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All Textbook Solutions for Auditing: A Risk Based-Approach to Conducting a Quality Audit

47MCQ 48MCQ 49RSCQ 50RSCQ Ray, the owner of a small company, asked Holmes, CPA, to conduct an audit of the company’s records. Ray told Holmes that the audit must be completed in time to submit audited financial statements to a bank as part of a loan application. Holmes immediately accepted the engagement and agreed to provide an auditor’s report within three weeks. Ray agreed to pay Holmes a fixed fee plus a bonus if the loan was granted. Holmes hired two accounting students to conduct the audit and spent several hours telling them exactly what to do. Holmes told the students not to spend time reviewing the controls but to concentrate on proving the mathematical accuracy of the ledger accounts and to summarize the data in the accounting records that support Ray’s financial statements. The students followed Holmes’ instructions and after two weeks gave Holmes the financial statements, which did not include footnotes because the company did not have any unusual transactions. Holmes reviewed the statements and prepared an unqualified auditor’s report. The report, however, did not refer to GAAP or to the year-to-year application of such principles. Briefly describe each of the ten standards included in the PCAOB guidance and indicate how the action(s) of Holmes resulted in a failure to comply with each standard.52RSCQ 53RSCQ 54RSCQ Professional guidance indicates that the auditor should consider revenue recognition to be high risk in planning an audit of a company’s financial statements. a. Identify the activities that affect the revenue cycle. b. Identify the financial statement accounts typically associated with the revenue cycle.56RSCQ Assume that an organization asserts that it has $35 million in net accounts receivable. Describe specifically what management is asserting with respect to net accounts receivable.58RSCQ 59RSCQ 60RSCQ 61RSCQ 62RSCQ 63RSCQ 64RSCQ 65RSCQ 66RSCQ 67RSCQ 68RSCQ 69RSCQ 70RSCQ 71RSCQ 72RSCQ 73RSCQ 74RSCQ 75RSCQ 76RSCQ 77RSCQ 78RSCQ 79RSCQ 80RSCQ 81RSCQ 82RSCQ 83RSCQ 84RSCQ 85RSCQ 86RSCQ 87RSCQ 88RSCQ 89RSCQ 90FF 91FF 1TFQ 2TFQ 3TFQ 4TFQ 5TFQ 6TFQ 7TFQ 8TFQ 9TFQ 10TFQ 11TFQ 12TFQ 13TFQ 14TFQ 15TFQ 16TFQ 17TFQ 18TFQ 19TFQ 20TFQ 21MCQ 22MCQ 23MCQ 24MCQ 25MCQ 26MCQ 27MCQ 28MCQ 29MCQ 30MCQ 31MCQ 32MCQ 33MCQ 34MCQ 35MCQ 36MCQ 37MCQ 38MCQ 39MCQ 40MCQ 41RSCQ 42RSCQ 43RSCQ 44RSCQ Refer to Exhibit 6.2 and describe the differences between vouching and tracing.46RSCQ 48RSCQ 49RSCQ 50RSCQ 51RSCQ 52RSCQ 53RSCQ Indicate how the auditor could use substantive analytical procedures in resting the following accounts: a. Interest expense related to bonds outstanding. b. Natural gas expense for a public utility company. c. Supplies expense for a factory. d. Cost of goods sold for a fast-food franchisor (e.g., Wendy’s or McDonald’s). Note that cost of goods sold tends to average about 35% of sales in fast-food franchises. e. Salary expense for an office (region) of a professional services firm.55RSCQ 56RSCQ 57RSCQ 58RSCQ 59RSCQ 60RSCQ 61RSCQ 62RSCQ 63RSCQ 64RSCQ 65RSCQ 66RSCQ 67RSCQ 68RSCQ 69FF 70FF 71FF 72FF MINISCRIBE (LO 1, 2) As reported in the Wall Street Journal (September 11, 1989), MiniScribe, nc., inflated its reported profits and inventory through a number of schemes designed to fool the auditors. At that time, MiniScribe was one of the major producers of disk drives for personal computers. The newspaper article reported that MiniScribe used the following techniques to meet its profit objectives: • An extra shipment of $9 million of disks was sent to a customer near year-end and booked as a sale. The customer had not ordered the goods and ultimately returned them, but the sale was nor reversed in the year recorded. • Shipments were made from a factory in Singapore, usually by air freight. Toward the end of the year, some of the goods were shipped by cargo ships. The purchase orders were changed to show that the customer took title when the goods were loaded on the ship. However, title did not pass to the customer until the goods were received in the U.S. • Returned goods were recorded as usable inventory. Some were shipped without any repair work performed. • MiniScribe developed a number of just—in—time warehouses and shipped goods to them from where they were delivered to customers. The shipments were billed as sales as soon as they reached the warehouse. For each of the techniques described, identify the audit evidence that might have enabled the auditor to uncover the fraud.1TFQ 2TFQ 3TFQ 4TFQ 5TFQ 6TFQ 7TFQ 8TFQ 9TFQ 10TFQ 11TFQ 12TFQ 13TFQ In terms of the timing of the risk response, the following procedures can be completed only at or after period end: comparing the financial statements to the accounting records, evaluating adjusting journal entries made by management in preparing the financial statements, and conducting procedures to response to risks that management may have engaged in improper transactions at period end.15MCQ 16MCQ 17MCQ 18MCQ 19MCQ 20MCQ 21MCQ 22MCQ 23MCQ 24MCQ 25MCQ 26MCQ 27MCQ 28MCQ 29RSCQ 30RSCQ Define the following terms: (a) performance materiality, (b) tolerable misstatement, (c) clearly trivial.32RSCQ 34RSCQ 35RSCQ 36RSCQ How does inherent risk relate to internal controls? Why is it important to assess inherent risks of material misstatement prior to evaluating the quality of an organization’s internal controls?38RSCQ 39RSCQ 40RSCQ 43RSCQ 45RSCQ 46RSCQ 47RSCQ 48RSCQ 49RSCQ 52RSCQ 53RSCQ 54RSCQ 55RSCQ 56RSCQ 57RSCQ 58FF 1TFQ 2TFQ 3TFQ 4TFQ 5TFQ 6TFQ 7TFQ 8TFQ 9TFQ 10TFQ 11TFQ 12TFQ 13TFQ 14TFQ 15MCQ 16MCQ 17MCQ 18MCQ 19MCQ 20MCQ 21MCQ Refer to Exhibit 8.6. Assume a 5% risk of overreliance,a tolerable deviation rate of 8%, a sample size of 100, and that the number of deviations is five. What is the upper limit of the possible deviation rate, and what does it mean? a. 10.3%. The auditor is 95% confident that the real error rate in the population is no greater than 10.3%. b. 10.3%. The auditor is 95% confident that the real error rate in the population is no greater than 5%. c. 5%. The auditor is 92% confident that the real error rate in the population is no greater than 10.3%. d. 5%. The auditor is 92% confident that the real error rate in the population is no greater than 5%.23MCQ 24MCQ 25MCQ 26MCQ 27MCQ 28MCQ 29RSCQ 30RSCQ 31RSCQ 32RSCQ 33RSCQ 34RSCQ 35RSCQ 36RSCQ 37RSCQ 38RSCQ 39RSCQ 40RSCQ 41RSCQ 42RSCQ 43RSCQ 44RSCQ 45RSCQ 46RSCQ 47RSCQ What is stratification? Distinguish between top-stratum items and lower-stratum items.49RSCQ 50RSCQ 51RSCQ 52RSCQ 53RSCQ 54RSCQ 55RSCQ 56RSCQ 57RSCQ 58RSCQ 59RSCQ 60RSCQ 61RSCQ 62RSCQ 63RSCQ 1TFQ 2TFQ 3TFQ 4TFQ 5TFQ 6TFQ 7TFQ 8TFQ 9TFQ 10TFQ 11TFQ 12TFQ 13TFQ 14TFQ 15TFQ 16TFQ Which of the following statements is true regarding assertions in the revenue cycle? a. It is typical that all five assertions for revenue are equally important. b. If a client has an incentive to overstate revenues, the existence assertion would be more relevant than the completeness assertion. c. Audit evidence about the existence of revenues is also the most appropriate evidence about the valuation of receivable. d. The allowance for doubtful account has important implications for the ownership assertion of accounts receivable.18MCQ 19MCQ 20MCQ 21MCQ 22MCQ 23MCQ 24MCQ Which of the following statements is false regarding planning analytical procedures in the revenue cycle? a. As revenue is typically regarded as a high-risk account, planning analytical procedures related to revenue are not required. b. The first step in planning analytical procedures includes developing an expectation of recorded amounts or ratios, and evaluating whether that expectation is precise enough to accomplish the relevant objective. c. Trend analysis would not be appropriate as a plan-fling analytical procedure in the revenue cycle. d. All of the above statements are false.26MCQ 27MCQ 28MCQ 29MCQ 30MCQ 31MCQ 32MCQ Refer to Exhibit 9.1. Which accounts are relevant in the revenue cycle? Identify the relationships among them.34RSCQ 35RSCQ An important task ¡n the audit of the revenue cycle is determining whether a client has appropriately recognized revenue. a. What is the five-step process that companies should use in recognizing revenue? Why might the auditor need to do additional research and consider additional criteria on revenue recognition? b. The following are situations in which the auditor will make decisions about the amount of revenue to be recognized. For each of the following scenarios, labeled (1) through (6): . Identify the key issues to address in determining whether or not revenue should he recognized. . Identify additional information the auditor may want to gather in making a decision on revenue recognition. . Based only on the information presented, develop a rationale for either the recognition or nonrecognition of revenue. 1. AOL sells software that is unique as a provider of Internet services. The software contract includes a service fee of $19.95 for up to 500 hours of Internet service each month. The minimum requirement is a one-year contract. The company proposes to immediately recognize 30% of the first-year’s contract as revenue from the sale of software and 70% as Internet services on a monthly basis as fees are collected from the customer. 2. Modis Manufacturing builds specialty packaging machinery for other manufacturers. All of the products are high end and range in sales price from $5 million to $25 million. A major customer is rebuilding one of its factories and has ordered three machines with total revenue for Modis of $45 million. The contracted date to complete the production was November, and the company met the contract dare. The customer acknowledges the contract and confirms the amount. However, because the factory is not yet complete, it has asked Modis to hold the products in the ware house as a courtesy until its building is complete. 3. Standish Stoneware has developed a new low-end line of baking products that will be sold directly to consumers and to low-end discount retailers. The company had previously sold high-end silverware products to specialty stores and has a track record of returned items for the high-end stores. The new products tend to have more defects, but the defects are not necessarily recognizable ¡n production. For example, they are more likely to crack when first used in baking. The company does not have a history of returns from these products, but because the products are new, it grants each customer the right to return the merchandise for a full refund or replacement within one year of purchase. 4. Omer Technologies is a high-growth company that sells electronic products to the custom copying business. It is an industry with high innovation, but Omer’s technology is basic. In order to achieve growth, management has empowered the sales staff to make special deals to increase sales in the fourth quarter of the year. The sales deals include a price break and an increased salesperson commission but not an extension of either the product warranty or the customer’s right to return the product. 5. Electric City is a new company that has the exclusive right to a new technology that saves municipalities a substantial amount of energy for large-scale lighting purposes (e.g., for ball fields, parking lots, and shop ping centers). The technology has been shown to be very cost effective in Europe. In order to get new customers to try the product, the sales force allows customers to try the product for up to six months to prove the amount of energy savings they will realize. The company is so confident that customers will buy the product that it allows this pilot-testing period. Revenue is recognized at the time the product is installed at the customer location, with a small provision made for potential returns. 6. Jackson Products decided to quit manufacturing a line of its products and outsourced the production. However, much of its manufacturing equipment could be used by other companies. In addition, it had over $5 million of new manufacturing equipment on order in a noncancelable deal. The company decided to become a sales representative to sell the new equipment ordered and its existing equipment. All of the sales were recorded as revenue.37RSCQ 38RSCQ 39RSCQ 40RSCQ 41RSCQ 42RSCQ 43RSCQ 45RSCQ 46RSCQ 47RSCQ Stainless Steel Specialties (SSS) is a manufacturer of hot water—based heating systems for homes and commercial businesses. The company has grown about 10% in each of the past five years. The company has not made any acquisitions. Following are some statistics for the company: Additional information available to the auditor includes: The company has touted its new and improved technology for the increase both in sales and in gross margin. The company claims to have decreased administrative expenses, thus increasing net profits. The company has reorganized its sales process to a more centralized approach and has empowered individual sales managers to negotiate better prices to drive sales as long as the amounts are within corporate guidelines. The company has changed its salesperson compensation by increasing the commission on sales to new customers. Sales commissions are no longer affected by returned goods if the goods are returned more than 90 days after sale and/or by not collecting the receivables. SSS has justified the changes in sales commissions on the following grounds: The salesperson is not responsible for quality issues—the main reason that customers return products. The salesperson is not responsible for approving credit; rather credit approval is under the direction of the global sales manager. a. What is the importance of the information about salesperson compensation to the audit of receivables and revenue? Explain how the auditor would use this information in planning analytical procedures. b. Perform planning analytical procedures using the data included in the table and the information about the change in performance. For each year, you will most likely want to focus on the % change of the various statistics over the prior year. Focus on Steps 3, 4, and 5 of the planning analytical procedures process. What are the important insights that the auditor should gain from performing such procedures? c. Why should the auditor be interested in a company’s stock price when performing an audit, as stock price is dependent, at least in part, on audited financial reports? d. What information about SSS might the auditor consider as fraudrisk factors? e. Identify specific substantive audit procedures that should be per formed as a result of the planning analytical procedures performed by the auditor (Step 6 of the planning analytical procedures process).49RSCQ 50RSCQ 51RSCQ 52RSCQ 53RSCQ 54RSCQ 55RSCQ 56RSCQ 57RSCQ 58RSCQ 59RSCQ 60RSCQ 61RSCQ 62RSCQ 63RSCQ 64RSCQ 65RSCQ 66RSCQ 67RSCQ 68RSCQ 69RSCQ

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