Sullivan and Peters, CPAs have audited the financial statements of XYZ, Inc. as of December 31, 2014 and gave them a clean opinion on their financial statements.
Since XYZ is publicly traded, they also audited the firm's internal controls.
They identified material weaknesses related to the method of accounting for sales commissions and separation of duties related to purchasing transactions.
Sullivan and Peters was able to gather sufficient evidence and did not encounter any scope limitations. Review their draft audit report attached to the end of this exam and identify five deficiencies.
Group your deficiencies by paragraph in the report and provide a brief explanation of why you feel they were deficiencies.
PRQ's management identified a material weakness in the company's internal controls during its assessment process.
They corrected this weakness about a month prior to the end of the annual reporting period. Management reassessed controls in the area, and believes they were effective as of the end of the reporting period.
After reevaluating and retesting the relevant controls, you agree that the new controls are well designed, but since the controls over this particular area are applied only once at the end of each month (i.e., the controls have only operated two times since being corrected), you do not believe you have sufficient audit evidence to assess their operating effectiveness.
Management's written assessment concludes that the company's internal control was effective as of the report date. The transaction stream over which these controls operate process a relatively minor amount of money each year.
Assume that you are the partner in charge of the PRQ audit engagement. Explain all the modifications you would make to your audit report on internal controls and explain why you recommend the changes, if any. If you don't recommend any changes, explain why not.
Your audit of HIJ, Inc. followed the following time line of events:
HIJ's fiscal year ended 12/31/2013.
Event 1 - On 1/15/14 HIJ's management informed you that a major competitor had just introduced a new product that made a
substantial portion of their inventory obsolete and only resalable for a fraction of the cost shown on the balance sheet as of
12/31/13.
Event 2 - On 2/25/14 HIJ sold the line of business that produced that obsolete inventory items to another firm. The sale
represented approximately 25% of HIJ's product line.
You completed your fieldwork and dated you audit report as of 3/1/14.
HIJ distributed their financial statements and your report on 3/15/14.
Event 3 - HIJ's internal audit department contacted you to tell you that they had discovered massive fraud that their CFO had
perpetrated during 2013 that led to a material overstatement of the firm's accounts receivable and sales as of 12/31/2013.
These errors were clearly material to the financial statements taken as a whole.
Describe what actions you would need to take, if any, based on each of the three events. Be complete and describe any
changes you would require in HIJ's financial statements for 2013, your audit report for 2013, and any additional actions, if any,
required by GAAS. Also, justify your selections by stating why you would take them based on the type of each event.
Event 1 -
Event 2 -
Event 3 -
You are auditing a major consumer products manufacturer.
You are building your audit plan and trying to determine your approach to auditing their ending inventory balance as well as the long-term debt balance.
Their inventory consists of a large number of items that are similar in value. Your assessment of the design of internal controls over inventory recording and valuation is that these controls are well-designed and haven't changed since you audited them last year and found they were working properly.
However, you have not been able to retest the controls yet for this year
They only have three major bond issues that make up the long-term debt account balance and each bond issue contains complex provisions like conversion features and debt covenants.
Would you use a sampling technique to test their inventory balance and, if so, would you use statistical or non-statistical sampling? Explain your answer.
Would you use a sampling technique to test their long-term debt balance and, if so, would you use statistical or non-statistical sampling? Explain your answer.
You are auditing a firm's ending inventory balance. You got a complete listing of every item that made up the ending inventory balance.
At the same time that the client took its physical count of the items in ending inventory, you selected a sample of items from the listing and performed you own count of the number of that item in ending inventory. You then compared your count to the client's count and noted any differences in your working papers.
Then you obtained a listing of the costs assigned to each item of inventory in your sample and verified the cost to purchase invoices from the vendors.
Finally, you multiplied the number in your count by your costs and compared the resulting amount to a listing that the client had provided that included their totals for each item.
You traced the total of their listing to their general ledger account.
For each of the following tests you performed, describe the purpose of the test to include all the financial statement
assertion(s) involved.
Counting the items in inventory
Verifying the costs per item
Tracing the total to the general ledger
The total amount shown on the client's inventory listing you used for your tests did match their general ledger balance, but you
found differences in both the number of items in inventory and costs per items that totaled to more than your tolerable
misstatement. Discuss what alternatives you have to address this difference.
Describe one condition relevant to this example that might warrant using a non-statistical sampling technique and explain why non-statistical sampling would be appropriate under that condition.
For each of the following misstatements that might be found in a year-end account balances balance
state what PCAOB financial statement assertion was violated because of the error and why;
describe a control activity that might have prevented or detected the misstatement;
and a test of balance audit procedure that might detect it.
Make sure you answers are sufficiently detailed to be clear about how the error violated the assertion and how each internal
control or testing procedure would detect the error.
Assume in all cases that the Cash Management function in the Treasurer's
office of the firm involved prepares monthly bank reconciliations.
A check was omitted from the outstanding checklist on the year-end bank reconciliation. The check cleared a week after year-end.
Assertion(s) violated -
Internal control -
Test of balance -
Loan proceeds were credited directly to the firm's bank account four days before year-end. However, the loan was not shown as outstanding on the year-end financial statements and the cash proceeds from the loan were not included firm's ending cash balance.
Assertion(s) violated -
Internal control -
Test of balance -
Approximately 50% of the client's ending accounts receivables listed in their year-end accounts receivable balance had been factored without recourse. However, these accounts still showed in the firm's ending accounts receivable balance.
Note that in most factoring arrangement's, the customer is not notified that their account has been factored and the selling firm merely forwards receipts on factored accounts to the factoring company.
Assertion(s) violated -
Internal control -
Test of balance -
The ending accounts payable balance was materially understated because a significant number of individual balances due were excluded from the ending balance.
Assertion(s) violated -
Internal control -
Test of balance -
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Shareholders of XYZ, Inc.:
We have audited management's assessment, included in the accompanying Management's Report, on Internal Control over Financial Reporting, that XYZ, Inc. has not maintained effective internal control over financial reporting as of December 31, 2014, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO criteria). XYZ's management is responsible for assessing the effectiveness of internal control over financial reporting.
Our responsibility is to express an opinion on management's assessment and an opinion on the effectiveness of the company's internal control over financial reporting based on our audit.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States).
Those standards require that we plan and perform the auditor obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects.
Our audit included obtaining an understanding of internal control over financial reporting, evaluating management's assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.
A company's internal control over financial reporting includes those policies and procedures that
(1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and
dispositions of the assets of the company;
(2) provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted accounting principles and that receipts and
expenditures of the company are being made only in accordance with authorizations of management and directors of the
company; and
(3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or
disposition of the company's assets that could have a material effect on the financial statements.
Two material weaknesses were identified in the design and operation of internal controls over the accounting for sales
commissions and separation of duties related to purchases of inventory.
Given the nature of the transactions and processes involved and the potential for a misstatement to occur as a result of the
internal control deficiencies existing on December 31,2014, we have concluded that there is more than a remote likelihood that
a material misstatement in the annual or interim financial statements would not have been prevented or detected by internal
controls.
These material weaknesses were considered in determining the nature, timing, and extent of audit tests applied in our audit of
the 2014 financial statements.
In addition to the materiel weaknesses noted above, we identified several deficiencies in internal control over financial
reporting that we deemed to be less significant than a material weakness.
These deficiencies have been separately communicated to XYZ's management.
In our opinion, because XYZ has not maintained an effective internal control over financial reporting, we are unable to evaluate
management's assessment that XYZ did not maintain effective internal control over financial reporting as of December 31,
2014.
Also in our opinion, because of the effect of the material weaknesses described above on the achievement of the 'objectives of
the control criteria, XYZ has not maintained. in all material respects, effective internal control over financial reporting as of
December 31, 2014, based on the COSO criteria.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) the
balance sheets of XYZ as of December 31,2014 and 2011, and related statements of income, shareholders' equity, and cash
flow for each of the three years in the period ended December 31, 2014.
Sullivan and Peters, CPAs.
December 31, 2014