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MODULE 3

EVIDENCE

2' 75

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Problem I

(15 to 25 minutes)

Kane,CPA, is auditingStar Wholesaling Company's

financial statementsand is aboutto perform substantive

auditprocedures on Star'strade accounts payable balances.

After obtainingan understandingof Star's internal control

for accountspayable, Kane assessedcontrol risk at nearthe

maximum. Kane requestedand receivedfrom Star a sched-

ule of the tradeaccounts payable prepared using the trade

accountspayable subsidiary ledger (voucherregister).

Required:

Describethe substantiveaudit procedures Kane should

apply to Star's tradeaccounts payable balances. Do not

includeprocedures that would be appliedonly in the audit

of related-partypayables, amounts withheld from employ-

ees,and accrued expenses such as pensions and interest.

,[,oarc^z

(15 to 25 minutes)

Larkin,CPA, hasbeen engaged to auditthe financial

statementsof VernonDistributors, Inc., a continuingaudit

client,for the yearended September 30, 200L After ob-

tainingan understandingofVernon's internalcontrol,

Larkin assessedcontrol risk at the maximumlevel for all

financialstatement assertions conceming investments'

Larkin determinedthat Vernonis unableto exercisesignifi-

cantinfluence over any investeeand none are related parties.

Larkin obtainedfrom Vernondetailed analyses of its

investmentsin domesticsecurities showing:

.

The classificationbetween culrent and noncurrent

portfolios;

.

A descriptionofeach security,including the inter-

estrate and maturity date of bondsand par valueand divi-

dendrate on stocks;

.

A notationofthe locationofeach security,either

in theTreasurer's safe or held by an independentcustodian;

.

The

numberof sharesof stock or face amountof

bondsheld at thebeginning and end of theyear;

.

The beginningand ending balances at costand at

market,and the unamortized premiumor discounton bonds;

.

Additions to and salesfrom the portfolios for the

year,including date, number of shares,face amount of

bonds,cost, proceeds, and realized gain or loss;

.

Valuationallowances at the beginningand end of

theyear and changes therein:

.

Accruedinvestment income for eachinvestment at

thebeginning and end of the year,and income eamed and

collectedduring the year.

Larkin then preparedthe following partial audit pro-

gram of substantiveauditing procedures:

  • l. Footand crossfoot the analyses.

  • 2. Tracethe endingtotals to the generalledger and finan- cial statements.

  • 3. Tracethe beginningbalances to the prior year's work- ing papers.

  • 4. Obtain positive confirmationas of the balancesheet dateof the investmentsheld by any independentcusto- dian.

  • 5. Determinethat incomefrom investmentshas been prop- erly recordedas accruedor collectedby referenceto publishedsources, by computation,and by tracingto recordedamounts.

  • 6. For investmentsin nonpublicentities, compare carrying valueto informationin themost recently available au- ditedfinancial statements.

  • 7. Determinethat all transfersbetween the currentand noncurrentportfolios havebeen properly authorized and recorded.

  • 8. Determinethat any other-than-temporarydecline in the priceof an investmenthas been properly recorded.

Required:

  • a. Identifythe primary financial statement assertion rela-

tive to investmentsthat would be addressedby eachof the

procedures#4 through#8 anddescribe the primary audit

objectiveof performingthat procedure. Use the formatil-

lustratedbelow.

  • b. Describethree additional substantive auditing proce-

duresLarkin shouldconsider in auditingVernon's invest-

ments.

,,[,,o*^,

(15to 25 minutes)

Young,CPA, is consideringthe procedures to be ap-

pliedconcerning a client'sloss contingencies relating to

litigation,claims, and assessments.

Required:

What substantiveaudit procedures should Young apply

whentesting for losscontingencies relating to litigation,

claims,and assessments?

1[,oo*^o

(15to 25 minutes)

Edwards,CPA, is engagedto auditthe financialstate-

mentsof MatthewsWholesaling for the yearended Decem-

ber 31, 2001. Edwardsobtained and documented an under-

standingof internalcontrol relating to the accountsreceiv-

ableand assessed control risk relatingto accountsreceivable

at the maximumlevel. Edwardsrequested and obtained

from Matthewsan agedaccounts receivable schedule listing

thetotal amountowed by eachcustomer as of December31'

2001,and sent positive confirmation requests to a sampleof

the customers.

Required:

What additionalsubstantive audit proceduresshould

Edwardsconsider applying in auditingthe accountsreceiv-

able?

276

MODULE 3

EVIDENCE

Problem5

(15 to 25 minutes)

Analyticalprocedures consist of evaluationsof finan-

cial informationmade by a studyof plausiblerelationships

amongboth financialand nonfinancial data. They range

from simplecomparisons to theuse of complexmodels in-

volving manyrelationships and elements of data. They in-

volvecomparisons of recordedamounts, or ratiosdeveloped

from recordedamounts, to expectationsdeveloped by the

auditors.

Required:

  • a. Describethe broad purposes ofanalytical procedures.

  • b. Identifythe sourcesof informationfrom which an audi-

tor developsexpectations.

  • c. Describethe factorsthat influence an auditor'sconsid-

erationof thereliability of datafor purposesof achieving

auditobiectives.

,/,,o*^u

(15 to 25 minutes)

Bell, CPA, wasengaged to auditthe financial state-

mentsof KentCompany, a continuingaudit client. Bell is

aboutto auditKent's payroll transactions. Kent usesan in-

housepayroll department to computepayroll data and pre-

pareand distribute payroll checks.

Duringthe planning process, Bell determinedthat the

inherentrisk of overstatement of payrollexpense is high. In

addition,Bell obtainedan understandingof internalcontrol

andassessed control risk at the maximumlevel for payroll-

relatedassertions.

Required:

Describethe audit procedures Bell shouldconsider per-

formingin the auditof Kent'spayroll transactions to ad-

dressthe risk of overstatement.Do not discussKent's in-

ternalcontrol.

Problem 7 appearson thefollowing page.

Problem E

(15 to 25 minutes)

Green,CPA, is auditingthe financialstatements of

TaylorCorporation for the yearended December 31, 2001.

Greenplans to completethe fieldwork and sign the auditor's

report aboutMay 10, 2002. Greenis concernedabout

eventsand transactions occurring after December 31, 2001,

that may affect the 2002 financial statements.

Required:

  • a. What arethe generaltypes of

subsequentevents that

requireGreen' s considerationand evaluation?

  • b. What arethe auditing proceduresGreen should con-

siderperforming to gatherevidence concerning subsequent

events?

Problem 9

(15to 25 minutes)

Cole & Cole,CPAs, are auditing the financial state-

mentsof ConsolidatedIndustries Co. for the yearended

December31, 2001. On April 2,2002, an inquiry letterto J.

  • J. Young,Consolidated's outside attorney, was drafted to

corroboratethe informationfurnished to Cole by manage-

mentconcerning pendingand threatened litigation, claims,

andassessments, and unasserted claims and assessments'

On May 6,2002, C. R. Brown,Consolidated's Chief Finan-

cial Officer,gave Cole a draftofthe inquiry letterbelow for

Cole'sreview before mailing it to Young.

Required:

Describethe omissions,ambiguities, and inappropriate

statementsand terminology in Brown's letterbelow.

  • J. J. Young.Attorney at Law

123Main Street

Anytown,USA

DearJ.J. Young:

In connectionwith an auditof our flnancialstatements

at December3 I , 200| , andfor the yearthen ended, man-

agementof theCompany has prepared, and fumished to our

auditors,Cole & Cole,CPAs,456 Broadway, Anytown,

USA, a descriptionand evaluation of certaincontingencies,

includingthose set forth below involvingmatters with re-

spectto which you havebeen engaged and to which you

havedevoted substantive attention on behalfof the Com-

panyin the form of legalconsultation or representation.

Your responseshould include matters that existed at De-

cember3 I , 200I . Becauseof theconfidentiality of all these

matters,your responsemay be limited.

In November2001, an actionwas brought against the

Companyby an outsidesalesman alleging breach of con-

tractfor salescommissions and pleading a secondcause of

actionfor an accountingwith respectto claimsfor feesand

commissions.The causesof actionclaim damagesof

$300,000,but the Companybelieves it hasmeritorious de-

fensesto the claims. The possibleexposure of the Company

to a successfut judgment on behalfof theplaintiff is slight.

In July 199'7,an actionwas brought against the Cont-

panyby IndustrialManufacturing Co. (Industrial)alleging

patentinfringement and seeking damages of $20,000,000.

The actionin US DistrictCourt resulted in a decisionon

October16,2001, holding that the Companyinfringed

sevenIndustrial patents and awarded damages of

$14,000,000. The Companyvigorously denies these alle-

gationsand has filed an appealwith the US Courtof Ap-

pealsfor the FederalCircuit. The appealprocess is ex-

pectedto take approximatelytwo years,but thereis some

chancethat Industrialmay ultimatelyprevail.

Pleasefurnish to our auditorssuch explanation, if any,

thatyou considernecessary to supplementthe foregoing

information,including

an explanationof thosematters as to

which your views may differ from thosestated and an iden-

tification of the omissionof any pendingor threatenedliti-

gation,claims, and assessments or a statementthat the list of

suchmatters is complete.Your responsemay be quotedor

referredto in the financial statementswithout further corre-

spondencewith you.

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262

MODULE 3

EVIDENCE

OTHEROBJECTIVEOUESTIONS

.

Problem

I

[/( T

'

(15 to 25 minures)

In obtainingevidential matter in supportoffinancial statementassertions, the auditordevelops specific audit objectives in

light ofthoseassertions. Audit proceduresare then selected to accomplishaudit objectives.

Required:

Your clientis Hillmart,a retaildepartment store that does no production.For eachspecific inventory audit objective listed

below selectthe mostclosely related financial statement assertion and the mostappropriate audit procedure. Financial state-

mentassertions and audit procedures may be selectedonce, more than once, or not at all.

F inancial statement as se rtion

  • A. Completeness

  • B. Existenceor Occurrence

  • C. Presentationand Disclosure

  • D. Rightsand Obligations

  • E. Valuationor Allocation

Specificaudit obiective

  • 1. The entityhas legal title to inventories.

  • 2. Recordedinventory quantities include all productson hand.

  • 3. Inventoriesare reduced, when appropriate, to replacement costor netrealizable value.

  • 4. Costof inventoriesis properlycalculated.

  • 5. The

majorcategories of inventoriesand their basis of valua-

tion areadequately reported in thefinancial statements.

Audit procedure

  • F. Examinecurrent vendors' price lists.

  • G. Reviewdrafts of thefinancial statements.

  • H. Selecta sampleof itemsduring the physical inventory count and determine thatthey havebeen included on countsheets.

    • L Selecta sampleof recordeditems and examine supporting vendors' invoices andcontracts.

  • J. Selecta sampleofrecorded items on countsheets during the physical inven-

Problem 2

tory countand determine that itemsare on hand.

  • K. Testreasonableness of direct labor rates.

(15to 25 minutes)

To supportfinancial statement assertions, an auditordevelops specific audit objectives. The auditorthen designs substan-

tive teststo satisfyor accomplisheach objective.

Required:

Items I through 10 representaudit objectives for

the investments,accounts receivable, and property and equipment ac-

counts.To theright of eachset of auditobjectives is a listingof possibleaudit procedures for thataccount. For eachaudit ob-

jective, selectthe auditprocedure that would primarilyrespond to the objective.Select only oneprocedure for eachaudit ob-

jective.

A proceduremay be selectedonly once,or not at all.

Items to be answered

Audit obiectives Jbr investments

  • l. Investmentsare properly described and classified in

)

thefinancial statements.

Recordedinvestments represent investments actually

ownedat thebalance sheet date.

  • 3. Trading investmentsare properly valuedat fair market valueat thebalance sheet date.

Audit n roc e dure s .fo r inve stment s

Traceopening balances in the subsidiaryledger to

prior year'saudit working papers.

Determinethat employees who areauthorized to sell

investmentsdo not haveaccess to cash.

Examinesupporting documents for a sampleof invest-

ment transactionsto verifv that orenumbereddocu-

mentsare used.

Determinethat any impairmentsin theprice of invest-

mentshave been properly recorded.

Verify that transfersfrom the currentto the noncurrent

investmentportfolio havebeen properly recorded.

Obtainpositive confirmations as of thebalance sheet

dateof investmentsheld by independentcustodians.

Traceinvestment transactions to minutesof theBoard

of Directorsmeetings to determinethat transactions

wereproperly authorized.

MODALE 3

EVIDENCE

263

Audit objectivesfor accountsreceivable

  • 4. Accountsreceivable represent all amountsowed to the entityat the balancesheet date. The entity haslegal right to all accountsreceivable at the balancesheet date.

  • 6. Accountsreceivable are stated at netrealizable value. Accountsreceivable are properly describedand pre- sentedin thefinancial statements.

Audit obiectives.for propertv & equipment

  • 8. The entityhas legal right to propertyand equipment acquiredduring the year.

  • 9. Recordedproperty and equipment represent assets that actuallyexist at thebalance sheet date.

  • 10. Net propertyand equipment are properly valued at the balancesheet date.

Audit Droceduresfor accountsreceivable

  • A. Analyze the relationshipof accountsreceivable and salesand compare it with relationshipsfor preceding periods.

  • B. Performsales cutoff teststo obtain assurancethat sales transactionsand corresponding entries for inventories andcost ofgoods soldare recorded in the sameand properperiod.

  • C. Reviewthe agedtrial balancefor significantpast due accounts.

  • D. Obtainan understandingofthe businesspurpose of transactionsthat resulted in accountsreceivable bal- ances.

  • E. Reviewloan agreementsfor indicationsof whether accountsreceivable have been factored or pledged.

  • F. Reviewthe accountsreceivable trial balancefbr amountsdue from officersand employees.

  • G. Analyzeunusual relationships between monthly ac- countsreceivable balances and monthly accounts pay- ablebalances.

Audit procedures for propert! & eauipment

Traceopening balances in the summaryschedules to

the prior year'saudit working papers.

Reviewthe provisionfor depreciationexpense and

determinethat depreciable lives and methods used in

thecurrent yearare consistent with thoseused in the

prior year.

  • C. Determinethat the responsibility for maintainingthe propertyand equipmentrecords is segregatedfrom the responsibilityfbr custodyof propertyand equipment.

  • D. Examinedeeds and title insurancecertificates.

  • E. Performcutofftests to verify that propertyand equip- mentadditions are recorded in the properperiod.

  • F. Determinethat property and equipment is adequately insured.

  • G. Physicallyexamine all majorproperty and equipment additions.

Problem 3

(15 to 25 minutes)

Analyticalprocedures are an importantpart ofthe auditprocess. They consistofevaluations offinancial informationmade

by a studyof plausiblerelationships among both financialand nonfinancial data. Analyticalprocedures may be performed

duringplanning, as a substantivetest, or asa partofthe overallreview ofan audit'

 

Required:

For items I through 10, selectthe stageof the auditfor which the statementis mostaccurate using the following replies:

A.

Planningthe audit.

B.

Substantivetesting.

C.

Overallreview.

D.

Statementis not correctconcerning analytical procedures.

Each responsemay be selectedonce, more than once,or not at all.

Items to be answeredconcerning analyticalprocedures

  • 1. Not requiredto be performedduring this stage.

  • 2. Shouldfocus on enhancingthe auditor'sunderstanding ofthe client'sbusiness and the transactionsand events that have occurredsince the lastaudit date.

MODULE

3

EVIDENCE

Statements, questions, excerpts,and comments

269

  • 11. We haveno plans or intentionsthat may materiallyaffect the canying value or classificationof assetsand liabilities.

  • 12. As discussedin Note 14to the financialstatements, the Companyhas had numerousdealings with businessescontrolled by, andpeople who arerelated to, the officersof the Company.

  • 13. There were

unreasonabledelays by managementin permitting the commence-

mentof the auditand in providingneeded information.

  • 14. If this statementis not correct,please write promptly,using the enclosed enve- lope,and give detailsof anydifferences directly to our auditors.

  • 15. The Companyhas suff'ered recurring losses from operationsand has a net capitaldeficiency that raises substantial doubt about its ability to continueas a

goingconcern.

Problem 10

(15to 25 minutes)

Required:

Items I through 15 representa seriesof unrelatedprocedures that an accountantmay considerperforming in separateen-

gagementsto reviewthe tlnancialstatements of a nonpublicentity (a review)and to compilethe financial statements of a non-

publicentity (a compilation).Select, as the best answer for eachitem, whether the procedure is required (&l or not required

i'N , for both reviewand compilation engagements. Make two selectionsfor eachitem.

Procedures

  • l. Theaccountant

should establish an understanding

with

theentity regarding the nature and limitations of the ser-

vicesto be perfbrmed.

  • 2. The accountantshould make inquiries concerning actions takenat the boardof directors'meetings.

  • 3. The accountant,as the entity's successor accountant, shouldcommunicate with the predecessoraccountant to obtainaccess to the predecessor'sworking papers.

9.

The accountantshould obtain a managementrepresenta-

tion letterfrom the entity

10.

The accountantshould study the relationships of thefi-

nancialstatement elements that would be expectedto

conform to a predictablepattern.

ll.

The accountantshould communicate to theentity's sen-

ior managementillegal employee acts discovered by the

accountantthat are clearly inconsequential.

  • 4. The accountantshould obtain a levelof knowledgeof the 12. accountingprinciples and practices of theentity's indus- try.

The accountantshould make inquiries about events sub-

sequentto thedate of the financialstatements that would

havea materialeffect on thefinancial statements.

  • 5. The accountantshould obtain an understandingofthe entity'sinternal control.

  • 6. The accountantshould perform analytical procedures designedto identifyrelationships that appear to be un- usual.

  • 7. The accountantshould make an assessment

ofcontrol

risk.

  • 8. The accountantshould send a letterofinquiry to theen- tity's attomeyto corroboratethe informationfurnished by managementconcerning litigation.

13.

The accountantshould modify the accountant'sreport if

thereis a changein accountingprinciples that is ade-

quatelydisclosed.

14.

The accountantshould submit a hardcopy of thefinan-

cial

statementsand accountant's report when the finan-

cial statementsand accountant's report are submitted on

a computerdisk.

15'

The accountantshould perfbrm specificprocedures to

evaluatewhether there is substantialdoubt about the en-

tity'sability to continueas a goingconcern.

Problemrt

/

Required:

(15 to 25 minutes)

Items I through L2 representpossible errors and irregularitiesthat an auditor suspectsare present. The accompanyingllsl

of Auditing Proceduresrepresents procedures that the auditor would considerperforming to gatherevidence concerning possi-

ble errorsand irregularities. For eachitem, selectone or two procedures,as indicated,that the auditor most likely would per-

form to gatherevidence in supportofthat item. The procedureson the list may be selectedonce, more than once,or not at all.

270

MODULE 3

EVIDENCE

Possiblemisstatements due to errors and fraud

  • 1. The auditorsuspects that a kiting schemeexists because an accountingdepartment employee who canissue and record checksseems to be leadingan unusuallyluxurious lifestyle. (Selectonly L procedure)

  • 2. The auditor suspectsthat the controllerwrote severalchecks and recordedthe cashdisbursementsjust before year-end but did not mail the checksuntil after the first week of the subsequentyear. (Selectonly L procedure)

  • 3. The entity borrowedfunds from a financial institution. Although the transactionwas properly recorded,the auditor sus- pectsthat the loancreated a lien on theentity's real estate that is not disclosedin its financialstatements. (Select only 1 procedure)

  • 4. The auditordiscovered an unusuallylarge receivable from oneofthe entity'snew customers.The auditorsuspects that the receivablemay be fictitiousbecause the auditorhas never heard of the customerand because the auditor'sinitial attemptto confirmthe receivable has been ignored by thecustomer. (Select only 2 procedures)

  • 5. The auditorsuspects that fictitious employees have been placed on thepayroll by theentity's payroll supervisor, who has accessto payrollrecords and to the paychecks.(Select only I procedure)

  • 6. The auditorsuspects that selected employees of theentity received unauthorized raises from the entity'spayroll supervisor, who hasaccess to payrollrecords. (Select only I procedure)

  • 7. Theentity'scashreceiptsofthefirstfewdaysofthesubsequentyearwereproperlydepositedinitsgeneral operatingac- countafter the year-end.However, the auditorsuspects that the entity recorded the cash receipts in its booksduring the lastweek ofthe yearunder audit. (Select only I procedure)

  • 8. The auditorsuspects that vouchers were prepared and processed by an

accountingdepartment employee for merchandise

thatwas neither ordered nor receivedby the entity. (Selectonly 1 procedure)

  • 9. The detailsof invoicesfbr equipmentrepairs were not clearlyidentified or explainedto the accountingdepartment employ- ees. The auditorsuspects that the bookkeeper inconectly recorded the repairs as fixed assets.(Select only I procedure)

  • 10. The auditorsuspects that a lappingscheme exists because an accountingdepartment employee who hasaccess to cashre- ceiptsalso maintains the accountsreceivable ledger and refuses to takeany vacationor sick days. (Select only 2 proce- dures)

    • I l. The auditorsuspects that the entity is inappropriatelyincreasing the cash reported on its balancesheet by drawinga check

on oneaccount and not recordingit asan outstandingcheck on thataccount and simultaneously recording it asa depositin

a secondaccount. (Select only I procedure)

  • 12. The auditorsuspects that the entity's controller has overstated sales and accounts receivable by recordingfictitious sales to regularcustomers in theentity's books. (Select only 2 procedures)

List of audi

Comparethe detailsof the cashreceipts journal entrieswith

the detailsofthe correspondingdaily depositslips.

  • B. Scanthe debitsto the fixed assetaccounts and vouch se- lectedamounts to vendors'invoices and manasement'sau- thorization.

  • C. Perform analytical proceduresthat

compare documented

authorizedpay ratesto

the entity's budgetand forecast.

  • D. Obtain the cutoff bank

statementand compare the cleared

checksto

the year-endbank reconciliation.

  • E. Preparea bank transferschedule.

  • F. Inspectthe entity's deedsto its real estate.

  • G. Make inquiriesof the entity's attorneyconcerning the de- tails of real estatetransactions.

  • H. Confirm the terms of borrowing arrangementswith the lender.

  • I. Examine selectedequipment repair orders and supporting documentationto determinethe proprietyof the charges.

  • J. Sendrequests to confirm the entity's accountsreceivable on a surprise basis at an interim date.

  • K. Send a secondrequest for confirmation of the receivable to the customerand make inquiriesof a reputablecredit

concerninsthe customer'screditworthiness.

res

  • L. Examinethe entity's shippingdocuments to verify that the merchandisethat producedthe receivablewas actually sentto the customer.

  • M. Inspectthe entity's correspondencefiles for indicationsof customerdisputes for evidencethat certainshipments were on consignment.

  • N. Performedit checksof dataon the payroll transactiontapes.

  • O. Inspectpayroll checkendorsements for similar handwriting.

  • P. Observepayroll checkdistribution on a surprisebasis.

  • Q. Vouch data in the payroll registerto documentedauthorized pay ratesin the humanresources department's files.

  • R. Reconcilethe payroll checkingaccount and determineif therewere unusualtime lags betweenthe issuanceand pay- ment ofpayroll checks.

  • S. Inspect the file ofprenumbered vouchers for consecutive numbering and

proper approval by an appropriate employee.

  • T. Determine that the details of selectedprenumbered vouchers matchthe relatedvendors' invoices.

  • U. Examinethe supportingpurchase orders and receivingre- ports fbr selectedpaid vouchers.

MODALE 3

EVIDENCE

271

Problem 12

(15 to 25 minutes)

This consistsof 19 items. Selectthe best answer for eachitem. Usea No. 2 pencilto blackenthe appropriateovals on the

Answer Sheetto indicateyour answers.Answer all items. Your gradewill be basedon the total numberof correct

"OrO,J;.",J.t.

Required:

Items I through 19 representa seriesofunrelated statements,

questions, excerpts, and comments taken from variousparts

of an auditor'sworking paper file. On thenext page there is a list of the likely sourcesof the statements,

questions, excerpts,

andcomments. Select, as the best answer for

eachitem, the mostlikely source.Select only one sourcefor eachitem. A source

may be selectedonce, more than once, or not at all.

  • l. Duringour auditwe discoveredevidence of thecompany's failure to safeguardinventory from loss,damage, and misap- propriation.

    • 2. The companyconsiders the decline in valueof equitysecurities classified as available-for-sale to be temporary.

    • 3. Was thedifference of opinionon the accruedpension liabilities that existed between the engagementpersonnel and the actuarialspecialist resolved in accordancewith firm policy andappropriately documented?

    • 4. Our auditis designedto providereasonable assurance of detectingmisstatements

that, in

our judgment, couldhave a mate-

rial effbcton the financialstatements taken as a whole. Consequently,our auditwill not

necessarilydetect all misstate-

mentsthat exist due to efTor,fraudulent financial reporting, or misappropriationof assets.

  • 5. Therehave been no communicationsfiom regulatoryagencies concerning noncompliance with

or deficienciesin financial

reportingpractices.

  • 6. Nothingcame to our attentionthat caused us to believethat at October3 I , 2000,there was any change in thecapital stock, increasein long-termdebt, or decreasein consolidatednet current assets or stockholders' equity as compared with the amountsshown in the September30. 2000unaudited condensed consolidated balance sheet.

  • 7. It is ouropinion that the possible liability to thecompany in thisproceeding is

nominalin amount.

  • 8. As discussedin Note4 to the financialstatements,

the company experienced a net lossfor the yearended July 3 l , 2000,

andiscurrentlyindefaultundersubstantiallyall

ofitsdebtagreements.

Inaddition,onSeptember25,2000,thecompany

filed a prenegotiatedvoluntary petition fbr relief underChapter I I of the US BankruptcyCode. Thesematters raise sub-

stantialdoubt about the company's ability to continueas a goingconcern.

  • 9. During the yearunder audit, we wereadvised that management consulted with Better& Best,CPAs. The purposeof this consultationwas to obtainanother CPA firm's opinionconcerning the company's recognition of certainrevenue that we

did

believeshould be deferredto futureperiods. Better & Best'sopinion was consistent with our opinion,so management

not recognizethe revenuein thecurrent year.

  • 10. The companybelieves that all materialexpenditures that have been deferred to futureperiods will be recoverable.

  • 11. Our useof professional judgment andthe assessment of auditrisk andmateriality for the purposeof our auditmean that mattersmay haveexisted that would havebeen assessed

differently by you. We makeno representationas to the suffi-

ciencyor appropriatenessof the informationin our workingpapers fbr

your purposes.

  • 12. Indicatein the spaceprovided below whether this informationagrees with your records.If thereare exceptions, please provideany informationthat will assistthe auditorin reconcilingthe difference.

  • 13. Blank checksare maintained in an unlockedcabinet along with the check-signingmachine. Blank checksand the check- signingmachine should be lockedin separatelocations to preventthe embezzlement

of funds.

  • 14. Our auditcannot be reliedupon to disclosesignificant deficiencies in thedesign or operationofinternal control. Neverthe- less,we will communicateto you all reportableconditions and potential areas for improvementthat we becomeaware of duringthe course of our audit.

  • 15. The timetableset by managementto completeour auditwas unreasonable

considering the failure of the company'sperson-

nel to completeschedules on a timely basisand delays in providingnecessary information.

  • 16. Severalemployees have disabled the antivirusdetection software on their PCsbecause the softwareslows the processing of dataand occasionally rings false alarms. The companyshould obtain antivirus software that runs continuously at all systementry points and that cannot be disableby unauthorizedpersonnel.

  • 17. In connectionwith an auditof our financialstatements,

management has prepared, and furnished to our auditors,a descrip-

tion andevaluation of certaincontinsencies.

272

MODALE 3

EVIDENCE

  • 18. The companyhas no plansor intentionsthat may materiallyaffect the carrying value or classificationof assetsand liabili- ties.

  • 19. In planningthe samplingapplication, was appropriate consideration given to therelationship of the sampleto the audit objectiveand to preliminaryjudgments aboutmateriality levels?

List of Sources

  • A. Practitioner'sreport on management'sassertion aboutan entity'scompliance with specifiedre- quirements.

  • B. Auditor'scommunications on reoortableconditions.

I.

Letter fbr underwriters.

J.

Accountsreceivable confirmation request.

K.

Requestfor bankcutoff statement.

L.

M.

N.

o.

 

auditor.

P.

Predecessor

auditor.

(15 to 25 minutes)

Explanatoryparagraph ofan auditor'sreport on fi-

  • C. Audit inquiry letterto legalcounsel.

  • D. Lawyer'sresponse to auditinquiry letter.

  • E. Audit committee'scommunication to the auditor.

nancialstatements.

Partner'sengagement review noles.

Managementrepresentation letter.

  • F. Auditor'scommunication to the auditcommittee

Successorauditor's communication with predecessor

(otherthan with respectto reportableconditions).

  • G. Reporton the applicationofaccounting principles.

  • H. Auditor'sengagement letter.

auditor's communication with successor

Problem13

Required:

  • a. Items I through 10 representtick marks(symbols) that indicate procedures pertbrmed or commentsdocumented in audil

ing the Long-term debt accountof AmericanManufacturers, Inc. Select,from the list of procedures/comments

below, the

procedure/comment that the auditor most likely performed/documentedat each point of the auditwhere a tick markwas made

on the workingpapers. Select only oneprocedure/comment

for eachitem. A procedure/comment

may be selectedonce or not

at all. Assumethat the workingpapers tbot andcrossfoot.

  • b. Items l1 through 18 representtick marks(symbols) that indicate procedures pertbrmed or commentsdocumented in au-

diting the Property, plant, and equipmentand Accumulated depreciation accounts of AmericanManufacturers, Inc. During

the yearunder audit, American Manuf'acturers

purchased new computersdirectly from wholesalersand constructed an addition

tooneofitsbuildings.Thecompany'semployeesalsorefurbishedthefixturesofseveralolderbuildings. Select,fiomthelist

of procedures/comments

below, the procedure/comment

that the auditormost likely performed/documentedat each point of the

auditwhere a tick mark wasmade on the workingpapers. Select only oneprocedure/comment

for eachitem. A proce-

dure/commentmay be selectedonce or not at all. Assumethat the workingpapers foot andcrossfbot.

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