MODAUD2 Unit 9 Audit Completion T31516
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UNIT 9 COMPLETING THE AUDIT Estimated Time: 1.5 HOURS Discussion Questions 9-1: Match each statement or description (1-5) with the term (A-F) to which it is most likely related. A. Interim audit work B. Management representations C. Second-partner review D. Attorney letters E. Communication with individuals charged with governance F. Management letter ___ 1. Audit documentation and financial statements, including footnotes, are given a final review on large engagements. ___ 2. Based on the facts, known to us, after a full investigation, it is our opinion that no liability will be established against this entity. ___ 3. Audit procedures performed several weeks or months before the balance sheet date. ___ 4. There have been no irregularities involving management or employees who have significant roles in the client's internal control. ___ 5. We discussed the following recommendation for streamlining the receiving department document flow with Ms. Phyllis Cook, receiving department supervisor. ___ 6. Includes statements regarding auditors' judgment of the quality of the client's accounting principles. * Note: Each term is associated with only one statement. Discussion Questions 9-2: Multiple Choice – Case type (choose the best answer) Michael Ewing is auditing the financial statements of Dallas Company for the year ended December 31, 2008. In concluding the process of gathering sufficient appropriate evidence, Michael has asked to meet with his supervisor on the audit (John Ross) to discuss responsibility for events occurring after the balance sheet date. (1) Which of the following statements is not correct: a. A subsequent event is an event or transaction that occurs after the balance sheet date but prior to the audit report release date (and the issuance of the entity’s financial statements). b. Michael’s responsibility for subsequent events depends upon when he learns of these events. If he learns of a subsequent event prior to the audit report release date, he is responsible for these events until the audit report release date. If he learns of these events following the audit report release date, his responsibility is limited to the audit completion date. c. Type I subsequent events provide new information about a condition that existed at the balance sheet date that requires adjustment of amounts included in the financial statements. d. Type II subsequent events involve occurrences that had both their cause and manifestation after the balance sheet date. These events should be disclosed in the financial statements (FS) and, for particularly significant subsequent events, pro forma FS should be prepared (these statements present the entire FS “as if” the event had occurred on the balance sheet date). e. Type II subsequent events should only be disclosed in the financial statements and pro forma FS are never prepared. Auditing Practice II Workbook
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(2) The following procedures can assist Michael in identifying subsequent events, except: a. Reading the latest interim financial statements and comparing them with the financial statements being reported upon. b. Inquiring of officers and other executives having responsibility for financial and reporting matters about contingent liabilities or commitments; significant changes in capital stock, long-term debt, or working capital since the balance sheet date; and unusual adjustments since the last balance sheet date. c. Reading minutes of meetings of shareholders, directors, and appropriate committees. d. Obtaining an attorney letter from any legal counsel engaged by the client and obtaining management representations. e. None of the above. (3) Assume that on Jan 8, 2009, Dallas Co. agreed to acquire Houston, Inc. in a significant transaction. Michael’s audit completion date was Feb 7, 2009, and Dallas issued their financial statements (and Michael’s reports on its financial statements and internal control over financial reporting) on Feb 14, 2009. Which of the following statements is not correct? a. If Michael became aware of the SE on Jan 10, 2009, he could evaluate the disclosure of this event without additional considerations, since he became aware of the transaction prior to the audit completion date. b. If on March 2, 2009, Dallas Co. announced that it will also acquire San Antonio Co., Michael needs to disclose the acquisition in the 2008 audit. c. If Michael became aware of the SE on Feb. 10, 2009, he could evaluate the disclosure of this event, since his reports (and the FS) have not been issued. However, since he became aware of the SE following the audit completion date, he would ordinarily dual date the auditors’ report to limit his responsibility beyond the audit completion date to the disclosure related to the SE. d. If Michael became aware of the SE on Feb. 20, 2009, he should request that Dallas Co’s management to disclose the facts and their impact on the FS to persons relying on the FS if the following conditions exist: (a) the facts are reliable and existed at the report date; (2) the facts affect the FS and auditors’ reports; and, (c) persons are continuing to rely on the FS and auditors’ reports. e. If on March 2, 2009, Dallas Co. announced that it will also acquire San Antonio Co., Michael has no responsibility with respect to this acquisition in the 2008 audit. Case Study Case 1 Paul and John, CPAs, have completed the field work for the SARS Deli audit, and are considering the impact on SARS Deli’s audited financial statements of certain events occurring between the balance sheet, December 31, 2015, and the date of field work completion, February 12, 2016. SARS Deli’s audited net income for 2015 was P19.8 million. The following occurrences are the subject of consideration. 1. On Jan. 22, 2016, SARS Deli settled a lawsuit filed by a consumer who was made ill by SARS Deli salami bar that somehow had been tainted. The customer consumed the salami in 2015 and brought legal action in June of that year. The original lawsuit asked for medical reimbursement and damages totaling P23 million. The January settlement was for P1.46 million. Auditing Practice II Workbook
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2. On Nov. 20, 2015, JOLLY’s Party Store, a SARS Deli competitor, sued SARS Deli for alleged patent infringement. The infringement relates to a meat storage process, patented by JOLLY’s, for longer and safer storage of meats and other refrigerated products. SARS Deli’s defense is that although their process also provides for longer storage it differs markedly from JOLLY’s process. On Jan. 22, 2016, a judge awarded the plaintiffs P5.5 million in damages. SARS Deli’s outside legal counsel, in a letter to the auditors, stated their intent to appeal the decision and believe the defendant will ultimately prevail. 3. On Jan. 30, 2016, SARS Deli was forced to recall assorted beefstick and cheese boxes produced by its Luzon factory and sold in 2015 to wholesale distributors and retail outlets on East Mindanao. Although the products posed no health hazard, these had been inadvertently processed without salt. The products subject to recall had cost SARS Deli P5.0 million and sold for P7.0 million. The meats and cheeses had no residual value and were discarded upon return to Luzon. 4. On Feb. 5, 2016, SARS Deli acquired MCDY Meats Limited, a Singapore meat processor. The transaction was completed by exchanging SARS Deli stock and cash for MCDY stock and was accounted for as purchase. 5. Although in previous years the auditors had never considered the need for a year-end allowance for adjustment for future sales returns and allowances, they are seriously considering one for 2015. Their concern arises from the abnormal incidence of price adjustments occurring in Jan. 2016 and related to Dec. 2015 sales. An examination of January credit memos issued to customers revealed total adjustments of P977,000 relating to December sales. 6. An examination of the Jan. 2016 Board of Directors’ meeting minutes disclosed approval of a bonus equal to 12% of audited net income after bonus. Required: a. Assuming the auditors have set the individual item materiality threshold at 5% of audited net income, classify each of the mentioned subsequent events by writing Type I as adjusting and Type II as non-adjusting. b. For Type I events, draft the necessary audit adjustments. Case 2 Carebears Industries manufactures and sells food products and food processing machinery. While preparing the December 31, 2015 financial statements for Carebears, the following information was discovered relating to contingencies and possible adjustments to liabilities. Carebears’ 2015 financial statements were issued on April 1, 2016. 1. On Nov. 12, 2015, a former employee filed a lawsuit against Carebears’ alleging age discrimination and asking for damages of P950,000. At Dec. 31, 2015, Carebears’ attorney indicated that the likelihood of losing the lawsuit was possible but not probable. On March 5, 2016, Carebears agreed to pay the former employee P225,000 in return for withdrawing the lawsuit.
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2. After a tax audit of the 2015 return, the BIR has questioned some expenses paid to a major stockholder. At April 2016, the BIR has not yet made an assessment of additional taxes, but Carebears feels it will. Carebears’ accountants and legal counsel believe the deductions were appropriate but that if an assessment is made, there is a reasonable possibility that subsequent court action would result in an additional tax liability of P85,000. 3. Carebears grants a one-year warranty for each processing machine sold. Past experience indicates that the costs of satisfying warranties are approximately 2% of sales. During 2015, sales of processing machines totaled P19,400,000. 2015 expenditures for warranty repair costs were P198,000 related to 2015 sales and P210,000 related to 2016 sales. The Jan. 1, 2015 balance of the warranty liability account was P280,000. 4. Carebears is the plaintiff in a P600,000 lawsuit filed in 2015 against Bulacan farms for failing to deliver on contracts for produce. The suit is in final appeal. Legal counsel advises that it is probable that Carebears will prevail and will be awarded P300,000. 5. Included with certain food items sold in 2015 were coupons redeemable for a kitchen appliance at the rate of five coupons per appliance. During 2016, 30,000 coupons were issued and 5,000 coupons were redeemed. Although this is the first promotion in years, past experience indicates that 70% of the coupons are never redeemed. An inventory of kitchen appliances is maintained, and a count shows that 1,000 are on hand at December 31, 2015, with a normal retail value of P20,000 and a cost to Carebears of P8,500. Required: a. Determine the appropriate means of reporting each situation by writing AL if the company needs to make possible adjustments to liability account, CL if the company needs to disclose a contingent liability and CA if the company needs to disclose a contingent assets. b. For your AL answers, draft the necessary audit adjustments.
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