Problem 1:
Assume that you are auditing the financial statements of Agee Corporation. During the course of the audit, you discover the following circumstances.
1. Management of Agee has decided to discontinue the production of consumer electronics, which represents a moderately large line of business for the company.
2. In auditing facility rent expense, you note that the amount is about 30 percent less than in the prior year. When you discuss the matter with management, you are informed that the company previously had leased the building on a 12-month lease. However, the company entered into a 10-year building lease agreement at the beginning of the year (about nine months ago), which provided for no lease payments for the first 4 months of the lease. Therefore, rent expense was less than for the prior year.
3. Management has provided you with the following information about a test of impairment of the company's clothing and apparel reporting unit and a large piece of equipment used in the consumer products division of the company. The Clothing and Apparel reporting unit has $1,200,000 in goodwill associated with it.
Clothing and Apparel Reporting Unit
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Carrying value of the unit
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$12,600,000
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Discounted value of estimated future cash flows
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12,200,000
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Market value of the unit
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11,500,000
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Equipment
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Carrying value of the equipment
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$1,200,000
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Undiscounted estimated future cash flows
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1,250,000
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Discounted value of estimated future cash flows
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1,000,000
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Market value of the equipment
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975,000
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Required:
Describe the implications of each of these circumstances, including any additional information or evidence that the auditors might require to resolve the issues identified.
Problem 2:
The following are typical questions that might appear on an internal control questionnaire relating to plant and equipment:
1. Has a dollar minimum been established for expenditures to be capitalized?
2. Are subsidiary ledgers for plant and equipment regularly reconciled with general ledger controlling accounts?
A) State the purpose of each of the above controls.
B) Describe the manner in which each of the above procedures might be tested.
C) Assuming that the operating effectiveness of each of the above procedures is found to be inadequate, describe how the auditors might alter their substantive procedures to compensate for the increased level of risks of material misstatements.
Problem 3:
The auditors of SSC Company, a nonpublic company, are working on both audit objectives for the various accounts.
The auditors have established the objectives listed below as a part of the audit. For each objective, select a substantive procedure (from the list of substantive procedures) that will help achieve that objective. Each of the procedures may be used once, more than once, or not at all.
Audit Objectives
a Determine the existence of year-end recorded accounts payable and that the client has obligations to pay these liabilities.
b Establish the completeness of recorded accounts payable.
c Determine that the presentation and disclosure of accounts payable are appropriate.
d Determine that the valuation of warranty loss reserves is measured in accordance with GAAP.
Substantive Procedures
1. Obtain a trial balance of payables and reconcile with the accounts payable subsidiary ledger.
2. Vouch sales from throughout the year.
3. Vouch purchases recorded after year-end.
4. Vouch sales recorded shortly before year-end.
5. Vouch major warranty expenses paid during 20X8.
6. Inquire of management concerning the existence of related party transactions.
7. Test the computations made by the client to set up the accrual.
8. Test the reasonableness of general and administrative labor rates.
9. Confirm outstanding year-end balances of payables.
10. Confirm warranty expenses payable as of year-end.
Problem 4:
The following are typical questions that might appear on an internal control questionnaire for accounts payable.
1. Are monthly statements from vendors reconciled with the accounts payable listing?
2. Are vendors' invoices matched with receiving reports before they are approved for payment?
A) Describe the purpose of each of the above internal control activities.
B) Describe the manner in which each of the above procedures might be tested.
C) Assuming that the operating effectiveness of each of the above procedures is found to be inadequate, describe how the auditors might alter their substantive procedures to compensate for the increased level of the risk of material misstatement.
Problem 5:
Review the flowchart in Problem 14-34 (page 628 of the text) which depicts the activities relating to the purchasing, receiving, and accounts payable departments of Model Company, Inc. Assume that you are a supervising assistant assigned to the Model Company audit.
Joe Werell, a beginning assistant, analyzed the flowchart and has supplemented the flowchart by making certain inquiries of the controller. He has concluded that the internal control over purchasing, receiving, and accounts payable is strong and has provided the following list of what he refers to as internal control strengths. Review his list and for each internal control strength indicate whether you agree or disagree that each represents a strength. For those in which you disagree, briefly explain why.
Internal Control Strengths Prepared by Joe Werell
Purchasing
1. The department head of the requisitioning department selects the appropriate supplier.
2. Proper authorization of requisitions by department head is required before purchase orders are prepared.
3. Purchasing department makes certain that a low-cost supplier is always chosen.
4. Purchasing department assures that requisitions are within budget limits before purchase orders are prepared.
5. The adequacy of each vendor's past record as a supplier is verified.
Receiving:
6. Secure facilities limit access to the goods during the receiving activity.
7. Receiving department compares its count of the quantity of goods received with that listed on its copy of the purchase order.
8. A receiving report is required for all purchases, including purchases of services.
9. The requisitioning department head independently verifies the quantity and quality of the goods received.
10. Requisitions, purchase orders, and receiving reports are matched with vendor invoices as to quantity and price.
Accounts Payable
11. Accounts payable department personnel recompute the mathematical accuracy of each invoice.
12. The voucher register is independently reconciled to the control accounts monthly by the originators of the related vouchers.
13. All supporting documentation is marked "paid" by accounts payable immediately prior to making it available to the treasurer.
14. All supporting documentation is required for payment and is made available to the treasurer.
15. The purchasing, receiving, and accounts payable functions are segregated.
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