ADMS 4551 Fall 2018 Final Exam solutions

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4551

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Accounting

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Apr 3, 2024

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ADMS 4551 – Fall 2018 Solution Document Question 1 PART 1-A . Factor Increase/decrease Rational Owners are actively involved in the business Decrease Owner oversight of the operations will assist in identifying errors in financial statements Control environment weak as Catherine makes unilateral decisions Increase Decisions she has made may have f/s impact and no one in the company will be aware of the decision Close to violating bank covenant Increase bias to overstate current assets and understate liabilities First time audit Increase Auditor limited knowledge Francis is very control conscious and takes precaution to maintain a high level of control Decrease Insititues controls and sets tone at top. Less errors are likely in this type of environment Francis wants to purchase the company Increase Bias to understate net income Sales & A/R cycle PART 1-B. Provide customers with a 30 day returns policy Sales- occurrence, A/R valuation/existence IR Inc. more easily susceptible to understatement given management bias due to covenant violation Weak controls over price changes Sales - Accuracy ( AR - valuation), CR Inc. increases RMM because Catherine changes prices without full authorization from Francis, she also makes made verbal changes to previous sales (applying the price change retroactively). She could have made other verbal agreements with customers that have not been appropriately recorded Strong controls over granting credit to existing customers and new customers A/R valuation CR Dec. decreases RMM as there is less risk that the accounts receivable are uncollectible PART 1-C Combined - Moderate controls reliance in the cycle 1

ADMS 4551 – Fall 2018 Solution Document Planned reliance on controls on new customers and granting of credit. (strong controls in this area) Will not rely on controls related to price changes (weak controls in this area) PART 1-D. Control Test of control Nancy reviews external credit ratings (if available), the customer’s financial statements and obtains bank and other references. In the case of existing customers she also reviews the customers past payment history. Valuation of A/R Obtain a listing of new customers and changes to existing customer credit terms. For a sample of new customers review the analysis prepared by Nancy. Review the evidence she obtained to support her recommendations. Francis diligently reviews the research conducted by Nancy. She often requires Nancy to reduce her recommended limits and has often denied extending credit to potential customers despite Nancy’s recommendation. Valuation of A/R For each new customer selected, review analysis performed by Francis. Discuss with Francis process she undergoes to make decisions related to credit. Nancy and Francis are the only employees who have access rights to add new customers and make changes to credit terms. Sales – Occurrence - Existence and Valuation of A/R Review ERP access rights and confirm that Nancy and Francis are the only ones authorized to make changes to customer credit terms. Check the system to ensure that all changes were authorized by Nancy and Francis user i.D. At the end of each week the system generates a report noting all changes to the customer Masterfile. This report is reviewed by both Francis and Catherine. Obtain copies of reports and review evidence that the items were reviewed by Francis and Catherine. More relevant controls …. 2

ADMS 4551 – Fall 2018 Solution Document PART 1-E. i) Positive confirmations should be used: - Individual large balances - Internal controls over pricing are not strong – ie changes in prices made retroactively ii) Item or Category in A/R Rational - Customers in the greater than $150,000 range - constitute 61% coverage can be obtained - Balances in the > 60 day range for the category for $100,001 to $150,000 range. - since these are a greater proportion of older balances when compared to the other categories - Customers with credi balances - Since unusual to have large credit balances - Randomly select customers form the 0-$50K and $40 -$100 - Remaining categories still material. Inventory Cycle PART I-F . Factor 1 – Inventory styles often change, 50 different styles are discontinued each year RMM – increases, inventory could be overstated due to obsolescence Inherent risk Assertion – Valuation and allocation Factor 2 – Strong controls over the inventory counting RMM – decreases because less likely that quantities reported are incorrect due to error Control risk Assertion – Inventory (existence, completeness) Factor 3 In the business of manufacturing products and use of average costing for costing items RMM – increases because complexity of average costing in an manufacturing environment (allocation of raw material, labour and variable and fixed overhead costs Inherent risk Assertion – Inventory – valuation Factor 4 Purchase raw materials in U.S. dollars RMM Increases because U.S. currency to Canadian dollar in constantly changing, purchases could be recorded at the incorrect amount 3

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ADMS 4551 – Fall 2018 Solution Document Inherent risk Assertion – Inventory valuation Factor 5 Inventory is susceptible to theft as it is attractive and useful items for employees RMM increases because inventory could be overstated due to shrinkage. Inherent risk Assertion – Inventory existence PART 1-G . - Any items with a selling price less than average cost - Any items that have a quantity on hand greater than the number of items sold in the past year. - Items that were produced greater than a year ago PART 2-A i) Control Agree/Disagree Rational 1 Disagree The CUER is 10.7%, this is above TER and therefore the control is not operating effectively 2 Agree The CUER is 4.2% which is less than TER and therefore can conclude that control operating effectively. 3 Disagree Agree that control is not operating effectively but the rational provided by the auditor is incorrect. Should have compared the CUER to the TER. The CUER is 12.6%, which is above TER of 9%, ii) Items can be paid for that are never received or were not authorized, assets/expenses could be overstated, assets (existence), expenses (occurrence), Procedure: Assets – physically attend inventory count, physically count fixed assets, Expenses – Vouch expenses to the related invoices/p.O., request explanation as to the nature of the expenses. PART 2-B i) Catherine Draper controlled the legal letter process - Recommendation – The legal letter can be sent by Catherine but the lawyer must reply directly to the auditor, this increases the reliability of the audit evidence - The auditor should have requested that the lawyer respond directly to his office ii) Completeness – Any relevant procedure: review legal expense files, review of board minutes to Feb 28 th , obtaining a management representation letter PART 2-C 4

ADMS 4551 – Fall 2018 Solution Document - Can infer that hey were many errors in the previous audits and that the auditor thought the control environment was weak. 5