Questions -

Q1) Joe Zebrowski was an internal auditor for a retail drug chain. He detected a computer programmer who worked on the firm's accounts payable system stealing from the firm. The programmer had miss-programmed the portion of the program to truncate all cash discounts instead of rounding them. That is, when the firm paid a bill within the vendor's cash discount period, the program calculated the amount of the discount and then deducted that amount from the amount of the check written to the vendor. These calculations rarely came out to an even penny and the program should have rounded any amount for a half a penny up to the next highest penny and dropped any amounts less than a half a penny from the discount amount to round down to the next lowest penny. Instead, the programmer programmed the system to always drop any partial penny from the amount and always lower the discount amount to lower full penny.

Instead of being discarded, the programmer also had the program put them is a secret storage location and let them accumulate. Once the amounts in the secret location reached a certain level, the programmer would have the program write him an expense reimbursement check for the accumulated amounts. He was able to access the program to write himself a check because when he developed the program, he left a secret back door into the program that bypass the account/password access control of the program. Programmers worked in the home office and rarely had any reason to travel or incur significant reimbursable expenses.

a) Describe two internal control(s) that should have prevented this fraud and how each control should have worked. Also discuss how the programmer might have been able to circumvent the control even if it were in place and working properly. You answer needs to be specific to the case. For example, if you believe segregation of duties should have prevented the theft, you need to describe the segregation of specific duties and how segregating those specific duties should have prevented the fraud.

i) Control #1 -

ii) Control #2 -

b) Describe an audit test that the internal audit department might have used to detect the fraud and explain how it would have detected the fraud.

Q2) Stephanie is auditing a major consumer products manufacturer. She is building her audit plan and trying to determine her approach to auditing their ending inventory balance as well as the long-term debt balance. Their inventory consists of a large number of items that are similar in value. For a variety of reasons, she has assessed the inherent risk of the inventory account as moderate to high. Her assessment of the design of internal controls over inventory recording and valuation is that these controls are well designed and haven't changed since she audited them last year and found they were working properly. However, she has not retested the controls yet for this year.

Stephanie's auditee only has three major bond issues that make up the long-term debt account balance. Each bond issue contains complex provisions like conversion features and debt covenants. The three bonds differ in size and one of them alone makes up 50% of the total balance.

The following questions cover all possible alternatives for testing the inventory and long-term debt balances and I have asked you to makes assumptions in them. Some of these assumptions may be extreme and I realize that. I just want you to apply the basic principles for testing to each question even if the assumptions involved are extreme.

a) Should Stephanie use a sampling technique to test their inventory balance? Why or why not?

b) Assuming she decided to sample the inventory, should she use statistical or non-statistical sampling? Explain your answer.

c) Assuming she decided to use statistical sampling to test the inventory, should she use Monetary Unit Sampling or Variables Sampling?. Explain your answer.

d) Should she use a sampling technique to test their long-term balance? Why or why not?

e) Assuming she decided to sample the long-term debt account, should she use statistical or non-statistical sampling? Explain your answer.

f) Assuming she decided to use statistical sampling for the long-term debt account, would she use Monetary Unit Sampling or Variables Sampling? Explain your answers.

Q3) Jake Jones is auditing an ending inventory balance. He obtained a complete listing of every item that made up the ending inventory balance from the auditee's subsidiary inventory ledger. The listing included the number of items is inventory, the cost per unit assigned to each item, and the extended cost (cost times quantity). At the same time that the auditee took its physical count of the items in ending inventory, he selected a sample of items from the listing and performed his own count of the number of that item in ending inventory. He then compared his count to the auditee's count and noted any differences in his working papers.

Then he obtained he used the costs in the listing and verified those cost to purchase invoices from the vendors. Finally, he multiplied the number in his count by the invoice costs and compared the resulting amount to a listing that the client had provided that included their totals for each item. He traced the total of their listing to their general ledger account.

a) For each of the following tests he performed, describe the purpose of the test to include all the audit objective(s) involved. Be sure to explain how the test supports each objective.

i) Counting the items in inventory

ii) Verifying the costs per item

iii) Tracing the total to the general ledger

b) When Jake ran his inventory tests as described above using a statistical sampling technique, he found differences in the inventory recorded cost that totaled to more than your tolerable misstatement. Discuss what alternatives he has to address this difference and how each alternative might compensate for or correct the sample results he found.

i) Alternative 1

ii) Alternative 2

iii) Alternative 3

iv) Alternative 4

c) Discuss which how Jake should order these alternatives and why. That is, which alternative should he try first, second, third, and fourth and why?

Q4) The following is a list of misstatements that might be found in a year-end account balance. For each:

• state the audit objective(s) that was violated because of the error and why;
• describe one control activity that might have detected or prevented the misstatement;
• and describe a test of balance audit procedure that auditors might use to find it.

Make sure you answers are sufficiently detailed to be clear about how the error violated the audit objective and how each internal control or testing procedure would detect the error. Assume in all cases that the auditee's controller prepares regular bank reconditions.

a) An accounting clerk omitted a check from the outstanding checklist on the year-end bank reconciliation. The check cleared a week after year-end.

i) Audit objective(s) violated -

ii) Internal control -

iii) Test of balance -

b) The auditee's bank credited the auditee's bank account four days before year-end with cash received from a loan the auditee had secured. However, the loan was not shown as outstanding on the year-end financial statements and the cash proceeds from the loan were not included firm's ending cash balance.

i) Audit Objective(s) violated -

ii) Internal control -

iii) Test of balance -

c) The auditee had factored without recourse a little over 50% of their ending accounts year-end accounts receivable balance. "Factoring" is when a firm sells its accounts receivable to another firm, usually a financial institution. "Without recourse" means that the purchasing firm cannot return the receivables to the selling firm if they can't collect them. Thus, full title to the receivables has passed to the purchasing firm. However, these accounts still showed in the auditee's ending accounts receivable balance. Note that auditee does not notify the customer who owed the account to the auditee that their account has been factored and the selling firm merely forwards receipts on factored accounts to the purchasing company.

i) Audit Objective(s) violated -

ii) Internal control -

iii) Test of balance -

d) The auditee's ending accounts payable balance excluded a significant number of amounts due vendors that created a materially understated in accounts payable.

i) Audit Objective(s) violated -

ii) Internal control -

iii) Test of balance -

Q5) Your audit of AJAX, Inc., a public company registered with the SEC, followed the following timeline of events. Assume that all events are material to the financial statements taken as a whole.

• AJAX's fiscal year ended 12/31/2013.
• Event 1 - On 1/15/14 AJAX's management informed you that a major competitor had just introduced a new product that made a substantial portion of their inventory obsolete and only resalable for a fraction of the cost shown on the balance sheet as of 12/31/13.
• Event 2 - On 2/25/14 AJAX sold the line of business that produced that obsolete inventory items to another firm. The sale represented approximately 25% of AJAX's product line.
• You completed your fieldwork and dated you audit report as of 3/1/14.
• AJAX distributed their financial statements and your report on 3/15/14.
• Event 3 - On 4/1/14 AJAX's internal audit department contacted you to tell you that they had discovered massive fraud that their CFO had perpetrated during 2013 that led to a material overstatement of the firm's accounts receivable and sales as of 12/31/2013. These errors were clearly material to the financial statements taken as a whole.

Describe what actions you would need to take, if any, based on each of the three labeled events. Be complete and describe any changes you would require in AJAX's financial statements for 2013, your audit report for 2013, and any additional actions, if any, required by GAAS. Also, justify your selections by stating why you would take them based on the type of each event.

a) Event 1 -

b) Event 2 -

c) Event 3 -

Q6) One of the final audit procedures for any audit is to obtain letters from the auditee's attorneys.

a) Why do auditors require attorney's letters? What potential financial reporting issue are they testing?

b) Who requests the letters from the attorney and why?

c) Why might attorneys resist providing the information needed by the auditor?