Assignment - DISCUSSION QUESTIONS AND PROBLEMS

Q1. The following are concepts discussed in Chapter 8

1. Preliminary judgment about materiality

2. Control risk

3. Risk of fraud

4. Inherent risk

5. Risk of material misstatements

6. Known misstatement

7. Estimated total misstatement in a segment

8. Planned detection risk

9. Estimate of the combined misstatement

10. Significant risk

11. Acceptable audit risk

12. Performance materiality

Required -

a. Identify which items are audit planning decisions requiring professional judgment.

b. Identify which items are audit conclusions resulting from application of audit procedures and requiring professional judgment.

c. Under what circumstances is it acceptable to change those items in part a, after the audit is started? Which items can be changed after the audit is 95% completed?

Q2. This problem requires you to access PCAOB Auditing Standard No. 12, Identifying and Assessing Risks of Material Misstatements. Use this standard to answer each of the questions below. For each answer, document the paragraph(s) in AS No.12 supporting your answer.

a. What types of information does AS No. 12 suggest the auditor should consider when obtaining an understanding of the company and its environment?

b. What types of performance measurements might affect the risk of material misstatement?

c. What specific issues should be included in the discussion among engagement team members regarding the risk of material misstatement?

d. What factors should the auditor consider to determine if a risk is a "significant risk"?

e. What guidance is provided about revising the risk assessment as the audit continues?

Q3. Moranda and Sills, LLP, has served for over 10 years as the auditor of the financial statements of Highland Bank and Trust. The firm is conducting its audit planning for the current fiscal year and is in the process of performing risk assessment procedures. Based on inquiries and other information obtained, the auditors learned that the bank is finalizing an acquisition of a smaller community bank located in another region of the state. Management anticipates that the transaction will close in the third quarter, and, while there will be some challenges in integrating the IT systems of the acquired bank with Highland systems, the bank should realize a number of operational cost savings over the long-term.

During the past year, the bank has expended its online service options for customers, who can now remotely deposit funds into and withdraw funds from checking and savings accounts. The system has been well received by customers and the bank hopes to continue expanding those services. The challenge for Highland is that they are struggling to retain IT personnel given the strong job market for individuals with those skills.

Credit risk management continues to be a challenge for all banks, including Highland, and regulators continue to spend a lot of time on credit evaluation issues. The bank has a dedicated underwriting staff that continually evaluates the collectability of loans outstanding. Unfortunately, some of the credit review staff recently left the bank to work for a competitor. Competition in the community banking space is tough, especially given the slow loan demand in the marketplace.

The bank has expanded its investment portfolio into a number of new types of instruments subject to fair value accounting. Management has engaged an outside valuation expert to ensure that the valuations are properly measured and reported.

Fortunately, the bank's capital position is strong and it far exceeds regulatory minimums. Capital is available to support growth goals in the bank's three-year strategic plan.

Required -

a. Describe any risks of material misstatement at the financial statement level.

b. Describe any risks of material misstatement at the assertion level.

c. Which, if any, risks would be considered a significant risk?

Q4. Describe what is meant by acceptable audit risk. Explain why each of the following statements is true:

a. A CPA firm should attempt to achieve the same audit risk for all audit clients when circumstances are similar.

b. A CPA firm should decrease acceptable audit risk for audit clients when external users rely heavily on the statements.

c. A CPA firm should decrease acceptable audit risk for audit clients when engagement risk is high.

d. Different CPA firms should attempt to achieve reasonably similar audit risks for clients with similar circumstances.

Q5. The Kowal Manufacturing Company employs about 50 production workers and has the following payroll procedures.

The factory foreman interviews applicants and on the basis of the interview either hires or rejects them. When applicants are hired, they prepare a W-4 form (Employee's Withholding Exemption Certificate) and give it to the foreman. The foreman writes the hourly rate of pay for the new employee in the comer of the W-4 form and then gives the form to a payroll clerk as robe notice that the worker has been employed. The foreman verbally advises the payroll depart mad of rate adjustments.

A supply of blank time cards is kept in a box near the time clock at the entrance to the factory. Each worker takes a time card on Monday morning, fills in his or her name, and punches the time clock upon their daily arrival and departure. At the end of the week the workers drop the time cards in a box near the door to the factory.

On Monday morning, the completed time cards are taken from the box by a payroll clerk. One of the payroll clerks then enters the payroll transactions into the computer, which records all information for the payroll journal that was calculated by the clerk and automatically updates the employees' earnings records and general ledger. Employees are automatically removed from the payroll when they fail to turn in a time card.

The payroll checks that are not directly deposited into employees' bank accounts are manually signed by the chief accountant and given to the foreman. The foreman distributes the checks to the workers in the factory and arranges for the delivery of the checks to the workers who are absent. The payroll bank account is reconciled by the chief accountant, who also prepares the various quarterly and annual payroll tax reports.

Required -

a. List the most important weaknesses in their processes and state the misstatements that are likely to result from the weakness.

b. For each weakness that increases the likelihood of fraud, identify whether the likely fraud is misappropriation of assets or fraudulent financial reporting.

Q6. This problem requires you to access PCAOB Auditing Standards to answer each of the following questions. You can access those standards by viewing content found under the link "Standards." For each answer, document the paragraph(s) in the relevant standard supporting your answer. Review PCAOB auditing standards related to the auditor's consideration of fraud in a financial statement audit, to answer questions in parts a. through d. Review PCAOB Auditing Standard No. 12, Identifying and Assessing Risk of Material Misstatement, to answer parts e. and f.

Required -

a. You have determined that there is a fraud risk related to the existence and accuracy of inventory. Review the guidance in PCAOB auditing standards to provide examples of auditor responses involving changes to the nature, timing, and extent of audit procedures related to this assessed fraud risk for inventory.

b. What do PCAOB auditing standards say about how the auditor should assess risk related to revenue recognition?

c. What examples of auditor responses to fraud risk related to revenue recognition are provided in PCAOB auditing standards?

d. What kind of documentation is required for the auditor's consideration of fraud?

e. What kinds of inquiries about fraud risks are required by PCAOB Standard No. 12?

f. How does PCAOB Standard No. 12 define "fraud risk factors"? Do all conditions have to be present for fraud risk to exist?

Q7. The following audit procedures are included in the audit program of Harris Manufacturing, Inc.

1. Use audit software to examine journal entries in the sales, cash receipts, purchases, cash disbursements, payroll and general journals for any amounts exceeding $1million and for any entries with unusual account codings. Review related supporting documentation for reasonableness.

2. Examine the estimate for the Allowance for Doubtful Accounts recorded in the prior year audited financial statements. Obtain information about receivable write offs recorded during the current fiscal year for receivables included in the prior year audited financial statements and obtain other information perform a hindsight evaluation of the reasonableness of the allowance account included in the prior year audited financial statements.

3. Continue to observe inventories at Harris two main distribution centers, but for this year examine inventories at its two smaller warehouses not examined in prior years. Management does not expect you to examine those additional warehouses.

4. During the current year, Harris has entered into a joint venture partnership with a company that serves similar customers, but makes an entirely different product than Harris. Inquire of management about the business rationale for this transaction.

5. Review for reasonableness any manual journal entries made by management to adjust the computer-generated accounting records.

Required -

a. What is the overarching purpose for performing all of these procedures?

b. How might each audit procedure in 1 through 5 help the auditor identify fraud risk?

Q8. Each year near the balance sheet date, when the president of Bargon Construction. Inc., takes a 3-week vacation to Hawaii, she signs several checks to pay major bills during the period she is absent. Jack Morgan, head bookkeeper for the company, uses this practice to his advantage. Morgan makes out a check to himself for the amount of a large vendor's invoice and because there is no acquisitions journal, he records the amount in the cash disbursements journal as an acquisition from the supplier listed on the invoice. He holds the check until several weeks into the subsequent period to make sure that the auditors do not get an opportunity to examine an electronic copy of the cancelled check. Shortly after the first of the year when the president returns. Morgan resubmits the invoice for payment and again records the check in the cash disbursements journal. At that point, he marks the invoke 'paid' and files it with all other paid invoices. Morgan has been following this practice successfully for several years and feels confident that he has developed a foolproof method.

Required -

a. What is the auditor's responsibility for discovering this type of embezzlement?

b. What weaknesses in Bargon's processes exist?

c. What evidence can the auditor use to uncover the fraud?

Q9. A growing number of organizations have been the target of hacking attacks or cyber attacks, in recent years. High-profile samples in the U.S. include Target Corp., Home Depot Inc., the Internal Revenue Service, and other government agencies such as the Office of Personnel Management. Companies and governments need to consider the risks of a cyber attack, and consider backup plans in the event a cyber attack results in a loss of hardware, software, or data. The Committee of Sponsoring Organizations of the Tread way Commission (COSO) issued a thought paper, COSO it the Cyber Age to help organizations assess and mitigate risks associated with cyber security through the existing COSO Framework. Visit the COSO Web site and refer to the "Guidance" tab. Read the thought paper to answer the following questions:

Required -

a. The COSO guidance acknowledges that "cyber risk is not something that can be avoided; instead it must be managed." Why is cyber risk unavoidable? Does this acknowledgement make it more or less difficult to address and mitigate cyber risk?

b. At the control environment level (the first of the five components of internal control), what should organizations do to address cyber risk?

c. The paper identifies five broad categories of cyber attack perpetrators and motivations. Briefly describe each group of perpetrators and their motivation.

d. What types of control activities are recommended to address cyber risks?