Answers Audit

7/28/2019 Answers Audit

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Chapter 11 (New) Chapter 16 (Old)

Case 1. a. Given identified financial control weaknesses,

the auditor may elect to expand the extent of

substantive testing, or search for and test

compensating controls. In the present case, the

following errors and irregularities may occur,

given the control weaknesses in the payroll

subset of the expenditure cycle:

1. Hours may be in error, inasmuch as the

time cards are prepared by employees

and not reviewed. This could lead to

overstatement or understatement of

wages expense in the income

statement. This could also affect the

carrying value of finished goods

inventories if Quicky is a manufacturing

company.

2. The payroll could be padded

inasmuch as signed checks are returned

to the department supervisors for

distribution. This could result in

overstatements of salaries and wages

expense on the income statement. It

could also cause a finished goods

inventory overstatement.

b. If, based on the initial understanding, controlsare thought to be adequate, the auditor should

consider the following alternatives:

1. Document the understanding, assess

control risk below maximum, as

considered appropriate, and document

the basis for conclusions; or

2. Document the understanding and test

controls as a means for further

reduction in the assessed level of

control risk. This alternative would be

chosen if the following conditions exist:

a. Controls are thought to be

effective; and

b. Cost reductions through

reduced substantive testing

exceed cost of further testing

of controls.

c. 1. Auditors must study and evaluate interna

control each year because the environment

within which the client operates is subject

to constant change; and controls must

adapt to these changes if the system is to

remain effective. The auditor must identify

the environmental changes and determinethat the relevant control points remain

covered after the changes.

2. A minimum audit is necessary, even unde

conditions of excellent internal control

because of the following inherent

limitations in all internal control systems:

Internal control assumes the

nonexistence of collusion;

Management can override the financia

controls;

Temporary breakdowns in the contro

system may occur and produce

material errors;

Given that these inherent limitations could

produce material financial statementmisstatements, and given that the audit

report provides reasonable assurance that

the financial statements do not contain

material misstatements, the auditor must

perform a minimum audit, even unde

conditions of excellent internal control if

such assurance is to be provided.


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Case 2.

ISLANDER DRUG STORE, INC.

Processing Cash Collections

Internal Control Questionnaire

-Question Yes No

Are customers who pay by check

identified via store I.D. card or other

means?

Does company policy prohibit accepting

checks for anything except

merchandise sales plus a nominal

cash amount?

Is a receipt produced by the cash

register given to each customer?

Is the reading of each cash register

taken periodically by an employeewho is independent of the handling

of cash receipts?

Are cash counts made on a surprise

basis by an individual who is

independent of the handling of

cash receipts?

Is the reading of each cash register

compared regularly to the cash

received?

Is a summary listing of cash register

readings prepared by an employee

who is independent of physically

handling cash receipts?

Are receipts forwarded to an

independent employee who makes

the bank deposits?

Are each days receipts deposited intact

daily?

Is the summary listing of cash register

receipts reconciled to the duplicate

deposit slips authenticated by the

bank?

Are entries to the cash receipts journalprepared from duplicate deposit

slips or the summary listing of cash

register readings?

Are the entries to the cash receipts

journal compared to the deposits

per bank statement?

Are areas involving the physical

handling of cash reasonably

safeguarded?

Are employees who handle receipts

bonded?

Are charged back items (NSF checks,

etc.) directed to an employee who

does not physically handle receipts

or have access to the books?

Chapter 12 (New) Chapter 11 (Old) Check Chap 10 SCase 1. a. Antonios activity is an irregularity (intentiona

distortion of financial statements) rather than

error (unintentional mistake). It is also an illega

act on Antonios individual part.

b. The problem does not describe the kind o

related party transactions discussed in PSA 550.

c. Yes, a weakness in internal control exists. It may

be considered a material weakness because the

compensating control (internal auditors work

on slow-moving inventory) did not operate in a

timely enough manner to detect the irregularity

before it had gotten large.


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If a material weakness in internal control exists,

Brava & Campos are obligated to report it to

management and/or the board of directors.

d. The problem description indicates that this

element of the audit was conducted in a

negligent manner. Theres nothing wrong about

auditing a sample of the transactions, but

Campos follow-up and explanation of the

missing receiving reports leaves much to be

desired. At the very least he could have

reviewed the reports produced by Antonio at a

later date, and he could have traced the

purchases to the inventory records and perhaps

noticed an over-stocking condition. The

auditors had some evidence that an irregularity

might exist, but they failed to apply extended

audit procedures properly.

Case 2. a. Yes. Nicolas was a party to the issuance of false

financial statements and as such is a joint

tortfeasor. The elements necessary to establish

an action for common law fraud are present.

There was a material misstatement of fact,

knowledge of falsity (scienter), intent that the

plaintiff bank rely on the false statement, actual

reliance and damage to the bank as a result

thereof. If action is based upon fraud there is

no requirement that the bank establish privity of

contract with the CPA. Moreover, if the action

by the bank is based upon ordinary negligence,

which does not require a showing of scienter,

the bank may recover as a third-party

beneficiary (an exception to the strict privity

requirement). Thus, the bank will be able to

recover its loss from Nicolas under either

theory.

b. No. The lessor was a party to the secret

agreement. As such, the lessor cannot claim

reliance on the financial statements and cannot

recover uncollected rents. Even if he was

damaged indirectly, his own fraudulent actions

led to his loss, and the equitable principle of

unclean hands precludes him from obtaining

relief.

c. Nicolas was not independent. His report is

improper and he is probably subject to

disciplinary action by the professiona

organization or regulatory body. According to

the ethics interpretation on actual or

threatened litigation:

An expressed intention by the present

management to commence litigation against the

auditor alleging deficiencies in audit work fo

the client is considered to impair independence

if the auditor concludes that there is a strong

possibility that such a claim will be filed.


Case 2. Types of procedures used by auditors in generalwith examples:

1. Recalculation by the auditor

* recomputing the clients calculation of

depreciation expense

2. Observation by the auditor

* observation, test-counting of clients

physical inventory-taking

3. Confirmation by letter

* obtaining accounts receivable confirmations

* obtaining clients lawyers letter

4. Inquiry and written representations

* ask client personnel about accounting

events

* complete an internal control questionnaire

* obtain written client representation letter

5. Vouching

* find brokers invoices and cancelled checks

showing agreement with record amounts

for securities investments

6. Tracing


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* select a sample of shipping documents and

trace them to sales invoices, sales journal

recording and posting to general ledger

7. Scanning

* scan expense accounts for credit entries

* scan payroll check lists for unusually large

checks

8. Analytical procedures any example that fits

one of these:

* compare financial information with prior

periods

* compare financial information with budgets

and forecasts

* study predictable financial information

patterns (e.g., ratio analysis)

* compare financial information to industry

statistics

* study financial information in relation to

nonfinancial information

Case 5. a. A material decline in sales may indicate

unrecorded sales; a decrease in cost of goods

sold may be due to unrecorded purchases; and

an increase in cost of good sold may be the

result of omissions from the ending inventory.

An increase or decrease in gross profit will result

from any one or a combination of the above

omissions.

b. A decline in the miscellaneous revenue account

balance, or the absence of a previously existing

source of miscellaneous revenue, could be

attributable to a failure to record miscellaneousrevenue.

c. Unrecorded accounts payable at year-end would

cause an increase in calculated accounts payable

turnover.

d. An apparent increase in accounts receivable

turnover may, in fact, be the result of failure to

record credit sales transactions.

e. A higher than average operating return may be

indicative of unrecorded purchases or operating

expenses; a lower than average return could

result from unrecorded sales.


Case 1. a. Evidential matter obtained from independen

sources outside an enterprise provides greate

assurance of reliability (competency) than that

which is secured solely within the enterprise.

b. Accounting data and financial statements

developed under satisfactory conditions of internal

control are more reliable (competent) than those which

are developed under unsatisfactory conditions of interna

control.

c. Direct personal knowledge obtained by theindependent auditor through physica

examination, observation, computation, and

inspection is more persuasive than information

obtained indirectly.

Case 2. 1. Types of evidence

Evidentialitems/sources

in reliability rank

d. Letter from

creditor

1. External

a. Monthly

statements

2. External-internal

b. Voucher register 3. Internal


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c. Audit

computation of

discounts

4. Mathematical

(based on

unaudited data)

2.

c. Audit

computation of

expense

amounts

1. Mathematical

(based on

unaudited data)

a. Letter from bond

trustee

2. External

d. Cancelled checks 3. External-internal

b. Minutes of

directors

meetings

4. Internal


Case 1. a. Areas requiring the auditors to make judgment

decisions when statistical sampling techniques

are employed (only four required):

(1) Defining population, characteristics to be

tested, and deviations. Unless a

relationship is defined between the

occurrence rate of deviations in the

population and either the validity of theclients financial statement or the strength

of internal control, little useful information

is gained by estimating the occurrence rate.

(2) Determining the appropriate statistical

selection techniques for drawing a random

sample. The auditors must recognize the

advantages and disadvantages of stratified

selection, unstratified selection, and

systematic selection, and determine which

technique is appropriate for selecting aneconomical random sample.

(3) Establishing the required maximum

tolerable deviation rate and the risk of

assessing control risk too low for the

procedure. This requires judgment

decisions regarding materiality, time, cost,

and the planned assessed level of control

risk.

(4) Interpreting sample results. This requires a

decision as to whether the results support

the auditors planned assessed level o

control risk, or whether additional sampling

is necessary to reach a conclusion.

(5) Following up on the discovery of critica

errors or unacceptable deviation rates.

(6) Determining the circumstances under which

statistical sampling is appropriate, and

those in which other techniques should be

used in lieu, of or to supplement, the

statistical sampling techniques.

This is an open-ended question. The student

may identify numerous other areas in which the

auditors must make judgment decisions.

b. If the CPAs sample shows an unacceptable

deviation rate, they may take the following

actions:

(1) They may enlarge their sample to increase

the precision of their estimate.

(2) They may isolate the type of deviation and

expand examination as it relates to the

transactions that give rise to that type omisstatement.

(3) The auditors usual response to an

unacceptably high deviation rate is to

increase their assessed level of control risk

Accordingly, the auditors would increase

the intensity of their substantive tests.

c. Techniques for selecting an unstratified random

sample of accounts payable vouchers include

the following:

Random Sample. A random sample is a sample

of a given size drawn from a population in a

manner such that every possible sample of that

size is equally likely to be drawn. Items may be

selected randomly by:


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(1) Table of Random Numbers. Use one of a

number of published tables. Using four

columns in the table, select the first 80

numbers which fall within the range of 1 to

3,200. The starting point in the table

should be selected randomly and the path

to be followed through the table should be

set in advance and followed consistently.

(2) Random Number Generator: Using

generalized audit software, generate a list

of 80 random numbers.

Systematic Sample. A systematic sample is

drawn by selecting every nth

item beginning with

a random start.

(1) Every nth

item. Select every 40th

voucher

after selecting the initial voucher (from 1 to

40) randomly.

(2) Several random starting points. For

example, use two random starting points

and select 40 of the 80 vouchers from each

of the two sequences. Select every 80th

voucher (3,200/40) after each of the two

random starting points between 1 and 80

for each of the two sequences.

Case 2. a. (1) Since the results of tests of controls

typically play a significant role in

determining the nature, timing, and extent

of other audit procedures, the auditors

usually specify a low level of risk of

assessing control risk too low. It is usually

set at 5 or 10 percent.

(2) In determining the tolerable deviation rate,an auditor should consider the planned

assessed level of control risk and the extent

of assurance desired from the evidential

matter included in the sample.

(3) In determining the expected population

deviation rate, an auditor should consider

the results of prior years tests, the overall

control environment, or utilize a

preliminary sample.

b. (1) There is a decrease in sample size if theacceptable level of the risk of assessing

control risk too low is increased.

(2) There is a decrease in sample size if the

tolerable deviation is increased.

(3) There is an increase in sample size if the

population deviation rate is increased.

c. Using a statistical sampling approach, Figure

18.4 reveals that 7 deviations in a sample of size

100 results in an achieved upper deviation rate

of 12.8%, well in excess of the tolerable

deviation rate (8%). The sample results should

thus be interpreted as not supporting the

planned assessed level of control risk.

Using a nonstatistical sampling approach, the

7% estimated population deviation rate

identified in the sample (7 deviations / 100

sample items) approaches the tolerable

deviation rate of 8%. Therefore, using a

nonstatistical approach, the sample result would

also be interpreted as not supporting the

planned assessed level of control risk.

d. Statistical sampling allows the auditors to

quantify sampling risk. As described in part (c)

only when statistical sampling is used do the

auditors know that the achieved uppe

deviation rate is 12.8%.



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Case 1. a. Alpha risk is the risk of rejecting a population

that is essentially correct. Beta riskis the risk of

accepting a population that is materially

incorrect. Alpha risk affects audit efficiency

because overauditing results from incorrectly

rejecting a population. Beta risk impacts audit

effectiveness because underauditng results

from incorrectly accepting a population.

Collectively, alpha and beta risk comprise

sampling risk, defined as the probability that the

auditor will draw erroneous conclusions about a

population.

b. Attention to, and quantification of, alpha and

beta risk assist the auditor in applying an audit

risk approach to substantive testing. During the

audit planning stage, the auditor identifies areas

of high audit risk and sets detection (beta) risklow for these areas. The result is that more

substantive testing is devoted to the high risk

areas relative to the lower risk areas. This

approach enhances both audit efficiency and

audit effectiveness.

c. Because it is closely related to the basis for the

auditors opinion, alpha risk is usually set equal

to overall audit risk. Beta risk is set on the basis

of the auditors evaluation of inherent risk and

control risk. The greater these risk factors, as

determined by the auditor during the audit

planning stages, the lower the beta risk set by

the auditor. The lower the acceptable beta risk,

the larger the sample sizes for substantive

testing purposes. Alpha and beta risk,

therefore, provide the necessary link between

audit risk analysis and substantive audit testing.

Case 2. a. (1) Mean-per-unit estimates the total value of

a population by (1) using the sample mean

as an estimate of the true population mean,

and (2) extending this estimated population

mean by the number of items in the

population. The computations are as

follows:

(1) Estimated population mean =

P582,000 / 200 lots = P2,910 per

lot

(2) Estimated total value =

P2,910 per lot x 2,000 lots =

P5,820,000

(2) Ratio estimation estimates total population

value by (1) using the ratio of the sample

audited values to book values as an

estimate of the ratio of population auditedvalue to book value, and (2) applying the

estimated ratio to the population book

value. The computations are as follows:

(1) Estimated ratio of audited to book

value =

P582,000 / P600,000 = 97%


97% x P5,900,000 = P5,723,000

(3) Difference estimation estimates tota

population values by (1) using the average

difference between the audited and book

values of sample items as an estimate of

the average difference for all population

items, (2) extending the estimated average

difference by the number of items in the

population, and (3) using the resulting

estimate of the total difference between

audited and book value to compute the

estimated total value. The computations

are as follows:


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(1) Estimated average difference in audit

and book values:

(P582,000 - P600,000) / 200 lots

= - P90 per lot

(2) Estimated total difference =

- P90 per lot x 2,000 lots = -

P180,000


P5,900,000 - P180,000 =

P5,720,000

b. The sample contains an element of sampling

error with respect to the average peso value of

production lots. The mean book value of the

population is P2,950 (P5,900,000 / 2,000 lots),

while the mean book value in the sample is

P3,000 (P600,000 / 200 lots). Mean-per-unit

estimation uses the mean value of the sample as

the basis for estimating total value. Thus, if the

sample contains a disproportionate number of

higher (or lower) priced items, this sampling

error will affect the estimate of the total

population value.

The estimate of total value developed in ratio

estimation is based upon the ratio of audited

values to book values, rather than upon mean

peso value. If this ratio has no tendency to vary

with the peso value of the lot, the estimate of

total value is not affected by the mean value of

items in the sample. However, sampling error

may still be present if the sample lots are not

representative of the population with respect to

the ratio of audited values to book values.

Case 3. The auditors would project the misstatement found

in the sample to the population using either the ratio

or difference approach. The ratio approach would

result in a projected misstatement of P65,500. This

may be computed by first calculating the ratio of the

audited to book value as 1.0131 [P23,100 / P22,800

(since there is a net understatement of P300, theaudited value is P23,100)] and estimating the

audited value of the population as:

1.0131 x

P5,000,000 = P5,065,500 (rounded)

The projected misstatement is thus P65,500 under

the ratio method.

The difference approach results in an average

difference of P1.50 (P300 net difference divided by

200 items). Multiplying by the 100,000 invoice

indicates a projected misstatement of P62,400

(P1.50 x 41,600).

Case 4.The audit risk (ultimate risk) of materiamisstatement in the financial statements (AR) is the

product of:

(1) Inherent risk (IR), the risk of materia

misstatement in an assertion, assuming there

were no related internal controls.

(2) Control risks (CR), the risk of materia

misstatement occurring in an assertion, and not

being prevented or detected on a timely basis

by the internal control structure.

(3) Detection risk (DR), the risk that the auditors

procedures will lead them to conclude an

assertion is not materially misstated, when in

fact such misstatement does exist.

In equation form, this relationship is expressed as

follows:


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AR = IR x CR x DR

This equation may be restated to solve for the

allowable detection risk as follows:

DR = AR / (CR x IR)

Using the risk levels set forth in the problem, the

allowable risk of reliance upon substantive tests is

computed as illustrated below:

DR = .02 / (.2 x .5) =.20

Thus the risk of incorrect acceptance should be

limited to 20 percent if the auditors are to achieve

their objective of holding audit risk to 2 percent.

Case 5. a. (1) Required sample size is calculated as

follows:

Sample size =

Sample size =

= 69

Note: The reliability factor is from the zero

misstatements row of the PPS sampling

table given in the case.

(2) The sampling interval is calculated simply by

dividing the book value of receivables by

the sample size, as follows:

Sampling interval = Recorded

receivables / Sample size

= P500,000 / 69 = P7,246

b. The results may be evaluated as follows:

(1) Projected misstatement =

Bo

ok

Va

lu

e

Aud

ited

Val

ue

Missta

tement

Tain

ting

%

Sam

plin

g

Inter

val

Project

ed

Missta

temen

P

50

P

47

P 3 6% P7,2 P 4

80

0

76

0

40 5% 7,2 3

8,

500

8,1

00

400 NA N 4

P1,1

(2) Basic precision = Reliability facto

x Sampling interval

Recorded amount of population

x Reliability factor

P500,000 x 3


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=

3.0 x P7,246

= P21,738

(3) Incremental allowance =

Relia

bility

Facto

r

Incre

ment

Increm

nt1)

Projecte

d

Misstat

ement

Increm

ental

Allowa

nce

3.00

4.75 1.75 .75 P435 P326

6.30 1.55 .55 362 199

P525

(4) Upper limit on misstatement =

P1,197 + P21,738 + P525

= P23,460

NOTES:

Projected misstatement

(a) Tainting percentages are calculated as

the difference between book and

audited value divided by book value

(e.g., (P50 P47) / P50 = 6%).

(b) No tainting percentage is calculated for

items in excess of the sample interval

and the actual misstatement is

extended to projected misstatement

(as for the third error).

Basic precision is always the reliability

factor for zero misstatements multiplied

times the sampling interval.

Incremental allowance

(a) Reliability factors are read from the PPS

sampling table given in the case

starting at zero misstatements.

(b) Increment 1 is the difference in the

two adjacent reliability factors minus 1

(e.g., 4.75 3.00 1.00 = .75).

(c) Misstatements in excess of the

sampling interval are not considered in

the incremental allowance. This is

because the nature of the process

requires that all items in excess of the

sampling interval be included in the

sample therefore no allowance fo

items not in the sample is necessary.

c. The results obtained in part b would indicate

that the auditors may accept the population as

not containing a tolerable misstatement at the 5

percent level of risk of incorrect acceptance

The auditors would also consider the results

obtained in conjunction with other audit tests.

Case 6. a. The advantages of probability-proportional-to

size (PPS) sampling over classical variables

sampling are as follows:

PPS sampling is generally easier to usethan classical variables sampling.

The size of a PPS sample is not basedon the estimated variation of audited

amounts.

PPS sampling automatically results in astratified sample.

Individually significant items areautomatically identified.

If no misstatements are expected, PPSsampling will usually result in a smallesample size than classical variables

sampling.

A PPS sample can be easily designedand sample selection can begin before

the complete population is available.

b. Sampling interval = Recorded receivables /

Sample size


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=

P300,000 / 60

= P5,000

c. Projected misstatement =

Bo

ok

Va

lu

e

Aud

ited

Val

ue

Missta

tement

Tain

ting

%

Sam

plin

g

Inter

val

Project

ed

Missta

tement

P

40

0

P

32

0

P 80 20

%

P1,0 P 20

50

0

0 500 10

0%

1,0 1,00

3,

00

0

2,5

00

N NA 50

P1,70


Case 1. 1. Controlled access to blank sales invoices.

a. Observation. Visit the storage location

yourself and see if unauthorized persons

could obtain blank sales invoices. Pick

some up yourself to see what happens.

b. Someone could pick up a blank and make

out a fictitious sale. However, getting it

recorded would be difficult because of the

other controls such as matching with a copy

from the shipping department. (Thus acontrol access deficiency may be

compensatedby other control procedures.)

2. Sales invoices check for accuracy.

a. Vouching and Recalculation. Select a

sample of recorded sales invoices and

vouch quantities thereon to bills of lading,

vouch prices to price lists, and recalculate

the math.

b. Errors on the invoice could cause lost

billings and lost revenue or overcharges to

customers which are not collectible (thus

overstating sales and accounts receivable).

3. Duties of accounts receivable bookkeeper.

a. Observation and Inquiry. Look to see who is

performing bookkeeping and cash

functions. Determine who is assigned to

each function by reading organization

charts. Ask other employees.

b. The bookkeeper might be able to steal cash

and manipulate the accounting records to

give the customer credit and hide the theft(Debit a customers payment to Returns

and Allowances instead of to cash, or just

charge the control total improperly).

4. Customer accounts regularly balanced with the

control account.

a. Recalculation. Review the clients working

paper showing the balancing/reconciliation

Do the balancing yourself.

b. Accounting entries could be made

inaccurately or incompletely and the

control account may be overstated or

understated.

Case 2. The discussion could take several directions

including some or all of the following:

1. Material Weakness. The facts seem to suggesa condition in which specific control features

(few or none are described) or the degree of

compliance with them do not reduce to a

relatively low level the risk that errors or

irregularities in amounts that could be materia

to the financial statements may occur and not

be detected within a timely period by

employees in the normal course of performing

their assigned functions. Castro has authority


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and influence over too many interrelated

activities. Nothing he does seems to be subject

to review or supervision. He even is able to

exclude the internal auditor.

An identification of the potential irregularities

will illustrate the misdeeds he can perpetrate

almost single-handedly.

2. Potential irregularities include:

a. Castro can collude with customers to rig

low bids and take kickbacks, thereby

depriving the company of legitimate

revenue.

b. Castro can direct purchases to favored

suppliers, pay unnecessarily high prices and

take kickbacks. He might even set up a

controlled dummy company to sell

overpriced materials to the company. No

competitive bidding control prevents these

activities.

c. Castro, through the control of physical

inventory, can (i) remove materials for

himself, and (ii) manipulate the inventory

accounts to conceal shortages.

d. Castro can order truck shipping services for

his own purposes and cause the charges to

be paid by the company.

e. Castro can manipulate the customer billing

(similar to a above) to deprive the company

of legitimate revenue while taking an

unauthorized commission or kickback.

3. Almost every desirable characteristic of good

internal control has been circumvented:

a. Segregation of Functional Responsibilities.

Castro has authorization and custodial

responsibilities.

b. Authorization, Supervision. Castro is

apparently subject to no supervision or

review. The accounting staff is probably

powerless to challenge transactions

because of Samuels apparent approval o

Castros powers.

c. Controlled Access. The whole situation

gives Castro access to necessary papers

records, and assets to carry out his one-

man show.

d. Periodic Comparison. No one else

apparently has any access to the materials

inventory in order to conduct an actua

count for comparison to the book value

(recorded accountability) of the inventory.

Case 3. The purpose of this question is to get the student to

consider where the functions that are considered

incompatible in a manual system occur in a

computer system.

The functions should be separated in a manual or

computer accounting system such that different

people authorize the sales transactions, record the

transactions, have custody to the assets (inventory

and reconcile the books to the assets.

Different people should: indicate the sales orde

source document (authorize), prepare the computerprogram (authorize and record), operate the

computer (record), have custody of inventory and

correct errors (reconciliation).

Case 4. If the credit limits are set and entered incorrectly

the credit approval process will be systematically

deficient.

Case 5. Memorandum


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TO: Board of Directors, The Potter

Art League

FROM: (Students name)

DATE:

SUBJECT: Control weaknesses related to Cash

Admission Fees

You requested a report which identifies the weaknesses in the

existing system of cash admission fees and my

recommendations. Below are the weaknesses that exist and

my recommendations for procedures that overcome these

weaknesses. I will be pleased to discuss these at the next

board meeting and offer further explanations that may be

necessary.

Weakness: There is no segregation of duties between

persons responsible for collecting admission fees and persons

responsible for authorizing admission.

Recommendation: One clerk (hereafter referred to as the

collection clerk) should collect admission fees and issue

prenumbered tickets. The other clerk (hereafter referred to as

the admission clerk) should authorize admission upon receipt

of the ticket or proof of membership.

Weakness: An independent count of paying patrons is not

made.

Recommendation: The admission clerk should retain a

portion of the prenumbered admission ticket (admission ticket

stub).

Weakness: There is no proof of accuracy of amounts

collected by the clerks.

Recommendation: Admission ticket stubs should be

reconciled with cash collected by the treasurer daily.

Weakness: Cash receipts are not promptly prepared.

Recommendation: The cash collections should be recorded

by the collection clerk daily on a permanent record that will

serve as the first record of accountability.

Weakness: Cash receipts are not promptly deposited. Cash

should not be left undeposited for a week.

Recommendation: Cash should be deposited at least once

each day.

Weakness: There is no proof of accuracy of amounts

deposited.

Recommendation: Authenticated deposit slips should be

compared with daily cash collection records. Discrepancies

should be promptly investigated and resolved. In addition, the

treasurer should establish a policy that includes an analytica

review of cash collections.

Weakness: There is no record of the internal accountability o

cash.

Recommendation: The treasurer should issue a signed

receipt of all proceeds received from the collection clerk

These receipts should be maintained and should be

periodically checked against cash collection and deposi

records.

Case 6. a. The purposes of these audit procedures are:

1. To substantiate the validity of the asset

cash in the balance sheet, as it may

substantially consist of cash in transit

from several sales divisions.

2. To determine proper cash cutoff, i.e., to

detect any unintentional errors overstating

or understating cash between the current

and the following accounting period.

3. To disclose kiting (if any), e.g.

perpetrated by the home office cashier in

collusion with one or more sales divisions

employees.

b. Audit Program for Sales Divisions Audit Steps

1. Prepare a schedule of transfer payments

made by the branch for a period covering

two weeks prior and two weeks after the

end of the fiscal period showing:

Check number

Date of entry in cash

disbursements book


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Amount of check

Date of perforation by paying bank

Transfer checks outstanding at the

date of cutoff

Transfer checks outstanding at the

date of reconciliation.

2. Compare dates of issue on canceled checks

and of entries.

3. Trace and compare dates of perforation and

dates of payment on the bank statement

and the cutoff statement.

4. Compare dates of issue of checks to date of

perforation looking for:

a. unusual delays in payment

b. discrepancy in accounting periods

for the two dates.

5. Scan cancelled checks and cash

disbursements records during the year for:

a. names of payees,

b. consecutive numbers of checks to

determine whether any payments

other than regular transfers to main

office were made from this account.

6. Reconcile individually several transfers

during the year to corresponding collections

presumed to be transferred as of each

individual date.

7. Reconcile total collections for the year to

total transfers.

Case 7. 1. a. Recorded payroll transactions are valid (no

fictitious employees).

b. Paychecks might be delayed and terminated

workers might continue to be paid (with

theft of check by someone else) if payroll is

not promptly notified of new hires and

terminations.

2. a. Recorded payroll deductions are valid.

b. Incorrect amounts might be deducted from

pay.

3. a. Recorded payroll transactions are validand

authorized.

b. If payroll department personnel were also

responsible for time records, they would

have effective control over transaction

authorization (i.e., hours worked approval

and could overpay themselves or friends.

4. a. Payroll and labor cost transactions are

complete.

b. Cost accounting records might contain

more or fewer pesos than actually paid (pe

payroll data). Simple errors in cost analyse

might occur.


Case 1. a. The CPAs test of the sales cutoff at June 30

should include the following steps:

1. Determine what JETOs cutoff policy is

review the policy for reasonableness, and

compare it to the prior year for consistency

2. Select a sample of sales invoices (including

the last serial invoice number) from those

recorded in the last few days of June and

the first few days of July.

3. Trace these sales invoices to shipping

documents and determine that sales have

been recorded in the proper period in

accordance with company cutoff policy.

4. Determine that the cost of goods sold has

been recorded in the period of sale.

5. Select a sample of shipping documents fo

the same period and trace these to the


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sales invoice. Determine that the sale and

the cost of goods sold have been recorded

in the proper period.

6. Review the cutoff for sales returns and

allowances, determine that it has been

based upon a consistent policy and that

there have not been abnormal sales returns

and allowances in July; this might indicateeither an overstatement of sales during the

audit period or the need for a valuation

account at June 30 to provide for future

returns and allowances.

b. (1) The CPA will use the July 10 cutoff bank

statement in his review of the June 30 bank

reconciliation to determine whether:

(a) The opening balance on the cutoff bank

statement agrees with the balance per

bank on the June 30 reconciliation.

(b) The June 30 bank reconciliation

includes those canceled checks that

were returned with the cutoff bank

statement and are dated or bear bank

endorsements prior to July 1.

(c) Deposits in transit cleared within a

reasonable time.

(d) Interbank transfers have been

considered properly in determining the

June 30 adjusted bank balance.

(e) Other reconciling items which had not

cleared the bank at June 30 (such as

bank errors) clear during the cutoff

period.

(2) The CPA may obtain other audit

information by:

(a) Investigating unusual entries on the

cutoff bank statement.

(b) Examining canceled checks, particularly

noting unusual payees or

endorsements.

(c) Reviewing other documentation

supporting the cutoff bank statement.

Case 2. The procedure followed appears to be appropriate

except that the examination of detail transactions

for three months might be considered to be

excessive in view of the exceptionally good interna

control. A lighter test of such transactions, designed

to test the effectiveness of the control procedures

might be devised.

The procedures followed should be supplemented

by the following:

1. Review the companys method of sales cutoff at

year-end and test billings and shipments

(including returns) for an adequate periodbefore and after year-end to establish that cut

off procedures have been adhered to.

2. Examine collections in early part of subsequen

period to determine if a substantial portion of

the receivables has been collected.

3. Examine agreements entered into with the

distributors. If price protection clauses are

included, review the current price position and

distributor inventory positions to determine

whether a reserve for such protection is

needed.

4. When a company deals with a limited number o

customers, it is dependent upon the continued

solvency ofallsuch customers.

5. Obtain a representation letter from appropriate

company officials covering the receivables.

Case 3. 1. a. Notes payable are authorized according to

company policy (proper authorization).

b. For each note outstanding or paid during

the year, vouch to written authorizing

document.

c. Funds might be borrowed in the companys

name without the knowledge of responsible

officers.


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2. a. Recorded notes payable are valid and

documented (separation of duties).

b. Observe the client personnel record-

keeping duties.

c. Someone might intercept a check made out

to a bank and convert company funds to his

or her own use. Notes payable records

could be falsified for a short time to hide

the theft.

3. a. Valid liabilities are recorded and none

omitted (sound error checking practices).

b. Observe client personnel making

comparisons. Review correcting journal

entries that result from the comparison.

c. Purchases or other liabilities may fail to be

recorded and the error not detected by any

other means.

4. a. Recorded liabilities and cash disbursements

valid and documented (sound record

keeping).

b. Inspect notes to see if they are marked

paid.

c. Notes may get paid a second time if put

back through the cash disbursements

system (intentionally or inadvertently).

Case 4. a. The fact that the client made a journal entry to

record vendors invoices which were received

late should simplify the CPAs audit forunrecorded liabilities and reduce the possibility

of a need for a further adjustment, but the

CPAs audit is nevertheless required. If the

client has not journalized late invoices, the CPA

is compelled in his testing to substantiate what

will ultimately be recorded as an adjusting

entry. In this examination the CPA should audit

entries in the 2004 voucher register to ascertain

that all items which according to dates of

receiving reports or vendors invoices were

applicable to 2004 have been included in the

journal entry recorded by the client.

b. No. The CPA should obtain a letter in which

responsible executives of the clients

organization represent that to the best of their

knowledge all liabilities have been organized

However, this is done as a normal audit

procedure to afford additional assurance to the

CPA and it does not relieve him of the

responsibility for doing his own audit work.

c. Whenever a CPA is justified in relying on work

done by an internal auditor, he should curtai

(but not eliminate) his own audit work. In thi

case, the CPA should have ascertained early in

his examination that Ozones internal auditor is

qualified by being both technically competent

and reasonably independent. Once satisfied as

to these points, the CPA should discuss the

nature and scope of the internal audit program

with the internal auditor and review his working

papers in order that the CPA may properly

coordinate his own program with that of the

internal auditor. If the Ozone internal auditor is

qualified and has made tests for unrecorded

liabilities, the CPA may limit his work in this

audit area.

d. In addition to the 2005 voucher register, the

CPA should consider the following sources for

possible unrecorded liabilities:

1. Unentered vendors invoice file.

2. Status of tax returns for prior years stil

open.

3. Discussions with employees.

4. Representations from management.

5. Comparison of account balances with

preceding year.

6. Examination of individual accounts during

the year.

7. Existing contracts and agreements.


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8. Minutes.

9. Attorneys bills and letter of representation.

10. Status of renegotiable business.

11. Correspondence with principal suppliers.

12. Audit testing of cutoff date for reciprocal

accounts, e.g., inventory and fixed assets.

Case 5. a. Lourdes should find in the audit working papers

a planning memo describing the clients

inventory-taking plan and notes about the

auditors first-hand observation of the

instructions being given to counters, along with

a memo about the auditors observation of the

counting. This memo should tell about

supervision of the audit staff, and the working

papers (test counts) should show the review

signatures of the supervising auditors.

b. Working papers should document performance

of these substantive procedures for the

existence and completeness assertions:

1. Conduct an observation of the companys

physical inventory count.

2. Scan the inventory compilation for items

added from sources other than the physical

inventory count. . .

3. At year end, obtain the number of the last

shipping and receiving documents . . . Use

these to scan the sales, inventory/cost of

sales, and accounts payable entries for

proper cutoff.

4. Confirm or inspect inventories held in public

warehouses.

Case 6. The three categories of major losses or

manipulations in the area of investments are: theft

of diversion of funds, manipulation of accounting,

and business espionage. Business espionage is

generally outside the sphere of independent

auditors interest.

Case 7. a. The objectives (specific assertions) for the audit

of non-current investment securities are to

obtain evidence regarding the:

Existence of the investment securitiesat the balance sheet date.

Ownership of the investmentsecurities.

Cost and carrying value of theinvestment securities.

Proper presentation and disclosure ofthe investment securities in the

financial statement.

Proper recognition of interest income. Proper recognition of investment gains

and losses.

b. The following audit procedures should be

undertaken with respect to the audit of Tess

investment securities:

Inspect and count securities in thecompanys safe and safe deposit box.

Examine brokers statements to obtainassurance that all transactions were

recorded.

Examine documents in support opurchases and sales of investment

securities.

Inspect the minutes of the board ofdirectors meetings.

Review the audited financiastatements of the (25 percent

investee.

Verify the equity method of accountingwas used for carrying value of the

investment in Dee Industrial.

Obtain a client representation letterthat confirms the clients

representations concerning the

noncurrent investment securities.

Verify the calculation of interestincome.

Review the propriety of thepresentation and disclosure of the

securities in the financial statements.

Make certain that the clientrepresentation letter includes the

proper assertions concerning accounts

payable.

Investigate and resolve confirmationexceptions and other matters requiring

follow-up.


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Case 8. a. The audit objectives in the examination of long-

term debt are to determine that:

1. All liabilities were properly recorded.

2. Items recorded as liabilities are bona fide

obligations.

3. Interest expense and/or amortization was

properly computed and recorded.

4. The client is not in violation of restrictions

or requirements imposed on it by the terms

of the loan agreement.

5. Satisfactory authority existed to enter into

long-term obligation agreements.

6. All long-term obligations are properly

classified in the balance sheet.

7. Assets pledged as security are adequately

disclosed.

b. The following procedures should be included in

an audit program for the examination of the

long-term note between Odette and First

National Bank:

1. Confirm the loan and terms of the

agreement with the bank.

2. Review the agreement between Odette and

the bank to determine that:

a. The debt is long-term (by reference to

dates).

b. Provisions of the agreement have not

been violated, e.g., that Odette is

complying with any restrictions on the

payment of dividends, on the amount

of working capital to be maintained, oron the uses to which the funds may be

employed and is maintaining the plant

pledged as security for the loan.

c. The agreement was signed by person(s)

having authority.

3. Trace the receipt of funds into the bank

account and cash receipts book.

4. Check the computation of interest expense

for the period May 1 to June 30, and trace

the recording of the expense and the

accrual on the books.

5. Determine that authority to borrow was

granted and is recorded in the board o

directors minutes.


Case 1. a. (1) The functions of audit working papers are

to aid the CPA in the conduct of his work

and to provide support for his opinion and

his compliance with auditing standards.

(2) Working papers are the CPAs records of the

procedures performed, and conclusions

reached in the audit.

b. The factors that affect the CPAs judgment of the

type and content of the working papers for a

particular engagement include:

1. The nature of the auditors report.

2. The nature of the clients business.

3. The nature of the financial statements

schedules or other information upon which

the CPA is reporting and the materiality of

the items included therein.

4. The nature and condition of the clients

records and internal controls.

5. The needs for supervision and review o

work performed by assistants.

c. Evidence which should be included in audi

working papers to support a CPAs compliance

with generally accepted auditing standard

includes:

1. Evidence that the financial statements oother information upon which the auditor is

reporting were in agreement or reconciled

with the clients records.

2. Evidence that the clients system of interna

control was reviewed and evaluated to

determine the nature, timing, and extent of

audit procedures.


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3. Evidence of the auditing procedures

performed in obtaining evidential matter

for evaluation

4. Evidence of how exceptions and unusual

matters disclosed by auditing procedures

were resolved or treated.

5. Evidence of the auditors conclusions on

significant aspects of the engagement with

appropriate commentaries.

d. The CPA should perform an adequate

examination at minimum cost and effort and the

preceding years programs will aid in doing this.

The preceding years audit programs ordinarily

contain information useful in the current

examination (such as descriptions of the unique

features of a clients operations or records, a

formalized sequence of audit steps in logical

order, and approximate time requirements toperform various phases of the work). The

auditor should decide whether to use the old

program or prepare a new one.

Case 2. In general, the working paper is not set up in a

logical manner to show what the auditor wants to

accomplish. The primary objective of the working

paper is to verify the ending balance in notes

receivable and interest receivable. A secondary

objective is to account for all interest income, cash

received and cash disbursed for new notes, collateralas security, and other information about the notes

for disclosure purposes.

Specific deficiencies of the working paper presented in the

question are:

a.

DEFICIENCY

b.

IMPROVEMENT

1. Tick mark

explanation

tested does not

indicate specifically

what was done.

Should have separate tick

marks meaning:

Agreed toconfirmation

Footed Traced to cash

receipts journal

Recomputed, etc.2. Explanation of

some tick marks is

Explain all tick marks on

the same page of the

not given. working paper.

3. Classification of

long-term portion

indicates no

verification.

Recompute portions of

notes which are long-

term.

4. Paid-to-date row is

confusing.

Column should say date

paid to and this should

be confirmed.

5. Due dates are

missing for C.C. Co.,

P. Pablo and Tetra

Co.

Include due dates on

working paper for these

notes.

c. SPREADSHEET SOLUTION

The purpose of using an Excel spreadsheet in

this problem is to give the student some

experience in preparing a simple working paper

using an Excel spreadsheet. It should be

explained to students that this type of working

paper may or may not be prepared in actua

practice, and that often templates are used to

prepare more time-consuming working papers

Also, whether or not tick marks are

computerized is a matter to be decided. The

advantage is that the completed audit work can

then be stored and reviewed electronically, a

direction many firms are going. On the othe

hand, it may be more efficient to indicate audit

work manually as it is performed, and a contrast

in the color of the tick marks through use of a

colored pencil may be desirable.

The formulas used are self-evident, so no listing

is provided. Two items deserve comment:

1. An advantage of using a spreadsheeprogram for these types of analyses is

that footing and crossfooting are done

automatically.

2. When auditor tick marks are done

by computer, a problem arises as to how to place them on

the worksheet. One could use narrow columns inserted

between the scheduled client data, or, as done here, the tick

marks are placed in blank rows beneath the related data.


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FOURTH PACIFIC COMPANY Schedule N-1 Date

A/C # 110NOTE RECEIVABLE Prepared by JD 1/21/04

12/31/03 Approved by PP 2/15/04

Account # 110Notes Receivable Interest

Maker

Date

Made /

Due

Interest

Rate /

DatePaid to

Face

Amount

Value

ofSecurity

Balance

12/31/02 Additions Payments

Balance

12/31/03

Receivable

12/31/02 Earned Received

Receivable

12/31/03

Alba Co. c * 6/15/02 / 5% / 5000 None 4000 0 1000 3000 104 175 0 279

6/15/04 None

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