Instructions: Total Marks-100

 All questions are to be attempted.

 Answer must be brief, relevant, neat and clean.
 Start answering each question from a fresh sheet

Green Ltd. has been growing rapidly (the company has grown about 10% in each of the past five years)
and has recently engaged your firm as its auditor. However, on contacting the previous auditor, you learn
that a dispute led to the firm’s dismissal. The client wanted to recognize income on contracts for items
produced but not shipped. The change in accounting principle would have increased net income by 33%
during the last year. The company’s profits have been increasing over the past several years. Following
are some of the statistics for the company:
Overview of Operational Data Green Ltd.
(Sales and Net Income Reported in $ Millions)

2014
(Major
2010 2011 2012 2013 2014 Competitor)
Sales $800.00 $880.00 $950.00 $1,050.00 $1,300.00 $1,500.00
Net Income $28.00 $38.00 $42.00 $52.00 $68.00 $80.00
Stock Price $17.00 $24.00 $19.00 $28.00 $47.00 $49.00
Percentage Of Market Share 9% 9.40% 9.60% 10.80% 14.00% 16.00%
Gross Profit (%) 28.00% 28.30% 28.80% 29.20% 33.60% 36.00%
Account Receivable $180.00 $170.00 $196.00 $210.00 $297.00 $250.00
Inventory $96.00 $114.40 $114.00 $126.00 $234.00 $400.00
Account Payable $28.00 $32.00 $33.00 $38.00 $45.00 $46.00
Number of Days Sales in Receivable 16 16 15 16 29 14
Number of Days' Sales in Ending Inventory 47 46 46 47 69 46

Additional information available to the auditor includes the following:

 The company used its new and improved technology for the increase both in sales and in gross
margin.
 The company claims to have decreased administrative expense, thus increasing net profits.
 The company has reorganized its sales process to a more centralized approach and has
empowered individual sales managers to negotiate better prices to drive sales as long as the
amounts are within corporate guidelines.
 The company has changed its salesperson compensation by increasing the commission on sales to
new customers.
 Sales commissions are no longer affected by returned goods if the goods are returned more than
90 days after sale and/or by not collecting the receivables. Green Ltd. has justified the changes in
sales commissions on the following grounds:
 The salesperson is not responsible for quality issues—the main reason that products are
returned.
 The salesperson is not responsible for approving credit; rather credit approval is under the
direction of the global sales manager.

1
Required:

1. Assume that you had expected that your client’s performance would be similar to that of the
client’s major competitor. Based on these expectations, identify potential risk areas, and explain
why they represent potential risks. Identify the elements of inherent risk associated with the
revenue cycle. [Marks-20]

2. Perform preliminary analytical review procedures using the data included in the table and the
information about the change in performance. What are the important insights that the auditor
should gain from performing the analytical review? Suggest possible explanations for any
unexpected results. [Marks-20]

3. Why should the auditor be interested in a company’s stock price when performing an audit? What
is the importance of the information about salesperson compensation to the audit of receivables
and revenue? Explain how the information would be used in performing preliminary analytical
procedures. [Marks-20]

4. Identify the appropriate internal control which, if properly designed and implemented, most likely
could assist in preventing or detecting material misstatement. [Marks-20]

Inherent and Fraud Risks Internal Controls

a Invoices for goods sold are posted to incorrect
customer accounts.

b Goods ordered by customers are shipped but

are not billed to anyone.

c Invoices are sent for shipped goods but are

not recorded in the sales journal.

d Invoices are sent for shipped goods and are

recorded in the sales journal but are not
posted to any customer account.

e Credit sales are made to individuals with

unsatisfactory credit ratings.

5. How do auditors use their knowledge about the risk of material misstatement, including their
knowledge of the design effectiveness of controls, in developing an audit approach? Comment on
extensiveness of testing, types of audit procedures, and the rigor of audit procedures in higher-
versus lower-risk settings. [Marks-20]