Auditing And Assurance Services
17th Edition
ISBN: 9780134897431
Author: ARENS, Alvin A.
Publisher: PEARSON
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Chapter 7, Problem 13RQ
To determine
Comment on the strengths and shortcomings in Person M’s use of ratio and trend analysis.
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At the completion of every audit, Roger Morris, CPA, calculates alarge number of ratios and trends for comparison with industry averages and prior-yearcalculations. He believes the calculations are worth the relatively small cost of doing thembecause they provide him with an excellent overview of the client’s operations. If the ratiosare out of line, Morris discusses the reasons with the client and often makes suggestionson how to bring the ratio back in line in the future. In some cases, these discussions withmanagement have been the basis for management consulting engagements. Discuss themajor strengths and shortcomings in Morris’s use of ratio and trend analysis.
Gale Gordon, CPA, has found ratio and trend analysis relativelyuseless as a tool in conducting audits. For several engagements, he computed the industryratios included in publications by Standard and Poor’s and compared them with industrystandards. For most engagements, the client’s business was significantly different fromthe industry data in the publication and the client automatically explained away any discrepancies by attributing them to the unique nature of its operations. In cases in which theclient had more than one branch in different industries, Gordon found the ratio analysisto be no help at all. How can Gordon improve the quality of his analytical procedures?
The auditor is evaluating the internal control of a new client. Management has prepared its assessment of internal control and has concluded that it has some deficiencies but no significant deficiencies and no material weaknesses. However, in reviewing the work performed by management, including the internal auditor, the auditor observes the following:
-Sample sizes taken by the internal auditor were never more than ten transactions, and most of the tests of operating effectiveness were based on a sample of one performed as part of a walkthrough of a transaction.-Management has fired the former CFO and a new CFO has not been appointed, but management indicates it has depth in the accounting area and is searching for a new CFO.-The company has no formal whistleblowing function because management has an “open-door” policy so that anyone with a problem can take it up the line.-Management’s approach to monitoring internal control is to compare budget with actual expenses and investigate…
Chapter 7 Solutions
Auditing And Assurance Services
Ch. 7 - Prob. 1RQCh. 7 - Prob. 2RQCh. 7 - Prob. 3RQCh. 7 - Prob. 4RQCh. 7 - Prob. 5RQCh. 7 - Prob. 6RQCh. 7 - Prob. 7RQCh. 7 - Prob. 8RQCh. 7 - Prob. 9RQCh. 7 - Prob. 10RQ
Ch. 7 - Prob. 11RQCh. 7 - Prob. 12RQCh. 7 - Prob. 13RQCh. 7 - Prob. 14RQCh. 7 - Prob. 15RQCh. 7 - Prob. 16RQCh. 7 - Prob. 17RQCh. 7 - Prob. 18RQCh. 7 - Prob. 19RQCh. 7 - Prob. 20RQCh. 7 - Define what is meant by a tick mark. What is its...Ch. 7 - Prob. 22RQCh. 7 - Prob. 23.1MCQCh. 7 - Prob. 23.2MCQCh. 7 - Prob. 23.3MCQCh. 7 - Prob. 24.1MCQCh. 7 - Prob. 24.2MCQCh. 7 - Prob. 24.3MCQCh. 7 - Prob. 25.1MCQCh. 7 - Prob. 25.2MCQCh. 7 - Prob. 25.3MCQCh. 7 - Prob. 26.1MCQCh. 7 - Prob. 26.2MCQCh. 7 - Prob. 26.3MCQCh. 7 - Prob. 27DQPCh. 7 - Prob. 28DQPCh. 7 - Prob. 29DQPCh. 7 - Prob. 30DQPCh. 7 - Prob. 31DQPCh. 7 - Prob. 32DQPCh. 7 - Prob. 33DQPCh. 7 - Prob. 34DQPCh. 7 - Prob. 36DQPCh. 7 - Prob. 37DQPCh. 7 - Prob. 40DQP
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- You are a new staff accountant with a large regional CPA firm, participating in your first audit. You recall fromyour auditing class that CPAs often use ratios to test the reasonableness of accounting numbers provided by theclient. Since ratios reflect the relationships among various account balances, if it is assumed that prior relationships still hold, prior years’ ratios can be used to estimate what current balances should approximate. However,you never actually performed this kind of analysis until now. The CPA in charge of the audit of Covington PikeCorporation brings you the list of ratios shown below and tells you these reflect the relationships maintained byCovington Pike in recent years.Profit margin on sales = 5%Return on assets = 7.5%Gross profit margin = 40%Inventory turnover ratio = 6 timesReceivables turnover ratio = 25 timesAcid-test ratio = 0.9 to oneCurrent ratio = 2 to 1Return on shareholders’ equity = 10%Debt to equity ratio = 1/3Times interest earned ratio = 12…arrow_forwardThe auditors use an analytical procedures during the course of an audit. The most important phase of performing these procedures is the: Vouching of all data supporting various rates, Investigation of significant variations and unusual relationships, Comparison of client-computed statistics with industry data on a quarterly and full-year basisarrow_forwardMarilyn Terrill is the senior auditor for the audit of Uden Supply Company for the year ended December 31, 20X4. In planning the audit, Marilyn is attempting to develop expectations for planning analytical procedures based on the financial information for prior years and her knowledge of the business and the industry, including these: Based on economic conditions, she believes that the increase in sales for the current year should approximate the historical trend. Based on her knowledge of industry trends, she believes that the gross profit percentage for 20X4 should be about 2 percent less than the percentage for 20X3. Based on her knowledge of regulations, she is aware that the effective tax rate for the company for 20X4 has been reduced by 5 percent from that in 20X3. Based on a review of the general ledger, she determined that average depreciable assets have increased by 10 percent. Purchases of equipment occurred relatively evenly throughout the year. Based on her knowledge of…arrow_forward
- Imagine that you are a senior auditor and your firm has been selected to audit a medium-sized company with a single location. Describe the four phases of an audit and discuss the key factors that would help you determine how to plan the audit for this company. Provide specific examples. Determine both the relationship of risks in the planning of the audit and factors that influence those risks. Speculate on which type of risk creates the most uncertainty for the auditor and recommend at least two ways to plan the audit to mitigate those risks. Provide specific examples.arrow_forwardPlease decide control risk, inherent risk and planned audit evidence will be affected (increase or decrease) in the following cases, and then list your analysis: i. You determine through analytical procedures that working capital, debt to equity ratio and other indicators of financial stability have worsened during the year. ii. In auditing inventories, you obtain an understanding of the internal control structure and perform test of controls. You find it significantly improved compared with that of the preceding year. You also observe that due to technology changes in the industry, the client's inventories may be somewhat obsolete. Please do fast ASAP fastarrow_forwardYou have accepted the engagement of auditing the financial statements of the C. Reis Company, a small manufacturing firm that has been your client for several years. Because you were busy writing the report for another engagement, you sent a staff accountant to begin the audit with the suggestion that she start with accounts receivable. Using the prior year’s audit documentation as a guide, she prepared a trial balance of the accounts, aged them, prepared and mailed positive confirmation requests, examined underlying support for charges and credits, and performed other work she considered necessary to obtain evidence about the validity and collectability of the receivables. At the conclusion of her work, you reviewed the audit documentation she prepared and found she had carefully followed the prior year’s audit documentation.Required:The opinion rendered by auditors states that the audit was made in accordance with generally accepted auditing standards. Identify the important…arrow_forward
- Which of the following BEST (select one) describes why auditing can be viewed as a continuous cyclical process? a) The audit plan is used to develop the audit schedule. b) Many audit departments review the same areas each year as part of the audit plan. c) Historical and current information from audits should be incorporated into the risk assessment. d) Businesses go through economic cycles, so audit plans must go through cycles.arrow_forwardWhich of the following is a correct statement regarding audit evidence? a. A large sample of evidence provided by an independent party is always considered persuasive evidence. b. The auditor must obtain a sufficient amount of relevant and reliable evidence to form an opinion on the fairness of the financial statements. c. A small sample of only one or two pieces of highly appropriate evidence is always considered persuasive evidence. d. Evidence is usually more reliable for balance sheet accounts when it is obtained within six months of the balance sheet date.arrow_forwardEvaluate the following quotation: “If a CPA firm completes a nonpublic company audit of Adam Company’s financial statements following AICPA generally accepted auditing standards and is satisfied with the results of the audit, an unmodified audit report may be issued. On the other hand, if no audit is performed of the current year’s financial statements, but the CPA firm has performed satisfactory audits in prior years, has confidence in the management of the company, and make a quick review of the current year’s financial statements, a qualified report may be issued.” Do you agree? Give reasons to support your answer.arrow_forward
- The auditors of Landi Corporation wish to use a structured approach to nonstatistical sampling to evaluate the reasonableness of the accounts receivable. Landi has 15,000 receivable accounts with a total book value of $2,500,000. The auditors have assessed the combined level of inherent and control risk at a moderate level and believe that their other substantive procedures are so limited as to require a “maximum” risk assessment. After considering the overall audit plan, the auditors believe that the test’s tolerable misstatement is $57,500. Use figure below to determine the reliability factor. Please calculate the sample size. Risk That Other Substantive Procedures Will Fail to Detect a Material Misstatement Combined Assessment of Inherent and Control Risk Maximum Moderate Low Maximum 3.0 2.3 1.9 Slightly below Maximum 2.7 2.0 1.6 Moderate 2.3 1.6 1.2 Low 1.9 1.2 1.0arrow_forwardMiles Lawson, CPA, believes that the final summarization is theeasiest part of the audit if careful planning is followed throughout the audit. He makessure that each segment of the audit is completed before he goes on to the next. When thelast segment of the audit is completed, he is finished with the audit. He believes this maycause each part of the audit to take a little longer, but he makes up for it by not having todo the final summarization. Evaluate Lawson’s approacharrow_forwardDiane Smith, CPA, performed tests of controls and substantivetests of transactions for sales for the month of March in an audit of the financialstatements for the year ended December 31, 2013. Based on the excellent results of boththe tests of controls and the substantive tests of transactions, she decided to significantlyreduce her substantive tests of details of balances at year-end. Evaluate this decision.arrow_forward
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