What are possible ways for an account to be misstated

Question

Question 1

Part 1:Audit opinions

Cutty University Press Inc. (CUP) manufactures and sells professional training and education books internationally and follows IFRS. You, a CGA, have been engaged as CUP's auditor for its December 31, 2014, fiscal year-end.

For each of the following situations, state the level of materiality of the condition (material but not pervasive, material and pervasive, or immaterial) and the form of the audit report you would issue. In addition, state the reason why the level of materiality has been assigned. Assume each situation is independent of the others.

1. Subsequent to the date of the financial statements, you are told there has been a fire at one of CUP's production facilities that has not been disclosed in any documentation provided by the company.
2. You are not able to count the un-deposited cash receipts at a number of branch offices around the country on the last day of the fiscal year. As an alternative, the year-end bank reconciliation shows the deposits as credits.
3. Two days after the fiscal year-end, CUP's primary supplier of pulp (a key raw material in production) informs the company that prices will be increasing by 10%. CUP has revalued the inventory based on this information, and it creates a material change in the financial statements due the importance of pulp as a component of the inventory. The change made by CUP is sufficiently disclosed in the notes to the financial statements.
4. CUP typically ships products two days after customers place their order on the company's website. The company records revenues based on when the customer's order is placed, rather than when the product ships. For the current year, you have determined that the number of orders placed but not shipped at the balance sheet date is not material.
5. CUP's chief financial officer refuses to provide you with the minutes of board meetings, although he has provided a certified and notarized statement of all director's resolutions passed in the year.

Use the following table format for your answer:

Condition (description of the auditing issue resulting from the event)	Materiality level (including supporting discussion)	Type of audit report

Part 2:Management's responsibilities

CUP has established a comprehensive accounting information system and set of internal control processes. Management believes that the control and information system is sufficient to ensure the smooth operation of the organization, and the company believes it maintains a high quality of oversight of the financial information and report generation throughout the system. Management states in its communications with you that it does not perform ongoing monitoring of internal controls , given the efficacy of the system.

Required:

Do you support management's assessment of the accounting system and claims? Explain your answer.

Part 3: Audit sampling methodology

CUPsells its instructional materials to a number of large professional organizations and firms, in addition to individuals. During the accounts receivable (A/R) confirmation process, you note there are 1,176 accounts with total receivables of $1,650,000. In your selected sample there are 18 accounts that have total amounts receivable above $10,000. The aggregate balance of these receivables is $432,000. In the rest of your sample there are 81 accounts that have a balance under $10,000, which total $36,000. Materiality for the December 31, 2014, fiscal year-end audit is determined to be $75,000.

Required:

1. If this was a non-statistical sample, what type of selection technique(s) would have been used? What issues would the auditor need to be aware of in this situation? Explain your answer.
2. Would a stratification approach have been useful in this case? In your response include a discussion of the advantages and disadvantages of using a stratification approach.
3. What would be the preferred statistical technique to be used by the auditor? Briefly explain your answer.
4. Consider the following misstatements in a statistical sample. How would you evaluate the result? What steps should be performed next? Explain your answer.

	Recorded value	Audit value
Over $10,000	$432,000	$408,000
Under $10,000	$36,000	$24,000
Partial list of individual items
Item 1	$2,000	$1,800
Item 2	$1,300	$1,200
Item 3	$500	$400
Item 4	$350	$325

Part 4: Audit documentation

CUP allows students to log on to a website that provides assessments and tracks progress. Recently, these online services have become an increasingly important component of CUP's overall revenues. As part of the audit this year, you have focused attention on reliance on the internal controls concerning online services. The different programs (for example, Accounting Prep., LawSchool Prep., or MedSchool Prep.) have different levels of popularity and different levels of relative performance among students. You notice the following regarding how CUP monitors student progress for the various programs:

1. There are no records about how often a student attempts a test or uses the homework practice provided.
2. There are no records kept of how often a student makes use of the online tutors.
3. Students sometimes use false login information, such as e-mail addresses, gender, age, or profession.
4. The volume of users has increased over 500% in the last two years, bringing into question CUP's ability to manage such large volumes of users and store their information.

Required:

1. What types of evidence-gathering audit procedures (state at least four) would you use to obtain audit evidence over how CUP monitors student progress for the various programs? Where would you obtain the evidence? In your answer, state the level of confidence you would have in the objectivity of the evidence-gathering audit procedures. (16 marks)
   Use the following table to format your response to this question:

Evidence-gathering audit procedure	Evidence artifact (example of type of evidence obtained)	Source of collection	Level of objectivity (high, medium, low)

1.  What transaction evidence could you obtain to help confirm the online operations of CUP? In your answer, explain the audit procedure that would be performed and the applicable audit assertion(s) that would be tested. Provide at least four types of audit procedures that could be performed.

Part 5: Applying materiality

The purpose of risk assessment and testing is to verify the assertions made by management in the financial statements.

You, a CGA, are evaluating the audit results for current assets in the December 31, 2014, year-end audit of Handy Carpentry. You have set the materiality for current assets at $15,000 for overstatements and at $25,000 for understatements. The results of your findings are as follows:

	Tolerable misstatement		Estimate of total misstatement
Account	Overstatements	Understatements	Overstatements	Understatements
Cash	$3,000	$3,000	$2,000	-
Accounts receivable	9,000	15,000	3,000	$18,000
Inventory	9,000	12,000	4,000	9,000
Prepaids	3,000	4,000	2,000	2,000
Total	$24,000	$34,000	$11,000	$29,000

Required:

1. A co-worker at your firm suggests that the tolerable amount of overstatements needs to be the same as understatements for all accounts to achieve balance. Do you agree with this statement? Provide support for your answer.
2. If overall materiality is assessed at $15,000, would the totals of the tolerable misstatements exceed the materiality for both understatements and overstatements?
3. What are possible ways for an account to be misstated? Provide two examples of common types of misstatements that may occur in specific accounts.
4. Given the audit results, should you be more concerned about the existence of material overstatements or understatements for Handy Carpentry Co.? Indicate which account would cause the most concern (if any) and explain why.
5. Ignore the table above. If the estimate of total misstatements (overstatement) in each account is less than the tolerable misstatement for each account, but the total aggregate estimate of total misstatements (overstatement) exceeds overall materiality, what steps should an auditor perform next?

Part 6:Dollar-unit sampling

Answer the following questions:

1. Why is dollar-unit sampling preferable if the auditor is concerned that material errors are likely to occur in larger invoices? Provide an example to help support your answer.
2. Discuss two disadvantages of using the dollar-unit sampling method.
3. Answer the following using the table provided in Topic 6.5 (Exhibit 6.5-1):

As part of your work on the audit of GasCorp Inc. you need to test the existence of accounts receivable. You note the tolerable misstatement level of accounts receivable is $500,000. At year-end, the balance of accounts receivable is $12,000,000 and is made up of 500 accounts. Using an acceptable risk of incorrect acceptance (ARIA) of 5%, an estimated error rate in the population of 0.25%, and an average percentage of error assumption of 25%, what sample size should you use to test the existence of accounts receivable?

(Note: Round your calculated amount as necessary in order to use the exhibit provided in Topic 6.5. For example, if the tolerable deviation rate is calculated to be 11.25%, the tolerable deviation rate of 10% should be used from the exhibit to assess the sample size.)

1. With regard to part c), what effect would lowering the tolerable misstatement level of accounts receivable to $250,000 have on your sample size? Assume all other factors remain the same. Explain your answer.