Assignment:
1. The following are examples of documentation typically obtained by auditors:
1. Duplicate sales invoices
2. Subsidiary accounts receivable records
3. Vendors' invoices
4. General ledgers
5. Title insurance policies for real estate
6. Notes receivable
7. Bank statements
8. Cancelled payroll checks
9. Cancelled notes payable
10. Payroll time cards
11. Purchase requisitions
12. Articles of incorporation
13. Receiving reports (documents prepared when merchandise is received)
14. Minutes of the board of directors
15. Signed W-4s (Employee's Withholding Exemption Certificates)
16. Remittance advices
17. Signed lease agreements
18. Duplicate copies of bills of lading
Required
a. Classify each of the preceding items according to type of documentation: (1) internal or (2) external.
b. Explain why external evidence is more reliable than internal evidence.
2. The following are nine situations, each containing two means of accumulating evidence:
1. Confirm receivables with consumers versus confirming accounts receivable with business organizations.
2. Physically examine 3-inch steel plates versus examining electronic parts.
3. Examine duplicate sales invoices when several competent people are checking each other's work versus examining documents prepared by a competent person on a one-person staff.
4. Physically examine inventory of parts for the number of units on hand versus examining them for the likelihood of inventory being obsolete.
5. Discuss the likelihood and amount of loss in a lawsuit against the client with client's in-house legal counsel versus discussion with the CPA firm's own legal counsel.
6. Confirm the oil and gas reserves with a geologist specializing in oil and gas versus confirming a bank balance.
7. Confirm a bank balance versus examining the client's bank statements.
8. Physically count the client's inventory held by an independent party versus confirming the count with an independent party.
9. Obtain a physical inventory count from the company president versus physically counting the client's inventory.
Required
a. Identify the six factors that determine the reliability of evidence.
b. For each of the nine situations, state whether the first or second type of evidence is more reliable.
c. For each situation, state which of the six factors affected the reliability of the evidence.
3. You have performed preliminary analytical procedures on one of your audit engagements and observed the following independent situations:
1. The allowance for obsolete inventory increased from the prior year, but the allowance as a percentage of inventory decreased from the prior year.
2. Long-term debt increased from the prior year, but total interest expense decreased as a percentage of long-term debt.
3. The dollar amount of operating income is consistent with the prior year, although the entity was more profitable on a net income basis.
4. The quick ratio decreased from the prior year, although the amount of cash and net accounts receivable is almost the same as the prior year.
Required
Below are possible explanations for each of the observed changes in the financial statement amounts and ratios. For each observed change, select the most likely explanation(s) from the list below.
Note: There may be more than one explanation for a given observed change, and an explanation can be used more than once.
a. Shipments of inventory sold prior to year end were included in the client's inventory counts as of the balance sheet date.
b. Selling and general administrative expenses were lower this year relative to last year.
c. Sales have decreased compared to the prior year, and the client is maintaining less inventory as a result.
d. Portions of existing long-term debt were refinanced at lower interest rates.
e. The effective tax rate decreased, as compared to the prior year.
f. The client purchased a large block of inventory on account close to year end.
g. Sales increased at a greater percentage than cost of goods sold, as compared to the prior year.
h. Client inventory items are off-site on consignment at retailers and are thus excluded from the year-end inventory counts.
i. Short-term borrowings were refinanced on a long-term basis at lower interest rates.
4. In the audit of the Worldwide Wholesale Company, you did extensive ratio and trend analysis as part of preliminary audit planning. Your analytical procedures identified the following:
1. Commission expense as a percent of sales was constant for several years but has increased significantly in the current year. Commission rates have not changed.
2. The rate of inventory turnover has steadily decreased for three years.
3. Inventory as a percent of current assets has steadily increased for four years.
4. The number of days' sales in accounts receivable has steadily increased for three years.
5. Allowance for uncollectible accounts as a percent of accounts receivable has steadily decreased for three years.
6. The absolute amounts of depreciation expense and depreciation expense as a percent of gross fixed assets are significantly smaller than in the preceding year.
Required
g. Evaluate the potential significance of each of the changes in ratios or trends identified in your analysis on the fair presentation of financial statements.
h. State the follow-up procedures you would perform for each fluctuation to determine whether a material misstatement exists.