Chapter 19 Completing the Tests in the Acquisition and Payment Cycle: Verification of Selected Accounts

Revie

!uestions

19"1 Because the source of the debits in the asset account is the acquisitions journal (or similar record), the current period acquisitions of property, plant and equipment have already been partially verified as part of the acquisition and payment cycle. The disposal of assets, depreciation and accumulated depreciation are not tested as a part of the acquisition and payment cycle. 19"# The reason for the emphasis on current period acquisitions in auditing property, plant, and equipment is that there is an expectation that permanent assets will be ept and maintained on the records for several years. The assets carried over from the preceding years can be assumed to have been verified in the prior years! audits. "f it cannot be shown through tests of controls and substantive tests of transactions that all disposals have been recorded, additional testing of the prior balance could be required. # first year audit also necessitates tests of the beginning balance. 19"$ $any clients may accidentally or intentionally record purchases of assets in the repair and maintenance account. The misstatement is caused by a lac of understanding of generally accepted accounting principles and some clients! desire to avoid income taxes. %epair and maintenance accounts are verified primarily to uncover unrecorded property purchases. "n other cases, however, management has fraudulently capitali&ed repair and maintenance expenses to boost profitability and assets. The auditor typically vouches the larger amounts debited to those expense accounts at the same time that property accounts are being audited. 19"% The audit procedures that may be applied to determine that all property, plant and equipment retirements have been recorded are as follows' (. ). %eview whether newly acquired assets replace existing assets. "f so, inquire as to whether the old asset has been removed from the boo s. #naly&e gains on the disposal of assets and miscellaneous income for receipts from the disposal of assets. *ompare these to property, plant and equipment accounts to see whether the asset has been removed from the boo s.

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19"% &continued' -. .. 19"( are' %eview planned modification and changes in product lines, taxes, or insurance coverage for indications of deletions of equipment. $a e inquiries of management and production personnel about the disposal of assets.

The two considerations to be ept in mind in auditing depreciation expense (. ). /hether the client is following a consistent depreciation policy from period to period. The accuracy of the client!s calculations.

#n overall reasonableness test can be made by calculating the depreciation rate for the year times the undepreciated fixed assets. "n addition, it is desirable to chec the accuracy of the depreciation calculation. The extent of the accuracy tests will vary depending on the engagement circumstances. 19") 0ince the source of the debits to prepaid insurance is the acquisitions journal or similar record (assuming all insurance premiums are charged to prepaid insurance rather than insurance expense), the current period premiums have already been partially verified as a part of the acquisition and payment cycle. The allocation of the premium between prepaid insurance is not tested as a part of the acquisition and payment cycle. 19"* The audit of prepaid insurance should ordinarily ta e a relatively small amount of audit time because' (. ). -. The balance in prepaid insurance is normally immaterial1 There are ordinarily few transactions during the year and most transactions are immaterial1 The transactions are ordinarily not complex.

19"+ The evaluation of the adequacy of insurance is a test of reasonable protection against the loss of existing assets. The verification of prepaid insurance is performed to determine whether' (. ). -. The balances represent proper charges against future operations. The additions represent charges to these accounts and are reflected at actual cost. #morti&ation or write,off is reasonable under the circumstances.

The evaluation of adequacy of insurance coverage is more important because of the potential loss due to under,insurance. 2erification of prepaid insurance usually involves an immaterial amount and is not emphasi&ed in most audits.

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19"9 The audit of prepaid expenses differs from the audit of other asset accounts, such as accounts receivable or property, plant, and equipment, because prepaid expenses are often immaterial. #nalytical procedures are often sufficient for auditing prepaid expenses, while tests of details of balances are usually required for other accounts such as accounts receivable and property, plant, and equipment. 19"1, 3ebits to accrued rent arise from the cash disbursements journal, which is verified as a part of tests of controls and substantive tests of transactions for cash disbursements. The credits typically arise from the general journal and may not have been verified as a part of these tests. 4urthermore, tests of controls and substantive tests of transactions do not include verification of the inclusion of accruals on all existing property and verification of the consistent treatment of the accruals from year to year. 19"11 5roperty tax accruals ta e little audit time for most audits, and since there are relatively few transactions to test and they are typically material in amount, it is common to verify the accounts (66 percent. 7n the other hand, accounts payable ta es quite a bit of audit time and since there are usually a large number of transactions to test and they are typically varied in amount, it is common to verify the account on a test basis. 19"1# The following documents will be used to verify accrued property taxes and related expense accounts' (. ). -. .. 3eeds to properties 5roperty tax returns *ancelled chec s "nvoices from the taxing authority

19"1$ Three expense accounts that are tested as part of the acquisition and payment cycle or the payroll and personnel cycle are' (. ). -. 5roperty tax expense 5ayroll expense %ent expense

Three expense accounts that are not directly verified as part of either of these cycles are' (. ). -. 3epreciation expense #morti&ation of patents 8ear,end bonuses to officers

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19"1% The analysis of expense accounts is a procedure by which selected expense accounts are verified by examining underlying supporting vendors! invoices or other documentation to determine if the transactions ma ing up the total are correctly stated. The emphasis in most expense account analysis is on the occurrence of recorded amounts, accuracy, and classification. 5otentially the same objectives are accomplished in tests of controls and substantive tests of transactions as for expense account analysis. The major differences are that tests of controls and substantive tests of transactions are selected from all of the acquisitions and cash disbursements journals for the entire period whereas transactions examined for expense analysis are limited to the account being analy&ed. 9evertheless, the procedures are closely related, and if the tests of controls and substantive tests of transactions procedures results are satisfactory, reduced expense account analysis is implied. 19"1( The approach for verifying depreciation expense should emphasi&e the consistency of the method of depreciation used and the related computations, since these aspects of depreciation expense are the main determinants of the account balance. The use of analytical procedures and reperformance tests is important for depreciation expense. "n verifying repair expense, the emphasis should be on vouching transactions that may be capital items1 therefore, examining supporting docu, mentation for transactions from months with unusually large totals or transactions that are themselves large or unusual is the normal audit approach followed. The approach is different because in repairs and maintenance the primary objective is to locate improperly classified fixed assets, whereas in depreciation the emphasis is on consistency from period to period and accurate depreciation calculations. 19"1) The factors that should affect the auditor!s decision whether or not to analy&e an account balance are' (. ). -. .. :. ;. The analytical procedures indicate there is a high li elihood of misstatement in an account. The tests of controls and substantive tests of transactions indicate there is a high li elihood of misstatement in an account. The account is li ely to contain misstatements because it is difficult for the client to properly classify or value the transactions. The auditor nows that the account is frequently subject to abuse or misstatement. The analysis of the account might disclose a contingency. Tax returns and the 0<* require the disclosure of certain information, which the account is li ely to provide.

4our expense accounts that are commonly analy&ed in audit engagements are' (. ). -. .. =egal expense Travel and entertainment expense Tax expense %epair and maintenance expense (+,.

-ultiple Choice !uestions .rom CPA /0aminations a. a. a. a. (() (-) (() ()) b. b. b. b. (() (.) (.) (.) c. c. c. c. (.) (.) (-) (.)

19"1* 19"1+ 19"19 19"#,

1iscussion !uestions and Pro2lems

19"#1
3T/456 ( ) S89STA4T3V/ A813T PR5C/18R/ *ompare to government study depreciation table. Test all expense charges to these accounts that exceed a certain amount. *ompare supporting documentation on property acquisitions to the recorded value. (() *onfirm loans with the ban and perform other tests for unrecorded loans. ()) <xamine plant asset additions and agree to recorded amounts and dete Trace from equipment recorded on the accounting records to the equipment. *ompare depreciation expense for administration and manufacturing to previous years. *hec the client!s physical count of the tools.

34T/R4A7 C54TR57 >se of government study depreciation tables. <stablish a policy for deciding which items require capitali&ation and establish an internal verification procedure. %equire internal verification in the recording of property acquisitions. %equire the deposit of all cash directly into the ban account.

?ave office manager periodically report to the accounting department whether or not there have been abandonments or replacements. "nternally verify charges for depreciation expenses. #ssign tools to individual foreman and periodically count the tools.

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19"##
a6 P8RP5S/ (. To assure that recording asset misstatements are minimi&ed. (<xistence, completeness) ). To minimi&e accounting classification misstatements. (*lassification) -. To minimi&e depreciation calculation and recording misstatements. (#ccuracy) .. To minimi&e improper purchases. (<xistence) 26 T/ST 5. C54TR57 T5 T/ST .5R /:3ST/4C/ 5. C54TR57 2erify that master file exists and is used. c6 S89STA4T3V/ PR5C/18R/ T5 T/ST .5R -3SSTAT/-/4TS 5hysically examine fixed assets and trace to master file.

2erify that written policies exist.

<xamine supporting documentation for transactions to determine if policies are followed for account classification. Test calculations and postings of depreciation charges.

<xamine records for indication of periodic verification of master file.

<xamine a sample of purchase invoices of fixed assets in excess of A)6,666 for Board of 3irectors! approval. <xamine the company!s physical count of equipment that compares tags on the equipment to records of tags.

<xamine a sample of purchase invoices of fixed assets for propriety and reasonableness. Trace a sample of recorded equipment to the related equipment to ma e sure it exists.

:. To provide a record of fixed assets and protect against their loss. (*ompleteness and existence)

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19"#$
a6 T;P/ 5. /V31/4C/ 8S/1 #nalytical procedure *onfirmation 26 T;P/ 5. PR5C/18R/ #nalytical procedure Test of details of balances c6 < d6 59=/CT3V/&S' 9ot applicable <xistence *ompleteness #ccuracy *utoff *ompleteness <xistence #ccuracy 5osting and summari&ation 9ot applicable *ompleteness #ccuracy *ompleteness Timing #ccuracy 7ccurrence #ccuracy Timing *lassification *ompleteness *utoff #ccuracy #ccuracy 7ccurrence

3T/456 ( )

. : ; @ B

"nternal documentation 5hysical examination %ecalculation #nalytical procedure "nquiry of client <xternal documentation (cancelled chec s) <xternal documentation

Test of control Test of details of balances 0ubstantive test of transactions #nalytical procedure Test of details of balances 0ubstantive test of transactions 0ubstantive test of transactions

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<xternal documentation

Test of details of balances Test of details of balances Test of control

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%ecalculation 7bservation

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19"#%

a.

9o. "n a first audit the auditorCs attention cannot be confined to activity in the year under audit because (() some balance sheet accounts include material amounts which originated in prior years, ()) some income and expense accounts include entries which are based on decisions or transactions of prior years, and (-) consistency over the years in the application of generally accepted accounting principles is necessary for fairly presented financial statements. #lso, some audit testing of a nonrecurring nature will be necessary in an initial engagement because the auditor does not have the benefits of (() familiarity with the company!s history, personnel, system and operations, ()) information regarding the composition and reliability of beginning of the year balances, and (-) preceding year!s audit wor ing papers. *onsequently, in the first audit the auditor will require such corporation documents as bylaws, articles of incorporation, minutes since incorporation, organi&ation charts and flowcharts, and must comprehensively obtain an understanding of internal control and assess control ris to determine the scope of audit testing. The audit program procedures that the auditor should use to verify the Danuary (, )66+, balances in the land, building and equipment, and accumulated depreciation accounts of ?ardware $anufacturing *ompany should include the following' (. %ead the minutes since incorporation in )66: to ascertain that for major property transactions approved, all transactions were recorded in the accounts, and recorded transactions were properly approved. 0can activity in the general ledger accounts since incorporation in )66: for both fixed assets and accumulated depreciation to identify items of large amount and unusual nature which will warrant further investigation. <xamine support for principal property additions to ascertain that the capitali&ation includes costs of freight,in, installation, and major improvements and labor, and overhead on self, constructed assets. #scertain that fixed assets donated by stoc holders were recorded at fair mar et value on the date of donation and that contributed capital was properly credited. *ompare the yearly totals of repairs and maintenance account balances and test abnormally high amounts to see that they do not include assets charged to expense. <xamine recorded deeds supporting ownership of buildings and determine that any encumbrance was properly reported in the financial statements. <xamine support (asset and accumulated depreciation) for recorded disposals or abandonments of material amounts.

b.

).

-.

.. :. ;. @.

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19"#% &continued' B. Tour the plants and account for major property items on hand to substantiate the reasonableness of fixed asset master file records and to ascertain that idle, obsolete or worthless assets are not being reported at more than their fair value in the financial statements. Test the assigned lives of depreciable assets and the bases, methods and computations of accumulated depreciation for propriety and consistency. %eview charges to the accumulated depreciation accounts to determine that they properly represent disposals, abandon, ments or extraordinary repairs. %eview the gains and losses on property disposals as an additional means of assurance that the depreciation lives and methods used are reasonable. 0can federal income tax returns of prior years and revenue agents! reports pertaining to them to determine whether adjustments made for tax purposes should also be made on the boo s. 3etermine that generally accepted accounting principles of income tax allocation are being used for differences between tax depreciation and financial statement depreciation. "nspect real estate and property tax bills to further substantiate ownership and valuation of fixed assets.

+. (6. ((. ().

(-. (.. 19"#(

P8RP5S/ (. To assure that the clients! detailed schedule equals the total in the general ledger. (3etail tie,in) ). To assure that taxes on property included on the schedule of accrued taxes are not over, or underpaid. (#ccuracy) -. To assure that the accruedEprepaid account is correctly stated. (#ccuracy)

/VA78AT354 5. A1/!8AC; This procedure is necessary as a starting point to perform detailed tests. This procedure is adequate for its purpose.

This procedure is adequate for its purpose.

7verall, the program fails to emphasi&e the possibility of omitted property from the list. The ey to an adequate audit of accrued property taxes is ma ing sure all owned property and only owned property is included and on the list.

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19"#)
73A9373T; T>AT C5871 9/ 84C5V/R/1 a. *ontingent liability related to a =awsuit b. Building used as collateral for a loan or a mortgage tied to the buildingCs purchase c. >nrecorded lease d. 9ote payable A813T PR5C/18R/ T5 84C5V/R 73A9373T; %eview minutes of the Board of 3irectors! meetings. <xamine documents of ownership to determine if the loan is collaterali&ed and send confirmations to major ban s. <xamine lease agreements. <xamine underlying records for loans related to the interest expense and send confirmations to major ban s. 7btain a confirmation from the life insurance company. 7btain confirmation from ban for loans. <xamine a sample of travel and expense reports to ma e sure they comply with "%0 requirements.

e. =oan by borrowing against an insurance policy f. 9ote payable

g. "ncome taxes payable for nondeductible expenses

19"#* The ban er has failed to recogni&e that the audit tests discussed relate as much to the income statement as to the balance sheet. 4or example, obtaining an understanding of internal control and the tests of controls and substantive tests of transactions are heavily income statement oriented, analytical procedures are more closely related to the income statement than to the balance sheet, and even tests of details of the balance sheet help to uncover misstatements in the income statement. The typical audit recogni&es the interrelationship between the income statement and the balance sheet and uses this interrelationship to help design more effective tests to uncover misstatements in both statements. The auditor is and should be greatly concerned about the fair presentation of the income statement. Case ? @ard Pu2lishing Company a. The tests of acquisition and cash disbursement transactions have two purposes' to determine whether related internal accounting controls are functioning (tests of controls), and to determine whether the trans, actions actually contain any monetary misstatements (substantive). The results of the tests apply to the population of all acquisitions and cash disbursements, including plant and equipment and lease acquisitions and cash disbursements, even though the specific sample

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19"#+ &continued' tested does not include any such transaction. Thus, if the results of the tests are favorable, it is concluded that there is a lower expectation of misstatements in plant and equipment and lease transactions, and vice,versa. b. # summary of the results from tests of controls and substantive tests of transactions for acquisitions and cash disbursements from *ase (B,-) is' all transaction,related audit objectives are being met at a satisfactory level except' (. #ll supporting documents are not always attached to the vendor!s invoice. Note: Students using a nonstatistical approach to Case 18-32 may not conclude that the results for this attribute [9 b !1"# are unacceptable$ depending on their estimate of C%&' (o)e*er$ most students )ill li+ely conclude that the results are unacceptable #ll vendorsC invoices are not initialed for internal verification. ?alf of those not initialed had account classification errors.

).

The impact of these results and the results from items ( through @ affect the balance,related audit objectives for plant and equipment in the following way'
R/S87TS 5. T/STS 5. C54TR57S A41 S89STA4T3V/ T/STS 5. TRA4SACT354S $isstatements unli ely $isstatements moderately li ely $isstatements unli ely $isstatements moderately li ely $isstatements highly li ely

9A7A4C/"R/7AT/1 A813T 59=/CT3V/ 3etail tie,in <xistence *ompleteness #ccuracy

R/S87TS .R5C54C78S354S 1"* F F *onclusion ( supports *onclusion . indicates a need for additional evidence *onclusion ; indicates a need for additional evidence F *onclusion - indicates a need for additional evidence F

*lassification

*utoff %eali&able value

$isstatements unli ely 9o significant evidence provided $isstatements unli ely

%ights and obligations

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19"#+ &continued' *onclusions -, :, and @ indicate a need for more extensive auditing for existence, completeness, accuracy, and classification. #ll large items should be verified and samples should be larger than normal. #ll other tests can be performed at minimum levels. c. The results of tests of controls and substantive tests of transactions are directly related to the tests of many expense accounts, primarily through tests for account classification, but also through tests of accuracy and existence. 4or example, if the auditor concludes that the internal controls are effective for recording acquisition transactions, the li elihood of misstatements for accounts such as supplies, purchases, and repairs and maintenance is greatly reduced. The auditor must eep in mind, however, that certain expense accounts are not usually verified as a part of tests of controls and substantive tests of transactions. #n example is depreciation expense. 0imilarly, certain accounts may have a higher inherent ris such as legal expense and therefore require additional testing even if tests of controls and substantive tests of transactions results are satisfactory. #lso, analytical procedures and tests of details of balances for balance sheet accounts results affect the extent of auditing needed for expense accounts. The results of tests of controls and substantive tests of transactions indicate the potential for significant classification misstatements. (0ee the results for #udit 5rocedure +b(:) for classification in 5art ) of *ase (B,-).) This potential for misclassification misstatement combined with the analytical procedures results in *onclusion ; indicate a need for more extensive account analysis for repairs and maintenance, small tools expense, and the three other accounts where there are significant changes from prior years. 9o other conclusions should cause the auditor significant concern in the audit of expense accounts. "tems ( through ; would have been found in the following way' (. The company!s policies for depreciating equipment are available from several sources' a) b) c) d) The prior year!s audit schedules and permanent file. 4ootnote disclosure in the annual report and 0<* 4orm (6,G. *ompany procedures manuals. 3etailed fixed asset records.

d.

19"#9

a.

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19"#9 &continued' ). The ten,year lease contract would be found when supporting data for current year!s equipment additions were examined. #lso, it may be found by a review of company lease files, contract files, or minutes of meetings of the board of directors. The calculations would li ely be shown on a supporting schedule and can be traced to the general journal. The building wing addition would be apparent by the addition to buildings during the year. The use of the low construction bid amount would be found when support for the addition was examined. /hen it was determined that this inappropriate method was followed, the actual costs could be determined by reference to construction wor orders and supporting data. The wing could also be examined. The paving and fencing could be discovered when support was examined for the addition to land. The details of the retirement transactions could be deter, mined by examining the sales agreement, cash receipts documentation, and related detailed fixed asset record. This examination would be instigated by the recording of the retirement in the machinery account or the review of cash receipts records. The auditor would become apprised of a new plant in several ways' a) b) c) d) 2olume would increase. #ccount details such as cash, inventory, prepaid expenses, and payroll would be attributed to the new location. The transaction may be indicated in documents such as the minutes of the board, press releases, and reports to stoc holders. 5roperty tax and insurance bills examined show the new plant.

-.

.. :.

;.

7ne or more of these occurrences should lead the auditor to investigate the reasons and circumstances involved. 3ocuments from the city and appraisals could be examined to determine the details involved.

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19"#9 &continued' b. The appropriate adjusting journal entries are as follows' (. ). 9o entry necessary. This is an operating lease and should not have been capitali&ed. 5repaid rent =ease liability #llowance for depreciation, machinery and equipment $achinery and equipment 3epreciation expense To correct initial recording of lease' <quipment rent expense 5repaid rent To record nine months rent' +E() x A:6,666 H A-@,:66 -. The wing should have been recorded at its cost to the company. (#ccounts originally credited) Buildings A(:,666 To correct initial recording of new wing' 3epreciation expense #llowance for depreciationF Buildings A-,(;@ To correct depreciation for excess cost. 3epreciation on beginning balance (,)66,666E): H .B,666 3epreciation recorded on addition :(,:66 , .B,666 H -,:66 A-,(;@ A(:,666 A-@,:66 A-@,:66 A :6,666 -:.,666 )6,)66 A.6.,666 )6,)66

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19"#9 &continued' *orrect depreciation for addition' %emaining useful life of addition is () years (;66,666E(,)66,666 x ): H (),(E) years1 (),(E) , I H () years) 3epreciation H A(;6,666E() x I H A;,;;@ *orrection H A;,;;@ , A-,:66 H A-,(;@ .. The paving and fencing are land improvements and should be depreciated over their useful lives. =and improvements (may be combined with buildings with buildings accountF buildings and improvements) =and A:6,666

A:6,666

To correct initial recording of paving and fencing' 3epreciation expense #llowance for depreciationF =and "mprovements A),:66 A),:66

To record first year!s depreciation on paving and fencing' A:6,666E(6 x I H A),:66 :. The cost and allowance for depreciation should have been removed from the accounts and a gain or loss on sale recorded. *ost of asset #llowance for depreciation' To ()E-(E6B J .B6,666E(6 x -,(E) 4or )66+ J .B6,666E(6 x I 9et boo value *ash proceeds =oss on sale A.B6,666

(;B,666 ).,666 (+),666 )BB,666 );6,666 A)B,666

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19"#9 &continued' The correcting entry is' #llowance for depreciationF $achinery and <quipment =oss on sale of assets $achinery and <quipment 3epreciation expense ;. A)6-,666 )B,666 A))6,666 ((,666

3onated property should be capitali&ed at its fair mar et value. =and Buildings *ontributed capital, 3onated 5roperty A(66,666 .66,666 A:66,666

To record land and building for new plant donated by *rux *ity' 3epreciation expense #llowance for depreciationF Buildings To record depreciation on new plant' A.66,666E): x I H AB,666 19"$, a. To: In-Charge Auditor AB,666 AB,666

From: Audit Manager Subject: Concerns about the schedule prepared by the client and the staff assistant in the audit of Vernal Manufacturing Company The analytical procedures schedule for the audit of Vernal Manufacturing Company is completely inade uate and needs to be redone! There are se"eral deficiencies: #! The headings$ references$ and inde%ing on the audit schedule are incomplete! It appears that the schedule &as prepared by the client$ but it is not possible to determine from the schedule! A classified income statement &ould pro"ide more useful information than the single-step statement (+,(;

'!

pro"ided!

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19"$, &continued' (! The schedule should include the additional columns sho&ing the percent of net sales for #'-(#-)* and #'(#-)+! This information &ould permit us to more effecti"ely e"aluate the relati"e change in each account! There is no indication that the general ledger totals &ere compared to general ledger balances or that calculations &ere tested! There is no identification of accounts that &e are concerned may be materially misstated! For e%ample$ the .#$(*# change in insurance e%pense appears immaterial but the ,'/0 change in other e%pense may be significant! There is no indication of specific accounts that re uire additional in"estigation and the nature of such in"estigation! There is no indication that the client2s e%planations ha"e been e"aluated and supported by e"idence! Management in uiry is a &ea3 form of e"idence and unsatisfactory by itself!

,!

-!

1!

/!

b.

4or every explanation provided by the client, an alternative possibility is a misstatement in the financial statements. The auditor must be satisfied that significant differences are not material misstatements. The following are a few examples'
ACC584T P5SS397/ -3SSTAT/-/4T *utoff error for sales %eturns due to technological deficiencies in products that may indicate obsolete inventory "ncluding proceeds of the sale of equipment as income rather than decreasing the equipment account 0mall increase in cost of goods sold compared to net sales may indicate an overstatement of ending inventory or understatement of any of the accounts ma ing up cost of goods sold

0ales 0ales returns and allowances $iscellaneous income

*ost of goods sold

c.

To perform a meaningful determination of the most important variances, an alternative design of the audit schedule follows. "t is (+,(B

much easier to determine relevant variances with an adequate analytical procedures schedule.

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19"$, &continued'
P/R AB7 1#"$1",+ 0ales 0ales returns and allowances 9et 0ales *ost of goods sold' Beginning inventory 5urchases 4reight,in 5urchase returns 4actory wages 4actory benefits 4actory overhead 4actory depreciation <nding inventory Total Lross margin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mount Percent (6).:K A(,-@@,+(+ ().:K) ((@B,;;;) (66.6K (,(++,):(..:K (+B,;-)) -:.@K B;;,.(. 6.@K )6,.:6 (6.;K) (B,;;@ ((.+K (:B,@() ).(K -,;+( :.(K (),(6; -.-K ()+,::+) ()).:K) (@;;,+;+) :6.)K (B.,BB6 .+.BK (,6(.,-@(.BK 6..K (.6K 6.)K 6.BK (.;K 6..K 6.)K 6.)K 6.@K 6.6K 6.)K 6..K 6.)K 6.@K (.:K 6.:K (6.+K -B.+K (..K 6.-K (.@K @,(6),(;@ ),B;: (,B+6 (B,@-B ):,B6) @,.:. ((;,;;@) .,6++ -(,)@( B@B 6 )(,-6; (,+:6 (-,+:6) ()),:B-) (,-B( B-,@6. +-6,;;+ (@,.+6 )-,-6@ .6,@+@ (;.-K )@:.-K (..-K (;.;K) --.BK .:.(K ()..:K) (;.(K (.+K ).:K (B.;K) ::.)K ..6K )@.6K ..)K ;.@K -.6K +.:K --.6K (+.@K )(..K (.-.;K) )B.6K B:.;K )..(K 6.6K (:6.:K ((.@K (:..K) ((-.;K) -.(K B.@K --.)K (..:K .)@.-K -)..K

0elling, general and administrative' <xecutive salaries (;@,.:+ <xecutive benefits -),-)( 7ffice salaries +:,;@: 7ffice benefits (+,BBB Travel and entertainment :;,B.: #dvertising (-6,B@B 7ther sales expense -.,BB6 0tationery and supplies -B,))( 5ostage (.,;:@ Telephone -;,::( 3ues and memberships -,;.. %ent (:,;6@ =egal fees (.,(:. #ccounting fees (;,@66 3epreciation, 0LM# @-,.:6 Bad debt expense (;;,.:. "nsurance ..,-)( +;(,@6: Total operating income ),B6(,.)+ 7ther expenses' "nterest expense ()6,.-) 7ther :,.:: Total ():,BB@ 7ther income' Lain on sale of assets .-,))) "nterest income ).$iscellaneous income ;,-;: Total .+,B-6 "ncome before taxes ),@):,-@) "ncome taxes +);,;); 9et income A(,@+B,@.;

((.:K) ((B;,.))) (.-(.-K) 6.6K ()6) (B.)K) 6.-K (+,((- -66.-K ((.)K) ((;@,-)+) (--:.BK) -:.+K @)),:.);.:K (6.;K +-,+@. (6.(K ):.-K A ;)B,:;+ -..+K

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19"$, &continued' The following are variances of special significance to the audit that have been determined from the revised analytical procedures wor sheet. Before doing additional wor , there should be further discussion with nowledgeable management about the variances identified. #fter investigating management!s explanations, the following additional audit procedures may be appropriate'
P5T/4T3A7 A113T354A7 A813T PR5C/18R/S 5erform extensive cutoff tests and other tests for possible overstatements. <xamine supporting documents for the largest sales returns and allowances and consider the effect on inventory valuation. 3o careful tests of physical counts, costing, cutoff, inventory, and tests for obsolescence.

ACC584T (. 0ales ). 0ales returns and allowances

-. *ost of goods sold. *ost of goods sold increased only A(B:,666, but sales increased (.) million. .. Travel and entertainment :. Telephone

<xamine supporting documentation for large travel and entertainment expenses. *ompare telephone expense by month to determine the possibility of a misclassification. #naly&e legal expense to determine the possibility of lawsuits or other legal actions that might affect the financial statements. *ompare depreciation by month to determine the possibility of the failure to record one month!s depreciation. 5erformed detailed analytical procedures and other tests of accounts receivable to evaluate the adequacy of the allowance for uncollectible accounts. #naly&e other expense to determine the nature of other expense and the possibility of misclassification or incorrect accounting. #naly&e the account to determine the nature of the transactions and any misclassification or incorrect accounting.

;. =egal expense

@. 3epreciation expense

B. Bad debt expense

+. 7ther expense

(6. Lain on the sale of assets

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3nternet Pro2lem Solution: -anaging .i0ed Assets

19"1 #cquiring fixed assets may involve significant monetary investments. $anaging and accounting for fixed assets is often an overwhelming tas to small companies merely because of the volume of transactions. There are a number of software programs available to assist with the management and accounting for fixed assets. 0earch the "nternet for two or three companiesC fixed asset software pac ages that interest you. 5repare a brief written evaluation of the software programs compared by you. *ontrast the software to the extent possible based upon information that is available on the companyCs /eb site. Ans er: 0tudent responses will vary. #lthough the problem is broad, it is designed to encourage students to explore alternative software pac ages. Because there are many software vendors on the "nternet, instructors may wish to assign software pac ages to students.

(4ote' "nternet problems address current issues using "nternet sources. Because "nternet sites are subject to change, "nternet problems and solutions may change. *urrent information on "nternet problems is available at www.pearsonhighered.comEarens.)

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