1). Sammy Smith is the partner in charge of the audit of Blue Distributing Corporation, a wholesaler that owns one warehouse containing 80 percent of its inventory. Smith is reviewing the audit documentation that was prepared to support the firm's opinion on Blue's financial statements and wants to be certain that essential audit procedures are well documented. Referencing this week's lecture, respond to the following:
• What evidence should Smith expect to find indicating that the observation of the client's physical count of inventory was well planned and that assistants were properly supervised?
• What substantive procedures should Smith find in the audit documentation of management's balance assertions about existence and completeness of inventory quantities at the end of the year? Refer to Appendix 9B for the audit plan's procedures.
WEEK LECTURE:
We are already into Week 5 and will be studying Chapter 9 Production Cycle and Chapter 10 Finance and Investment Cycle. Chapter 9 is focused on inventory, which, much like last week with accounts receivable and payroll, is a key area that is ripe with fraud. Companies have tried to overstate inventory in an effort to make their assets higher and their balance sheet appear stronger. Our first discussion question this week will require us to examine inventory controls and how an auditor properly tests inventory.
The Public Company Accounting Oversight Board (PCAOB) website lists AU Section 331 which is the official standard for testing inventory,https://pcaobus.org/Standards/Auditing/Pages/AU331.aspx. There are many parts to review for inventory, starting with the procurement or purchase of the inventory. Then, there will be storage and, finally, sales and returns. There are some key internal controls that should be in place and our textbook highlights a few of these. Here is a more complete detailed list of basic controls, https://www.accountingtools.com/inventory-internal-controls. Once an auditor investigates and gains an understanding of the process and controls, the auditor then needs to perform substantive tests to validate the controls. Appendix 9B give examples of audit programs and testing that an auditor would consider. Additionally, here are some more detailed guidelines: https://accounting-financial-tax.com/2011/08/how-to-conduct-inventory-audit-guidelines/.
Chapter 10 Finance and Investment Cycle includes a number of topics including fair market value, lease accounting, related party transactions, and impairments. One of the biggest controversial areas in accounting currently is off balance sheet accounting. Examples of off balance sheet financing include joint ventures, research and development partnerships, and operating leases (rather than purchases of capital equipment). Operating leases are by far the most common among these. The asset itself is kept on the lessor's balance sheet, and the lessee reports only the required rental expense for use of the asset. Generally Accepted Accounting Principles (GAAP) have set numerous rules for companies to follow in determining whether a lease should be capitalized (included on the balance sheet) or expensed. Here is a nice summary of off balance sheet financing:
https://finance.yahoo.com/news/understanding-off-balance-sheet-financing-160000514.html;_ylt=AwrSbno0gptTPUQAwo1XNyoA;_ylu=X3oDMTEzNjU4NjkyBHNlYwNzcgRwb3MDOARjb2xvA2dxMQR2dGlkA1ZJUDQ1NF8x.
There are a number of advantages with off balance sheet accounting with the two main advantages being including increased borrowing capacity and more attractive looking financial statements and ratios. Here is a site that explains these and other advantages: https://www.ehow.com/info_8788309_advantages-offbalance-sheet-financing.html.
USING SAME LECTUREAS 1 FOR QUESTION 2 ALSO.
2). Union Pacific Corp. opened its new 19-story, $260 million headquarters in Omaha, Nebraska. The railroad operator is the owner of the city's largest building, the Union Pacific Center. Under an initial operating lease, Union Pacific guaranteed 89.9 percent of all construction costs through the building's completion date. After completing the building, the company signed a new operating lease, which guarantees 85 percent of the building's cost. Both were "synthetic " leases, which allows the company to take income tax deductions for interest and depreciation while maintaining complete operational control (Weil, 2004). Referencing this week's lecture, respond to the following:
• Explain why Union Pacific would want to structure the lease to be an operating lease.
• What audit evidence would you require for testing the appropriate accounting for this lease?
3). Read problem 11.56 Client Request for Attorney Letter on pages 491 and 492 of the textbook. Describe the omissions, ambiguities, and inappropriate statements and terminology in Brown's letter. Remember that this is Brown's letter requesting a response to auditors, but it must request responses in the manner most useful to auditors. Reference this week's lecture as a foundation for your post.
WEEK LECTURE:
We will be covering Chapter 11 Completing the Audit and Chapter 12 Reports on Audited Financial Statements. In Chapter 11, procedures performed during fieldwork are covered; examples include completing substantive procedures, attorney letters, ability to continue as a going concern, and financial statement disclosure. In accordance with Generally Accepted Accounting Principles (GAAP), all contingencies must be properly disclosed in the financial statements. A contingency is a situation where there is uncertainty as to the possible gain or loss that will be decided when one or more future events occur or fail to occur. There are many examples of contingencies including warranties, income tax disputes, guarantees of debt on behalf of another party, and lawsuits. Lawsuits are the most common and auditors need to first ensure they are aware of any client lawsuits and then ensure these are properly disclosed on the financial statements. There are some specific procedures that auditors should follow when dealing with potential lawsuits; these are listed at the bottom of page 466 and continue onto page 467 in our textbook. The auditor may need to send an attorney letter to ascertain specifics.
Our next chapter is a critical chapter as it covers the various audit reports and opinions. The audit report contains the auditor's opinion and is the final product from the auditor. There are four types of opinions: unmodified, qualified, adverse, and disclaimer. These are all discussed on page 507. As we have seen in studying our previous chapters, there is a lot of judgment that goes into auditing and forming the final opinion. This requires an auditor to step back and assess all that was found during the audit and come to final judgment on the opinion. There are different scenarios in giving audit opinion and we will discuss one situation in our second discussion question.
USING SAME LECTURE AS QUESTION 3 FOR 4 ALSO
4). Lando Corporation is a domestic company with two wholly-owned subsidiaries. Michael, CPA, has been engaged to audit the financial statements of the parent company and one of its subsidiaries and to serve as the group auditor. Thomas, CPA, has audited the financial statements of the other subsidiary whose operations are material in relation to the consolidated financial statements. The work performed by Michaels is sufficient for serving as the group auditor and to report as such on the financial statements. Michael has not yet decided whether to refer to the part of the audit performed by Thomas. Referencing this week's lecture, please answer the following:
• What responsibilities does Michael have with respect to Thomas when deciding whether to rely on the work of Thomas?
• What are the reporting requirements with which Michael must comply in naming Thomas and referring to the work done by Thomas?
• What report should be issued if Michael does not wish to assume responsibility for Thomas's work or refer to Thomas's work?