QUESTION 1
You are an audit supervisor of Ahmad Anwar Associates and are currently planning the audit of your client, Diamond Co (Diamond), which manufactures elevators. Its year-end is 31 July 2016 and the forecast profit before tax is $15•2 million. The company undertakes continuous production in its factory, therefore at the year-end it is anticipated that work in progress will be approximately $950,000. In order to improve the manufacturing process, Diamond placed an order in April for $720,000 of new plant and machinery; one third of this order was received in May with the remaining expected to be delivered by the supplier in late July or early August. At the beginning of the year, Diamond purchased a patent for $1•3 million, which gives them the exclusive right to manufacture specialized elevator equipment for five years. In order to finance this purchase, Diamond borrowed $1•2 million from the bank, which is repayable over five years. In January 2016 Diamond outsourced its payroll processing to an external service organization, Dove Payrolls Co (Dove). Dove handles all elements of the payroll cycle and sends monthly reports to Diamond detailing the payroll costs. Diamond ran its own payroll until 31 December 2015, at which point the records were transferred over to Dove. The company has a policy of revaluing land and buildings and the finance director has announced that all land and buildings will be revalued at the year-end. During a review of the management accounts for the month of May 2016, you have noticed that receivables have increased significantly on the previous year-end and against May 2015. The finance director has informed you that the company is planning to make approximately 65 employees redundant after the year- end. No decision has been made as to when this will be announced, but it is likely to be prior to the year-end.
Required:
a. Define audit risk and explain the components of audit risk.
b. Describe SIX audit risks, and explain the auditor's response to each risk, in planning the audit of Diamond Co.
c. Explain the additional factors Ahmad Anwar Associates should consider during the audit in relation to Diamond Co's use of the payroll service organization.
QUESTION 2
Most grocery stores use bar code scanning technologies that interface with cash registers used to process customer purchases. Cashiers use the scanners to read bar code labels attached to each product, which the system then uses to obtain unit prices, calculate transaction totals, including sales taxes, and update perpetual inventory databases. Similarly, cashiers scan bar codes on coupon or member discount cards presented by the customer to process discounts. Along with the scanning technologies, groceries use point-of-sale technologies that allow customers to swipe debit and credit cards for payment, while still maintaining the ability for customers to pay with cash.
Required:
a. Which financial statement accounts are impacted by the use of these technologies in a typical grocery store?
b. Identify risks inherent to this business process in a grocery store that might affect the financial statement accounts identified in part a. For each risk, describe how these technologies help reduce the inherent risk.
c. How does the use of these technologies create new risks for a grocery store?
d. How might an auditor use technology to test the operating effectiveness of a bar code scanner based check-out system?
QUESTION 3
Auditing standards require the auditor to obtain an understanding of the entity and its environment as a basis for assessing the risks of material misstatements. Business models differ across organizations and industries leading to unique business processes needed to account for transactions. While the core business functions for the sales and collection cycle are generally relevant to all organizations, the underlying business processes and related documents and records are often unique to each organization. Below are four descriptions of different businesses.
1. The majority of universities generate a significant portion of their revenue from tuition. Universities bill students in advance for classes that will be taken in an upcoming term. For full time students most universities charge a set tuition amount after students enroll in a minimum number of courses per term.
2. The Aroma Coffee sells regular and specialty coffees and teas in over 15000 stores spanning more than 50 countries. Customers use cash, debit or credit cards and pre-paid Aroma cards to purchase individual drinks that are served to them within minutes.
3. Most people have a personal physician who provides medical care when needed, including annual physicals and other medical services. Patients make appointments to be seen by their physician, who examines the patient and prescribes treatments and medications when needed. Insured patients often pay a co-payment with the balance paid by the insurance company.
4. Buku.com is one of the world's largest online retailers of all kinds of products. While consumers can find a wide variety of products available at Buku.com, the company is known for its huge selection of new and used books that can be purchased on its Web site.
Required:
Analyze each of the above independent business scenarios to answer each of the following questions:
a) Using the eight business functions for the sales and collection cycle, briefly describe the underlying business processes related to each of the eight functions for the above independent scenarios.
b) What documents or other source evidence would you use to test the occurrence transaction-related audit objective for sales for each of the four scenarios?
c) For which of the four scenarios would the sales returns and allowances business function not be applicable?
d) For which of the four scenarios would the write-off of uncollectible accounts and bad debt expense business functions not be applicable?