Case solutions_Lesson 3
Case 1
b. c.
GENERAL
TRANSACTION-
SPECIFIC TRANSACTION- MANAGEMENT RELATED AUDIT
RELATED AUDIT OBJECTIVE ASSERTION OBJECTIVE
a. Existing cash disbursement 2. Completeness 7. Completeness
transactions are recorded.
b. Recorded cash disbursement 3. Accuracy 8. Accuracy
transactions are for the amount of
goods or services received and
are correctly recorded.
c. Cash disbursement transactions 3. Accuracy 9. Posting and
are properly included in the summarization
accounts payable master file and
are correctly summarized.
d. Recorded cash disbursements 1. Occurrence 6. Occurrence
are for goods and services
actually received.
e. Cash disbursement transactions 4. Classification 10. Classification
are properly classified.
f. Cash disbursement transactions 5. Cutoff 11. Timing
are recorded on the correct dates.
Case 4
Kashir Advertising Credits – An insufficient number of confirmations (eight) were sent.
The use of alternative procedures is probably acceptable. However, one credit was
confirmed by telephone rather than by written confirmation. Although the differences
found were immaterial, the auditors should have determined the reason for the
differences and projected any errors to the population. Also, only six confirmations were
received in return and the other two were not followed up on. Thirty additional credits
were selected for testing. Whether this is a sufficient number is a matter of judgment and
depends on several factors. With a fairly small sample, it is critical that the items
selected for testing adequately represent the population. The testing relied solely on
internal documentation, which is insufficient to support the credits. The placing of the ad
is insufficient evidence without supporting evidence from the vendor confirming the
reduction in accounts payable.
Nashwa Credits – These credits were confirmed by telephone and were not supported
by a written confirmation. The staff auditor was suspicious of the client’s unwillingness to
allow written confirmation of the amounts as well as the client’s changing explanation of
the nature of the credits, but did not perform additional testing to resolve any doubts
about the validity of the credits.
Zaki Credits – The auditor obtained an oral confirmation that these credits were not
valid. The client indicated that the auditor's information was incorrect but would not allow
the auditor to obtain written confirmation for these credits. In addition, the credit memos
had been altered, which should have further indicated to the auditor that the credits were
not valid.
Accounts Payable Accrual – The auditors sent 50 accounts payable confirmations.
Whether this is a sufficient number of confirmations is a matter of judgment. However,
the adequacy of the confirmations as evidence is significantly undermined by the
knowledge that the client told his suppliers how to respond. As a result, the auditor
should have verified the confirmed balances using alternative procedures. There was no
discussion of the performance of alternative procedures for non-responses or resolution
of the six responses that were not reconciled to Grande’s records. There was no action
on the $290,000 unrecorded liability found through extrapolating confirm testing. The
auditors agreed to an adjustment of $260,000 when their cutoff tests indicated a
potential liability of $500,000 for cutoff and $290,000 for confirms. It would be
appropriate for the auditors to agree to a lower amount only if additional testing
supported a lower accrued liability.
Case 3
a. The company’s ability to pay its bills is marginal (quick ratio = 0.97), and its ability to generate
cash is weak (days to convert inventory to cash = 266.7 in 2016 versus 173.8 in
2012). The earnings per share figure is misleading because it appears stable
while the ratio of net income to common equity has been halved in two years. The
accounts receivable may contain a significant amount of uncollectible accounts
(accounts receivable turnover reduced 25% in four years), and the inventory may
have a significant amount of unsalable goods included therein (inventory turnover
reduced 40% in four years). The company’s burden for increased inventory and
accounts receivable levels has required additional borrowings. The company may
experience problems in paying its operating liabilities and required debt
repayments in the near future.
b. Based on the ratios shown, the following aspects of the company should receive special
emphasis in the audit:
1. Ability of the company to continue to acquire inventory, replace obsolete or
worn-out fixed assets, and meet its debt obligations based on its current
cash position.
2. Reasonableness of the allowance for uncollectible accounts based on the
reduction in accounts receivable turnover and increase in days to collect
receivables.
3. Reasonableness of the inventory valuation based on the decreased
inventory turnover and increased days to sell inventory.
4. Computation of the earnings per share figure. It appears inconsistent
that earnings per share could remain relatively stable when net earnings
divided by common equity has decreased by 50%. This could be due
to additional stock offerings during the period, or a stock split.
