Problem
Smithson, CPAs, was contacted by Real-Rip-Off Stores Inc. (RRO), a furniture manufacturing company that operates in three provinces, to become the company's new auditors for the 2016 financial statements. Robert, the partner assigned to the file, had to first learn about the client's industry and determine if his CPA firm had the necessary expertise to do the audit. He researched the industry, met with the company's directors, and read over the audit reports for the past 3 years. Robert noted that the largest accounts on the balance sheet were finished goods inventory and accounts receivable.
Robert's initial plans included contacting the prior auditing firm to obtain a copy of working papers pertaining to interim work done on the inventory account, as Smithson was being appointed in February 2017, well after the December 31 inventory count for the 2016 year. Robert met with RRO's management to explain Smithson's standard policy of confirming accounts receivable, which Robert wanted to schedule right away due to the timing of their appointment. RRO's board of directors explained that there would be no problem, except that one of the major customers, LOUIE Construction Ltd. (LOUIE), would not likely respond. The directors suggested simply reducing the receivable to whatever amount Robert felt comfortable with. and not to bother contacting LOUIE.
When Robert contacted the previous auditors, he was informed that LOUIE was owned by the brother of a major shareholder of RRO. LOUIE would not confirm that they owed a substantial (material) sum to RRO, and RRO's supporting records for the accounts receivable were inadequate to support the amount claimed. The board of directors would not agree to adjust the financial statements as the auditors had insisted, and ultimately, the previous auditors resigned.
Task
1. Has the scope of the auditor's work been limited, as described in the above scenario? Explain briefly why any audit work may have been limited by the set of circumstances given.
2. Assume that the previous auditors were able to obtain sufficient appropriate evidence on all other items in their audit, except for the LOUIE receivable, which is material. Rather than resign, what could the previous auditors have done? Explain. '
3. Robert plans to use analytical procedures to compare current year account balances to balances of a prior period. List three other examples of the use of analytical procedures.
4. Assume that Robert determined that a combined audit approach should be used.
a. Explain briefly (one or two sentences) what the term "combined audit approach" means.
b. What is the assessed level of control risk when a combined audit approach is used?
c. When a combined approach is not justified, what approach does the auditor use? Briefly explain what this means in terms of the type of audit testing required for the rest of the audit.