ASSIGNMENT
MULTIPLE CHOICE QUESTIONS FROM CPA EXAMINATIONS
8-23 (OBJECTIVES 8-1, 8-3, 8-4) The following questions concern the planning of the engagement. Select the best response.
a. Analytical procedures used in planning an audit should focus on identifying
(1) material weaknesses in internal control.
(2) the predictability of financial data from individual transactions.
(3) the various assertions that are embodied in the financial statements.
(4) areas that may represent specific risks relevant to the audit.
b. Which of the following will most likely indicate the existence of related parties?
(1) Writing down obsolete inventory prior to year end
(2) Failing to correct deficiencies in the client’s internal control
(3) An unexplained increase in gross margin
(4) Borrowing money at a rate significantly below the market rate
c. Which of the following is least likely to be included in the auditor’s engagement letter?
(1) Details about the preliminary audit strategy
(2) Overview of the objectives of the engagement
(3) Statement that management is responsible for the financial statements
(4) Description of the level of assurance obtained when conducting the audit
8-24 (OBJECTIVE 8-2) The following questions pertain to client acceptance. Choose the best response.
a. When approached to perform an audit for the first time, the CPA should make inquiries of the predecessor auditor. This is a necessary procedure because the predecessor may be able to provide the successor with information that will assist the successor in determining whether
(1) the predecessor’s work should be used.
(2) the company follows the policy of rotating its auditors.
(3) in the predecessor’s opinion, internal control of the company has been satisfactory.
(4) the engagement should be accepted.
b. A successor would most likely make specific inquiries of the predecessor auditor regarding
(1) specialized accounting principles of the client’s industry.
(2) the competency of the client’s internal audit staff.
(3) the uncertainty inherent in applying sampling procedures.
(4) disagreements with management as to auditing procedures.
c. Which of the following circumstances would most likely pose the greatest risk in accepting a new audit engagement?
(1) Staff will need to be rescheduled to cover this new client.
(2) There will be a client-imposed scope limitation.
(3) The firm will have to hire a specialist in one audit area.
(4) The client’s financial reporting system has been in place for 10 years.
8-25 (OBJECTIVES 8-5, 8-6) The following questions deal with materiality. Choose the best response.
a. Which one of the following statements is correct concerning the concept of materiality?
(1) Materiality is determined by reference to guidelines established by the AICPA.
(2) Materiality depends only on the dollar amount of an item relative to other items in the financial statements.
(3) Materiality depends on the nature of an item rather than the dollar amount.
(4) Materiality is a matter of professional judgment.
b. In considering materiality for planning purposes, an auditor believes that misstatements aggregating $10,000 will have a material effect on an entity’s income statement, but that misstatements will have to aggregate $20,000 to materially affect the balance sheet. Ordinarily, it is appropriate to design audit procedures that are expected to detect misstatements that aggregate
(1) $20,000.
(2) $15,000.
(3) $10,000.
(4) $30,000.
c. A client decides not to record an auditor’s proposed adjustments that collectively are not material and wants the auditor to issue the report based on the unadjusted numbers. Which of the following statements is correct regarding the financial statement presentation?
(1) The financial statements are free from material misstatement, and no disclosure is required in the notes to the financial statements.
(2) The financial statements do not conform with generally accepted accounting principles (GAAP).
(3) The financial statements contain unadjusted misstatements that should result in a qualified opinion.
(4) The financial statements are free from material misstatement, but disclosure of the proposed adjustment is required in the notes to the financial statements.
MULTIPLE CHOICE QUESTIONS FROM BECKER CPA EXAM REVIEW
8-26 (OBJECTIVES 8-1, 8-2, 8-6) The following questions deal with client acceptance, audit planning, and materiality. Choose the best response.
a. In which of the following circumstances would an auditor of an issuer be least likely to reevaluate established materiality levels?
(1) The materiality level was established based on preliminary financial statement amounts that differ significantly from actual amounts.
(2) The client disposed of a major portion of the client’s business.
(3) The client released third-quarter results before the SEC-prescribed deadline.
(4) Significant new contractual arrangements draw attention to a particular aspect of a client’s business that is separately disclosed in the financial statements.
b. Which of the following procedures would a CPA least likely perform during the planning stage of the audit?
(1) Determine the timing of testing
(2) Take a tour of the client’s facilities
(3) Perform inquiries of outside legal counsel regarding pending litigation
(4) Determine the effect of information technology on the audit
c. A successor auditor’s inquiries of the predecessor auditor should include questions regarding
(1) the number of engagement personnel the predecessor assigned to the engagement.
(2) the assessment of the objectivity of the client’s internal audit function.
(3) communications to management and those charged with governance regarding significant deficiencies in internal control.
(4) the response rate for confirmations of accounts receivable.
DISCUSSION QUESTIONS AND PROBLEMS
8-27 (OBJECTIVES 8-2, 8-3, 8-4, 8-5) The following are various activities an auditor does during audit planning.
1. Review accounting principles unique to the client’s industry
2. Determine the likely users of the financial statements
3. Evaluate the appropriate financial statement measures for determining amounts likely to be considered material by users of the financial statements
4. Identify whether any specialists are required for the engagement
5. Send an engagement letter to the client
6. Tour the client’s plant and offices
7. Specify materiality levels to be used in testing of accounts receivable
8. Compare key ratios for the company to those for industry competitors
9. Review management’s risk management controls and procedures
10. Identify potential related parties that may require disclosure
For each procedure, indicate which of the first four parts of audit planning the procedure primarily relates to (1) accept client and perform initial audit planning, (2) understand the client’s business and industry, (3) perform preliminary analytical procedures, (4) set preliminary judgment about materiality and performance materiality.
8-28 (OBJECTIVE 8-3) In your audit of Canyon Outdoor Provision Company’s financial statements, the following transactions came to your attention:
1. Canyon Outdoor’s operating lease for its main store is with MTS Properties, which is a real estate investment firm owned by Andrei Mikhailov. Mr. Mikhailov is a member of Canyon Outdoor’s board of directors.
2. One of Canyon Outdoor’s main suppliers for kayaks is Hessel Boating Company.
Canyon Outdoor has purchased kayaks and canoes from Hessel for the last 25 years under a long-term contract arrangement.
3. Short-term financing lines of credit are provided by Cameron Bank and Trust. Suzanne Strayhorn is the lending officer assigned to the Canyon Outdoor account.
Suzanne is the wife of the largest investor of Canyon Outdoor.
4. Hillsborough Travel partners with Canyon Outdoor to provide hiking and rafting adventure vacations. The owner of Hillsborough Travel lives in the same neighborhood as the CEO of Canyon Outdoor. They are acquaintances, but not close friends.
5. The board of directors consists of several individuals who own stock in Canyon Outdoor. At a recent board meeting, the board approved its annual dividend payable to shareholders effective June 1.
Required
a. Define what constitutes a “related party.”
b. Which of the preceding transactions would most likely be considered a related party transaction?
c. What financial statement implications, if any, would each of the above transactions have for Canyon Outdoor?
d. What procedures might auditors consider to help them identify potential related party transactions for clients like Canyon Outdoor?
8-29 (OBJECTIVES 8-2, 8-3) Your audit firm was recently engaged to conduct the financial statement audit for BBH Automotive, an original equipment manufacturer (OEM) in the automotive industry. As the senior manager on the engagement, you are performing initial audit planning and developing an understanding of BBH’s business and industry. While the lead engagement partner has experience in the automotive industry, you have only worked on one other automotive engagement. As part of the planning process, you are reviewing news articles and thought papers on the impact of autonomous vehicles on the industry, including OEMs. You come across a 2017 publication by KPMG titled “Islands of Autonomy: How Autonomous Vehicles Will Emerge in Cities Around the World,” in which the authors predict that sales of personally owned sedan vehicles in the U.S. will drop from approximately 5.4 million in 2017 to 2.1 million by the year 2030 due to shifts in mobility patterns, particularly in major cities.
You are also aware that BBH Automotive recently had a significant recall on one of their parts that is a component of a popular sedan sold by one of the large automotive manufacturers. You read that a lawsuit has been filed related to an accident caused by the defective part.
a. Based on the information above, identify at least three business risks for BBH Automotive.
b. What impact could each of these business risks potentially have on the client’s financial statements, including footnote disclosures? Be specific in terms of the accounts and disclosures affected and in what way they would be affected.
c. You meet with the lead engagement partner and she asks you to provide a more in-depth assessment of the potential impact of autonomous vehicles on the automotive supplier market in preparation for a meeting with the CEO of BBH. Go to the KPMG website and access the “Islands of Autonomy” publication, or other publications from KPMG U.S.
Manufacturing Institute’s Automotive Center about the future of the automotive industry, at www.kpmg.com/us/automotive. Identify at least two additional risks related to autonomous vehicles, and draft questions related to these business risks as well as the business risks identified in part a. above. You will ask BBH Automotive’s CEO about how the company plans to address these risks.
d. What are additional sources of information that you could use to identify additional potential business risks?
8-30 (OBJECTIVE 8-3) The minutes of the board of directors of the Tetonic Metals Company for the year ended December 31, 2019, were provided to you.
Meeting of March 5, 2019
The meeting of the board of directors of Tetonic Metals was called to order by James Cook, the chairman of the board, at 8:30 a.m. The following directors were in attendance:
Irene Arnold James Cook Brian McDonald
Robert Suarez Larry Holden Tony Williams
Mary Beth Cape Heather Jackson
The board approved the minutes from the November 22, 2018, meeting.
The board reviewed the financial statements for the most recent fiscal year that ended December 31, 2018. Due to strong operating results, the board declared an increase in the annual dividend to common shareholders from $0.32 to $0.36 per common share payable on May 10, 2019, to shareholders of record on April 25, 2019.
Required
Research
Required:
Tony Williams, CEO, led a discussion of the seven core strategic initiatives in the 2019–2021 strategic plan. The most immediate initiative is the expansion of Tetonic operations into the Pacific Northwest. The board approved an increased budget for 2019 administrative expenses of $1 million to open offices in the Portland, Oregon, area.
Mr. Williams also led a discussion of a proposed acquisition of one of Tetonic’s smaller competitors. The board discussed synergies that might be possible if the operations of the acquired company could be successfully integrated with the operations of Tetonic. The board granted Williams and the management team approval to continue negotiations with the other company’s board and management.
The board continued its discussion from prior meetings about the October 2018 report from the Environmental Protection Agency (EPA) regarding dust im- pact at Tetonic’s zinc refineries. Legal counsel for Tetonic updated the board on the status of negotiations with the EPA regarding findings contained in the report. The board asked management to include an update on the status of any resolutions for its next meeting. The board also asked management to schedule a conference call, if necessary, for the board if issues need to be resolved before the next meeting.
Officer bonuses for the year ended December 31, 2018, were approved for payment on April 14, 2019, as follows:
Tony Williams—Chief Executive Officer $375,000
Mary Beth Cape—Chief Operating Officer $250,000
Bob Browning—Chief Financial Officer $225,000
The Audit Committee and the Compensation Committee provided an update
of issues discussed at each of their respective meetings.
The meeting adjourned 5:30 p.m.
Meeting of October 21, 2019
The meeting of the board of directors of Tetonic Metals was called to order by James Cook, the chairman of the board, at 8:30 a.m. The following directors were in attendance:
Irene Arnold James Cook Brian McDonald
Robert Suarez Larry Holden Tony Williams
Mary Beth Cape Heather Jackson
The board approved the minutes from the March 5, 2019, meeting.
Tony Williams, CEO, provided an overview of financial performance and operating results for the 9 months ended September 30, 2019. Given the volatility in the economy, Tetonic sales have fallen by over 8 percent compared to the same period in 2018. To address the drop in revenues, Tetonic has scaled back mining operations by a similar percentage to reduce labor and shipping costs. Bob Browning, CFO, updated the board on discussions with banks that will be financing the acquisition of the Tetonic competitor. The terms of the $7 million financing include a floating interest rate that is 2 percent above prime over the 10-year life of the loan. Payments will be made quarterly, and Tetonic will have to maintain compliance with certain loan covenant restrictions that are tied to financial performance. The board approved the acquisition and related loan transaction and scheduled a closing date for the financing to be November 1, 2019.
To prepare for the proposed acquisition, the board approved an increase in the capital expenditures budget of $1.5 million to cover costs of expanding computer operations, including new servers. The new equipment is needed to successfully integrate IT operations at Tetonic and the acquired company. The equipment will be installed in December 2019. Existing equipment that was purchased in 2017 will no longer be used in the IT operations at Tetonic.
The board discussed the creation of an incentive stock option plan for senior executives as a way to better align management and shareholder incentives. Consultantsfrom a compensation advisory firm and tax attorneys from a national accounting firm led a discussion of the components of the proposed plan, including discussion of the related tax implications. The board asked the consultants to revise the plan based on comments received at the meeting for presentation at the board’s next meeting. Tetonic’s external auditor provided an update of its interim work related to tests of the operating effectiveness of internal controls over financial reporting.
The audit partner presented a written report that provided information about three deficiencies in internal control considered to be significant by the auditor.
Legal counsel for Tetonic updated the board on final resolution of the EPA report findings. The final settlement requires Tetonic to modify some of the air handling equipment at its zinc refineries, which is expected to cost about $600,000.
No other penalties were imposed by the EPA.
The Audit Committee and the Compensation Committee provided an update of issues discussed at each of their respective meetings.
a. How do you, as the auditor, know that all minutes have been made available to you?
b. Read the minutes of the meetings of March 5 and October 21. Use the following format to list and explain information that is relevant for the 2019 audit:
Information Relevant to 2019 Audit Audit Action Required
1.
2.
c. Read the minutes of the meeting of March 5, 2019. Did any of that information pertain to the December 31, 2018, audit? Explain what the auditor should have done during the December 31, 2018, audit with respect to 2019 minutes.
8-31 (OBJECTIVE 8-4) Your comparison of the gross margin percent for Jones Drugs for the years 2016 through 2019 indicates a significant decline. This is shown by the following information:
2019 2018 2017 2016
Sales (thousands) $ 14,211 $ 12,916 $ 11,462 $ 10,351
CGS (thousands) 9,223 8,266 7,313 6,573
Gross margin $ 4,988 $ 4,650 $ 4,149 $ 3,778
Percent 35.1 36.0 36.2 36.5
A discussion with Tanvi Anand, the controller, brings to light two possible explanations.
She informs you that the industry gross profit percent in the retail drug industry declined fairly steadily for three years, which accounts for part of the decline. A second factor was the declining percent of the total volume resulting from the pharmacy part of the business.
The pharmacy sales represent the most profitable portion of the business, yet the competition from discount drugstores prevents it from expanding as fast as the nondrug items such as magazines, candy, and many other items sold. Anand feels strongly that these two factors are the cause of the decline.
The following additional information is obtained from independent sources and the client’s records as a means of investigating the controller’s explanations:
Jones Drugs ($ in thousands) Industry Gross
Profit Percent for
Retailers of Drugs
and Related ProductsDrug Sales
Nondrug
Sales
Drug Cost of
Goods Sold
Nondrug Cost
of Goods Sold
2019 $5,126 $9,085 $3,045 $6,178 32.7
2018 5,051 7,865 2,919 5,347 32.9
2017 4,821 6,641 2,791 4,522 33.0
2016 4,619 5,732 2,665 3,908 33.2
Required
a. Evaluate the explanation provided by Anand. Show calculations to support your conclusions.
b. Which specific aspects of the client’s financial statements require intensive investigation in this audit?
8-32 (OBJECTIVE 8-4) In the audit of the Worldwide Wholesale Company, you did extensive ratio and trend analysis as part of preliminary audit planning. Your analytical procedures identified the following:
1. Commission expense as a percent of sales was constant for several years but has increased significantly in the current year. Commission rates have not changed.
2. The rate of inventory turnover has steadily decreased for three years.
3. Inventory as a percent of current assets has steadily increased for four years.
4. The number of days’ sales in accounts receivable has steadily increased for three years.
5. Allowance for uncollectible accounts as a percent of accounts receivable has steadily decreased for three years.
6. The absolute amounts of depreciation expense and depreciation expense as a percent of gross fixed assets are significantly smaller than in the preceding year.
a. Evaluate the potential significance of each of the changes in ratios or trends identified in your analysis on the fair presentation of financial statements.
b. State the follow-up procedures you would perform for each fluctuation to determine whether a material misstatement exists.
8-33 (OBJECTIVES 8-3, 8-4) Target and Kohl’s are chains of stores that cater to customers who desire name-brand goods at lower prices. The Securities and Exchange Commission (SEC) Form 10-K filing rules require management of U.S. public companies to include background information about the business, as well as the most recent financial condition and results of operations. Access each company’s most recent Form 10-K. These can be obtained through the SEC website (www.sec.gov), or directly from the investor relations section of the Target (www.target.com) and Kohl’s (www.kohls.com) websites.
a. Read the description of each company’s business in Part I, Item 1 of Form 10-K.
Evaluate the similarity of each company as a basis for making financial comparisons.
b. Each company follows what is called a 52/53-week year in which the fiscal year ends on the Saturday nearest January 31. Given the nature of these companies, why does
a year end near January 31 make sense? Note that most public companies have a December 31 year end.
c. Use the financial statements included in Part II, Item 8 to calculate the gross margin percentage and inventory turnover ratio for each company for the most recent year.
Which company has the higher gross margin percentage? Which company has the higher inventory turnover?
d. Evaluate whether the relation between the gross margin percentage and inventory turnover makes sense given the description of each company’s business.
8-34 (OBJECTIVES 8-5, 8-8) You are evaluating audit results for assets in the audit of Roberts Manufacturing. You set the preliminary judgment about materiality at $50,000. The account balances, performance materiality, and estimated overstatements in the accounts are shown next.
Account
Account
Balance
Performance
Materiality
Estimate of Total
Overstatements
Cash $ 50,000 $ 5,000 $ 1,000
Accounts receivable 1,200,000 30,000 20,000
Inventory 2,500,000 50,000 ?
Other assets 250,000 15,000 12,000
Total $4,000,000 $100,000 ?
Required
Required
Required
a. Assume you tested inventory amounts totaling $1,000,000 and found $10,000 in overstatements. Ignoring sampling risk, what is your estimate of the total misstatement in inventory?
b. Based on the audit of the assets accounts and ignoring other accounts, are the overall financial statements acceptable? Explain.
c. What do you believe the auditor should do in the circumstances?
8-35 (OBJECTIVE 8-7) Ling, an audit manager, is planning the audit of Modern Technologies, Inc. (MT, Inc.), a manufacturer of electronic components. This is the first year that Ling’s audit firm has performed the audit for MT, Inc. Ling set the preliminary judgment about materiality for the financial statements as a whole at $66,000 and is now in the process of setting performance materiality for asset accounts. Asset balances for the current year (unaudited) and prior year (audited) are listed below, as well as Ling’s initial determination of performance materiality for each account. Based on preliminary discussions with management, a tour of the production facility, and background reading about the electronic components industry, Ling determines that MT, Inc., has strong credit policies, and most customers pay their full balance on time. Competition in the electronic components industry is high, and inventory can become obsolete quickly due to rapid technology changes (inventory turnover is a measure that analysts focus on when assessing performance for electronic component manufacturers). Production equipment is relatively specialized and additional investment is required when new electronic components are introduced.
Current Year
(unaudited)
Performance
Materiality
Prior Year
(audited)
Cash $ 397,565 $10,000 $ 356,122
Accounts receivable,
net of allowance
2,583,991 25,000 2,166,787
Inventory 1,953,845 15,000 1,555,782
Total current assets 4,935,401 4,078,691
Property, plant, and
equipment, net
1,556,342 20,000 1,458,963
Other assets 153,000 20,000 149,828
Total assets $6,644,743 $5,687,482
a. What factors should Ling consider in setting performance materiality for the asset accounts?
b. Explain why Ling set performance materiality for cash at the lowest amount.
c. Explain why Ling set performance materiality for inventory at a lower amount as compared to accounts receivable, PP&E, and other assets.
d. Explain why Ling set performance materiality for accounts receivable at the highest amount.
e. Does setting materiality at a lower level result in collecting more or less audit evidence (as compared to setting materiality at a higher level)?
8-36 (OBJECTIVES 8-6, 8-7, 8-8) Following are statements of earnings and financial position
for Wexler Industries.
Consolidated Statements of Earnings,
Wexler Industries (in Thousands)
For the Year Ended
March 31, 2019 March 31, 2018 March 31, 2017
Revenue
Net sales $ 8,351,149 $ 6,601,255 $ 5,959,587
Other income 59,675 43,186 52,418
8,410,824 6,644,441 6,012,005
Required
Required
For the Year Ended
March 31, 2019 March 31, 2018 March 31, 2017
Costs and expenses
Cost of sales 5,197,375 4,005,548 3,675,369
Marketing, general, and administrative
expenses
2,590,080 2,119,590 1,828,169
Provision for loss on restructured
operations
64,100 — —
Interest expense 141,662 46,737 38,546
7,993,217 6,171,875 5,542,084
Earnings from continuing operations
before income taxes
417,607 472,566 469,921
Income taxes (176,700) (217,200) (214,100)
Earnings from continuing operations 240,907 255,366 255,821
Provision for loss on discontinued
operations, net of income taxes (40,700) — —
Net earnings $ 200,207 $ 255,366 $ 255,821
Consolidated Statements of Financial Position
Wexler Industries (in Thousands)
Assets March 31, 2019 March 31, 2018
Current assets
Cash $ 39,683 $ 37,566
Temporary investments, including time
deposits of $65,361 in 2019 and $181,589
in 2018 (at cost, which approximates market)
123,421 271,639
Receivables, less allowances of $16,808 in 2019
and $17,616 in 2018
899,752 759,001
Inventories
Finished product 680,974 550,407
Raw materials and supplies 443,175 353,795
1,124,149 904,202
Deferred income tax benefits 9,633 10,468
Prepaid expenses 57,468 35,911
Current assets 2,254,106 2,018,787
Land, buildings, and equipment, at cost, less accumulated
depreciation
1,393,902 1,004,455
Investments in affiliated companies and sundry assets 112,938 83,455
Goodwill and other intangible assets 99,791 23,145
Total $3,860,737 $3,129,842
Liabilities and Stockholders’ Equity March 31, 2019 March 31, 2018
Current liabilities
Notes payable $ 280,238 $ 113,411
Current portion of long-term debt 64,594 12,336
Accounts and drafts payable 359,511 380,395
Accrued salaries, wages, and vacations 112,200 63,557
Accrued income taxes 76,479 89,151
Other accrued liabilities 321,871 269,672
Current liabilities 1,214,893 928,522
Consolidated Statements of Financial Position
Wexler Industries (in Thousands)
Liabilities and Stockholders’ Equity March 31, 2019 March 31, 2018
Long-term debt 730,987 390,687
Other noncurrent liabilities 146,687 80,586
Deferred income taxes 142,344 119,715
Stockholders’ equity
Common stock issued, 51,017,755 shares in 2019
and 50,992,410 in 2018
51,018 50,992
Additional paid-in capital 149,177 148,584
Cumulative foreign currency translation adjustment (76,572) —
Retained earnings 1,554,170 1,462,723
Common stock held in treasury, at cost, 1,566,598 shares (51,967) (51,967)
Stockholders’ equity 1,625,826 1,610,332
Total $3,860,737 $3,129,842
a. Use professional judgment in deciding on the preliminary judgment about materiality for earnings, current assets, current liabilities, and total assets. Your conclusions should be stated in terms of percents and dollars.
b. Assume that you define materiality for the financial statements as a whole as a combined misstatement of earnings from continuing operations before income taxes of 5 percent.
Also assume that you believe there is an equal likelihood of a misstatement of every account in the financial statements, and each misstatement is likely to result in an overstatement of earnings. Allocate materiality to these financial statements as you consider appropriate.
c. As discussed in part b., net earnings from continuing operations before income taxes was used as a base for calculating materiality for the Wexler Industries audit. Discuss why most auditors use before-tax net earnings instead of after-tax net earnings when calculating materiality based on the income statement.
d. Now assume that you have decided to allocate 75 percent of your preliminary judgment to accounts receivable, inventories, and accounts payable because you believe all other accounts have a low risk of material misstatement. How does this affect evidence accumulation on the audit?
e. Assume that you complete the audit and conclude that your preliminary judgment about materiality for current assets, current liabilities, and total assets has been met.
The actual estimate of misstatements in earnings exceeds your preliminary judgment.
What should you do?
8-37 ACL Problem (OBJECTIVE 8-4) This problem requires the use of ACL software, which can be accessed through the textbook website. Information about downloading and using ACL and the commands used in this problem can also be found on the textbook web- site. You should read all of the reference material preceding the instructions about “Quick Sort” before locating the appropriate command to answer questions a. through c.
For this problem, use the “Invoices” file in the “Sales and Collection” subfolder under tables in the ACL_Rockwood project. This file contains information on sales invoices generated during calendar year 2014, including those that have been paid versus those still outstanding. The suggested command or other source of information needed to solve the problem requirement is included at the end of each question.
a. Obtain and print statistical information for Invoice Amount. What is the total amount of invoices generated during the year? Do any invoices have a negative value?
(Statistics)
b. What is the total amount of invoices still outstanding (not yet paid) at the end of the year? Note the file includes a default payment date for unpaid invoices that will be updated once payment is received. (Summarize)
Required
Data
Analytics
Required
c. From the summary created in part b. above, click on the “Outstanding” invoices to examine the details of those still outstanding. Sort the “invoice_date” column in ascending order. What concerns do you have, if any, about the collectibility of the invoice amounts? (Quick Sort)
d. How might the evidence obtained in parts a. through c. above help the auditor in testing accounts receivable?
CASE
8-38 (OBJECTIVES 8-2, 8-3) Winston Black was an audit partner in the firm of Henson, Davis
& Company. He was in the process of reviewing the audit files for the audit of a new client, McMullan Resources. McMullan was in the business of heavy construction. Black was conducting his first review after the audit was substantially complete. Normally, he would have done an initial review during the planning phase as required by his firm’s policies; however, he had been overwhelmed by an emergency with his largest and most important client. He rationalized not reviewing audit planning information because (1) the audit was being overseen by Sarah Beale, a manager in whom he had confidence, and (2) he could “recover” from any problems during his end-of-audit review.
Now Black found that he was confronted with a couple of problems. First, he found that the firm may have accepted McMullan without complying with its new-client acceptance procedures. McMullan came to Henson, Davis & Company on a recommendation from a friend of Black’s. Black got “credit” for the new business, which was important to him because it would affect his compensation from the firm. Because Black was busy, he told Beale to conduct a new-client acceptance review and let him know if there were any problems. He never heard from Beale and assumed everything was okay. In reviewing Beale’s preaudit planning documentation, he saw a check mark in the box “Contact prior auditors” but found no details indicating what was done. When he asked Beale about this, she responded with the following:
“I called Gardner Smith [the responsible partner with McMullan’s prior audit firm] and left a voicemail message for him. He never returned my call. I talked to Ted McMullan about the change, and he told me that he informed Gardner about the change and that Gardner said, ‘Fine, I’ll help in any way I can.’ Ted said Gardner sent over copies of analyses of fixed assets and equity accounts, which Ted gave to me. I asked Ted why they replaced Gardner’s firm, and he told me it was over the tax contingency issue and the size of their fee. Other than that, Ted said the relationship was fine.”
The tax contingency issue that Beale referred to was a situation in which McMullan had entered into litigation with a bank from which it had received a loan. The result of the litigation was that the bank forgave several hundred thousand dollars in debt. This was a windfall to McMullan, and they recorded it as a gain, taking the position that it was nontaxable. The prior auditors disputed this position and insisted that a contingent tax liability existed that required disclosure. This upset McMullan, but the company agreed in order to receive an unmodified opinion. Before hiring Henson, Davis & Company as their new auditors, McMullan requested that the firm review the situation. Henson, Davis & Company believed the contingency was remote and agreed to the elimination of the disclosure.
The second problem involved a long-term contract with a customer in Montreal. Under accounting standards, McMullan was required to recognize income on this contract using the percentage-of-completion method. The contract was partially completed as of year end and had a material effect on the financial statements. When Black went to review the copy of the contract in the audit files, he found three things. First, there was a contract summary that set out its major features. Second, there was a copy of the contract written in French. Third, there was a signed confirmation confirming the terms and status of the contract. The space requesting information about any contract disputes was left blank, indicating no such problems.
Black’s concern about the contract was that to recognize income in accordance with accounting standards, the contract had to be enforceable. Often, contracts contain a cancellation clause that might mitigate enforceability. Because he was not able to read French, Black couldn’t tell whether the contract contained such a clause. When he asked Beale about this, she responded that she had asked the company’s vice president for the Canadian division about the contract and he told her that it was their standard contract.
The company’s standard contract did have a cancellation clause in it, but it required mutual agreement and could not be cancelled unilaterally by the buyer.
a. Evaluate and discuss whether Henson, Davis & Company complied with auditing standards in their acceptance of McMullan Resources as a new client. What can they do at this point in the engagement to resolve deficiencies if they exist?
b. Evaluate and discuss whether sufficient audit work has been done with regard to McMullan’s Montreal contract. If not, what more should be done?
c. Evaluate and discuss whether Black and Beale conducted themselves in accordance with auditing standards.
Required
8-39 (OBJECTIVES 8-3, 8-4)
Introduction
This case study is presented in seven parts. Each part deals largely with the material in the chapter to which that part relates. However, the parts are connected in such a way that in completing all seven, you will gain a better understanding of how the parts of the audit are interrelated and integrated by the audit process. The parts of this case appear in the following textbook chapters:
• Part I—Perform analytical procedures for different phases of the audit, Chapter 8.
• Part II—Understand factors influencing risks and the relationship of risks to audit evidence, Chapter 9.
• Part III—Conduct fraud brainstorming and assess fraud risks, Chapter 10.
• Part IV—Understand internal control and assess control risk for the acquisition and payment cycle, Chapter 12.
• Part V—Design tests of controls and substantive tests of transactions, Chapter 14.
• Part VI—Determine sample sizes using audit sampling and evaluate results, Chapter 15.
• Part VII—Design, perform, and evaluate results for tests of details of balances, Chapter 16.
Background Information
Your audit firm has recently been engaged as the new auditor for Pinnacle Manufacturing, effective for the audit of the financial statements for the year ended December 31, 2019.
Pinnacle is a medium-sized corporation, with its headquarters located in Detroit, Michigan. The company is made up of three divisions. The first division, Welburn, has been in existence for 35 years and creates powerful diesel engines for boats, trucks, and commercial farming equipment. The second division, Solar-Electro, was recently acquired from a high- tech manufacturing firm based out of Dallas, Texas. Solar-Electro produces state-of-the-art, solar-powered engines. The solar-powered engine market continues to mature, and Pinnacle’s top management believes that the Solar-Electro division will be extremely profitable in the future as the focus on global climate change continues and anticipated regulations make solar-powered engines mandatory for certain public transportation vehicles. Finally, the third division, Machine-Tech, engages in a wide variety of machine service and repair operations. This division, also new to Pinnacle, is currently in its second year of operations.
Pinnacle’s board of directors has recently considered selling the Machine-Tech division in order to focus more on core operations—engine manufacturing. However, before any sale will be made, the board has agreed to evaluate this year’s operating results. Excellent operating results may have the effect of keeping the division as part of Pinnacle for the next few years. The vice president for Machine-Tech is committed to making it profitable.
INTEGRATED CASE APPLICATION — PINNACLE MANUFACTURING: PART I
PART I
The purpose of Part I is to perform preliminary analytical procedures as part of the audit planning process. You have been asked to focus your attention on two purposes of analytical procedures: obtaining an understanding about the client’s business and indicating where there is an increased likelihood of misstatements.
a. Go to the Pinnacle link on the textbook website (www.pearsonhighered.com/arens) and open the Pinnacle_Financials Excel file. The financial statement data is also shown in
Figure 8-9. Using the Excel file, compute percent changes in all Pinnacle Income Statement and Pinnacle Balance Sheet account balances from 2017–2018 and 2018–2019.
b. The Excel file also includes a tab with the common ratios shown in Chapter 7 on pages 206–208. Selected ratios for prior years have already been calculated. Calculate
Required
FIGURE 8-9 Pinnacle Manufacturing Financial Statements
Pinnacle Manufacturing Company
Income Statement
For the Year Ended December 31
Net sales
Cost of goods sold
Gross profit
Operating expenses
Income from operations
Other revenues and gains
Other expenses and losses
Income before income tax
Income tax
Net income for the year
Earnings per share
$ 151,137,628
109,284, 780
41,852,848
37, 397 ,738
4,455,110
—
2, 181 ,948
2,273,162
703,437
1,569,725
$1.57
2019
$ 148,586,037
106,255,499
42,330,538
38,133,969
4,196,569
—
2,299,217
1,897,352
858,941
1,038,411
$1.04
2018
$ 144,686,413
101,988,165
42,698,248
37,241,108
5,457,140
—
2,397,953
3,059,187
1,341,536
1,717,651
$1.72
2017
2019 2018 2017
Pinnacle Manufacturing Company
Balance Sheet
As of December 31
Assets
Current assets
Cash and cash equivalents
Net receivables
Inventory
Other current assets
Total current assets
Property, plant, and equipment
Total assets
Liabilities
Current liabilities
Accounts payable
Short/current long-term debt
Other current liabilities
Total current liabilities
Long-term debt
Total liabilities
Stockholders’ equity
Common stock
Additional paid-in capital
Retained earnings
Total stockholders’ equity
Total liabilities & stockholders’ equity
$ 7,721,279
12,742,165
31,936,021
172,278
52, 571 ,743
62,863,047
$ 115,434,790
$ 12,969,686
15 ,375,819
2 ,067,643
30,413,148
060,090
54,473,238
1,000,000
15,717,645
44 ,243,907
60,961,552
$ 115,434,790
$ 8,066,545
7,936,409
25 ,271,503
131,742
41,406,199
58,268,732
$ 99,674,931
$ 7,586,374
9,672,670
1 ,682,551
18,941,595
22,379,920
41,321,515
1,000,000
15,717,645
41,635,771
58 ,353,416
$ 99 ,674, 931
$ 7,324,846
8,619,857
25,537,198
143,206
41,625,107
61,635,530
$ 103,260,637
$ 9,460 ,776
10,298,668
1 ,767,360
21,526,804
22,342,006
43,868,810
1, 000,000
15,717,645
42,674,182
59,391,827
$ 103,260,637
24,
