Nature, Timing, and Extent of Procedures.
Objective of the Test: To determine whether misstatements in cash (existence) and accounts payable/inventory (existence, valuation, and completeness) would be prevented or detected on a timely basis.
Test the programmed application control of matching the receiver, purchase order, and invoice as well as the review and follow-up control over unmatched items. To test the programmed application control, perform the following procedures:
a. Identify, through discussion with company personnel, the software used to process receipts and purchase invoices.
b. Determine, through further discussion with company personnel, that they do not modify the core functionality of the software, but sometimes make personalized changes to reports to meet the changing needs of the business.
c. Establish, through further discussion, that the inventory module operated the receiving functionality, including the matching of receipts to open purchase orders.
d. Identify, through discussions with the client and review of the supplier’s documentation, the names, file sizes (in bytes), and locations of the executable files (programs) that operate the functionality under review.
e. Identify the objectives of the programs to be tested; i.e. whether appropriate items are received (for example, match a valid purchase order), appropriate purchase invoices are posted (for example, match a valid receipt and purchase order, non-duplicate reference numbers) and unmatched items (for example, receipts, orders or invoices) are listed on the exception report.
f. Determine whether the programmed control is operating effectively by performing a walkthrough in the month of July.
Test the detect control of review and follow up on the Unmatched Items Report, by performing the following procedures in the month of July for the period January to July:
a. Make inquiries of the employee who follows up on the weekly-unmatched items reports and determine why items appear on it.
b. Observed the performance of the control.
c. Reperformed the control.
d. Determine that the company had not made significant changes in their controls from interim to year-end by discussing with company personnel the procedures in place for making such changes.
7-17
a. Based only on these facts, this deficiency represents a significant deficiency for the following reasons: The magnitude of a financial statement misstatement resulting from this deficiency would reasonably be expected to be more than inconsequential, but less than
material, because individual sales transactions are not material and the compensating detective controls operating monthly and at the end of each financial reporting period should reduce the likelihood of a material misstatement going undetected. Furthermore, the risk of material misstatement is limited to revenue recognition errors related to shipping terms as opposed to broader sources of error in revenue recognition. However, the compensating detective controls are only designed to detect material misstatements. The controls do not effectively address the detection of misstatements that are more than inconsequential but less than material, as
evidenced by situations in which transactions that were not material were improperly recorded.
Therefore, there is a more than remote likelihood that a misstatement that is more than inconsequential but less than material could occur. (See AS2, A-138, Example D2 – Scenario A.)
b. Based only on these facts, this deficiency represents a material weakness for the following reasons: The magnitude of a financial statement misstatement resulting from this deficiency would reasonably be expected to be material, because individual sales transactions are frequently material, and gross margin can vary significantly with each transaction (which would make compensating detective controls based on a reasonableness review ineffective).
Additionally, improper revenue recognition has occurred, and the amounts have been material.
Therefore, the likelihood of material misstatements occurring is more than remote. Taken together, the magnitude and likelihood of misstatement of the financial statements resulting from this internal control deficiency meet the definition of a material weakness. (See AS2, A-139, Example D2 – Scenario B.)
c. Based on only these facts, this deficiency represents a material weakness for the following reasons: The magnitude of a financial statement misstatement resulting from this deficiency would reasonably be expected to be material, because the frequency of occurrence allows insignificant amounts to become material in the aggregate. The likelihood of material misstatement of the financial statements resulting from this internal control deficiency is more than remote (even assuming that the amounts were fully reserved for in the company’s
allowance for uncollectible accounts) due to the likelihood of material misstatement of the gross accounts receivable balance. Therefore, this internal control deficiency meets the definition of a material weakness. (See AS2, A-139, Example D2 – Scenario C.)
7-18
a. Based only on these facts, the combination of these significant deficiencies represents a material weakness for the following reasons: Individually, these deficiencies were evaluated as representing a more than remote likelihood that a misstatement that is more than
inconsequential, but less than material, could occur. However, each of these significant deficiencies affects the same set of accounts. Taken together, these significant deficiencies represent a more than remote likelihood that a material misstatement could occur and not be prevented or detected. Therefore, in combination, these significant deficiencies represent a material weakness. (See AS2, A-140, Example D3 – Scenario A.)
b. Based only on these facts, the auditor should determine that the combination of these significant deficiencies represents a material weakness for the following reasons:
• The balances of the loan accounts affected by these significant deficiencies have increased over the past year and are expected to increase in the future.
• This growth in loan balances, coupled with the combined effect of the significant deficiencies described, results in a more than remote likelihood that a material misstatement of the allowance for credit losses or interest income could occur.
Therefore, in combination, these deficiencies meet the definition of a material weakness. (See AS2, A-140-141, Example D2 – Scenario B.)
7-19
a. If the lack of an adequate antifraud program is considered a material deficiency by the auditor because of increased risk, then the auditor should issue an adverse opinion. However, if it is only considered to be a significant deficiency, then an unqualified report can be issued.
b. An unqualified report should be issued as no control deficiencies were identified.
c. Because the auditor identified a material misstatement in the financial statements, an adverse report on Fritz’s internal control over financial reporting must be issued.
d. The auditor must determine the magnitude of the possible misstatement of non-routine sales. If it is determined to be material then an adverse opinion should be issued. However, if materiality is not a concern, an unqualified opinion may be given.
e. Most likely an adverse opinion would be issued, unless the risk of compliance violations was not material.
7-20
a. The auditor must determine whether the restatements are significant or material
deficiencies. If material, an adverse opinion will be issued, otherwise an unqualified report may be given.
b. If other controls over financial reporting are present, the auditor may issue an unqualified opinion. However, if the deficiency carries a high risk of material misstatement, then an adverse opinion should be issued.
c. The auditor would most likely issue an adverse opinion because of the importance of the audit committee in the control process.
d. If the ineffective monitoring component is a material deficiency, then an adverse opinion should be issued. Otherwise, an unqualified opinion may be given.
e. The significance of financial fraud by the CFO is a material weakness and an adverse opinion should be issued.
f. Depending on the amount of risk of material misstatement due to the ineffective control environment, the auditor will issue an adverse opinion or an unqualified opinion.
g. Given the lack of management’s concern for internal control, an adverse opinion should be issued.
7-21
a. The auditor does not agree with Barns Security Systems management assessment and should therefore issue an adverse opinion.
b. As long as the auditor agrees with company’s assessment of controls, an unqualified report can be issued. However, AS2 paragraph 166 indicates that controls must operate for a sufficient time period to accommodate management and auditor testing. This does not appear to be possible in the scenario when the changes were made after management’s assessment.
c. The auditor should issue an adverse opinion if he or she does not believe sufficient time has passed to gather sufficient, competent evidence that the control deficiencies have been corrected.
7-22 The audit report should include the proper title; introductory, scope, definition, limitations, opinion, and explanatory paragraphs; and should describe the reason for the material
weakness. An example can be found in Exhibit 7-5.
7-23 The audit report should include the proper title; introductory, scope, definition, limitations, and opinion paragraphs; and should describe the reason for the material weakness. An
example can be found in Exhibit 18-20.
7-24 a. 2 b. 3 c. 1
7-25 The substantive auditing procedures Brown may consider performing include the following:
Using the perpetual inventory file:
• Recalculate the beginning and ending balances (prices x quantities), foot, and print out a report to be used to reconcile the totals with the general ledger (or agree beginning balance with the prior year’s working papers).
• Calculate the quantity balances as of the physical inventory date for comparison to the physical inventory file. (Alternatively, update the physical inventory file for purchases and sales from 6 January to 31 January, 2005, for comparison to the perpetual inventory at 31 January, 2005.)
• Select and print out a sample of items received and shipped for the periods (1) before and after 5 January and 31 January, 2005, for cutoff testing, (2) between 5 January and 31 January, 2005, for vouching or analytical procedures, and (3) prior to 5 January, 2005, for tests of details or analytical procedures.
• Compare quantities sold during the year to quantities on hand at year-end. Print out a report of items for which turnover is less than expected. (Alternatively, calculate the number of days’ sales in inventory for selected items.)
• Select items noted as possibly unsalable or obsolete during the physical inventory observation and print out information about purchases and sales for further consideration.
• Recalculate the prices used to value the year-end FIFO inventory by matching prices and quantities to the most recent purchases.
• Select a sample of items for comparison to current sales prices.
• Identify and print out unusual transactions. (These are transactions other than purchases or sales for the year, or physical inventory adjustments as of 5 January, 2005.)
• Recalculate the ending inventory (or selected items) by taking the beginning balances plus purchases, less sales (quantities and /or amounts), and print out the differences.
• Recalculate the cost of sales for selected items sold during the year.
Using the physical inventory and test count files:
• Account for all inventory tag numbers used and print out a report of missing or duplicate numbers for follow-up.
• Search for tag numbers noted during the physical inventory observation as being voided or not used.
• Compare the physical inventory file to the file of test counts and print out a report of differences for the auditor follow-up.
• Combine the quantities for each item appearing on more than one inventory tag number for comparison to the perpetual file.
• Compare the quantities on the file to the calculated quantity balances on the perpetual inventory file as of 5 January, 2005. (Alternatively, compare the physical inventory file updated to year-end to the perpetual inventory file.)
• Calculate the quantities and dollar amounts of the book-to-physical adjustments for each item and the total adjustment. Print out a report to reconcile the total adjustment to the adjustment recorded in the general ledger before year-end.
• Using the calculated book-to-physical adjustments for each item, compare the quantity and dollar amount of each adjustment to the perpetual inventory file as of 5 January, 2005, and print out a report of differences for follow-up.