Solution manual aswers auditing theory by cabrera chapter 10 ans

An audit program is a detailed outline of the auditing work to be performed, specifying the procedures to be followed in verification of each item in the financial statements.. The audit

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conditions in the industry may result in significant uncollectible accounts receivable.#Accounts receivable may be overvalued because the allowance for uncollectible accounts is not adequate.##2 An audit plan provides essential background information for an audit assignment, and outlines the objectives, timing, staffing, special risks and considerations, and other requirements of the engagement An audit program is a detailed outline of the auditing work to

be performed, specifying the procedures to be followed in verification of each item in the financial statements Although both the audit plan and the audit program are technically plans, the audit plan serves more as a broad overview ofthe engagement, while the audit program is more specific and limited in scope.3

The purpose of the team meeting on fraud risk is designed to allow the more experienced team members to share insights and exchange ideas about how andwhere the entity s financial statements might be susceptible to material �

misstatement due to fraud, to discuss how to design appropriate tests to detect the misstatements, and to emphasize the importance of maintaining the proper degree of professional skepticism regarding the possibility of fraud.4

During the planning process, the auditors make preliminary estimates of both risk and materiality for the engagement The auditors must plan their engagements to reduce the audit risk of issuing an unqualified opinion on

materially misstated financial statements to a relatively low level At the account balance level, audit risk actually has three components: (1) inherent risk, (2) control risk, and (3) detection risk On audits where the risk of misstatement is relatively high, the auditors must compensate by increasing the effectiveness of their audit procedures They may design more effective

procedures, increase the number of items selected for testing, or perform more procedures at the balance sheet date rather than at an interim date They may also add an element of unpredictability to the procedures.The auditors'

preliminary estimates of levels of materiality also affect the nature, timing, and extent of their planned procedures Materiality levels determine which accounts are significant enough to require audit, affect the size of the test samples, and determine the dollar amount of individual items that warrant

examination.5 (a) Auditors must obtain an understanding of the client and its environment in order to determine whether the client should be accepted and

to plan the audit This understanding encompasses the following:The nature of the client, including the client s application of accounting policies The � �

auditors understanding of this area will include the client s competitive � �position, organizational structure, accounting policies and procedures,

ownership, capital structure, and product lines The understanding will also encompass an understanding of the client s business model and its major business�processes.The industry, regulatory, and other external factors The factors �included here are industry conditions, such as the competitive environment, supplier and customer relationships, and technological developments They also include the regulatory, legal, and political environment, and general economic conditions Objectives and strategies and related business risks The auditors �obtain an understanding of the operating and financing strategies of management.They also obtain an understanding of management s risk assessment process This�assists the auditors in identifying significant business risks that may create risks of material misstatement of the financial statements.Methods of measuring and reviewing performance The auditors obtain an understanding of the methods �

management uses to measure and review performance at various levels within the organization These methods are important to determining incentives of

management and other employees The measures may also be used in designing effective analytical procedures.Internal control The auditors understanding of � �internal control assists them in planning the audit and assessing control risk.(b) Sources of information on prospective clients include trade publications, and governmental agency publications Previous audit reports, annual reports to stockholders, SEC filings, and prior years' tax returns are excellent sources offinancial background information Informal discussions between the auditors andkey officers can provide information about the history, size, operations,

accounting records, and controls of the enterprise Inquiries of others within the organization can provide information that confirms inquiries of management, and provides more detailed information about risks and business processes Inspection of internal documents and records can provide information about the nature of the client s operations and internal control The predecessor auditor �may also provide information.(c) Knowledge of the client and its environment helps the auditors in:(1) Identifying areas that may need special

consideration.(2) Identifying significant business risks that may result in risks of material misstatement of the financial statements (3) Assessing inherent risk and making preliminary assessments of control risk.(4) Making judgments about the appropriateness of accounting principles in use and the adequacy of disclosures.(5) Evaluating the reasonableness of estimates, such

as depreciation lives and the allowance for doubtful accounts.(6)

Evaluating the reasonableness of management representations.(7)

Developing an efficient audit strategy.(8) Determining the staffing requirements of the engagement 6 During the tour of the client's plant facilities, Sison inspects all inventory areas and makes note of the location, types, security, "housekeeping," and general condition of the

inventories He also visits the receiving and shipping departments and reviews the types of documents maintained His observations in these areas enable him

to form a preliminary impression of the adequacy of internal controls for

inventories, and possible problems with respect to obsolete or slow-moving inventories He also can begin formulating plans for staffing and carrying out the physical inventory observation.Sison s observation of the productive �

processes will acquaint him with the client's physical plant facilities and layout, the nature of the products and computer applications employed in the production process He may also obtain information on the client's

documentation such as for production orders, raw materials requisitioned to production, direct and indirect labor, and inspection and testing of finished products He meets the supervisory personnel, engineers, and other key

personnel responsible for production, and through inquiries and conversations learns of any unique production problems, including excessive spoilage and scrap As a result, he will be in a position to evaluate the client's cost accounting system during the course of the audit He will also inquire about the details of the client s business processes.Throughout the tour, Sison will �add to his impression of the client's business processes, control procedures andaccounting records He will notice, for example, what personnel have access to computer terminals and accounting records, whether plant assets have

identification tags, and whether documents such as production orders and

receiving reports are serially numbered or controlled by the computer.7 (a)

Misstatements due to fraudulent financial reporting are intentional

misstatements or omissions of amounts or disclosures in the financial statements

to deceive financial statement users Misstatements arising from

misappropriation of assets (sometimes referred to as defalcation) involve the theft of an entity s assets where the effect of the theft causes the financial �statement not to be presented in conformity with generally accepted accounting principles (b) The three conditions necessary for the commission of fraud include: (1) some type of incentive or pressure, (2) an opportunity to commit the fraud, and (3) an attitude that allows the individual to rationalize the act In a case of fraudulent financial reporting, members of top management mayhave an incentive to commit the act relating to maintaining the value of their stock options They may have an opportunity based on weaknesses in the

corporate governance of the organization Finally, they may be able to

rationalize the act by assuming that the company will make enough income next

period to allow them to correct the misstatement (c) The

auditors may respond to fraud risks by (1) a modification in the approach having an overall effect on how the audit is conducted, (2) an alteration in thenature, timing, and extent of the procedures performed, and (3) performance of procedures to further address the risk of management override of internal

control.8 (a) Shin may respond to fraud risks in the following three ways:(1) A modification in the overall approach to the audit which might involve:(a)

Applying increased professional skepticism and designing procedures that provide more reliable evidence.(b) Assigning additional staff with

specialized skill and knowledge or by assigning more experienced staff to the engagement Also the extent of the supervision of the staff should be adjusted

to reflect the fraud risks (c) Giving further consideration to the

appropriateness of the accounting principles used by the client (d)

Incorporating an added element of unpredictability in the selection of auditing procedures (2) An alteration in the nature, timing and extent of the procedures performed For example, Shin might apply procedures that providemore reliable evidence, shift more audit tests to year-end, or increase sample sizes for certain substantive tests (3) Perform procedures to further address the possibility of management override of internal control, including (1)

examining journal entries and other adjustments for evidence of fraud, (2) reviewing accounting estimates for biases, and (3) evaluating the business rationale for significant unusual transactions (b) Whenever the auditorsbelieve that there is evidence that fraud may exist, the matter should be

brought to the attention of an appropriate level of management Fraud involvingsenior management and fraud that causes a material misstatement of the financialstatements should be reported directly to the audit committee In very serious situations the auditors should consider resigning the engagement.II Multiple Choice Questions1 d#6 d#####2 a#7 d#####3 d#8 d#####4

d#9 d#####5 d#10 d#####III Comprehensive CasesCase 1 (1) (a)There is an increased risk of fraudulent financial reporting by subsidiarymanagement More specifically, subsidiary management would likely attempt to increase revenue or decrease expenses (b) The auditors would probablyrespond by performing more procedures at the subsidiary location Additional tests of revenue would be performed and the auditors would likely decide to observe inventory at year-end In addition, some of the procedures may be performed on an unannounced basis (2) (a) There is an increased risk of fraudulent financial reporting by management related to revenue (b) Theauditors would likely respond by utilizing more experienced audit team members Specifically, audit staff that had experience with complex revenue contracts in the telecommunications industry They would also likely increase the extent of the substantive tests of revenue (3) (a) There is an increased risk that the futures traders will fraudulent overstate the value of the contracts to increase their compensation (b) The auditors would likely respond to this situation by bringing in a specialist to assist in valuing the contracts

In addition, they would do extensive testing of the valuation of the contracts

(4) (a) There is an increased risk that management may be fraudulentlyoverstating income at one or more of the stores (b) The auditors would likely respond by doing increased testing of revenue and inventory at the stores The auditors could use the results of the analytical procedures to identify stores that are more likely to have fraudulent reported results (e.g., those with unusually high profit margins) The auditors also may not disclose the locations that they intend to visit for inventory observation

Case 2 Mr Gian LeePresidentPalace CorporationDear Mr Lee:Our recent tour

of Palace's plant was a most pleasant and interesting experience The

information obtained on this tour and during the discussion of your financial statements and accounting records has enabled us to plan the scope of an audit especially suited to your needs.Our fees are based on the time spent on the engagement by various members of our audit staff, and will be billed at our established rates The total time required for an initial engagement is usuallysomewhat greater than in repeat examinations, since the latter do not require analysis of past years' transactions Considerable savings in the cost of the audit may be made by utilizing the services of your accounting staff to help us

in certain phases of the work We can arrange for your employees to prepare for

us a number of working papers If you approve, we shall indicate to your chief accountant the exact nature of the working papers to be prepared.Our audit will

be performed in accordance with generally accepted auditing standards and will include all procedures which we consider necessary to provide a basis for

expression of our opinion on the fairness of the financial statements The audit will include:(1) A consideration of the internal control.(2) Tests of the financial statement accounts and balances to the extent we consider

necessary, based on our consideration of risks and internal control.(3)

Preparation of the federal and state income tax returns.(4)Issuance of ourauditor's report upon your financial statements.If our investigation indicates the desirability of any changes in internal control procedures, we shall prepare

a report on this subject for your consideration However, an audit cannot be relied upon to identify all weaknesses in internal control The purpose of our audit is to enable us to express an opinion on the fairness of the financial statements; the audit is designed to provide reasonable, but not absolute, assurance of detecting material fraud and defalcations, and we will notify you

if our audit does bring them to light.Although it is not possible to determine

in advance the exact number of days required for the engagement, our estimates indicate that the total fee will be between _ and _ The audit will be completed and our report submitted by March 1, 2009.We would like

an opportunity during the next few days to discuss with you and your chief accountant the nature of the preliminary work to be done by your staff We shall also be pleased to answer any further questions which you may have

concerning the determination of audit fees Very truly yours, Chariya, Modenaand Company, CPAs####10-# PAGE #4# Solutions Manual - Assurance Principles, Professional Ethics Understanding the Entity and Its Environment 10-# PAGE � �

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