This assignment relates to the Auditing and Assurance : A Systematic Approach - 11th edition. Part of my Accounting class.
1. Greenbloom Garden Centers is a small, privately held corporation that has two stores in Orlando, Florida. The Greenbloom family owns 100 percent of the company’s stock, and family members manage the operations. Sales at the company’s stores have been growing rapidly, and there appears to be a market for the company’s sales concept— providing bulk garden equipment and supplies at low prices. The controller prepares the company’s financial statements, which are not audited. The company has no debt but is considering expanding to other cities in Florida. Such expansion may require long-term borrowings and is likely to reduce the family’s day-to-day involvement in all of the company’s operations. The family does not intend to sell stock in the company.
Required: Discuss the factors that may make an audit necessary and potentially and potentially valuable for the company. Be sure to consider the concept of information risk.
2. You were recently hired by the CPA firm of Honson & Hansen. Within two weeks, you were sent to the first-year staff training course. The instructor asks you to prepare answers for the following questions:
a. How is audit evidence defined?
b. How does audit evidence relate to assertions and to the audit report?
c. What characteristics of evidence should an auditor be concerned with when searching for and evaluating audit evidence?
3. John Josephs, an audit manager for Tip, Acanoe & Tylerto, was asked to speak at a dinner meeting of the local Small Business Administration Association. The president of the association has suggested that he talk about the various phases of the audit process to help small business owners better understand what auditors do. John has asked you, his trusted assistant, to prepare an outline for his speech. He suggests that you answer the following:
a. List and briefly describe the various phases of an audit.
b. Describe how audit procedures involving tests of controls can provide indirect evidence about whether financial statement account balances are free of material misstatement.
c. One of the phases involves understanding an entity’s internal control. Why might the members of the association be particularly interested in the work conducted by auditors in this phase of the audit?
4. Audits can be categorized into five types: (1) financial statement audits, (2) audits of internal control, (3) compliance audits, (4) operational audits, and (5) forensic audits.
Required: For each of the following descriptions, indicate which type of audit (financial statement audit, audit of internal control, compliance audit, operational audit, or forensic audit) best characterizes the nature of the audit being conducted. Also indicate which type of auditor (external auditor, internal auditor, government auditor, or forensic auditor) is likely to perform the audit engagement.
a. Evaluate the policies and procedures of the Food and Drug Administration in terms of bringing new drugs to market.
b. Determine the fair presentation of Ajax Chemical’s balance sheet, income statement, and statement of cash flows.
c. Review the payment procedures of the accounts payable department for a large manufacturer.
d. Examine the financial records of a division of a corporation to determine if any accounting irregularities have occurred.
e. Evaluate the feasibility of forecasted rental income for a planned low-income public housing project.
f. Evaluate a company’s computer services department in terms of the efficient and effective use of corporate resources.
g. Audit the partnership tax return of a real estate development company. h. Investigate the possibility of payroll fraud in a labor union pension fund.
5. Dale Boucher, the owner of a small electronics firm, asked Sally Jones, CPA, to conduct an audit of the company’s records. Boucher told Jones that the audit was to be completed in time to submit audited financial statements to a bank as part of a loan application. Jones immediately accepted the engagement and agreed to provide an auditor’s report within one month. Boucher agreed to pay Jones her normal audit fee plus a percentage of the loan if it was granted. Jones hired two recent accounting graduates to conduct the audit and spent several hours telling them exactly what to do. She told the new hires not to spend time reviewing the entity’s system of internal control but to concentrate on proving the mathematical accuracy of the general and subsidiary ledgers and summarizing the data in the accounting records that supported Boucher’s financial statements. The new hires followed Jones’s instructions and after two weeks gave Jones the financial statements excluding footnotes. Jones reviewed the statements and prepared an unqualified auditor’s report. The report did not refer to generally accepted accounting principles, and no audit procedures were conducted to verify the yearto-year application of such principles.
Required: Briefly describe the four categories of Principles Underlying an Audit Conducted in Accordance with Generally Accepted Auditing Standards and indicate in what ways the action(s) of Jones violate(s) each of the four categories of principles. (AICPA, adapted)
Part I: Merry-Go-Round (MGR), a clothing retailer located primarily in shopping malls, was founded in 1968.11 By the early 1990s, the company had gone public and had expanded to approximately 1,500 stores, 15,000 employees, and $1 billion in annual sales. The company’s locations in malls targeted the youth and teen market. The company was listed by Forbes magazine as one of the top 25 companies in the late 1980s. However, in the early 1990s, the company faced many challenges. One of its cofounders died, and the other left to pursue unrelated business interests. The company faced stiff competition from other retailers (e.g., The Gap and Banana Republic), fashion trends changed, and mall traffic declined. Sales fell, and experts speculated that MGR failed to anticipate key industry trends and lost sight of its customer market. To try to regain its strong position, the company acquired Chess King, Inc., a struggling chain of men’s clothing stores located in malls, in 1993. The company’s sales continued to fall, and later in 1993 the company brought back one of its cofounders to manage the company and wrote down a significant amount of inventory. However, this inventory write-down caused the company to violate loan covenants. Facing bankruptcy, the company, based on the advice of its newly hired law firm Swidler and Berlin, hired turnaround specialists from Ernst and Young (E&Y) to help overcome the financial crisis and develop a longterm business plan. However, the company’s decline continued, and it filed for Chapter 11 reorganization in 1994. In 1996, the remaining assets were sold for pennies on the dollar. Subsequently, a group of 9,000 creditors (including former employees and stockholders) began litigation against parties it deemed responsible for their losses. These parties included E&Y, which the creditors sued for $4 billion in punitive and compensatory damages (E&Y’s fees from MGR totaled $4.5 million). The lawsuit alleged that E&Y’s incompetence was the main cause of MGR’s decline and demise. The lawsuit alleged in part that
∙ The turnaround team did not act quickly enough.
∙ The leader of the team took an eight-day vacation at a critical point during the engagement.
∙ The cost-cutting strategy called for only $11 million in annual savings, despite the fact that the company was projected to lose up to $200 million in 1994.
∙ While closing unprofitable stores was key to MGR’s survival, by 1995 only 230 of 1,434 stores had been closed and MGR still operated two stores in some malls.
∙ The turnaround team included inexperienced personnel—a retired consultant, a partner with little experience in the United States or with retail firms in general, and two recent college graduates.
∙ E&Y charged exorbitant hourly rates and charged unreasonable expenses (e.g., charges included reimbursement for a dinner for three of the consultants totaling in excess of $200).
E&Y denied any wrongdoing but in April 1999 agreed to pay $185 million to settle with the injured parties.
a. Although this was not an audit engagement for E&Y, some of the allegations against the firm can be framed in terms of the Principles Underlying an Audit Conducted in Accordance with Generally Accepted Auditing Standards. Which of the Principles was E&Y alleged to have violated?
b. Should there be specific professional standards for CPAs who consult? Given that non-CPAs who consult do not have formal professional standards, describe the advantages and disadvantages that result from CPAs being subject to such standards.
6. The audit committee of the board of directors of Rebel Corporation asked Tish & Field, CPAs, to audit Rebel’s financial statements for the year ended December 31, 2018. Tish & Field explained the need to make an inquiry of the predecessor auditor and requested permission to do so. Rebel’s management agreed and authorized the predecessor auditor to respond fully to Tish & Field’s inquiries.
Required: a. What information should Tish & Field obtain during its inquiry of the predecessor auditor prior to accepting the engagement? b. What additional audit procedures should Tish & Field perform in evaluating Rebel as a potential client? (AICPA, adapted)
7. A CPA has been asked to audit the financial statements of a publicly held company for the first time. All preliminary verbal discussions and inquiries among the CPA, the company, the predecessor auditor, and all other necessary parties have been completed. The CPA is now preparing an engagement letter.
Required: a. List the items that should be included in the typical engagement letter in these circumstances. b. Describe the benefits derived from preparing an engagement letter.
8. Section 301 of the Sarbanes-Oxley Act requires that public companies have an audit committee. Independent auditors are increasingly involved with audit committees.
Required: a. Describe what an audit committee is. b. Identify the reasons why audit committees have been formed and are currently in operation. c. Describe the functions of an audit committee. (AICPA, adapted)
9. 3-32 You are the audit manager for Ken-Ron Enterprises. Your firm has been the entity’s auditor for 15 years. Your firm normally uses a range of 3% to 5% of income before taxes to calculate overall materiality and 50–75% of overall materiality to calculate tolerable misstatement. Ken-Ron has reported the following financial statement data (in millions) for the last four years: 2018 2017 2016 2015 Income before taxes 105* 584 520 453 Total assets 23,422 16,137 13,239 11,966 Total revenues 20,272 13,289 9,189 8,984 *Note that the significant decline in income before taxes in 2018 is due to a large nonrecurring charge.
Required: a. If you planned on using income before taxes as the benchmark to compute overall materiality and tolerable misstatement, how would you compute those amounts for 2018? Prepare and justify your calculations.
b. Determine overall materiality and tolerable misstatement using either total assets or total revenues as the benchmark. Make the calculations by utilizing both .25% and 2%, the endpoints of the range that your firm’s guidance provides.
c. Assume that during the course of the 2018 audit you discovered misstatements totaling $50 million (approximately 50% of the 2018 income before taxes of $105 million). Discuss whether this amount of misstatement is material given your benchmark calculations from parts a. and b. above.