c.
The most serious concern in this audit is the evaluation of the allowance for uncollectible accounts. Given the adverse economic conditions and significant increase of loans receivable, the auditor must be greatly concerned about the adequacy of the allowance for uncollectible accounts and the possibility of uncollectible accounts being included in loans receivable. Given the internal controls, the auditor is not likely to be greatly concerned about the gross accounts receivable balance, except for accounts that need to be written off. Therefore, for the audit of gross accounts receivable there will be a greatly reduced assessed control risk and relatively minor confirmation of accounts receivable. In evaluating the allowance for uncollectible accounts, the auditor should test the controls over granting loans and following up on collections. However, given the changes in the economy, it will be necessary to do significant additional testing of the allowance for uncollectible accounts. Therefore an \is included for tests of details of balances for gross accounts receivable and an \net realizable value.
13-34 a. Factors which could explain the difference in the amount of evidence accumulated in different parts as well as the total time spent on the engagement are:
1. Internal control 2. Materiality of the account balance 3. Size of the populations 4. Makeup of populations 5. Initial vs. repeat engagement 6. Results of the current and previous audits 7. Existence of unusual transactions 8. Motivation of the client to misstate the financial statements 9. Degree of client integrity
10. Reliance by third parties on the audited financial statements
For an example, in the first audit, the partner has apparently
made the decision to emphasize tests of controls and substantive tests of transactions and minimize tests of details of balances. That implies effective internal controls and a low expectation of misstatement (low inherent and control risk.) In the third audit, the partner apparently has a high expectation of misstatements, and therefore believes it is necessary to do extensive tests of controls and substantive tests of transactions, as well as extensive tests of details of balances. Audit two is somewhere between audit one and three.
13-21
b.
The audit partners could have spent time discussing the audit approach
and scope with Bryan prior to the beginning of the field work.
c. The nature of these three engagements and the different
circumstances appear to be excellent examples of the tailoring of audit procedures to appropriate levels considering the circumstances. Bryan's judgment could have been improved on each engagement if the audit partner discussed the audit approach with her during the engagement. d.
In the first audit, the partner has apparently made the decision to
13-35 a.
emphasize tests of controls and substantive tests of transactions and minimize tests of details of balances. While this approach would be consistent with the integrated audit of a public company’s financial statements and internal control over financial reporting, the extent of testing of controls for the cash disbursements transactions would be extensive like that described in the third audit so that the auditor obtains a sufficient basis to report on internal controls.
The following is a time line for the audit procedures, showing the
sequence of the parts of a typical audit.
July Audit Report 31 Date 5, 9, 7, 2 8 1 3 4 6 Parts 5, 9, and 7 are all a part of planning and are therefore done early. These are in the sequence shown in Chapter 8. As part of planning the audit, the auditor obtains an understanding of internal control and initially assesses control risk. The auditor then performs tests of controls and substantive tests of transactions and reassesses control risk. Ideally, most analytical procedures are performed after the client has prepared financial statements, but before tests of details of balances are performed. Therefore, they should be done before confirmation of accounts payable to provide information about the expectation of misstatement. Confirmation of accounts payable should be done as early as possible after the balance sheet date to facilitate getting responses back, performing alternative procedures for nonresponses, and reconciling differences before the audit is completed.
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b.
?
Tests for review of subsequent events are normally the last
procedures done on the engagement before the audit report date. The audit report is issued after the audit report date.
The time line shows that 5, 9, 7 and 2 are frequently done before the balance sheet date.
The major deficiencies in the audit and the reasons for their occurrence are: 1.
The change in the accounting system to computerize the inventory, a change in accounting personnel, and the existence of a few more errors in the tests of controls should have alerted the auditors to expand the scope of the work. It was questionable to conclude that the internal controls were effective.
Reduction in the scope of the inventory work based on the lack of errors last year was improper since new internal controls were in use with new personnel this year and the inventory balance was higher.
The new division should have been audited more thoroughly. It came to Merkle through merger and was likely to have different operating characteristics and internal controls.
The determination that the errors in the sample were immaterial was improper. The errors should have been projected from the sample to the population, and the projected error should have been compared to tolerable misstatement, after considering risk. The obsolescence problem uncovered in the audit should have been evaluated carefully to consider the implications on potential obsolescence of inventory.
Given the new personnel on the engagement, Brewer apparently failed to adequately supervise and review the work of assistants.
There was an apparent lack of the use of analytical procedures. A decline in sales should have warned the auditor to a potential decline in profits and obsolete inventory.
Cases
13-36 a.
2.
3. 4.
5. 6.
13-23
b.
c.
Brewer should have been aware that the inventory internal controls and the personnel in that department were new, that the interim tests revealed more errors than normal, and that the inventory tests revealed more errors than normal despite the reduction in scope. In this situation, the scope of the inventory work should have been increased to reveal the magnitude of the problems encountered. In addition, because of the staff turnover on this engagement, Brewer should have devoted more of his time to supervising the work of the staff on this engagement.
The likelihood of Brewer losing the suit is high. The auditors appear not to have followed general standards 1 and 3 and standards of field work 1, 2, and 3 in the performance of the engagement. Although the misstatements result from fraud, the auditors may be held responsible because apparently the audit was not conducted in accordance with GAAS.
13-37 Part I
a. (1)
(2)
(3)
Assess acceptable audit risk. This would be done under both audit approaches.
Assess inherent risk. This would be done under both approaches.
Obtain an understanding of internal control. This would be done under both approaches, however, it may be more extensive where control risk is reduced below the maximum due to the knowledge gained through testing.
Assess control risk at less than 100%. This would be done only under the \control risk\approach, given that the client is a non-public entity.
Perform analytical procedures. This would be done under both approaches, although such procedures may be more extensive where control risk is reduced below the maximum. Assess planned detection risk. This would be done under both approaches.
(4)
(5) (6)
13-24
b.
The \1.
It should result in lower overall audit cost. This will occur where the client's business activity is complex and its volume of transactions is large. In this type of situation, internal controls can provide a great deal of assurance that many of the financial statement assertions are correct, and the audit effort to test those controls can be significantly less than full-scale substantive tests of balances would require.
For very large audits, it would be impossible to complete the audit on time and at an acceptable cost without relying on controls. Large clients are usually publicly held and must file their Form 10-K with the SEC within 60 days of their fiscal year end. These large companies generally have many locations, including worldwide operations. Controls must be relied upon to do these audits.
The more detailed investigation of controls that is required to reduce control risk, including testing, provides a better understanding of the system. This not only may provide a more concrete basis for conducting substantive tests, it creates more opportunities to make useful recommendations to the client.
Performance of detailed tests of transactions creates the opportunity to reveal employee defalcations that would otherwise not be discovered. In addition, employee knowledge that transactions will be examined serves as a deterrent to defalcation in the first place.
2.
3.
4.
c.
The primary advantage of the \approach is one of efficiency. Where clients are smaller, there is less opportunity to adequately segregate core duties, which makes it more difficult to rely on controls. Thus, the auditor focuses the audit work on the balance sheet as of the end of the client's fiscal year. Furthermore, by going into the client's office at one point in time and doing the entire audit, auditor scheduling problems are reduced and there is less disruption to the client.
13-25