Auditing

Question 1 

John Wilfero, the chief financial officer of Allied Systems Inc. (ASI), was hired earlier this year to assist in dealing with the explosive growth ASI was experiencing as a result of a successful new patent.

John has already successfully streamlined the accounts payable process and the accounts receivable billing process, and he is now looking into the credit process. Bill Hunter, who has been with ASI since its inception 30 years ago, has always had the responsibility of extending credit to new and existing customers and manually approving all sales orders that exceeded the customer’s credit limit. This has now become an extremely time-consuming, daily activity. In addition, Bill is responsible for job costing and purchasing of office supplies, which he has also been doing for 30 years. Bill has managed these responsibilities as best he can solely through manual processes.

John is concerned that, given the growth ASI is experiencing, the manual system is no longer efficient, and he believes the credit function should be automated. Automation would allow quicker responses to sales orders (which have been backing up to an unprecedented level, resulting in frustrated customers), automatic activation of new customers and elimination of human error. Error rates have been rising and have added to overall customer frustration. Bill believes that automation is overrated as the computer CANNOT compensate for areas of judgment, including allowing good customers to temporarily exceed their credit limits under certain circumstances.

John has invited ASI’s external auditors to share their views on this issue.

Required:

Provide five reasons why automation of the credit process would be beneficial to ASI.

Question 2 

Gurkem Jennings, a recent university graduate, is interested in becoming an external auditor. Gurkem does NOT understand the topic of planning the audit. Gurkem has read that during the planning phase of the audit, the audit team evaluates the audit risk, sets overall materiality and performance materiality, and reviews the prior year’s audit files to determine changes in processes and risks at the client since the prior year. Gurkem does NOT understand what those items have to do with planning.

Required:

Provide five reasons why the audit team should perform these activities during the planning of the audit.

Question 3 

Milly Inc. has hired an audit firm to examine the controls in place at Heffer Ltd., a company that Milly Inc. is considering acquiring. Milly Inc. requires assurance that the controls at Heffer Ltd. are working effectively before proceeding with the acquisition. The following information has been provided with respect to Heffer Ltd.’s controls:

Control 1: Purchase requests (PRs) from operating departments of Heffer Ltd. are authorized by a designated individual in the requesting department.

Control 2: The purchasing clerk verifies that there is an appropriate signature on the PR and then issues a prenumbered purchase order (PO). The purchasing clerk retains copies of the PR and the PO and files them by PO number.

Control 3: The purchasing manager reviews all POs and PRs to ensure that the PR is authorized by a designated individual. Approved POs are then forwarded to the buyer.

Control 4: The buyer must select a vendor from a preapproved list for all POs over $10,000. For POs under $10,000, the buyer can select any vendor.

Control 5: Capital assets purchased are tagged with an identification number and recorded in an Excel spreadsheet where depreciation is automatically calculated.

Required:

For each of the controls described above, briefly state the purpose of the control and describe a test to determine whether the control is operating effectively.

Question 4 

Explain the responsibility that the independent auditor has with respect to fraud. Identify and describe the two different types of fraud.

Question 5

Nook Ltd. (Nook) runs a private preschool for children from ages two and a half to five years. Although the preschool is privately run, Nook is eligible for a federal government grant of $600 per child per year if Nook complies with the provincial government’s new program titled Early Years Matter. The grant is provided at the beginning of the year, and a certified and independent report must be prepared at the end of the year to demonstrate that the preschool has complied with the guidelines for the year. In case of non-compliance, the grant must be returned.

Lauren Davies, the preschool’s principal, is wondering what type of certification the independent auditors could provide. Lauren has provided the following extract of the government grant’s guidelines:  Early Years Matter Grant Program Guidelines In order to comply with the grant requirements, eligible preschools must provide a certified independent report to confirm their compliance with the following requirements. The grant will be given for each eligible child enrolled in a full-day program at the preschool. Eligible children must meet the following criteria: • The child must be between two and a half and five years of age. • The child must be enrolled in a full-day program at the preschool for a period of at least 10 consecutive months. • The child’s guardian must be a permanent Canadian resident.

Educators must meet the following criteria: • The preschool must have a maximum ratio of six children to one educator. • Each educator must have an early childhood education (ECE) degree from a college or university.

Required:  a) Explain to Lauren how an assurance engagement could be used to provide a report on the compliance of Nook’s preschool with the government grant’s guidelines. Use the table below to help you organize your answer.  A three-party relationship exists   Appropriate subject matter exists   Suitable criteria exist   A conclusion can be provided   b) Recommend which level of assurance the administrators for the government grant should request for the report. Explain why each of a review and an audit would or would not be optimal.  c) Based on the grant guidelines of the Early Years Matter document, suggest three valid procedures that could be conducted as part of an audit.

Question 6

TD Aluminum Ltd. (TDA) has been an audit client of Bryer LLP for eight years. Francis Garful has been assigned to TDA’s audit and has been asked to perform the audit risk assessment. As part of the initial audit planning, Francis has already identified various risks faced by TDA. TDA manufactures and sells windows and eaves to various customers. TDA’s revenue recognition process is fairly simple; however, there are complexities in the audit of inventory and cost of goods sold. TDA purchases a significant amount of aluminum, and, as such, it is affected by any small variation in the price of this commodity. A change in aluminum price can affect the value of inventory as well as profits. The work-in-process inventory also poses a challenge when it comes to valuation. The information system used by TDA is outdated and does NOT properly track inventory; the information system lacks the proper functions to track inventory as it moves through the various stages of production. TDA’s management is NOT worried about this, because Ellen Fates, TDA’s controller, has been working with TDA for 10 years, and she prepares all estimates. Ellen is very good at what she does, and management rarely intervenes in this process. Risks identified by Francis:  • Accounting for work-in-process inventory is complex. • Management rarely intervenes in the estimate and allocation process done by Ellen. • The accounting information system used by TDA is out of date. • The cost of aluminum is volatile. Required:  a) For each of the risks identified by Francis, classify the risk (inherent risk, control risk or detection risk).  b) Explain how each of the risks could result in a financial statement misstatement.