Chapter 05 - Audit Planning and Types of Audit Tests

CHAPTER 5 AUDIT PLANNING AND TYPES OF AUDIT TESTS

Answers to Review Questions
5The auditor should inquire of the prospective client's bankers and attorneys, credit agencies, and other e bers of the business co unity !ho ay have kno!ledge about the integrity of the prospective client and its anage ent" The successor auditor is responsible for initiating the co unication !ith the predecessor auditor" #o!ever, the successor auditor should request per ission of the prospective client before contacting the predecessor auditor" The successor auditor's co unication !ith the predecessor auditor should include questions related to the integrity of anage ent, disagree ents !ith anage ent over accounting and auditing issues, and the predecessor auditor's understanding of the change in auditors" An engage ent letter is used to for ali$e the arrange ent reached bet!een the auditor and client" %t serves as a contract that outlines the responsibilities of both parties and is intended to prevent isunderstandings bet!een the t!o parties" The letter states the responsibilities of the auditor and anage ent, that the audit !ill be conducted in accordance !ith auditing standards, that certain types of audit procedures !ill be conducted and !ritten representations !ill be obtained fro anage ent, and that the audit ay not detect all aterial errors and fraud" &'hibit 5-( in the te't contains a sa ple engage ent letter" %n addition, the engage ent letter ight include) Arrange ents involving the use of specialists or internal auditors" Any li itation of the liability of the auditor or client, such as inde nification to the auditor for liability arising fro kno!ing isrepresentations to the auditor by anage ent" *+ote that regulatory bodies, such as the ,&C, ay restrict or prohibit such liability li iting arrange ents" Additional services to be provided relating to regulatory require ents Arrange ents regarding other services *e"g", assurance, ta' or consulting services-" The follo!ing factors can be used to .udge the co petence of the internal auditors) &ducational level and professional e'perience" Professional certification and continuing education" Audit policies, procedures, and checklists" Practices regarding their assign ents" The supervision and revie! of their audit activities" The quality of their !orking paper docu entation, reports, and reco endations &valuation of their perfor ance" The ob.ectivity of internal auditors can be deter ined by assessing the follo!ing factors) The organi$ational status of the internal auditor responsible for the internal audit function"

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Chapter 05 - Audit Planning and Types of Audit Tests

Policies to

aintain internal auditors' ob.ectivity about the areas audited"

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Chapter 05 - Audit Planning and Types of Audit Tests

5$5 An audit co ittee is a subco ittee of the board of directors co posed of independent e bers" The audit co ittee is responsible for the financial reporting and disclosure process" The co ittee should encourage fair reporting fro the perspective of the stockholders, creditors, and e ployees" The audit co ittee should eet regularly !ith the e'ternal and internal auditors, providing for the independence of the e'ternal and internal auditors" 5-% The auditor should be guided by the results of the risk assess ent procedures perfor ed to gain the understanding of the entity" Additional steps that should be perfor ed include the follo!ing) Assess the need for specialists" Assess the possibility of illegal acts" %dentify related parties" Conduct preli inary analytical procedures" Consider additional value-added services" The first type of illegal acts includes violations of la!s and regulations, such as ta' la!s, that are generally recogni$ed as having a direct and aterial effect on the deter ination of financial state ent a ounts" 0ther illegal acts are violations of la!s or regulations such as the ,ecurities Acts, the 0ccupational ,afety and #ealth Act, 1ood and 2rug Ad inistration regulations, environ ental protection la!s, equal e ploy ent statutes, and price fi'ing or other antitrust violations that ay have a aterial but indirect effect on the financial state ents" Circu stances that ay indicate a possible illegal act include the follo!ing) 3nauthori$ed transactions, i properly recorded transactions, or transactions not recorded in a co plete or ti ely anner" %nvestigation by a govern ent agency, enforce ent proceeding, or pay ent of unusual fines or penalties" 4iolations of la!s or regulations cited in reports of e'a inations by regulatory agencies" 5arge pay ents for unspecified services to consultants, affiliates, or e ployees" ,ales co issions or agents' fees that appear e'cessive" 5arge pay ents in cash or bank cashiers' checks" 3ne'plained pay ents to govern ent officials" 1ailure to file ta' returns or pay govern ent duties"

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Chapter 05 - Audit Planning and Types of Audit Tests

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The auditor can identify related parties by *(- evaluating the client7s procedures for identifying related parties, */- requesting a list of related parties fro anage ent, and *6- revie!ing filings !ith the ,&C and other regulatory agencies" ,o e additional audit procedures that ay identify transactions !ith related parties include) 8evie! the inutes of the board of directors and e'ecutive or operating co ittees for infor ation about aterial transactions authori$ed or discussed at their eetings" 8evie! conflict-of-interest state ents obtained by the co pany fro anage ent" 8evie! the e'tent and nature of business transacted !ith a.or custo ers, suppliers, borro!ers, and lenders for indications of previously undisclosed relationships" 8evie! accounting records for large, unusual, or nonrecurring transactions or balances, paying particular attention to transactions recogni$ed at or near the end of the reporting period" 8evie! confir ations of loans receivable and payable for indications of guarantees" %f guarantees are identified, deter ine their nature and the relationships of the guarantor to the entity" The three general types of audit tests are risk assess ent procedures, tests of controls and substantive tests" Risk assessment procedures are used by the auditor to obtain an understanding of the entity and its environ ent, including internal control" &'a ples include inquiries of anage ent and others, analytical procedures, and observation and inspection" Tests of controls are audit procedures perfor ed to test the operating effectiveness of controls in preventing or detecting aterial isstate ents at the relevant assertion level" &'a ples of tests of controls include inquiries of appropriate client personnel, inspection of docu ents and reports, observation of the application of a specific internal control, and reperfor ance of the application of the control by the auditor" Substantive procedures are perfor ed to detect aterial isstate ents *i"e", onetary errors- in an account balance, transaction classes, and disclosure co ponents of the financial state ents" &'a ples of substantive procedures are substantive tests of transactions, substantive analytical procedures, and tests of details of account balances"

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The purposes for using analytical procedures at the planning stage of an audit are *(- to enhance the auditor's understanding of the client's business and the transactions and events that have occurred since the last audit and */- to identify areas that ay represent risks relevant to the audit"

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Chapter 05 - Audit Planning and Types of Audit Tests

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The quality of an e'pectation is referred to as the precision of the e'pectation" Precision is a easure of the potential effectiveness of an analytical procedure: it represents the degree of reliance that can be placed on the procedure" Precision is a easure of ho! closely the e'pectation appro'i ates the unkno!n ;correct< a ount" The degree of desired precision !ill differ !ith the specific purpose of the analytical procedure" The precision of the e'pectation is a function of the ateriality and required detection risk for the assertion being tested" %f the assertion being tested requires a lo! level of detection risk, the e'pectation needs to be very precise" #o!ever, the ore precise the e'pectation, the ore e'tensive and e'pensive are the audit procedures used to develop the e'pectation, resulting in a cost=benefit trade-off" The second step in the substantive analytical procedures decision process is to define or calculate a tolerable difference" ,ince the e'pectation developed by the auditor !ill rarely be identical to the client's recorded a ount, the auditor ust decide the a ount of difference that !ould require further investigation" The si$e of the tolerable difference depends on the significance of the account, the desired degree of reliance on the analytical procedure, the level of disaggregation in the a ount being tested, and the precision of the e'pectation" Auditors often use rules of thu b such as, ;tolerable difference is (0> of the predicted a ount and=or a difference less than ?@5,000"<

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&'planations for significant differences observed for substantive analytical procedures ust be follo!ed up and resolved through quantification, corroboration, and evaluation" Quantification* Auantification involves deter ining !hether the e'planation or error can e'plain the observed difference" This ay require the recalculation of the e'pectation after considering the additional infor ation" 1or e'a ple, a client ay offer the e'planation that the inventory account increased by a certain percentage as co pared to the prior year due to a (/ percent increase in ra! aterials prices" The auditor should co pute the effects of the ra! aterials price increase and deter ine the e'tent to !hich the price increase e'plains *or does not e'plain- the increase in the inventory account" Corroboration* Auditors ust corroborate e'planations for une'pected differences by obtaining sufficient co petent audit evidence linking the e'planation to the difference and substantiating that the infor ation supporting the e'planation is reliable" This evidence should be of the sa e quality as the evidence obtained to support tests of details" Co on corroborating procedures include e'a ination of supporting evidence, inquiries of independent persons, and evaluating evidence obtained fro other auditing procedures" Evaluation: &valuation involves the effective use of professional skepticis , co bined !ith the desire to obtain sufficient co petent audit evidence, si ilar to other auditing procedures" The auditor should evaluate the results of the substantive analytical procedures to conclude !hether the desired level of assurance has been achieved" %f the auditor obtains evidence that a isstate ent e'ists and can be sufficiently quantified, the auditor akes note of his or her proposed ad.ust ent to the client7s financial state ents"

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Chapter 05 - Audit Planning and Types of Audit Tests

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The Audit Testing #ierarchy starts !ith tests of controls and substantive analytical procedures because they are generally both ore effective and ore efficient than starting !ith tests of details *i"e", substantive tests of transactions and substantive tests of account balances and disclosures-" ,o e of the buckets are larger than others because certain assertions !ill be ore i portant or present bigger risks for so e accounts than for others" 1or instance, e'istence *or validity- is typically ore i portant for accounts receivable than it is for accounts payable" After the auditor has deter ined the risks associated !ith the assertions for an account balance, she can deter ine the si$e of the assurance buckets *i"e", ho! uch assurance is needed- and then begin filling the buckets by applying the audit testing hierarchy" There are four categories of financial ratios discussed in the te't) short-ter liquidity ratios, activity ratios, profitability ratios, and coverage ratios" ,hort-ter liquidity ratios are indicators of the entity's ability to eet its current obligations !hen they beco e due" Activity ratios indicate ho! effectively the entity's assets are anaged" Profitability ratios are indicators of the entity's success or failure for a given period" Coverage ratios provide infor ation on the long-ter solvency of the entity, including the ability of the entity to continue as a going concern"

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Answers to +u,ti-,e-C.oi/e Questions

5- % 5- & 5- ' 5- ( 5-!) 5-! 5-!! 2 A A C B 2 2 5-!" 5-!# 5-!5 5-!% 5-!& 5-!' A A C A C B

So,utions to Pro0,e1s
5-!( a" The procedures #all should perfor before accepting the engage ent include the follo!ing) (" #all should e'plain to Ada s the need to ake an inquiry of 2odd and should request per ission to do so" /" #all should ask Ada s to authori$e 2odd to respond fully to #all's inquiries" 6" %f Ada s refuses to per it 2odd to respond or li its 2odd's response, #all should inquire as to the reasons and consider the i plications in deciding !hether to accept the engage ent"

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Chapter 05 - Audit Planning and Types of Audit Tests

9" #all should ake specific and reasonable inquiries of 2odd regarding atters #all believes !ill assist in deter ining !hether to accept the engage ent, including specific questions regarding) 1acts that ight bear on the integrity of anage ent" 2isagree ents !ith anage ent as to accounting principles, auditing procedures, or other si ilarly significant atters" 2odd's understanding as to the reasons for the change of auditors" 5" %f #all receives a li ited response, #all should consider its i plications in deciding !hether to accept the engage ent" b" The additional procedures #all should consider perfor ing during the planning phase of this audit that !ould not be perfor ed during the audit of a continuing client ay include the follo!ing) (" #all ay apply appropriate auditing procedures to the account balances at the beginning of the audit period and, possibly, to transactions in prior periods" /" #all ay ake specific inquiries of 2odd regarding atters #all believes ay affect the conduct of the audit, such as Audit areas that have required an inordinate a ount of ti e" Audit proble s that arose fro the condition of the accounting syste and records" 6" #all ay request Ada s to authori$e 2odd to allo! a revie! of 2odd's !orking papers" 9" #all should docu ent co pliance !ith fir policy regarding acceptance of a ne! client" 5" #all should start obtaining the docu entation needed to create a per anent !orking paper file" 5-") a" Prior to acceptance of the engage ent, Tish D 1ield should have co unicated !ith the predecessor auditor regarding) 1acts that ight bear on the integrity of anage ent" 2isagree ents !ith anage ent concerning accounting principles, auditing procedures, or other significant atters" The predecessor's understanding about the reason for the change" Any other infor ation that ay be of assistance in deter ining !hether to accept the engage ent" b" The for and content of engage ent letters ay vary, but they !ould generally contain infor ation regarding) The ob.ective of the audit" The esti ated co pletion date" Eanage ent's responsibility for the financial state ents" The scope of the audit" 0ther co unication of the results of the engage ent" The fact that because of the test nature and other inherent li itations of an audit, together !ith the inherent li itations of any syste of internal control, there is an unavoidable risk that even so e aterial isstate ent ay re ain undiscovered"
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Chapter 05 - Audit Planning and Types of Audit Tests

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Access to !hatever records, docu entation, and other infor ation ay be requested in connection !ith the audit" Arrange ents !ith respect to client assistance in the perfor ance of the audit engage ent" &'pectation of receiving fro anage ent !ritten confir ation concerning representations ade in connection !ith the audit" +otification of any changes in the original arrange ents that ight be necessitated by unkno!n or unforeseen factors" A request for the client to confir the ter s of the engage ent by ackno!ledging receipt of the engage ent letter" The basis on !hich fees are co puted and any billing arrange ents"

Additional procedures to be perfor ed prior to the beginning of field !ork are) 8eading the current year's interi financial state ents" 2iscussing the scope of the e'a ination !ith anage ent of the client" &stablishing the ti ing of the audit !ork" Arranging !ith the client for adequate !orking space" Coordinating the assistance of client personnel in data preparation" &stablishing and coordinating staffing require ents, including ti e budget" #olding a planning conference !ith assistants assigned to the engage ent and discuss possible fraud-related issues" 2eter ining the e'tent of involve ent, if any, of consultants, specialists, and internal auditors" Considering the effects of applicable accounting and auditing pronounce ents, particularly recent ones" Considering the need for an appropriate engage ent letter" Preparing docu entation setting forth the preli inary audit plan" Eaking a preli inary .udg ent about ateriality" Eaking a preli inary .udg ent about control risk" 3pdating the prior year's !ritten audit progra "

5-"! a" The typical engage ent letter generally includes the follo!ing) (" The na e and address of the person or persons !ho retained the auditor to perfor the auditing services" /" An opening paragraph that confir s the understandings of the auditor and the client" 6" A su ary of significant events that led to the retention of the services of the auditor" 9" A general description of the CPA fir that !ill conduct the e'a ination" 5" A state ent that the e'a ination !ill be perfor ed in accordance !ith PCA0B auditing standards" C" A description of the scope of the services to be rendered, !hich should establish the nature of the engage ent" @" Any scope restrictions or special li itations and their effect on the auditor's
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Chapter 05 - Audit Planning and Types of Audit Tests

report"

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Chapter 05 - Audit Planning and Types of Audit Tests

F" A state ent regarding the auditor's responsibility for the detection of fraud" G" An indication of the possible use of client personnel in connection !ith the audit !ork to be perfor ed" (0" A state ent that the auditor !ill provide a anage ent letter if required in the circu stances" ((" The ethod and ti ing of billings as !ell as billing rates and fee arrange ents" (/" ,pace for the client representative's signature, !hich indicates acceptance of the letter and the understandings therein" b" The benefits of preparing an engage ent letter include the avoidance of possible proble s bet!een the CPA and the client concerning *(- the scope of the !ork, */- the service to be rendered, and *6- the audit fee" %n addition, the Hin-chargeH auditor conducting the e'a ination can avoid isunderstanding the nature and scope of the engage ent if the engage ent letter is included in the per anent section of the audit !orking papers" The letter should eli inate isunderstandings and confusion about the type of financial state ents to be e'a ined, the esti ated report date, and the type of opinion e'pected" %n this respect, the letter lessens any proble s associated !ith the first standard of field !ork, !hich requires the !ork to be adequately planned and assistants to be properly supervised" %n addition to avoiding possible isunderstandings, any legal proble s relating to the auditor's failure to perfor certain procedures can be revie!ed !ith reference to the contractual co it ent assu ed" 1or e'a ple, if scope li itations prevent the auditor fro perfor ing nor al audit procedures, the auditor cannot be legally responsible if a fraud is not detected !hen clearly it !ould have been detected if such procedures !ere perfor ed" The engage ent letter is also useful as a reference docu ent !hen preparing for future engage ents" 5-"" a" An audit co ittee is an i portant part of a co pany's organi$ational structure" %t is a special co ittee for ed by the board of directors" %t should be a group of outside *independent- directors !ho have no active day-to-day operational role and !ho are a liaison bet!een the independent auditor and the board of directors" The audit co ittee assists and advises the full board of directors and in doing so aids the board in fulfilling its responsibility for public financial reporting" b" Audit co ittees are for ed to satisfy the shareholders' need for assurance that directors are e'ercising due care in the perfor ance of their duties" 1or public co panies they are required by regulation" They ay also be for ed so that a co pany can be ore responsive to the needs of those interested in financial reporting" Their for ation itself is recognition of the responsibilities of both the corporation and its auditor to the public investor" Also, they ay be for ed to reinforce auditor's independence, particularly the appearance of independence, fro the anage ent of a co pany !hose financial state ents are being e'a ined by the auditor"

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Chapter 05 - Audit Planning and Types of Audit Tests

c" The functions of an audit co ittee ay include the follo!ing) ,election of the independent auditor, discussion of audit fee !ith the auditor, and revie! of the auditor's engage ent letter" 8evie! of the independent auditor's overall audit plan *scope, purpose, and general audit procedures-" 8evie! of the annual financial state ents before sub ission to the full board of directors for approval" 8evie! of the results of the auditor's e'a ination including e'periences, restrictions, cooperation received, findings, and reco endations" Eatters that the auditor believes should be brought to the attention of the directors or shareholders should be considered" 8evie! of the independent auditor's evaluation of the co pany's internal control syste s" 8evie! of the co pany's accounting, financial, and operating controls" 8evie! of the reports of internal audit staff" 8evie! of interi financial reports to shareholders before the board of directors approves the " 8evie! of co pany policies concerning political contributions, conflicts of interest, and co pliance !ith federal, state, and local la!s and regulations, and investigation of co pliance !ith those policies" 8evie! of financial state ents that are part of prospectuses or offering circulars: revie! of reports before they are sub itted to regulatory agencies" 8evie! of the independent auditor's observations of financial and accounting personnel" Participation in the selection and establish ent of accounting policies: revie! the accounting for specific ite s or transactions as !ell as alternative accounting treat ents and their effects" 8evie! of the i pact of ne! or proposed pronounce ents by the accounting profession or regulatory bodies" 8evie! of the co pany's insurance progra " 8evie! and discussion of the independent auditor's anage ent letter" 5-"# a" %f Post discovers that Ieneral's financial state ents ay be aterially isstated due to fraud, Post should consider the i plications for other aspects of the audit and discuss the atter and approach to further investigation !ith an appropriate level of anage ent and the audit co ittee" Post should also atte pt to obtain sufficient co petent evidence to deter ine !hether, in fact, aterial fraud e'ist and, if so, its effect" Post ay suggest that Ieneral consult !ith its legal counsel on atters concerning questions of la!" b" %f Post is precluded fro applying necessary procedures, Post should disclai or qualify an opinion on the financial state ents and co unicate these findings to Ieneral's audit co ittee or its board of directors"

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Chapter 05 - Audit Planning and Types of Audit Tests

c" %f Post concludes that Ieneral's financial state ents are aterially affected by fraud, Post should insist that the financial state ents be revised and, if they are not, e'press a qualified or an adverse opinion on the financial state ents, disclosing all the substantive reasons for such an opinion" Additionally, Post should adequately infor Ieneral's audit co ittee or its board of directors about the fraud" d" Post ay have a duty to disclose fraud to third parties outside Ieneral's anage ent and its audit co ittee in the follo!ing circu stances) Jhen Ieneral reports an auditor change under the appropriate securities la!" Jhen a successor auditor appropriately akes inquiries of a predecessor auditor" Jhen responding to a subpoena" Jhen co unicating !ith a funding or other specified agency, as required for entities that receives financial assistance fro a govern ent agency" 5-"5 Audit Procedure ( / 6 9 Assertion Accuracy &'istence Cutoff 4aluation and allocation

5-"% a" Analytical procedures are used for three broad purposes) To assist the auditor in planning the nature, ti ing, and e'tent of other auditing procedures" As a substantive test to obtain evidential atter about particular assertions related to account balances or classes of transactions" As an overall revie! of the financial infor ation in the final revie! stage of the audit" b" An auditor's e'pectations *types of analytical procedures- are developed fro follo!ing sources of infor ation) 1inancial and operating data" Budgets and forecasts" %ndustry publications" Co petitor infor ation" the

c" The factors that influence an auditor's consideration of the reliability of data for purposes of achieving audit ob.ectives are !hether the Kno!ledgeable independent source of the evidence" The effectiveness of internal controls" The auditor7s direct personal kno!ledge" 2ocu entary evidence"
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Chapter 05 - Audit Planning and Types of Audit Tests

0riginal docu ents"

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Chapter 05 - Audit Planning and Types of Audit Tests

5-"& a" The calculation of the e'pectation for the reserve for returns account can be follo!s) +ont.,2 S3,es 4in )))s5 ? @6,600,000 F/,F00,000 G6,500,000 ((0,/00,000 (5F,/00,000 /0/,500,000 Histori/3, Return R3te 0"009 0"00C 0"0( 0"0(5 0"0/5 0"06/ Esti13te6 Returns /G6,/00 9GC,F00 G65,000 (C56,000 6,G55,000 C,9F0,000 (6,F(6,000 ' 0"9/5 ?5,F@0,5/5

ade as

+ont.s Luly August ,epte ber 0ctober +ove ber 2ece ber

Iross Eargin > Auditor e'pectation b"

Je can establish a tolerable difference by applying a percentage *50>- to the planning ateriality set for &arthJear of ?(,F00,000" This results in a tolerable difference of ?G00,000"

c" The e'pectation of ?5,F@0,5/5 is appro'i ately ?/0,000 less the book value of ?5,FG0,000" ,ince this a ount is less than the tolerable difference of ?G00,000, the analytical procedure supports the fair presentation of the reserve for returns account" d" %f the difference bet!een the auditor7s e'pectation and the book value is greater than the tolerable isstate ent, the auditor should consider perfor ing the follo!ing audit procedures) 8evie! the general .ournal and general ledger for any unusual entries" 8eevaluate the historical return rates" 8eevaluate the gross profit argin" Ask the client to ad.ust the books" 5-"' The accounts receivable turnover is slo!er for /00@, !hich i plies that the average collection period has increased" Arthur should first satisfy hi self that 8CT's credit ter s re ained unchanged over those years" %f the credit ter s have been liberali$ed, this increase in collection period ay be appropriate" Arthur should also satisfy hi self that these co putations do, in fact, represent the year's activity" An accounts receivable aging schedule can indicate !hether the longer collection period is due to a a.or delinquent custo er or is representative of 8CT's annual activity" Assu ing Arthur is satisfied that 8CT's credit ter s have not changed and that annual activity is fairly represented, he should include ore e'tensive audit procedures for sales and accounts receivable" The indicated trend ay be due to understated sales or overstated accounts receivable" Arthur should carefully revie! the year-end cutoff for sales to verify that sales are not understated" #e should also satisfy hi self that there are no unrecorded sales"
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Chapter 05 - Audit Planning and Types of Audit Tests

Arthur should verify that the accounts receivable are fairly stated at year-end" #e should check that lapping has not occurred" 1urther ore, he ay !ish to e'pand his nor al confir ations to cover a larger proportion of the receivables" %n addition, Arthur should satisfy hi self that the accounts receivable balance includes only bona fide trade receivables" The changed ratio does not auto atically i ply that an account is isstated" %t erely highlights an area for further inquiry" %t is possible that the changed ratio is perfectly valid and that the related accounts are fairly stated" %f this is so, the auditor should satisfy hi self as to the cause of the changed ratio" 1or e'a ple, 8CT ay have increased sales by being less HselectiveH of its custo ers" 1urther ore, tighter econo ic conditions ay have caused custo ers to pay their bills ore slo!ly" By inquiry of sales anagers, Arthur ay find out if there has been a change in the sales i' of products !ith varying credit ter s" The increased current ratio !as due to an increase in current assets greater than the increase in current liabilities" %ncreases in both current assets and current liabilities are !arranted because activity has increased fro /00C to /00@, but the a.or increase in current liabilities has been inco e ta'es" The inco e ta'es each year are directly proportional to that year's inco e before federal inco e ta'es: therefore, the a ount of inco e ta'es is logical, assu ing that Arthur is satisfied that each year's inco e before ta'es is fairly stated" The accounts payable, ho!ever, have declined" Arthur should satisfy hi self that the accounts payable are fairly stated" #e should consider the use of confir ation requests and check that the cutoff of payables !as handled properly" #e should carefully search for unrecorded payables" #e should investigate substantial decreases in long-ter liabilities and should ascertain that current aturities of long-ter liabilities are properly reported in the balance sheet" A ratio that is inconsistent fro one year to the ne't does not necessarily i ply isstate ents" The ob.ective of ratio analysis is to point out areas !here further investigation is !arranted" The auditor ust satisfy hi self that the accounts are fairly stated and that the change is .ustified"

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Chapter 05 - Audit Planning and Types of Audit Tests

So,utions to Dis/ussion C3ses

5-"( a" The current-year audit discovered that 1orestcrest Joolen Eills had not co pleted any construction !ork on the !ater treat ent facility that ust be built to co ply !ith the consent decree fro the +orth Carolina &PA" 1ailure to co plete this facility on ti e can result in fines and possible plant closure under the consent decree" This situation represents a aterial uncertainty that is likely to be re ote at this point in ti e" #o!ever, the auditor should deter ine if the client !ill continue !ork on the facility and if it can be co pleted !ithin the re aining three years" %f the client provides so e assurance that !ork !ill start on the facility and that construction can be co pleted on ti e, the auditor !ill likely issue a standard unqualified audit report" The co pletion infor ation can be obtained fro the co pany's president and its construction co pany" %f the client !ill not provide assurance on the future !ork on the facility and=or the construction cannot be co pleted on ti e, the auditor !ill have to consider !hat the potential effects of failure to co ply !ith the consent decree ight be" At this point, it is probably too early to consider issuing a Hgoing-concernH opinion on the co pany" The auditor ight require that client to provide ore detailed disclosure of the issue in the footnotes to the financial state ents" b" %f these facts !ere noted at the end of the seventh year of the consent decree, the auditor !ould again need infor ation on the possible ti ely co pletion of the facility" %f the facility can be co pleted, the auditor !ould ost likely issue a standard unqualified report" %f, ho!ever, the facility cannot be co pleted on ti e and the penalties under the consent decree are significant enough to raise doubts about the co pany's continued e'istence, the auditor !ould likely issue a odified report !ith an e'planatory paragraph for going concern" 5-#) (" 8eported ticket revenue differs fro the e'pectation by appro'i ately (9 percent **/,/00,000 - (,G//,(G0-= (,G//,(G0-: this difference is aterial and should be investigated" 0ne e'planation for the larger than e'pected reported ticket revenue could be that the football tea perfor ed better than e'pected" %n addition, perhaps the !eather also !as better than e'pected" Auditors can verify ticket sales, perhaps by co paring deposits of ticket revenue !ith reported attendance" The auditors also could check !eather conditions on ga e days to ascertain !hether favorable !eather conditions are a plausible e'planation for the higher attendance"

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Chapter 05 - Audit Planning and Types of Audit Tests

Deve,o-1ent o7 Au6itor8s E9-e/t3tion 1our regular ga es /9,000 Allocation 0"@ 0"/ 0"( Total attendance Total 1ans (C,F00 9,F00 /,900 /9,000 1our nor al ga es Bloo ington 3niversity 6(,/00 Allocation 0"@ 0"/ 0"( Total attendance Total 1ans /(,F90 C,/90 6,(/0 6(,/00 +or!alk 3niversity +or al ga e revenue) &'tra fans *total-) Bo' 3pper 9,F00 6,C00 (,/00 Price per Ticket (/ 5 */0> ore fans, @5> bo' seats, /5> upper deck/9C,000 Total 8evenue 96,/00 C,000 /G5,/00 +ight ga e *(0> higher ticket prices, 5> lo!er attendanceBase attendance 5ess) 1ree seats and 5> (5,9F5 9,5C0 /,/F0 //,6/5 tickets Price per Ticket (6"/0 F"F0 5"50 Total 8evenue /09,90/ 90,(/F (/,590 /5@,0@0 : ;(!!; () 5ess free /(,690 C,/90 6,(/0 Price per Ticket (9"90 G"C0 C"00 Total 8evenue 60@,/GC 5G,G09 (F,@/0 6F5,G/0 *60> higher attendance, /0> higher ticket price5ess free (C,600 9,F00 /,900 Price per Ticket (/ F 5 Total 8evenue (G5,C00 6F,900 (/,000 /9C,000 '9 GF9,000

/9,000

0"@ 0"/ 0"(

(C,F00 9,F00 /,900 /9,000

Tot3, esti13te6 revenue 7or t.e 2e3r

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Chapter 05 - Audit Planning and Types of Audit Tests

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Chapter 05 - Audit Planning and Types of Audit Tests

8eported ticket revenue differs fro the e'pectation by appro'i ately (9 percent **/,/00,000 M (,G/(,FC0-=(,G/(,FC0-: this difference is aterial and should be investigated" 0ne e'planation for the larger than e'pected reported ticket revenue could be that the football tea perfor ed better than e'pected" %n addition, perhaps the !eather also !as better than e'pected" Auditors can verify ticket sales, perhaps by co paring deposits of ticket revenue !ith reported attendance" The auditors also could check !eather conditions on ga e days to ascertain !hether favorable !eather conditions are a plausible e'planation for the higher attendance" %n a proble such as this, analytical procedures !ill be ost effective !hen accurate e'pectations can be developed" 1ro this infor ation provided in this proble , it appears that the auditor7s kno!ledge of Jestern7s ticket sales is sufficient to allo! the to develop a reasonable e'pectation"

So,utions to Internet Assi<n1ents

5-# The %nstitute of %nternal Auditors *%%A- ho e page *!!!"theiia"org- contains detailed infor ation about various activities of the %%A" This includes infor ation on the profession, certification, conferences, products, etc" A search of the Jeb site identified infor ation about independence and ob.ectivity" A search of the %nternet identified a nu ber of potential sources for infor ation on the ail order industry) The +ational Eail 0rder Association *!!!"n oa"co - is one site !here s all to ediu -si$ed organi$ations can go to get infor ation on education, ideas, resources, and contacts" The +ational 8etail 1ederation *!!!"nrf"co - aintains historical retail statistics" The %nternational ,ociety for ,trategic Earketing *!!!"iss "org- aintains a site that contains econo ics statistics fro the Census Bureau on various ,%C codes related to the ail order industry" 5astly, a nu ber of the a.or public accounting fir s have industry speciali$ation in retail" The sites of the fir s contain infor ation on the retail industry"

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