Discussion Questions Ch 7,8,9 Essay
What are the purposes of the two parts of the report of management? The purpose of the first part of the report of management is for management to state its responsibilities for internal control over financial reporting. The Second part of the report states management’s responsibility for the fair presentation of the financial statements. What is the auditor’s responsibility related to the report of management?
The auditor’s responsibility is to express an opinion on the fairness of the presentation of the financials, and an opinion on the effectiveness of internal control of financial reporting, including an opinion on whether management’s assessment of internal control is fairly stated. 6-25 Explain the differences among management assertions about classes of transactions and events. Management assertions about account balances and management assertions about presentation and disclosure… Management assertions relate to transactions and other events that are reflected in the accounting records.
In contrast, assertions about account balances relate to the ending account balances that are included in the financials, and assertions about presentation and disclosure relate to how those balances are reflected and disclosed in the financials. For each assertion, indicate whether it is an assertion about classes of transactions and events, an assertion about account balances, or an assertion about presentation and disclosure…and indicate the name of the assertion made by management….. a) Classes of transactions – Completeness ) Presentation and disclosure – Classification and understandability c) Account balances – Valuation and allocation d) Classes of transactions – Cutoff e) Classes of transactions – Classification f) Presentation and disclosure – Completeness g) Account balances – Completeness h) Account balances – Rights and obligations i) Presentation and disclosure – Accuracy and valuation j) Classes of transactions – Occurrence k) Account balances – Existence l) Classes of transactions – Accuracy m) Presentation and disclosure – Occurrence, rights, and obligations 7-33
Identify the type of audit evidence used for each audit procedure and identify the general balance-related audit objective or objectives satisfied by each audit procedure 1. Re-performance; Detain tie-in 2. Physical Examination; existence and accuracy 3. Inquiry of the client; realizable value 4. Physical examination; Completeness and Accuracy 5. Analytical Procedures; Accuracy 6. Documentation; Rights and obligations 7. Confirmation; Existence, Completeness, and Accuracy 7-38 McClure Advertising Credits— An Insufficient number of confirmations were sent.
Use of alternative procedures is acceptable however; one credit was confirmed by telephone rather than by written confirmation. The differences found were immaterial but the auditors would have determined the reason for the difference and an error should have been projected to the population. Twenty additional credits were selected for testing. The testing relied on internal documentation which is insufficient to support the credits. Placing the ad is insufficient evidence also without supporting evidence from the vendors supporting the reduction in the Accounts Payable.
Springbrook Credits—these credits were confirmed by telephone and were not supported by written confirmation. The staff auditor was suspicious of the clients’ unwillingness to allow written confirmation of the amounts as well as the changing explanation of the nature of the credits. No additional testing was performed to resolve any doubts about the validly of the credits. Ridolfi Credits—The auditor received oral confirmation that these credits were not valid. The client indicated that the auditor’s information was incorrect but would not allow the auditor to obtain written confirmation for these credits.
Also, the credit memos had been altered which should have indicated to the auditor that the credits were not valid. Accounts Payable Accrual— The auditors sent 50 accounts payable confirmations, which is the auditors choice whether this is enough. The adequacy of the confirmations as evidence is underminded by the knowledge that the client told the suppliers how to respond. In reality, the auditor should have verified the confirmed balances using alternative procedures. There is no discussion of alternate procedures for nonresponses or the resolution of six responses that were not reconciled to Grande’s records.
The auditors agreed to an adjustment of $260,000 when their cutoff tests indicated a potential liability of $500,000. It would be appropriate for the auditors to agree to a lower amount only if additional testing supported the lower accrued liability. 8-30 The auditor should also obtain the next year’s minutes, probably for February 2006, to make sure the previous minutes referred to were those from September 16, 2005. Additionally, the auditor will request the client to include a statement in the client representation letter stating that all minutes were provided to the auditor.
INFORMATION RELEVANT TO 2005 AUDIT| AUDIT ACTION REQUIRED| February 15:1. Approval for increased distribution costs of $500,000| During analytical procedures, an increase of $500,000 should be expected for distribution costs. | 2. Unresolved tax dispute. | Evaluate resolution of dispute and adequacy of disclosure in the financial statements if this is a material uncertainty. | 3. Computer equipment donated. | Determine that old equipment was correctly treated in 2004 in the statements and that an appropriate deduction was taken for donated equipment. | 4. Annual cash dividend. Calculate total dividends and determine that dividends were correctly recorded. | 5. Officers’ bonuses. | Determine whether bonuses were accrued at 12-31-04 and were paid in 2005. Consider the tax implications of unpaid bonuses to officers. | September 16:1. 2005 officers elected. | Inform staff of possibility of related party transactions. | 2. Officers’ salary information. | Note information in audit files for 2006 audit. | 3. Pension/profit sharing plan. | Determine if the pension/profit sharing plan was approved. If so, make sure all assets and liabilities have been correctly recorded. | 4.
Acquisition of new computer system. | Determine that there is appropriate accounting treatment of the disposal of the 1-year-old equipment. Also trace the cash receipts to the journals and evaluate correctness of the recording. | 5. Loan. | Examine supporting documentation of loan and make sure all provisions noted in the minutes are appropriately disclosed. Confirm loan information with bank. | 6. Auditor selection. | Thank management for selecting your firm for the 2005 audit. If your firm has experience with pension and profit sharing plans, ask management if there is anything they need help with regarding their new proposed plan. The auditor should have obtained and read the February minutes, before completing the 12-31-04 audit. Three items were especially relevant and require follow-up for the 12-31-04 audit: unresolved dispute with the IRS, replacement of computer equipment, and approval for the 12-31-04 bonuses. 8-34 1. Commission expense could be overstated during the current year or could have been understated during each of the past several years. Or, sales may have been understated during the current year or could have been overstated in each of the past several years. 2.
Obsolete or unsalable inventory may be present and may require markdown to the lower of cost or market. 3. Especially when combined with 2 above, there is a high likelihood that obsolete or unsalable inventory may be present. Inventory appears to be maintained at a higher level than is necessary for the company. 4. Collection of accounts receivable appears to be a problem. Additional provision for uncollectible accounts may be necessary. 5. Especially when combined with 4 above, the allowance for uncollectible accounts may be understated. 6. Depreciation expenses may be understated for the year. . ITEM 1 – Make an estimated calculation of total commission expense by multiplying the standard commission rate times commission sales for each of the last two years. Compare the resulting amount to the commission expense for that year. For whichever year appears to be out of line, select a sample of individual sales and re-compute the commission, comparing it to the commission recorded. ITEMS 2 AND 3 – Select a sample of the larger inventory items (by dollar value) and have the client schedule subsequent transactions affecting these items.
Note the ability of the company to sell the items and the selling prices obtained by the client. For any items that the client is selling below cost plus a reasonable markup to cover selling expenses, or for items that the client has been unable to sell, propose that the client mark down the inventory to market value. ITEMS 4 AND 5 – Select a sample of the larger and older accounts receivable and have the client schedule subsequent payments and credits for each of these accounts. For the larger accounts that show no substantial payments, examine credit reports and recent financial statements to determine the customers’ ability to pay.
Discuss each account for which substantial payment has not been received with the credit manager and determine the need for additional allowance for uncollectible accounts. ITEM 6 – Discuss the reason for the reduced depreciation expense with the client personnel responsible for the fixed assets accounts. If they indicate that the change resulted from a preponderance of fully depreciated assets, test the detail records to determine that the explanation is reasonable. If no satisfactory explanation is given, expand the tests of depreciation until satisfied that the provision is reasonable for the year.