ACC621: Audit Planning, Sample Selection, Considerations in Substantive Testing and Collecting Audit Evidence - Auditing Assessment Answers

December 20, 2017
Author : Julia Miles

Solution Code: 1ADJD

Question:

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General information about the assignment

The assignment must be your own individual work; i.e. it is not a group assignment. If it is believed that a student has copied material from another student or any other source without appropriate referencing, the necessary action will be taken under the University’s Student Academic Misconduct Policy: (https://www.usc.edu.au/explore/policies-and-procedures/ student-academicmisconduct-academic-policy). Therefore, it is critical that you provide complete referencing for any sources of information you use in preparing your assignment. This includes both in-text references and a list of references at the end of your assignment. Referencing should be in accordance with USC’s guidelines for Harvard referencing.

The assignment should only be submitted electronically via Safe Assignment on the course Blackboard site. If you wish to apply for an extension to your submission date, please email Kirsty Meredith (kmeredit@usc.edu.au) to explain the circumstances and attach any necessary supporting documentation. Late penalties will be applied for assignments submitted after 5pm on the due date without an approved extension. More details on late penalties are provided in the course outline.

The word count for each of the three parts provides you with a guide to the approximate number of words that you should use for each part. The suggested total word count is 1,600 words. However assignments between 1,300 and 1,900 words in length will be considered acceptable.

Part A: Audit Planning 

You are planning the audit of Bob’s Bikes and have accessed the preliminary trial balance for the entity. This is presented below. You would like to use this trial balance to identify accounts that are likely to require significant audit attention.

Your task: You must choose 5 accounts from the trial balance for audit testing. In doing so, you should:

? Make a preliminary judgement of materiality, ? Complete an analytical review using the trial balance, ? Consider whether there are any accounts that should be

selected regardless of their quantitative materiality, and ? Provide a brief rationale for your selection of each of the 5

accounts.

Materiality is covered in chapter 10 (week 6 lecture) and analytical reviews are covered in chapter 8 (week 3 lecture).

This may require independent reading beyond the chapters indicated in the course outline.

Please be sure to choose at least 1 revenue account, as this will be required for Part B.

A suggested template for presenting your answer is included later in this document.

Part B: Sample Selection 

You are now further into the audit process. You have finished your audit planning, including gaining an understanding of the entity’s internal control structure. You have decided to adopt a predominantly substantive approach for the revenue accounts and are now in the substantive testing stage of the audit.

Your task:

  • Select 1 of the revenue accounts that you identified in Part A,
  • Access the General Ledger detail for that account from the file: GL extract for Part B.doc (Go to Blackboard: Assessment: Assignment),
  • Use one of the following sample selection techniques: random, systematic or haphazard, to select 5 transactions from the ledger account for further audit testing,
  • Explain/demonstrate how your chosen sampling technique resulted in the selection of these 5 transactions, and
  • Provide an explanation of the benefits of your selected technique (including the limitations of the 2 alternative techniques).

A suggested template for presenting your answer is included later in this document.

Part C: Considerations in Substantive Testing and Collecting Audit Evidence 

Your task:

Please provide an answer to the following questions:

  1. What might be your reason for adopting a predominantly

substantive approach in Part B? 2. Which of the following assertions are you likely to be more

Chapters 9 through 13 will assist you in answering these questions. These topics are covered in lectures in weeks 4, 6, 7 and 8.

concerned about for the account used in Part B: occurrence or completeness? Why? 3. Which of the following audit procedures would be more appropriate: tracing or

vouching? Why? 4. Please list 1 other assertion that might be relevant for this account. 5. What evidence could you seek for the assertion you identified in question 4? You should list at least 1 example of corroboratory evidence and/or a specific audit procedure. 6. Assume your further testing revealed an error with one of the transactions you

selected in Part B, specifically a misstatement of $20,000.

  1. Is this likely to be considered acceptable? Why/why not? b. Would the magnitude of the misstatement be relevant if you were doing tests

of control rather than substantive testing? Why/why not? c. What other information would you need to know before projecting your results

to the entire account balance? 7. Under which circumstances might it be considered acceptable to use a part-year trial

balance, such as the one presented in Part A, for substantive testing?

A suggested template for presenting your answer is included below.

Sampling is covered in chapter 13 (week 8 lecture). We will discuss each of these 3 techniques in lectures and tutorials.

A suggested template for your answer

You may wish to format your answer as follows:

Title page

1.0 Part A: Audit planning

1.1 Preliminary judgement of materiality

1.2 Analytical review

1.3 Five accounts selected and rationales

2.0 Part B: Sample selection

2.1 Explanation/demonstration of sampling technique

2.2 Benefits of selected sampling technique

It is not necessary to include an overall introduction.

3.0 Part C: Considerations in substantive testing and collecting audit evidence

3.1 Question 1

3.2 Question 2

3.3 Question 3

3.4 Question 4

3.5 Question 5

3.6 Question 6

3.6.1 6a

3.6.2 6b

3.6.3 6c

3.7 Question 7

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Solution:

1.0 Part A: Audit planning

1.1 Preliminary judgement of materiality

ASA 320 provides that Misstatement and omissions are material where they could influence the decisions of users taken on the basis of the financials. Revenue is a critical measure for the business survival and growth. It is selected as the materiality base for the Income statement transactions. Since the variation from last year is only $ 3,752 being 3.8 % of last year’s sales and less than 5%, we set the materiality level for income and expenses at 6% being the lowest tolerance limit for materiality level. Inventory is a critical measure for the business survival and growth. It is selected as the materiality base for the Balance Sheet transactions. Since the item form 39% and the highest proportion of the total assets of the business, we set the materiality level for assets and liabilities at 9%, being the upper tolerance limit for materiality level.  

Qualitative factors to be considered include:

  • Inherent risks of family business where ownership and control are vested in one person.
  • Risk of the management engagement in fraudulent reporting.
  • Inherent risks of credit sales and their recoverability.
  • Absence of internal control and internal Audit.
  • Inherent risks in Cash Sales like theft or fraud.

1.2 Analytical review and qualitative considerations

Category Ratio Formula 2015 values 2015 2014 values 2014
Efficiency Inventory turnover Sales/ Average inventory 201515/175000             1.15 187450/189000         0.99
Profitability Cost of sales ratio Cost of sales /sales 53271/201515             0.26 63595/187450         0.34
Liquidity Current ratio Current Assets/Current Liabilities 412071/215000             1.92 389503/215000         1.81
Efficiency PPE turnover Net sales/Average PPE 201515/65000             3.10 187450/65000         2.88
Solvency Debt to equity Debt/Shareholders equity 215000/153024             1.41 215000/144033         1.49

Analytical procedures need to comply with ASA 520.

Accumulated depreciation Machinery

The significant difference; $ 21,666, in the accumulated depreciation for both the years may increase the audit control risk with respect to the machinery such that the internal control procedures may fail to identify fraud regarding depreciation, repairs and maintenance also affected by management discretion as a whole or at the account levels. As per ASA 315 Para 130, management intervention is also an instance of the existence of a possibility of material misstatement. (AUASB, 2016). PPE turnover has improved in the past year 2015 as per ratio analysis from 2.88 to 3.10 implying better asset utilization per unit of sales.

Wages

Wages being an inherent High risk account due to the nature and volume of transactions involved. It is important to verify the existence of strong internal controls so as to reduce overall audit risk by reducing the control and detection risk. The wages for the part year 2015 are lower than 2014 by $ 6184 being 13.2 % lower than last year. The difference may be inferred to the 2-month timing difference of the financials for both the years.

Cost of Sales

The area is prone to significant audit risk due to the risk of failure to record transactions and distorted favourable solvency and liquidity position so as to impress investors, customers and lenders. Interestingly, while the sales have increased, the COS has reduced by $ 10,324 being about 10.5 % of current year sales. The difference may be inferred to the 2-month timing difference of the financials for both the years. Cost of Sales has improved in the past year 2015 as per ratio analysis from 0.34 to 0.26 implying less cost for each dollar of sale

Sales

This area is prone to significant audit risk due to the absence of the provision or allowance of doubtful debts. The dependence of the system on completion of processing makes it prone to inherent risk.  The key assertion at risk is regarding the correctness, accuracy, classification disclosure of sales as bifurcated into cash sales and credit sales. The sales have increased by $ 14,065 over last year being about 7.5 % of last year sales.

Inventory

The key assertion at risk regarding inventory is the existence of an adequate internal control in respect to the security, valuation and disclosure of all purchase and Inventory transactions. Thereby Inventory forms about 39% of the total assets (189000/484571). Inventory turnover has improved in the past year 2015 as per ratio analysis from 0.99 to 1.15 implying better sales for each dollar of inventory. The current ratio has improved in the past year 2015 from 1.81 to 1.92 implying better liquidity in the short term. Debt equity has improved in the past year 2015 from 1.49 to 1.41 implying less reliance on external finance and better solvency due to better risk and asset ownership profile. (Www4.semo.edu, 2016)

1.3 Five accounts selected and rationales

The rationale behind the selection of all the five accounts in 1.2 is the result of the analytical procedures done above.

2.0 Part B: Sample selection

2.1 Explanation/demonstration of sampling technique

Sales Account

Sample selected using simple manual random sampling technique

  1. 10/7/2015 SJ Accounts Receivable Cr 8,000
  2. 20/11/2015 SJ Accounts Receivable Cr 8,035
  3. 19/02/2016 SJ Accounts Receivable Cr 6,200
  4. 08/04/2016 SJ Accounts Receivable Cr 7,985
  5. 30/04/2016 GJ Cost of Sales Dr 10,000

The above mentioned transactions were selected using the random sampling technique. the rationale behind the selection was to conduct an effective audit such that each transaction of the sales account population had an equal chance of selection. The entire process was accomplished in a single step and each transaction was selected independently of the other.

Each transaction of the sales account population was assigned a unique number. Each unique number were picked for the purpose of testing. Since the sample size was not very large, the computer-aided random selection was not preferred. To make sure that the process remained free form bias of the user, the selection was made on the basis of numbers assigned to the transactions rather than taking a glimpse of the transaction before making the selection. The GL extract was used to select the sample as instructed. As demonstrated by the selected transactions, one can easily discern that the selected sample is fair and fit for the purpose of substantiate testing purposes.

The audit objective is to test the transactions to ensure the correctness, accuracy, classification and disclosure of sales as bifurcated into cash sales and credit sales to reduce audit risk to a tolerable level. The materiality level is 6 % as set out earlier in the audit planning process. The size of the sample is 5 transactions as instructed. The main aim of the sample selection was to reduce the sampling risk to an acceptable level as the sample risk bears an inverse relationship with the sample size. These 5 transactions were selected at random to achieve the above mentioned objective.

ASA 530 suggests Random, Systematic and Haphazard techniques. The rationale for selecting the random technique was the general regard given to it as the best method of of sample selection for statistical evaluation of the results.

2.2 Benefits of selected sampling technique

The main benefit of the random selection was the simplicity of sample selection. Every transaction had a fair chance of selection from the account population as every item in the account had equal opportunity of being chosen.

The sample could easily be regarded as being representative of the account population due to the equal probability of selection. Where this is not the case, the random variation is often termed as the sampling error , rendering the whole exercise futile. This happens when bias enters the selection process. No complicated processes of division or sub division are involved

The unbiased selection and the representative benefit are very important to reach conclusions on the audit testing at the account as well as overall level. The main aim of the whole exercise was to draw conclusions on the population based on the results obtained from substantiate testing of the sample. (Explorable.com, 2016)

These benefits are in stark contrast to the criticism of the systematic technique which often results in sampling error where the population follows a fixed pattern and bias enters the sampling process. This would also have been the case in the sales revenue sample selection explained above as the transactions are following a fixed pattern in terms of amount and account credited.

The haphazard technique would have selected the sample without a structure and is used only when the population is not ordered numerically. Also, the technique suffers from the limitation of being prone to the bias avoiding the first or last entry in a ledger and the difficulty in locating items.

3.0 Part C: Considerations in substantive testing and collecting audit evidence

3.1 Question 1

The reason for adopting a predominantly substantive approach in Part B was  to obtain reasonable assurance that the sales account account balance is not materially misstated and ensure the correctness, accuracy, classification and  disclosure of sales as bifurcated into cash sales and credit sales to reduce audit risk to a tolerable level as per ASA 315 on Identifying and Assessing the Risks of Material Misstatement through Understanding the Entity and its Environment and ASA 330 the Auditor’s Responses to Assessed Risks.

3.2 Question 2

The assertion that seems to be more important for the sales account used in Part B would be ensuring completeness of the transactions from the source to the financials of the company with a well-defined audit trail. The occurrence assertion would rather be tested using analytical review procedures in the audit process.

3.3 Question 3

For the purpose of the sales revenue account, vouching would be preferable as it would ensure a check on the accuracy of the transactions with documentary evidence. Tracing is normally resorted to for balance sheet accounts to ensure the correctness, validity and completeness of the transactions. (S, 2015)

3.4 Question 4

Another important assertion is the cut off of the transactions to ensure that they were recorded in the correct reporting period.

3.5 Question 5

To ensure that the cut off for the sales revenue account was properly ensured; a sample of sales invoices, receipts and shipping documents ought to be verified before and after year-end for the transactions near about that date.

3.6 Question 6

3.6.1 6a

The misstatement is not acceptable as we set the materiality level for income and expenses at 6% being the lowest tolerance limit for materiality level which allows a tolerable misstatement level of $ 6,150 being 6% of the current year sales.

3.6.2 6b

The magnitude of the misstatement is not relevant for tests of control or substantive testing as we set the materiality level for income and expenses at 6% being the lowest tolerance limit for materiality level which allows a tolerable misstatement level of $ 6150 being 6% of the current year sales.

3.6.3 6c

Other information required for projecting the results to the entire account balance would be the result obtained from the analytical review procedures.

3.7 Question 7

A part year trial balance could be used in cases of first audits or where due to natural disasters, calamities, climatic disturbances or accidents, the records and accounts were destroyed. However, in such cases the auditor ought to qualify the report mentioning the fact as well as increase his substantiate and analytical procedures to reduce inherent risk, control risk and overall detection risk to minimum level.

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