short answer Flashcards
A) During 2014, your client was sued by a customer who slipped and fell in the washroom of one of their stores. The washroom floor had recently been cleaned but there were no warning signs posted. On her way down, she hit her head on the sink, which caused her to pass out. She claims to have suffered irreparable damages from the fall, including a phobia about using public washrooms. The amount of the claim is $750,000, with estimated legal bills of about $200,000. The client does not wish to disclose the lawsuit in the financial statements for fear of bad publicity. Materiality is set at $100,000. (3 marks)
This is a significantly material GAAP departure, which would result in an adverse opinion. This represents a contingent liability. The outcome of the lawsuit must be assessed for whether it will be likely and/or estimable. If it is likely and can be estimated, an amount should be accrued in the financial statements (an adjustment should be made). If it is likely but not estimable, note disclosure is still necessary under GAAP. Management has not accrued nor disclosed this significantly material item (nearly 10x materiality), therefore causing the overall fairness of financial statements to be in question. “These financial statements do not present fairly”.
B) Edmonton Fit Free Fund is a charitable organization devoted to helping Edmontonians lead healthy, fit lives. They offer free fitness classes to underprivileged citizens. A significant portion of their revenues are generated by fundraising. Fundraising is handled primarily by means of e-mail and door-to-door canvassing by volunteers. Volunteers conducting canvassing provide receipts at the door using pre-numbered receipts. Receipts are issued for donations $20 or higher. Funds raised by e-mail are sent receipts by e-mail. Materiality is set at $10,000 and recorded revenues from donors who did not receive donation receipts is $15,000. (3 marks)
This is a scope limitation, as the auditors would not be able to obtain satisfactory assurance over the completeness of fundraising revenues. It is difficult to measure whether this would be material or significantly material (since we were not able to audit completeness of revenues). However, the numbers and the case facts seem to suggest that this could be a material scope limitation (not significantly material):
- $10,000 materiality vs. $15,000 recorded revenues,
- the fact that donation receipts are issued for donations over $20, and
- it is limited to one type of revenue and one assertion (it is not pervasive to the entire audit).
Therefore, a modified audit report in the form of a qualification would be appropriate. “In our opinion, except for the effect of adjustments, if any, which we might have determined to be necessary had we been able to satisfy ourselves concerning the completeness of revenues referred to in the preceding paragraph, these financial statements present fairly, in all material respects…”
B) What two management assertions are usually most at risk when auditing accounts payable and accrued liabilities? Why? Describe two different substantive audit procedures you would perform to obtain assurance over these two assertions. (6 marks)
2 marks – correct identification of assertions (can be any 2 on the key)
2 marks for explanation why (must include both A/P and accruals)
2 marks for describing two substantive audit procedures (description, not just a list)
Assertions:
A/P: Completeness and cutoff
Accrued liabilities: Valuation, completeness, cutoff
Explanation:
Because there may be a bias to understate liabilities/expenses by not recording goods/services received before y/e and/or they may not be aware of potential liabilities for goods/services for which no invoice has been received and/or if they don’t have strong controls over cutoff in place. Valuation is a risk for accruals such as warranties or legal liabilities because the amount of settlement is based on an estimate and there may be a bias for management to understate these amounts.
Procedures:
Completeness and cutoff: search for unrecorded liabilities:
• subsequent cash disbursements(trace payments made after y/e to their receiving report/invoice; if goods received before y/e, check to ensure included in A/P at y/e)
• unmatched (unpaid) supplier invoices (look at invoices not yet paid to see if goods were rec’d before y/e: if yes, check that they were included in A/P)
• unmatched receiving reports (look at goods received but not invoiced or paid yet – if goods were rec’d before year end, check that they were included in A/P)
• Vendors’ statements – examine statements that summarize balances due as at y/e – make sure these are included as A/P
• analytical review (compare CY to PY looking for fewer payables or accruals)
• A/P confirmations (select from supplier master file (active vendors with nil balances or suppliers they typically do a lot of business with)
Valuation of accrued liabilities:
• Analytical Procedure: develop an expectation based on our understanding of the business (i.e. wage accrual, warranties, etc.), compare that expectation to balance in accrual account, discuss with management any differences and corroborate management’s explanation (if applicable).
• Valuation of legal liabilities: Confirmation: Send legal letters to obtain lawyer’s assessment of the contingency; if probable (likely) AND estimable need to ensure it is accrued as a liability in the F/S.
C) What two management assertions are most at risk when auditing long-term debt? Why? Describe two different substantive procedures you would perform to obtain assurance over these two assertions. (6 marks)
2 marks – correct identification of assertions
2 marks for explanation why
2 marks for describing two substantive audit procedures (description, not just a list)
Assertions:
Completeness and Classification/understandability
Explanation: Because there may be a bias to understate liabilities, risk of mis-class between current/long-term portion of debt, risk of incorrect allocation between principal and interest payments, and there are very specific disclosure requirements that need to be met.
Procedures:
Completeness:
• Send bank confirmation, asking banks to confirm debt outstanding and terms of debt.
Classification/understandability:
• Obtain loan agreement and loan amortization schedule to ensure principal/interest payments have been recorded correctly, and classification between current and long-term is correct.
• Examine F/S and notes to ensure long-term debt is presented and disclosed in accordance with GAAP: current/long-term portion, terms of debt, principal repayments required over the next 5 years and thereafter, etc.
D) What two management assertions are most at risk when auditing payroll (salaries and wages expense)? Why? Describe two different substantive procedures you would perform to obtain assurance over these two assertions. (6 marks)
2 marks – correct identification of assertions
2 marks for explanation why
2 marks for describing two substantive audit procedures (description, not just a list)
Assertions:
Occurrence, cutoff, classification (or valuation)
Explanation:
Due to the nature of the payroll cycle, there is a risk of overstatement of salaries and wages expense, either by paying employees for time not worked, paying employees who no longer work for the company, or paying fictitious employees. Employees will typically not report an overpayment. Cutoff is a risk because it is necessary that salaries and wages expenses are recorded up to and including the year-end date (regardless of when the last payroll payments were processed). Classification is a risk in manufacturing companies where a portion of employees’ salaries and wages are allocated to the cost of inventory, also impacting the valuation of inventory.
Procedures:
Occurrence:
• Choose a selection of payroll payments from salaries and wages expense in the G/L, agree to payroll register, choose employees from payroll register and verify payments made are correct – verify wage rates and deductions to personnel file, time worked to supervisor-approved time sheets or time cards.
Cutoff:
• Obtain information from payroll accountant about the last payroll payment processed. If it is on a date other than year end, verify that they’ve set up the appropriate accruals to record time worked but not paid (using analytical procedure/recalculation).
Classification (or valuation):
• Obtain information about how labour costs are allocated to inventory and recalculate to ensure appropriate amounts have been included in the cost of inventory (rather than being expensed as salaries and wages expense).
