Questions

1)
James M. Peters, CPAs has audited
the financial statements of XYZ, Inc. as of December 31, 2014 and gave them a
clean opinion on their financial statements.
Since XYZ is publicly traded, they also audited the firm’s internal
controls. They identified material
weaknesses related to the method of accounting for sales commissions and
separation of duties related to purchasing transactions. Peters was able to gather sufficient evidence
and did not encounter any scope limitations.
Review their draft audit report on internal controls attached to the end
of this exam and identify five errors or omissions in the report. Group your errors or omissions by paragraph
in the report and provide a brief explanation of why you feel they were errors
or omissions.

a)
Error or Omission #1 –

b)
Error or Omission #2 –

c)
Error or Omission #3 –

d)
Error or Omission #4 –

e)
Error or Omission #5 –

2)
You are auditing the accounts
receivable balance of a cable television provider. Individual accounts receivable balances tend
to be similar in amount and cover one or two months of unpaid fees. However, there are a lot of customer balances
due at the end of any period. The client
has a computerized billing system that makes it easy to access individual
customer’s records. The total accounts
receivable balance makes up 23% of the firm’s total assets. You did the audit last year and found few
exceptions in internal controls and few errors in their accounts receivable balance.

a)
What would be the primary test
of balances procedure you would use on the accounts receivable balance and
why? Make sure you are clear about what
balance-related audit objective(s) your test would cover and how.

b)
Given the test you selected in
a), answer the following questions and explain your answers. Make you explanations as complete as you can
and cover as many reasons as possible to support your position.

i)
Would you use a sampling
technique to execute the test or not?

ii)
Assuming that you would use a
sampling technique, would you use a statistical or non-statistical method?

iii)
Assuming you used a statistical
sampling approach, would you use MUS or VS?

3)
You are auditing Southwest
Appliance, an appliance wholesaler.
Select the most appropriate audit procedure from the following list and
enter the number in the appropriate place on the grid. “Most appropriate” means you can
only select one procedure per row. Provide
an explanation of how the audit procedure would support the balance-related
audit objective listed for the row. An
audit procedure may be selected once, more than once, or not at all. The audit procedures are:

1.
Review of bank confirmations
and loan agreements

2.
Review of drafts of the
financial statements

3.
Selection of a sample of
revenue transactions and determination that they have been included in the
sales journal and accounts receivable subsidiary ledger.

4.
Selection of a sample of
shipping documents for a few days before and after year-end.

5.
Confirmation of accounts
receivable

6.
Review of aging of accounts
receivable with the credit manager

4)
The following table contains a
list of typical audit procedures for acquisition activities. For each procedure, classify them as either
substantive analytical procedures (AP), tests of details of account balances
(TB), tests of controls (TC), or substantive tests of transactions (ST). Finally, list one audit objective that the
test is designed to support and include an explanation of how the test supports
that audit objective.

5)
You are auditing XYZ company
for the year ended 12/31/2014 and will be expressing an opinion on their
financial statements as of that date.
You have not completed your audit report when these facts come to your
attention. For each of the following,
independent scenarios, describe how they should affect the financial statements
for 12/31/2014, if at all. Assume all
the items are material.

a)
A large accounts receivable
from ABC to XYZ (material to the financial statements) was considered fully
collectible at 12/31/14. However, ABC
suffered a plant explosion on 1/25/15.
Because ABC was uninsured, it is not likely that the account will be
paid.

b)
The tax court ruled in favor of
XYZ on 1/26/15. The case involved
deductions XYZ claimed on their 2012 and 2013 tax returns. In accruing taxes payable, XYZ provided for
the full amount of the potential disallowances.
The IRS has indicated it will not appeal the court’s decision.

c)
XYZ’s manufacturing division,
whose assets constituted 45% of XYZ’s total assets, was sold on 2/1/15. The new owner assumed the bonded indebtedness
associated with the division.

d)
On 1/15/15, a major investment
advisor issued a negative report on XYZ’s future prospects. The market price of XYZ’s common stock
subsequently fell by 40%.

6)
Why do auditors obtain
management representation letters from their audit clients at the end of every
audit? Your answer should include a
general statement of the overall purpose of management representation letters
as well as two examples of the representations auditors ask the auditee
client’s management to make in a management representation letter.

7)
You are
auditing a firm’s ending inventory balance.
You obtained a complete listing of every item that made up the ending
inventory balance from the client’s subsidiary inventory ledger. At the same time that the client took its
physical count of the items in ending inventory, you selected a sample of items
from the listing and performed you own count of the number of that item in
ending inventory. You then compared your
count to the client’s count and noted any differences in your working
papers. Then you obtained a listing of
the costs assigned to each item of inventory in your sample and verified the
cost to purchase invoices from the vendors.
Finally, you multiplied the number in your count by your costs and compared
the resulting amount to client’s inventory subsidiary ledger. You traced the total of their subsidiary
ledger to their general ledger account.

a)
For each of
the following tests you performed, describe the purpose of the test to include
all the audit objectives involved.

i)
Counting
the items in inventory

ii)
Verifying the costs per item

iii)
Tracing the subsidiary ledger
total to the general ledger

b)
The total
amount shown on the client’s subsidiary ledger did match their general ledger
balance, but you found differences in the subsidiary ledger and your audit
tests in both the number of items in inventory and costs per items. These errors totaled more than your tolerable
misstatement. Discuss what alternatives
you have to address this difference.

Report of Independent
Registered Public Accounting Firm

To the
Board of Directors and Shareholders of XYZ, Inc.:

We have
audited management’s assessment, included in the accompanying Management’s
Report, on Internal Control over Financial Reporting, that XYZ, Inc. has not
maintained effective internal control over financial reporting as of December
31, 2014, based on criteria established in Internal Control-Integrated
Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission (COSO criteria). XYZ’s
management is responsible for assessing the effectiveness of internal control
over financial reporting. Our
responsibility is to express an opinion on management’s assessment and an
opinion on the effectiveness of the company’s internal control over financial
reporting based on our audit.

We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan and
perform the auditor obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. Our audit included obtaining
an understanding of internal control over financial reporting, evaluating management’s
assessment, testing and evaluating the design and operating effectiveness of
internal control, and performing such other procedures as we considered
necessary in the circumstances. We
believe that our audit provides a reasonable basis for our opinion.

A company’s
internal control over financial reporting is a process designed to provide
reasonable assurance regarding the reliability of financial reporting and the
preparation of financial statements for external purposes in accordance with
generally accepted accounting principles. A company’s internal control over financial
reporting includes those policies and procedures that (1) pertain to the
maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally
accepted accounting principles and that receipts and expenditures of the
company are being made only in accordance with authorizations of management and
directors of the company; and (3) provide reasonable assurance regarding
prevention or timely detection of unauthorized acquisition, use, or disposition
of the company’s assets that could have a material effect on the financial
statements.

Two
material weaknesses were identified in the design and operation of internal
controls over the accounting for sales commissions and separation of duties
related to purchases of inventory. Given
the nature of the transactions and processes involved and the potential for a
misstatement to occur as a result of the internal control deficiencies existing
on December 31,2014, we have concluded that there is more than a remote
likelihood that a material misstatement in the annual or interim financial
statements would not have been prevented or detected by internal controls.

These material
weaknesses were considered in determining the nature, timing, and extent of
audit tests applied in our audit of the 2014 financial statements.

In addition
to the materiel weaknesses noted above, we identified several deficiencies in
internal control over financial reporting that we deemed to be less significant
than a material weakness. These deficiencies have been separately communicated
to XYZ’s management.

In our
opinion, because XYZ has not maintained an effective internal control over
financial reporting, we are unable to evaluate management’s assessment that XYZ
did not maintain effective internal control over financial reporting as of
December 31, 2014. Also in our opinion,
because of the effect of the material weaknesses described above on the
achievement of the ‘objectives of the control criteria, XYZ has not maintained.
in all material respects, effective internal control over financial reporting
as of December 31, 2014, based on the COSO criteria.

We have also
audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States) the balance sheets of XYZ as of December 31,2014
and 2011, and related statements of income, shareholders’ equity, and cash flow
for each of the three years in the period ended December 31, 2014.

James M.
Peters, CPA.

December
31, 2014

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