auditing chapter 4 homework

Franklin Co. total assets $34,900,000 total revenue 29,600,000 equity 13,800,000 net income before taxes 1,600,000

Tyler Co. $2,700,000 4,500,000 1,000,000 90,000

a. Develop an estimate of the appropriate amount of planning materiality for Franklin Co. and describe how you arrived at the estimate

• Planning materiality would be $178,000 + .00313 (34,900,000 -30,000,000) = $ 193,337 • Net income 5% of 1,600,000 = 80,000 • Total assets .5% of 34,900,000 = 174,500 • Total revenue .5% of 29,600,000 = 148,000 • Total equity 1% of 13,800,000 = 138,000

b. Develop an estimate of the appropriate amount of planning materiality for Tyler Co. and describe how you arrived at the estimate.

• Planning materiality would be 38,300+ .00670 (4,500,000-3,000,000) = 48,350 • Net income 10% of 90,000= 9,000 • Total assets 1% of 2,700,000= 27,000 • Total revenue 1% of 4,500,000= 45,000 • Total equity 1% of 1,000,000= 10,000

18. Charles Halstead, CPA, has a number of clients who desire audits at the end of the calendar year. In an effort to spread his workload more uniformly throughout the year, he is preparing a list of audit procedures that could be performed satisfactorily before the year-end balance sheet date. What audit work, if any, might be done in advance of the balance sheet date?

• Audit work can begin in the interim period, the period before the cutoff date. This includes consideration of internal control and substantive test of transactions that have occurred to the interim date. . Stronger internal control allows for more interim work.

8. Should a separate audit program be prepared for each audit engagement, or can a standard program be used for most engagements?

• A separate audit program should be prepared for each audit engagement

b) For each of the four circumstances, indicate a possible appropriate response by the auditors.

1. Audits performed at the locations of the subsidiary company. Some procedures should be unannounced so they don't have a chance to change numbers. 2. Auditing staff should be skilled in complex sales agreements so they can understand the information better. 3. Auditor should have an expert in these contracts to value them. 4. Auditors should do more test on revenue for each chain store and do physical inventory.

I. Which of the following elements underlies the application on GAAS, particularly the standards of fieldwork and reporting? 1. Adequate disclosures 2. Quality control 3. Materiality and audit risk 4. Client acceptance

3. • Many decisions are affected by materiality and audit risk

c. Describe five characteristics of a small misstatement that might render it qualitatively material.

• Compliance with loan agreement, • Hiding illegal transactions, • Conforms with regulatory requirements, • Has to do with a portion of the business that is necessary for it to be profitable, • Occurs from an item that can be specifically measured.

a) For each of the four circumstances, indicate the fraud risk that the auditors should consider.

1. Fraud is increased due to the fact that the compensation is based on the net income, which could inspire them to inflate the net income to increase their compensation. 2. Risk based on revenue, financial reporting fraud 3. Risk of fraud by traders, overstatement on the contracts to increase their compensation 4. Management could be increasing the profits to one or more stores

J. Which of the following best describes what is meant by the term "fraud risk factor"? 1. Factors that, when present, indicate that risk evidence 2. Factors often observed in circumstances where frauds have occurred 3. Factors that, when present, require modification of planned audit procedures 4. Weakness in internal control identified during an audit

2. • Fraud risk factors are found where frauds have occurred before

L. Which of the following is most likely to be an overall response to fraud risks identified in an audit? 1. Supervise members of the audit team less closely and rely more upon judgment 2. Use less predictable audit procedures 3. Use only certified public accountants on the engagement 4. Place increased emphasis on the audit of objective transactions rather than subjective transactions

2. • Using less predictable audit procedure so the companies do not know what to expect when the audits begins.

A. In planning and performing an audit, auditors are concerned about risk factors for two distinct types of fraud: fraudulent financial reporting and misappropriation of assets. Which of the following is a risk factor for misappropriation of assets? 1. Generous performance based compensation system 2. Management preoccupation with increased financial performance 3. An unreliable accounting system 4. Strained relationships between management and the auditors

3. • If there is an unreliable accounting system then there is more chance for things to be wrong.

K. Three conditions generally are present when fraud occurs. Select the one below that is not one of those conditions. 1. Incentive or pressure 2. Opportunity 3. Supervisory position 4. Attitude

3. • It takes a little of each of these things to commit fraud and you do not have to be in a supervisory position to commit fraud.

D. Which portion of an audit is least likely to be completed before the balance sheet date? 1. Test of controls 2. Issuance of an engagement letter 3. Substantive procedures 4. Assessment of control risk

3. • Substantive procedures are the least likely to be completed before the balance sheet date because these

G. The primary objective of tests of details of transactions performed as substantive procedures is to: 1. Comply with GAAS 2. Attain assurance about the reliability of the accounting system 3. Detect material misstatements in the financial statements 4. Evaluate whether managements policies and procedures are operating effectively

3. • Verify that transactions are being entered correctly

E. Which of the following should the auditors obtain from the predecessor auditors before accepting an audit engagement? 1. Analysis of balance sheet accounts 2. Analysis of income statement accounts 3. All matters of continuing accounting significance 4. Facts that might bear on the integrity of management

4. • Facts that might bear on the integrity of management because everything else is obtained once the audit engagement is accepted

B. The audit committee of a company must be made up of: 1. Representatives from the clients management, investors, suppliers, and customers 2. The audit partner, the chief financial officer, the legal counsel, and at least one outsider 3. Representatives of the major equity interests, such as preferred and common stockholders 4. Members of the board who are not officers or employees

4. • Members of the board have to be independent and being an officer or employee makes you apart of the company.

C. Which of the following should not normally be included in the engagement letter for an audit? 1. A description of the responsibilities of client personnel to provide assistance 2. An indication of the amount of the audit fees 3. A description of the limitations of an audit 4. A listing of the client's branch offices selected for testing

4. • They should not know who is being tested because they can change information prior to the audit

H. The risk that the auditors will conclude, based on substantive procedures, that a material misstatement does not exist in an account balance when, in fact, such misstatement does exist is referred to as 1. Business risk 2. Engagement risk 3. Control risk 4. Detection risk

4. • Substantive procedures will help in determining if a detection risk occurs instead of a misstatement in the financial statement.

F. As one step in testing sales transactions, a CPA traces a random sample of sales journal entries to debits in the accounts receivable subsidiary ledger. This test provides evidence as to whether: 1. Each recorded sale represents a bona fide transaction 2. All sales have been recorded in the sales journal 3. All debit entries in the accounts receivable subsidiary ledger are properly supported by sales journal entries 4. Recorded sales have been properly posted to customer accounts

4. • This process just verifies that the sales are posted correctly