After determining that computer controls are valid, Hastings is reviewing the sales system of Rosco Corporation to determine how computer-assisted audit techniques may be used to assist in performing tests of Rosco’s sales records. Rosco sells corn from one central lo- cation. All orders are received by mail or fax and indicate the preassigned customer iden- tification number, desired quantity, proposed delivery date, method of payment, and shipping terms. Since price fluctuates daily, orders do not indicate a price. Price sheets are printed daily, and details are stored on computer. The details of orders are also maintained on computer.
Each morning the shipping clerk receives a computer printout that indicates details of customers’ orders to be shipped that day. After the orders have been shipped, the shipping details are entered in the computer, which simultaneously updates the sales journal, perpetual inventory records, accounts receivable, and sales accounts. The details of all transactions, as well as daily updates, are maintained on computer and are accessible by Hastings.
Required:
1. How may Hastings use computer-assisted audit techniques to perform substantive tests of Rosco’s sales records?
2. What other auditing procedures should Hastings perform in order to complete the audit of Rosco’s sales records?
(AICPA Adapted)
10-11 Identifying and Criticizing a Receivables Confirmation
An entry-level staff member in the Providence, Rhode Island, office of DeMarinis & Har- rison, LLP, has drafted the following receivable confirmation for the Newman Crosby Company, a December 31, 2005 year-end client.
January 2, 2006 Newman Crosby Company
305 Columbus Avenue Pawtucket, RI 02861 Carter, Rice, Storrs & Bement
Industrial Highway Providence, RI 02906
Please confirm the correctness of your December 31, 2005 account balance, $45,897, directly to us. Our auditors are DeMarinis & Harrison, CPAs. This is not a request for payment.
_________________________ Tess Gallagher, Controller ______ The above balance is correct.
______ The above balance is incorrect, as noted below:
Required:
1. What type of confirmation is illustrated? 2. What is wrong with the confirmation?
10-12 Interpreting Working Paper Evidence
Following is partial evidence from an audit working paper.
Disbursement Date Receipt Date
Per Per Per Per
Books Bank Books Bank
12/31 01/01 01/02 12/31
12/31 01/01 12/31 12/31
01/01 01/01 12/31 12/31
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Required:
1. What is the evidence attempting to detect? 2. Did it? Why or why not?
10-13 Interpreting Working Paper Evidence
Following is partial evidence from an audit working paper.
Shipped Recorded
FOB: Destination December 31 January 2
FOB: Shipping Point December 30 December 31
FOB: Destination January 1 January 1
FOB: Shipping Point December 31 January 1
Required:
1. What is the evidence attempting to detect? 2. Did it? Why or why not?
10-14 Working Paper Review: Bank Reconciliation
Following is an audit working paper that documents an auditor’s tests of a client’s bank reconciliation.
Ansonia Wire and Cable Co., Inc. A5
Bank Reconciliation ARE
December 31, 2005
Balance per bank, 12/31/05 $17,551,710@
Add: DIT, 12/31/05 1,578,143*
Less: O/S checks:
No. 5775 12/24 $1,431,897&
No. 5776 12/26 156,050&
No. 5777 12/27 234,875&
No. 5779 12/29 2,169,549&
No. 5780 12/31 1,191,240& (5,183,611)
Adjusted bank balance $13,946,242
Balance per books, 12/31/05 $14,473,098#
Less: Check from Apex, Inc., deposited 12/15,
returned NSF on 12/18 (526,856)@
Adjusted book balance $13,946,242
@ Agreed to 12/31/05 bank statement obtained from client/ARE * Agreed to cash receipts records/ARE
& Agreed to cash disbursements records/ARE # Agreed to client bank reconciliation/ARE
Required: List the deficiencies in this working paper.
10-15 Earnings Manipulation and Area Franchise Fees
Burger Chef Restaurants grants area franchises to operate up to two restaurants within a 100-square-mile area. The Uniform Franchise Offering Circular reveals that, following pay- ment of the lump sum fee, Burger Chef agrees to assist in selecting franchise locations and obtaining financing, negotiate lease terms for existing structures or construction costs for a new building, and provide both initial management training and periodic on-site con- sultation. The area franchise fee can be refunded. To date, no area franchisees have either reneged on the franchise agreements or gone out of business. In most markets, Burger Chef ranks at least fourth in marketwide fast food revenue. The product line consists of beef, fish, and poultry sandwiches and a full-service salad bar.
Thomson Learning™
Required: Identify, and explain the motive for, the key questions an auditor would address to judge when area franchise fees may be recognized as revenue.
1. Management Discretion and Earnings Manipulation
Earnings manipulation has been the subject of considerable attention both in the financial press and in academic research. For example, The Wall Street Journal, Forbes Magazine, and Business Week have all carried pieces on suspicious income and the 1988 Supplement to the University of Chicago’s Journal of Accounting Research is devoted exclusively to studies ad- dressing earnings management. Interestingly, many of the earnings manipulation issues disclosed by the press have resulted in professional pronouncements intended to improve the quality of reported earnings, among them FASB Statement No. 45, “Accounting for Franchise Fee Revenue.”
Required: Using the annual report file in an online research service (e.g., LEXIS- NEXIS, the SEC’s EDGAR [http://www.sec.gov]) or copies of annual reports in a library, se- lect the annual reports of two national franchisors (e.g., Burger King, Century 21, Holiday Inn, McDonald’s, Radisson Inns, Taco Bell, U-Haul) and draft a report that accomplishes both of the following:
1. Compare the footnote and line-item disclosures for area development and individual site franchises.
2. Using FASB Statement No. 45, paragraphs 5 through 11, as a guide, list and explain the questions an auditor would ask the management of either of the franchisors to moni- tor whether the franchisor complied with generally accepted accounting principles.
2. Revenue Recognition and Earnings Manipulation
Not unlike a number of other articles appearing in the national press, E. MacDonald, in “Auditors Miss a Fraud and SEC Tries to Put Them Out of Business” (The Wall Street Jour- nal, January 6, 2000), reports about an SEC investigation of the auditors of California Micro Devices, a computer chip maker alleged to have overstated revenue:
Within weeks, it became clear they had missed an audacious accounting fraud. An internal Cal Micro investigation uncovered “preposterous” revenue numbers “almost immediately,” . . . One- third of the company’s $45 million of fiscal 1994 revenue was spurious. Undetected by auditors . . . were a dozen or more accounting tricks that various employees, at various levels of management, had deployed to keep the stock buoyant. They included one particularly bold one: booking bogus sales to fake companies for products that didn’t exist.
The article is a sobering warning for auditors to be mindful that clients have incentives to overstate revenue. In fact, the Panel on Audit Effectiveness goes further by recommending that auditors introduce a “forensic-type fieldwork phase” to every financial statement audit. The Panel explains:
During this phase, auditors should modify the otherwise neutral concept of professional skepticism and presume the possibility of dishonesty at various levels of management, including collusion, override of internal control and falsification of documents. The key question that auditors should ask is ‘Where is the entity vulnerable to financial statement fraud if management were inclined to per- petrate it’?
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