question archive You are a partner in the firm of Dunning, Ko & Co
You are a partner in the firm of Dunning, Ko & Co
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You are a partner in the firm of Dunning, Ko & Co. and you are responsible for conducting the final independent review of audits completed by the firm. Dunning, Ko & Co. is a full-service medium-sized public accounting firm that specializes in the audits of moderate-sized high-technology companies.
You are currently reviewing the audit working papers and a draft of the audited financial statements of Simply Electric Inc. (Simply Electric) for the year ended December 31, 2019, as well as the draft audit report (an unqualified opinion dated February 19, 2020) that was prepared by the engagement partner.
Dunning, Ko & Co. have been auditors since the company's inception. The 2019 audit fieldwork was performed by a senior auditor (who had not previously worked on the audit of this particular client) and two junior auditors, and the working papers were reviewed by a manager and the engagement partner.
Based on your review of the working papers, the draft financial statements, and the audit report, you have noted the following:
Sales and Accounts Receivable
Balances for confirmation of accounts receivable were selected using systematic sampling and the dollar unit sampling methodology. A total of 40 confirmations were prepared and mailed out by the controller of Simply Electric to those accounts selected by the auditors. Of these, 36 were eventually returned directly to the auditors with no differences. The remaining four accounts were verified by vouching the balances reported as due to the sales invoices issued during 2019. No exceptions were found.
The junior auditor responsible for auditing the accounts receivable balances then discussed the provision for doubtful accounts with the controller and concluded that it was adequate, and included a note in the working papers of their discussion. No additional work was performed on accounts receivable or the allowance for doubtful accounts.
The senior auditor recalculated the returns and allowance using the historical rate of returns which was noted in the previous year's audit file. She calculated an appropriate year-end provision for returns and allowances to be in the range of $300,000 to $400,000. The client had booked a returns provision in the amount of $350,000 therefore she determined that no error was required to carry forward to the unadjusted error summary.
Inventory
The audit senior conducted the inventory count procedures. The following is an excerpt of the work performed at the count:
Inventory during the count was well organized and all items in the warehouse were appropriately tagged. Per the warehouse manager, all products with the inventory product quality issue had been set aside in a separate area of the warehouse. Inventory counters were working in pairs to ensure the accuracy of the count.
Inventory Test Counting
Selected a sample of 40 items from the inventory listing and performed a test count on each of these items. The following discrepancies were noted:
|
Product |
Description |
# of boxes per auditor |
# of boxes per count |
|
Product # 5267XYB |
Electrical Wire (40 cm length, 100 per box) |
30 boxes |
34 boxes |
|
Product # 645XMHN |
5 mm screws (1000 screws per box) |
10 boxes |
9 boxes |
Upon discussion, with the warehouse manager, these discrepancies are a result of one particular counter who was continuously making errors. The warehouse manager has since replaced this particular counter. No further audit work is required.
Selected a sample of 40 items from the inventory floor and performed a test count on each of these items. All items tested agreed to the count conducted by the counter.
Salaries and Benefits
The following is an excerpt of the work performed on the salaries and benefit's account:
Dec 31, 2019 Dec, 31, 2018 $ change % change
Salaries & Benefits account. $6,900,000 $4,950,000 1,950,000 40%
Per discussions with controller, the increase in salaries is a result of the hiring of 12 new sales representatives. This explanation appears reasonable. Obtained a listing which summarized the total annual salary for 2020 by employee. Re-added the schedule to verify the mathematical accuracy of the listing and agreed the total of $6,900,000 to the general ledger.
- List two 2 major deficiencies in the work performed in the accounts receivable testing and explain the nature of the deficiencies. What are some recommendations regarding further actions and/or audit procedures?
-List two 2 major deficiencies in the work performed in the testing of Inventory and explain the nature of the deficiencies. What are some recommendations regarding further actions and/or audit procedures?
- List two 2 major deficiencies in the work performed in the testing of Salaries and Benefits and explain the nature of the deficiencies. What are some recommendations regarding further actions and/or audit procedures?
Management Representation Letter
The management representation letter obtained by the audit senior on the last date of field work, February 10th, 2020. The letter was signed by both the CEO and CFO.
Sign Off
After considering these various issues, you decide to make a memo to the engagement partner, with a copy to the managing partner of the firm, expressing your views on these matters and what needs to be done before you are prepared to "sign off" on the engagement.
List one 1 major deficiency in the work performed in the completion of the audit and explain the nature of the deficiency. what are some recommendations regarding further actions and/or audit procedures?
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Answers:-
1) 2 major deficiencies in the work performed in the accounts receivable testing:
i) The revenue recognition policy is not clear and not in accordance with the reporting framework.
explantion: here, The senior auditor recalculated the returns and allowance using the historical rate of returns which was noted in the previous year's audit file.
ii) Inconsistent bad debt recognition with no second-person review process.
explanation: here, The junior auditor responsible for auditing the accounts receivable balances discussed the provision for doubtful accounts with the controller and concluded that it was adequate, and included a note in the working papers of their discussion. No additional work was performed on accounts receivable or the allowance for doubtful accounts.
Reccomendations regarding further actions or audit procedures:
- Confirm accounts receivable balances (especially larger amounts).
- Vouch subsequent period collections, making sure the subsequent collections relate to the period-end balances (sampling can be used).
- Thoroughly review allowance computations to see if they are consistent with prior years; compare allowance percentages to industry averages; agree to supporting documentation (e.g., histories of uncollectible amounts); recompute the related numbers.
- Create comparative summaries of all significant revenue accounts, comparing the current year amounts with historical data (three or more years if possible).
2) two 2 major deficiencies in the work performed in the testing of Inventory:
i) Damaged inventory whose value must be adjusted to reflect its actual value to the company (Valuation issues).
explanation: here, all products with the inventory product quality issue had been set aside in a separate area of the warehouse. value of damaged inventory is not considered.
ii) Miscounted (intentionally or otherwise) inventory. Overcounted inventory artificially raises reported earnings, while undercounted artificially lowers them.
explanation: here, there were descrepancies in the number of boxes per count and number of boxes per auditor.
Recommendations regarding further actions and/or audit procedures:
- Investigate inventory and accounting records to check necessary adjustments for obsolete and damaged inventory.
- Review inventory that is out on consignment and goods held on consignment and make necessary adjustments in the accounts.
- Prepare for a physical inventory count.
3) Two 2 major deficiencies in the work performed in the testing of Salaries and Benefits:
i) The wages calculations are generated by the payroll system and there are no checks performed.
explanation: the auditor should re check the salary data for accuracy. if system errors occur during the payroll processing, this would not be identified. This could result in wages being over or under calculated, leading to an additional payroll cost or loss of employee goodwill.
ii) There could be employees omitted along with fictitious employees added to the payment listing, so that although the total payments list agrees to payroll totals, there could be fraudulent payments being made.
explanation: the auditor should re check the salary data for accuracy and if there are any fraudulent activity.
Recommendations regarding further actions and/or audit procedures:
i) A senior member of the payroll team should recalculate the gross to net pay workings for a sample of employees and compare their results to the output from the payroll system.
ii) Review a sample of the gross to net pay calculations to see that they are undertaken and signed as approved.
iii) Obtain a sample of payments list and review for signature by the finance director as evidence that the control is operating correctly.
4) One 1 major deficiency in the work performed in the completion of the audit:
The auditor should provide at the end of the audit a document called an “Internal Control Letter” or set of “Management Letter Comments”. The final agreed issues should be included in this communication. Management should review the document with the staff as well as, those with oversight responsibility to ensure everyone understands the implications of the errors if not corrected and the new procedures that will be implemented going forward.
explanation: One of the main purposes of the audit is to identify processing errors that occurred. management should listen to what the auditors have to say and don’t hesitate to question their findings if you believe they are not correct.
Recommendations regarding further actions and/or audit procedures:
i) managers should work with auditors to understand the work they completed, why they believe an item is an issue and what is the best and most efficient way to correct any errors noted.
ii) Define “client” to include not only management but also the entity’s board of directors, audit committee, stockholders and the investing public to ensure the audit team considers all affected parties throughout the engagement.
iii) Signal to their audit teams that providing high quality audit services is a top priority and that the firm does not view such services as a commodity. A firm can do this by emphasizing the importance of audit quality in training programs and annual performance reviews.
iv) Encourage all personnel to maintain an attitude of professional skepticism that focuses on the importance of the auditor’s role in protecting the public interest and maintaining strong capital markets.
