Reference no: EM132504353

Task 1

You have been assigned to the audit of Processing Solutions, Inc., a privately held corporation that develops and sells computer systems. The systems are sold under one- to five-year contracts that provide for a fixed price for licensing, delivery, and setup of the systems and maintenance and technical support for the life of the contract. Your review Page of the working papers reveals that premature revenue recognition is a risk that must be addressed in the audit.

Question 1. Summarize the guidance of the FASB regarding recognition of revenue on contracts.

Question 2. Describe two techniques that management of Processing Solutions might use to overstate revenue.

Question 3. For the two techniques identified in requirement (b), describe an auditing procedure that might be employed by the auditors to detect the overstatement of revenue.

Task 2

Hale Nelson, CPA, is engaged to audit the financial statements of Hollis Manufacturing, Inc. Hollis engages in very complex sales agreements that create issues with respect to revenue recognition. As a result, Nelson has identified revenue recognition as an audit area of significant risk that requires special audit consideration.

Question 1. Describe the implications of Nelson's identification of revenue recognition as an area of significant risk.

Question 2. Describe how Nelson might decide to react to the significant risk related to revenue recognition.

Task 3

An assistant on the Carter Company audit has been working in the revenue cycle and has compiled a list of possible errors and fraud that may result in the misstatement of Carter Company's financial statements and a corresponding list of controls that, if properly designed and implemented, could assist in preventing or detecting the errors and fraud.

For each possible error and fraud numbered a through o, select one internal control from the following answer list that, if properly designed and implemented, most likely could assist management in preventing or detecting the errors and fraud. Each response in the list of controls may be selected once, more than once, or not at all.

Controls

Shipping clerks compare goods received from the warehouse with the details on the shipping documents. Approved sales orders are required for goods to be released from the warehouse. Monthly statements are mailed to all customers with outstanding balances. Shipping clerks compare goods received from the warehouse with approved sales orders. Customer orders are compared with the inventory master file to determine whether items ordered are in stock. Daily sales summaries are compared with control totals of invoices. Shipping documents are compared with sales invoices when goods are shipped. Sales invoices are compared with the master price file. Customer orders are compared with an approved customer list. Sales orders are prepared for each customer order. Control amounts posted to the accounts receivable ledger are compared with control totals of invoices.

Sales invoices are compared with shipping documents and approved customer orders before invoices are mailed. Prenumbered credit memos are used for granting credit for goods returned. Goods returned for credit are approved by the supervisor of the sales department. Remittance advices are separated from the checks in the mailroom and forwarded to the accounting department. Total amounts posted to the accounts receivable ledger from remittance advices are compared with the validated bank deposit slip. The cashier examines each check for proper endorsement. Validated deposit slips are compared with the cashier's daily cash summaries. An employee, other than the bookkeeper, periodically prepares a bank reconciliation. Sales returns are approved by the same employee who issues receiving reports evidencing actual return of goods.

Task 4
Nolan Manufacturing Company retains you on April 1 to perform an audit for the fiscal year ending June 30. During the month of May, you make extensive studies of internal control over inventories.

All goods purchased pass through a receiving department under the direction of the chief purchasing agent. The duties of the receiving department are to unpack, count, and inspect the goods. The quantity received is compared with the quantity shown on the receiving department's copy of the purchase order. If there is no discrepancy, the purchase order is stamped "OK-Receiving Dept." and forwarded to the accounts payable section of the accounting department. Any discrepancies in quantity or variations from specifications are called to the attention of the buyer by returning the purchase order to him with an explanation of the circumstances. No records are maintained in the receiving department, and no reports originate there.

As soon as goods have been inspected and counted in the receiving department, they are sent to the factory production area and stored alongside the machines in which they are to be Page 562processed. Finished goods are moved from the assembly line to a storeroom in the custody of a stock clerk, who maintains a perpetual inventory record in terms of physical units but not in dollars.

What weaknesses, if any, do you see in the internal control over inventories?

Task 5

For each of the independent situations described below select the appropriate inherent risk factor described and the effect of the inherent risk factor on the company's net income using the following:

Inherent Risk Factor	Effect on Net Income
(1) Complexity (2) Estimates (3) Industry circumstances (4) Other external circumstances (5) Susceptibility of asset to theft (6) Volume	(7) Overstatement (8) Understatement (9) No effect

Situation	Inherent Risk Factor	Effect of Inherent Risk Factor on Company's Net Income
a         Sales orders for a textbook distributor have increased 100% over the last year. Additionally, the company's inventory turnover has doubled since the previous year.
b         Gold Miner, Inc., has gold mines in a number of states. To hedge the price of its gold inventory, Gold Miner purchases gold futures contracts. The fair value of gold has declined significantly in the last few months.
c         Metal, Inc., supplies copper pipes to home builders. During year 1, copper prices doubled. At any given time, a significant amount of inventory is in transit or located at job sites.
d         Joe's Computers provides three-year money-back warranties on all laptops. During year 1, warranty claims decreased significantly and the company has not reduced the warranty reserve.
e         Global Co. imports most of its products from a foreign supplier. During year 1, a new technology made part of the Global Co. inventory obsolete.

Attachment:- Exercise.rar