Question 1
A CPA is reviewing a client's internal controls over merchandise receipts and subsequent payments to suppliers. The client's controller has described the system as follows:
"A purchase order copy is sent to the receiving room when an order is placed. There, it's held in a temporary alphabetical file, by vendor. When a shipment is received and unloaded, a receiving clerk counts the merchandise, prepares a pre-numbered receiving report, attaches the receiving report to the purchase order copy, and forwards both documents to accounts payable. The accounts payable clerk compares quantities on the purchase order and receiving report, but rarely finds any differences, unless there is a partial shipment, which the receiving clerk is required to note on the receiving report. The accounts payable clerk holds these documents in an alphabetical file, by vendor, until the invoice is received. We always pay our bills within the discount period and, after payment, we file the four documents - purchase order, receiving report, invoice, and cheque copy - in our paid invoice file, alphabetically by vendor. The paid invoices are kept on file for one fiscal year, and then transferred to storage."
The CPA has determined that 1,000 invoices were paid during the year and are still in the file, and she wants to sample these invoices, using an attribute sampling plan, to test for the following types of errors:
1. Missing purchase order
2. Missing receiving report
3. Quantities on purchase order don't match the receiving report, but the shipment isn't labelled by the receiving clerk as being a "partial shipment"
The CPA plans to determine the required sample size for examining the paid invoices by setting the acceptable risk of assessing control risk too low at a value of 5%, with an expected error rate of zero, and a tolerable error rate also set at a low value of 2%.
Required
a. Explain whether or not the CPA's testing strategy is reasonable and appropriate in this situation. (4 marks)
b. Explain in detail how the CPA could select the specific paid invoices to be examined in her sample(s) so that she is able to make valid inferences about the population error rates for the three attributes described in the question. (4 marks)
c. Assume the CPA examines a sample of 150 paid invoices and finds the following possible problem situations:
1. Two invoices for merchandise - no purchase order attached
2. Twelve invoices for utilities and other normal, recurring business-related services - no purchase orders or receiving reports
3. One invoice for merchandise - no receiving report attached
4. There were no differences between purchase orders and receiving report counts, except for partial shipments.
Evaluate these sample results by determining the computed upper error (deviation) rates, and state appropriate audit conclusions for each attribute. (8 marks)
Question 2
In the audit of Price Seed Corp. for the year ended September 30 the auditor set an upper error limit of $50,000 at a Beta risk of 10 percent. A dollar unit sample of one hundred was selected from a population that had a recorded accounts receivable balance of $1,975,000. The following differences were uncovered in the confirmation:
Accounts Receivable per records Accounts receivable per
confirmation Follow-up comments by
the auditor
1. 2,728.00 $2,498.00 Pricing errors on two invoices.
2. $5,125.00 0 Customer mailed cheque 9/26; company received cheque 10/3.
3. $3,890.00 $1,190.00 Merchandise returned 9/30 and counted in inventory; credit was issued 10/6.
4. $ 791.00 $ 815.00 Footing error on an invoice.
5. $ 548.00 $1,037.00 Goods were shipped 9/28; sale was recorded on 10/6
6. $3,115.00 $3,190.00 Pricing error on a credit memorandum.
7. $1,540.00 0 Goods were shipped on 9/29; customer received goods 10/3; sale was recorded on 9/30.
Required:
a) Calculate the upper and lower error bounds on the basis of the client errors in the sample. (14 marks)
b) Is the population acceptable as stated? (1 mark)
c) If not, what options are available to the auditor at this point? (3 marks)