale Company and client to determine whether the shipment is sale or a consignment Documentation
Chapter 8 30. Meeting minutes are official records and contain details of meetings of the board of directors and stockholders. Current meeting minutes always refer to the previous meeting minutes. Auditors should always ask for both current and previous years’ meeting minutes, as well as a statement that the organization provided all meeting minutes to the auditor. b.
Information relevant to 2009 audit Audit action required Meeting February 15, 2009: 1. Approved annual dividend to common stockholders as Class A = $10 per share and Class B = $5 per share. Calculate total dividend and determine that they were correctly recorded 2. Officer’s bonuses
Investigate whether bonuses were accrued at 12/31/2008 and were paid in 2009. Consider tax implication of all unpaid bonuses. Meeting September 16, 2009 3. New officers selection Inform staff of possibility of related party transactions 4. Officers salary information Write information in audit file and maintain the same for record 5. Loan Investigate the loan supporting documents, check all provision noted in the minutes are correctly disclosed 6. Acquisition of new computer systems Determination of accounting treatment of the disposal of previous year computers, trace cash receipt to the journal, and evaluate correctness of recording