21-16: Items 1 through 8 are selected questions typically found in questionnaires used by auditors to obtain an understanding of internal control in the inventory and warehousing cycle. In using the questionnaire for a client, a “yes” response to a question indicates a possible internal control, whereas a “no” indicates a potential deficiency.
- Are all shipments to customers authorized by prenumbered shipping documents?
- Are standard cost records used for raw materials, direct labor, and manufacturing overhead?
- Is there a stated policy with specific criteria for writing off obsolete or slow-moving goods?
- Is a detailed perpetual inventory master file maintained for raw materials inventory?
- Are physical inventory counts made by someone other than storekeepers and those responsible for maintaining the perpetual inventory master file?
- Is the clerical accuracy of the final inventory compilation checked by a person independent of those responsible for preparing it?
- Does the receiving department prepare prenumbered receiving reports and account for the numbers periodically for all inventory received, showing the description and quantity of materials?
- Is all inventory stored under the control of an inventory custodian in areas where access is limited?
- For each of the preceding questions, state the purpose of the internal control.
- For each internal control, list a test of control to test its effectiveness.
- For each of the preceding questions, identify the nature of the potential financial misstatement(s) if the control is not in effect.
- For each of the potential misstatements in part c., list a substantive audit procedure to determine whether a material misstatement exists.
21-19: Following are audit procedures commonly performed in the inventory and warehousing cycle for a manufacturing company:
1. Read the client’s physical inventory instructions and observe whether they are being followed by those responsible for counting the inventory.
2. Use audit software to compute inventory turnover by major product line and compare it to turnover in the prior year.
3. Account for a sequence of inventory tags and trace each tag to the physical inventory to make sure it actually exists.
4. Compare the client’s count of physical inventory at an interim date with the perpetual inventory master file.
5. Trace the auditor’s test counts recorded in the audit files to the final inventory compilation and compare the tag number, description, and quantity.
6. Compare the unit price on the final inventory summary with vendors’ invoices.
7. Account for a sequence of raw material requisitions and examine each requisition for an authorized approval.
8. Trace the recorded additions on the finished goods perpetual inventory master file to the records for completed production.
a. Identify whether each of the procedures is primarily a test of control or a substantive test.
b. State the purpose(s) of each of the procedures.
21-27: In an annual audit at December 31, 2016, you find the following transactions near the closing date:
1. Merchandise costing $625 was received on December 28, 2016, and the invoice was not recorded. You located it in the hands of the purchasing agent; it was marked “on consignment.”
2. A packing case containing products costing $816 was standing in the shipping room when the physical inventory was taken. It was not included in the inventory because it was marked “Hold for shipping instructions.” Your investigation revealed that the customer’s order was dated December 18, 2016, but that the case was shipped and the customer billed on January 10, 2017. The product was a stock item of your client.
3. Merchandise received on January 3, 2017, costing $720 was entered in the acquisitions journal on January 4, 2017. The invoice showed shipment was made FOB supplier’s warehouse on December 31, 2016. Because it was not on hand December 31, it was not included in inventory.
4. Merchandise costing $1,822 was received on January 3, 2017, and the related acquisition invoice recorded January 5. The invoice showed the shipment was made on December 29, 2016, FOB destination.
5. A special machine, fabricated to order for a customer, was finished and in the shipping room on December 31, 2016. The customer was billed on that date and the machine excluded from inventory, although it was shipped on January 4, 2017.
Assume that each of the amounts is material.
a. State whether the merchandise should be included in the client’s inventory.
b. Give your reason for your decision on each item.*
*Based on AICPA question paper, American Institute of Certified Public Accountants.
24-24: In analyzing legal expense for the Boastman Bottle Company, Mary Little, CPA, observes that the company has paid legal fees to three different law firms during the current year. In accordance with her CPA firm’s normal operating practice, Little requests standard attorney letters as of the balance sheet date from each of the three law firms.
On the last day of field work, Little notes that one of the attorney letters has not yet been received. The second letter contains a statement to the effect that the law firm deals exclusively in registering patents and refuses to comment on any lawsuits or other legal affairs of the client. The third attorney’s letter states that there is an outstanding unpaid bill due from the client and recognizes the existence of a potentially material lawsuit against the client but refuses to comment further to protect the legal rights of the client.
a. Evaluate Little’s approach to sending the attorney letters and her follow-up on the responses.
b. What should Little do about each of the letters?
24-26: Callie Peters is completing the audit of MakingNewFriends.com for the year ended December 31, 2016. Callie has been the audit manager on this engagement for the past three years. MakingNewFriends.com issued stock two years ago, but has had difficulty establishing a loyal client base and generating advertising revenues. In reviewing results for the current year, Callie noted the client has had operating losses for the past three years, and its working capital ratio has declined from 1.2 in 2015 to 0.9 in 2016. Callie discussed plans for the future with the management of MakingNewFriends.com, and they indicated they are planning on obtaining debt financing in fiscal 2017; however, they have not yet secured the financing with a bank. Management also indicated they are aggressively pursuing new advertising contracts and plan to increase advertising revenues by 20% in 2017.
a. According to auditing standards, what is the auditor’s obligation to consider whether the client can continue as a going concern?
b. Over what time period is the auditor required to consider the client’s ability to continue as a going concern?
c. What factors discussed above are relevant for a going-concern assessment for MakingNewFriends.com? What additional information might the auditor consider in the going-concern assessment?
d. What responsibility does the auditor have to evaluate whether management’s plans will be effective?
24-27: As a part of the audit of Ren Gold Manufacturing Company, a nonpublic company, management requests basic financial statements and separately, the same basic financial statements accompanied by additional information. Management informs you that the intent is to use the basic financial statements for bankers, other creditors, and the two owners who are not involved in management. The basic financial statements accompanied by the additional information are to be used only by management. Management requests the inclusion of specific information but asks that no audit work be done beyond what is needed for the basic financial statements. The following is requested:
1. A schedule of insurance in force.
2. The auditor’s feelings about the adequacy of the insurance coverage.
3. An aged trial balance of accounts receivable and evaluation of the adequacy of the allowance for uncollectible accounts.
4. A summary of fixed asset additions.
5. Material weaknesses in internal control and recommendations to improve internal control.
6. A 5-year summary of the most important company ratios, with the appropriate ratios to be determined at the auditor’s discretion.
7. A schedule of notes payable accompanied by interest rates, collateral, and a payment schedule.
a. What is the difference between basic financial statements and additional information?
b. What are the purposes of additional information accompanying basic financial statements?
c. For the previously listed items (1 through 7), state which ones could appropriately be included as additional information. Give reasons for your answer.
d. Assume that an unmodified opinion is appropriate for the basic financial statements report, that no testing was done beyond that required for the basic financial statements report, and that only appropriate information is included in the additional information. Write the proper auditor’s report.