Reference no: EM131112984

Question 1

Jeff Jacobs is a junior accountant with the Public Accounting firm of Maxwell and King LLP. Jeff was assigned to do the audit of the Astor Electronics Inc. audit. The incharge auditor had informed Jeff that the client had good controls over the procurement process but it was important to determine if they were operating effectively so that a proper assessment of the control risk could be made. Jeff decided to perform test of controls over procurement transactions using attribute sampling.

Jeff figured that a tolerable exception rate of 9% and a 5% risk of assessing control risk too low were appropriate for the tests he planned to perform. He had no idea how many deviations actually might exist in the population so he set the estimated population exception rate at 2% to be conservative. Based on the tables Jeff selected a sample of 70 items.

Because Jeff believed larger items deserved more attention than smaller items, he selected 50 items with values greater than or equal to $2,500 and 20 items with values less than $2,500. He thought it would be most appropriate to select transactions near the end of the fiscal year, so he randomly selected items for testing from the last two months.

Jeff was relieved when he found only six deviations from prescribed controls. One deviation was a missing supplier's invoice. Jeff spoke to the client who informed him that they lost a few invoices during their recent move. Jeff accepted the client's explanation since this was the only supplier invoice missing from the results of his work. Two deviations were missing approval signatures by an authorized manager. The manager explained that he had not approved the supplier invoices because he had been out of the office on the date the invoices were received and entered into the accounts payable system. He reviewed the two supplier invoices in question and told Jeff there were no problems with them. The other three deviations involved dollar errors. Two were errors in the extension of the supplier invoices that had not been detected by the client and the other was a misclassification error between expenses, which did not affect net income. Jeff considered these three dollar errors to be the only three actual control deviations. Based on the tables, using a 5% risk of assessing control risk too low, three deviations found and a sample 70, Jeff determined that the computed upper exception rate was 10.7.

Based on these results, Jeff concluded that that controls over procurement transactions were effective and accordingly he assessed the control risk at moderate (below maximum).

Required

a) Briefly explain eight deficiencies you note in Jeff's attribute sampling application.

b) What is the difference between sampling and non-sampling risk

Question 2

You have been assigned to the audit of Comfort Mattresses (CM), a new audit engagement for your firm, Loeb & Winkler, Public Accountants. You are responsible for the accounts payable section of this year's audit. You have prepared the following description of the accounts payable system from discussions with CM employees.

CM's head office processes the accounts payable for its mattress stores. When a new mattress store is set up on the automated accounts payable system, it is requested to send to head office a detailed accounts payable trial balance and an accounts payable vendor list, approved by the manager of the store. The accounts payable vendor list includes vendor name, address, discount terms, and other descriptive information, such as telephone number and personal contact.

The accounts payable department in the head office consists of an accounts payable supervisor and three clerks. The accounts payable supervisor assigns and records vendor codes on the original vendor list provided by the store manager. Vendor codes are assigned alphanumerically, based on the vendor's name. This list is used as a source of input to the computer system, and a photocopy of the list is returned to the store for its reference.

Vendor invoices are approved by the store manager, who codes them as to general ledger allocation and then sends them to head office for payment. The supervisor reviews the allocation of the invoices and passes them on to one of the clerks. Each clerk is responsible for specific stores. The clerks scan the vendor list, call up the vendor file on the screen, and enter the invoice details into the system. If the vendor is not on the vendor list, the clerks check for similar names on the screen to verify that the vendor has not been set up since the vendor list was printed and then adds a new vendor using the standard method. The clerks then record the invoice against this new vendor.

If the computer system identifies invoice numbers that have already been entered for payment, it issues an error message so that the accounts payable clerks can detect any invoices that have inadvertently been entered twice. However, the accounts payable clerks are able to override this error message since it is sometimes necessary for an invoice to be entered twice (e.g., if partial payment was made earlier and the balance is now being paid in full). Once an invoice has been entered for payment, the accounts payable clerk files the invoice alphabetically by vendor name.

Based on vendor invoice due dates, cheques are produced on Mondays and Wednesdays. Because of the high volume of cheques processed the accounts payable supervisor signs all cheques. However, cheques for amounts greater than $75,000 must also be signed by the head office controller. The cheques are mailed directly to vendors from head office. A copy of the cheque register, showing which invoices have been paid, is sent to the store. Vendors are sent a record of their account if they request one.

Manual cheques are also used for emergency purposes. Two authorized cheque signers are needed for manual cheques. The manual cheques are stored in the accounting department in an unlocked cabinet.

Required:

a) Identify three control weaknesses in CM's accounts payable system. For each control weakness explain the control objective that is not being met, describe the risk/ possible consequence of the weakness, and include a recommendation to address the weakness.

Arrange your answer in a table as follows:

Question 3

You are the In-charge accountant on the audit of Dezine Inc. (DI). It is March 25th, 2015 and your firm is part way through the December 2014 year-end audit. You are currently assigned to working on various sections within the Accounts Payable and Inventory section of the audit file. Inventory at year-end is $5.2 million. Materiality is set at $225,000.

Company Background

DI is a small manufacturer of women's jewelry (including bracelets, necklaces, earrings). Most of its products are made of silver, 14 Kt gold, and various semi-precious stones.

DI has its financial statements audited due to a $15M loan with RBC Business Financing Group. The terms of the loan requires meeting certain financial covenants - a minimum inventory value of $5M carried at "lower of cost or market" and a current ratio of 2:1. DI is also required to submit, within 90 days of its year-end, audited financial statements to RBC.

Information on Inventory Cycle

The majority of inventory consists of raw materials and finished goods. DI uses a periodic inventory system to track the physical quantity of goods on hand. The count is performed annually on December 31 of each year. Below are some details on the inventory and accounts payable cycle:

Raw Materials Inventory

- DI uses average costing method to price its raw materials (metals, stones, supplies and packaging).
- The Semi-precious stones and metals are purchased from suppliers in India and Mexico. Goods are shipped FOB Shipping point (Freight on Board - Shipping point means that ownership passed to the purchaser when it leaves the premises in India).
- Goods take on average 3 weeks to arrive once the supplier has shipped them. The supplier notifies DI that the goods were shipped by emailing them the freight and shipping documents.
- The party responsible (DI or the Vendor) for insuring the goods during shipment is agreed to before shipment.
- All purchase orders are sent to the accounting department once issued.
- Shipping documents and freight/ carrier invoices are emailed directly to the warehouse, after being reviewed (daily) by the purchasing manager and operations manager.
- All documents and freight/carrier invoices are sent to the accounting department.
- The accounting department matches the purchases orders and freight documents and then accrues the purchase.
Work-in-Process and Finished Goods Inventory
- DI uses a job order costing system. Costs are applied to the finished goods as they pass through casting, polishing stone setting, and packaging.
- A manual job ticket is attached to each production batch with quantity of metals, stones, packaging, and number of labour hours (the value is applied at standard labour hour rates).

REQUIRED

a) Identify and explain four [4] inherent risks that are present in the inventory cycle at DI. Tie each risk to the key assertion(s). Specifically tie your risks to case facts (not the inventory cycle in general)

b) Identify and explain three (3) control risk factors (in other words, what can go wrong) that are present in the inventory cycle at DI that could impact existence, cut-off and valuation of inventory at DI. For each control risk, provide an internal control that would prevent that risk from occurring.

Question 4

You are the audit senior for the 2015 year-end audit of Clearly Contacts (CC), a publicly traded Canadian company, that is one of the largest and fastest on-line vision care providers in the world. Because of the efficiencies of the Internet to bypass middlemen, CC has a significant competitive advantage in its market.

You are responsible for auditing the revenue cycle. Performance materiality for the CC audit is $100,000. CC's year-end is October 31, 2015.

Below is a summary of key information regarding the revenue cycle:

Revenue Recognition Policy - Revenue from product sales is recognized when the product has been shipped to the customer. At that point, the amount of sales revenue is determinable, no significant vendor obligations remain and the collection of the revenue is reasonably assured. A provision is made for product returns. Revenue collected in advance of the product being shipped is deferred.

Audit Strategy for Revenue - The audit strategy relies upon tests of controls, (including substantive tests of transactions), and substantive analytical procedures. There are no accounts receivable confirmations sent out. Your audit team has tested controls related to revenue transactions and concluded that controls are effective and support the control risk assessment of low for the revenue transaction-related assertions.

Change in Credit Policy - When reviewing the accounts, you noted that a new account, allowance for doubtful accounts, has been set up. Upon investigation, you find that in February 2014, CC implemented a program where the majority of customers were granted credit. CC developed this program to attract new customers who might be wary of ordering contact lenses from an on-line retailer and having to pay for them prior to receiving them. The company's program, named "Invoice Me Later, or IML, allows customers to order from CC and pay after receiving the product. Management estimates payment should be generally received in less than 15 days.

Estimate for Allowance for Doubtful Accounts - The majority of the balances outstanding are less than $150 and there are a large number of records. Management estimates an allowance based upon the aging of the receivable portfolio. Below is a summary of the aging and management's estimate for the allowance for doubtful accounts.

Aging of Accounts Receivable

Required

a) Explain the impact of the IML program on your audit strategy for the revenue cycle of CC. (Use the audit risk model and assertions to support your analysis).

b) Do you agree with the auditors' decision to not send out accounts receivable confirmations? Why or why not?

c) If the auditors planned to send out accounts receivable confirmations, what type of confirmations would you recommend? Explain why.