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Assignment1 - 3 2 Assignment#1 — SOLUTION ASSIGNMENT#1...

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Unformatted text preview: 3 - 2 Assignment #1 — SOLUTION ASSIGNMENT #1 — TEST OF TRANSACTIONS, PURCHASES AND CASH DISBURSEMENTS COMMENTS To THE INSTRUCTOR This is the final assignment of the series of assignments evaluating Internal Control. The students can review last year’s workpapers to obtain assistance on how to do the assignment. The assignment requires the student to determine control effectiveness for purchases and cash disbursement by assertion. This is done by the performance of dual purpose tests of transactions for purchases and the assumption that the audit for cash disbursements was performed with no exceptions. The assignment includes the performance of Tests of Controls for approvals and various document checks. Control exceptions include lack of approvals or lack of documentation. The student will have to make normal decisions about whether the specific missing document or missing approval is an exception or part of normal processing. The assignment includes the performance of Substantive Tests for existence, completeness, accuracy, timing, classification and posting and summarization. Substantive exceptions are for existence and classification. The student is required to record the audit work performed in a typical workpaper form and document exceptions on a separate workpaper. He-she is required to give some thought as to whether the documentation on a particular voucher results in an error or is a reasonable application of the clients policy. The student is to summarize the results of the work, determine quantitative totals and arrive at decisions about the amount of risk to be placed on Internal Control. The decisions combine both QUANTITATIVE and QUALITATIVE factors. The case is designed so that there is no clear cut decision concerning Control Risk. NOTE: Be sure the student has a copy of a Purchases Flowchart before attempting this assignment. If preparation of the flowchart was not assigned to the students in the Preliminary Assignment, you may wish to distribute the copy in the Instructor’s Manual. In order to keep the work load to a minimum, the assignment is limited to Purchases. As noted above, audit procedures for Cash Disbursements are assumed to be performed with no exceptions and shown on workpaper T - 4. Be sure the students include the results of Cash Disbursements procedures in their evaluation. An adjusting entry, Voucher 10-04 described below, normally resulting from this assignment is the following: (1) 330 Printing Equipment 18,760 811 Newsprint consumed 18,760 To capitalize freight on new printing equipment, per T-2 7v .g Assignment #1 —~ SOLUTION 3 - 3 Vouchers requiring attention. Voucher 10-04, Illinois Eastern Transport, creates several interesting control considerations for the student. 0 There is an accounting error of $18,760 resulting from the incorrect classification of the freight as a part of the Newsprint Inventory instead of Printing Equipment. This should be discovered in reading the description of the item on the voucher data. The name and location of the vendor provide additional evidence, since the name and location are not the usual newsprint freight carriers. 0 The student should raise the question as to whether this error is an isolated event or a systematic condition. A practical additional audit procedure would be to scan the Voucher Register for freight and newsprint items. This procedure would confirm that this is an isolated event with regard to freight and newsprint. If performed this procedure should be noted in the workpapers and the memo. At this point you may wish to discuss the issue of performing additional audit procedures and under whose authority this is done. 0 Many students process this as an Equipment voucher instead of Inventory and indicate the requirement of approval by the Board of Directors. However, for purposes of control risk evaluation, the client considered this an inventory voucher and processed it accordingly. There fore it was not required that the voucher be approved by the Board of Directors. This voucher gives you an excellent opportunity to discuss the issue of “what determines a control violation.” 0 Another common mistake made by students is to show an exception for “trace to the voucher register” for Voucher 10-04. This gives you an opportunity to discuss the distinction between a classification error and an error in posting. 0 For the adjusting entry many students will credit Acct 131, Inventory, instead of Acct 81 l, Newsprint and Ink. They forget that the inventory would have been adjusted for the physical count. Remind the students that they should read Assignment #4, paragraph 2 which explains the accounting for Inventory. Voucher 9-32, K-mart is a small posting error for $66 and should be discovered. Some students will propose an adjusting entry for this error. This was not adjusted in the solution because it is clearly immaterial. This item offers an opportunity to discuss the difference in audit judgments between financial statement materiality and control risk evaluations. Vouchers 3-17 and 6—30. These two approval errors should be discovered. See comments on Workpapers T-2 and T-3 for discussion and evaluation of these items. Voucher 4-19 for payment to Baynes and Grey, the auditors, may present some problems to the students. The Board of Directors approved Baynes and Grey as auditors without specifying an amount approved or the extent of services. Since Voucher 4-19 is for tax return preparation, many students consider this voucher an exception. The ambiguity in the minutes is presented to; l) have some realism {these things happen}, and 2) to challenge the students to think through the purpose of the control procedure and evaluate whether the purpose has been achieved. SEE also explanation on workpaper T-2. The students should raise the question, “In this case, is the Board of Directors exercising efiE'ctive control over expenditures? ” In other words, does the fact that the Board of Directors minutes fail to specify a dollar amount for the audit or include tax return preparation increase the risk of a material error in the financial statements? The author’s solution reflects no increase in risk. However an alternative opinion is not unreasonable. H ,M 3 - 4 Assignment #1 — SOLUTION Voucher 12-33 to National Newsprint for $10,480 is a timing or cut-off error. This error is not related to the purpose of the tests, but should be discovered and documented. It has been put on the face of the worksheet to emphasize this point. Note that in the evaluation column on the schedule of exceptions, “NotApplicable ” has been assigned instead of “Exception ” or ”No exception” per the instructions to the students. This voucher offers the opportunity to indicate that auditors should be alert and respond to all items discovered, regardless of whether or not the item falls within the specific objectives of the audit procedure. Students may propose an adjusting entry. The $10,480 is adjusted in Assignment #4, Inventory in the solution. The adjusting would be as follows: 421 Vouchers Payable 10,480 131 Inventory 10,480 To remove 20x3 newsprint purchase, per C—l Conclusions. Students may evaluate vouchers differently or come up with different sample sizes resulting in error rates different from the solution. The students’ evaluations will afi‘ect their decision concerning assessment of control risk. Based exclusively upon the number of errors or exceptions in the author’s solution, assessment of control risk at less than the maximum for validity would be incorrect. SEE discussion below under Audit Sampling for conclusions about specific error rates. A qualitative analysis of the functioning of the controls, exceptions and- or additional testing provides a reasonable basis for assessment at less than the maximum. The authors believe that there is justification to assess control risk at less than the maximum for all assertions tested and has prepared the solution on that basis. As a result of this judgment, some substantive tests of detail have been omitted fi'om later assignments. Specifically omitted are detail testing of certain operating accounts and any additional tests of purchases in the assignment covering newsprint inventory. Many students may come to the very logical conclusion that control risk should be assessed at the maximum. This assignment offers an opportunity to discuss the factors in arriving at an internal control decision. A lively discussion of the issues may ensue. Emphasis should be placed upon writing an effective memo to express the findings and conclusions concerning the assessment of Control Risk. A sample memo has been included in the case. Audit Sampling. This assignment offers an excellent opportunity to use audit sampling. A suggested percentage for Tolerable Rate is given in the case. However, modify the rate in any manner that is consistent with your teaching objectives. With a sample of 30, one error gives an error rate of 33%, well below the suggested Tolerable Rate (TR) of 7%. There is ample margin for sampling error and acceptance of the control as functioning effectively is justified. Two errors give an error rate of 6.7%, slightly below TR of 7%. With this error rate there is little margin for sampling error. There fore, the decision on a purely quantitative basis should be non-acceptance. Unless the students are well schooled in audit sampling or are given some help, they are likely to arrive at the wrong conclusion. The assignment is based upon non-statistical audit sampling. It is not based upon statistical sampling. The case would not be diffith to modify to perform statistical sampling, using attributes sampling. Random selection could be assumed for sample selection. Alternatively, random selection could be used to select a different sample or sample size than the sample given on Schedule T-l. Assignment#1 — SOLUTION 3 - 5 TIMemo VALLEY PUBLISHING COMPANY 12-31-20x2 TEST OF CONTROLS RELEVANT TO PURCHASES AND CASH DISBURSEMENTS I performed the test of purchases and cash disbursements for all assertions except completeness and cut-ofl‘. I selected 30 vouchers for audit. Such vouchers are representative of the total vouchers. I performed the audit procedures for the tests of purchases and cash disbursements transactions in accordance with the audit program and as indicated on Schedules T-l and T-4. Such audit procedures complied with Generally Accepted Auditing Standards. In addition, I reviewed the Voucher Register for all newsprint purchases for unusual or unknown vendors. ATolerable Rate (TR) of 7% was selected for all assertions tested. I believe the procedures performed provided sufficient evidence of operating effectiveness of the Internal Control to enable us to assess control risk for purchases and cash disbursements. No exceptions or unusual items were noted in the audit of cash disbursements transactions. I noted 8 purchase vouchers that required further review, of which 4 were deemed to be exceptions as noted on Schedule T—2. As noted on Schedule T-3, there were 2 existence errors and 1 error each for posting/summarization and classification which resulted in error rates of 6.7% and 3.3% respectively. After allowing for sampling error, the error rate of 3.3% was judged to be within the range of acceptability for the posting/summarization and classification assertions. The classification error is discussed further below. The error rate for approval of 6.7 % is slightly below the tolerable rate, but would be outside the range of acceptability when allowing for sampling error. Other factors to consider for this assertion: 1) Other controls in place and working effectively over existence, 2) No dollar errors discovered for the existence assertion, and, 3) Small difference between actual error rate and the tolerable error rate. Therefore, I believe we can accept the controls over existence as effective and set control risk below the maximum. The classification error was a misclassification of a freight charge of $ 1 8,760. Freight is usually for the purchase of newsprint and is normally charged to inventory. This freight charge was for the transportation of a new printing press and should have been applied to printing equipment. An adjusting entry was proposed to correct this item. As the result of this error, I extended the audit tests to determine if this was an isolated error. I scanned the Voucher Register to determine any unknown vendors for items charged to Newsprint Inventory. All other items were known vendors, including freight charges, and seemed proper. I therefore believe this was an unusual one time error and not representative of the processing of purchases and cash disbursements. I noted one timing (cut-off) error, National Newsprint for $10,480. Since these audit procedures were not designed to test cut-off, this voucher will be adjusted with Inventory, C—l. Based on my evaluation of the nature of the exceptions discovered, the compensating controls that exist, and the additional review of the voucher register, I do not believe the exceptions adversely affect control risk for all assertions tested. Therefore, based upon my understanding of the internal control and the results of the tests of effectiveness of internal control, I believe we can assess control risk at moderate for purchases, cash disbursements and related accounts, for all assertions except completeness and cut-off, in the audit of Valley Publishing Company for 20x2. R056” 37011!” I-I4-(X’3’ 3 - 6 Assignment #1 — SOLUTION VALLEY PUBLISHING COMPANY Tests of Purchases 1 2/31 /20x2 VOUCHERS | TESTS OF CONTROLS I SUBSTANTIVE TESTS VOUCHER PAYABLE | ----------------------------------------------------------- | --------------------------------------------------- NO. VENDOR #421 | A B C D E F G | H I J K L M ...................................... __ __..__-----.-.--.| _____ --_- --_-_ __ ____ ___-_ ----- I _..-.- __--_ ____. __- --_ ___.._ 1-05 National Newsprint Corporation (30,900) ~ ~ ~ NA ~ ~ ~ ~ ~ ~ ~ I | 2-09 Illinois Bell Telephone (2,169) NA ~ ~ NA ~ ~ ~ ~ ~ ~ ~ I | 2-14 Springfield Press Equipment (6,300) NA ~ ~ NA ~ ~ ~ ~ ~ ~ ~ | | 2-28 Janitor Supply Service (686) NA ~ ~ NA ~ ~ ~ ~ ~ ~ ~ | I 3-14 Olson Scruge (1,080) NA ~ ~ NA ~ ~ ~ ~ ~ ~ ~ | | 3-15 Midwest Gas Company (9,536) NA ~ ~ NA ~ ~ ~ ~ ~ ~ ~ I | 3-17 National Newsprint Corporation (30,960) X #1 X #1 ~ NA ~ X #1 ~ ~ ~ ~ ~ | | 3—22 Gilford Bostrow (3,800) NA ~ X #2 NA X #2 X #2 ~ X #2 ~ ~ ~ I | 4-18 City Utility Service Company (9,727) NA ~ ~ NA ~ ~ ~ ~ ~ ~ ~ | | 4-19 Baynes and Grey (8,750) NA ~ ~ X #3 ~ ~ ~ ~ ~ ~ ~ I | 5-18 WCCI (3,139) NA ~ ~ NA ~ ~ ~ ~ ~ ~ ~ I | 5—20 Tribune News Service (6,791) NA ~ ~ NA ~ ~ ~ ~ ~ ~ ~ | | 5-30 Pancho Gonzales (1,229) NA ~ ~ NA ~ ~ ~ ~ ~ ~ ~ | | 5-31 Handi Dan (38) NA NA ~ NA ~ ~ ~ ~ ~ ~ ~ | | 6-03 Canadian Paper, Ltd. (25,575) ~ ~ ~ NA ~ ~ ~ ~ ~ ~ ~ I | 6-11 Motor Carrier Corp. (2,805) ~ ~ ~ NA ~ ~ ~ ~ ~ ~ ~ | 6-30 Chamber of Commerce (5,500) NA ~ X #4 NA ~ ~ ~ ~ ~ ~ ~ I | 7-01 Langdon & Sons (3,240) NA ~ ~ NA ~ ~ ~ ~ ~ ~ ~ | | 7-04 National Newsprint Corporation (23,310) ~ ~ ~ NA ~ ~ ~ ~ ~ ~ ~ | | 842 Ad Supply Company (2,837) ~ ~ ~ NA ~ ~ ~ ~ ~ ~ ~ | 9-20 Center City Office Supply (84,500) ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ | 9-32 K—Mart (66) NA NA ~ NA ~ ~ ~ ~ ~ ~ X #5 | | 9-41 Funny Features, Inc (4,185) NA ~ ~ NA ~ ~ ~ ~ ~ ~ ~ I | 10-04 Illinois Eastern Transport (18,760) ~ ~ ~ NA ~ ~ ~ ~ X #6 ~ ~ I 10-31 Clay Office Repair Co (134) NA NA ~ NA ~ ~ ~ ~ ~ ~ ~ I 11-01 National Newsprint Corporation (2,260) ~ ~ ~ NA ~ ~ ~ ~ ~ ~ ~ I 11-05 Canadian Paper, Ltd. (63,045) ~ ~ ~ NA ~ ~ ~ ~ ~ ~ ~ I | 11-06 Motor Carrier Corp. (7,020) ~ ~ ~ NA ~ ~ ~ ~ ~ ~ ~ | | 11-25 Chicago Welding Co (3,640) ~ ~ ~ NA ~ ~ ~ ~ ~ ~ ~ I | 12-33 National Newsprint Corporation (10,480) ~ ~ ~ NA ~ ~ ~ X #7 ~ ~ ~ I TESTS OF CONTROLS A Purchase Requisition for purchases over $200. B Purchase Requisiton over $500 approved by Duncan. C Invoice approved by appropriate operating personnel. D Purchase of goods and services over $5,000 approved by the Board of Directors. E Vendors‘ Invoice checked for price & clerical accuracy by Ms. Henry. F Documents; requisition, purchase order, invoice, compared by Ms. Henry. G Documents cancelled by Ms. Styles. SUBSTANTIVE TESTS H Examine the voucher; determine that the documents exist & are in agreement. I Review the voucher for charge to the proper account. J Trace the voucher to the voucher register to determine that the amount is proper. K Trace the voucher to the voucher register to determine that the account is proper. L Foot and cross foot the Voucher Register on a test basis (Months of Mar, June, Sept and Dec - no exceptions noted) M Trace the totals to the General Ledger on a test basis (Months of Mar, June, Sept and Dec - no exceptions noted) ___—___—_____—___.—.____—_.—__—————-———-——-—— ~ Audit procedures performed, no exception noted. NA Control or Audit Procedure, NOT APPLICABLE. X # Item noted. SEE T-2 for Explanation. Assignment #1 —— SOLUTION VOUCHER ——_—__—_.———_——_ 3-22 4—19 6-30 9—32 1 0-04 12-33 'nmUOWZD I [*1 V E N D O R National Newsprint Corp. Gilford Bostrow Baynes & Grey Chamber of Commerce K-Mart Illinois Eastern Transport National Newsprint Corp. TESTS OF CONTROLS VALLEY PUBLISHING COMPANY AUDIT TEST AMOUNT A,B #1 (30,960) F c #2 (3,800) E,F,H D #3 (8,750) c #4 (5,500) K #5 (66) I #6 (18,760) H #7 (10,480) Purchase Requisition for purchases over $200 Purchase Requisiton over $500 approved by Duncan. Invoice approved by appropriate operating personnel. Purchase of goods and services over $5,000 approved by the Board of Directors. Vendors' Invoice checked for price & clerical accuracy by Ms. Henry. Documents; requisition, purchase order, invoice, compared by Ms. Henry. SUBSTANTIVE TESTS Tests of Purchases 12/31/20x2 ITEMS NOTED FROM SCHEDULE T-1 No purchase requisition or approval by Duncan in advance. No explanation. Item appears to be a genuine purchase. Duncan approved the item at the time of payment. [Existence] No invoice. Per verbal agreement. Authority from the Board of Directors and approved by Duncan. Item appears appropriate. No invoice or documents to check. Tax Service not explicitly approved by Bd of Dir. However, from past history, it is apparent that with the approval of "the auditors," the Bd intended to give approval to both Audit & Tax services. The invoice was not approved in advance. Henry was satisfied it was appropriate. Duncan approved the item at the time of payment. [ Existence] This charge is posted to Newspaper Services, #832, in error. This is a posting error. [Accuracy, posting & summarization] Freight charged to incorrect account. Should be Printing Equipment, #330. I reviewed all other newsprint purchases in the Voucher Register, and noted no vendors other than regular suppliers of paper. [Classification] Not an error for an assertion tested, but noted. This is a timing (cutoff) error. Received in 1/x3. This should be a 20x3 expense. Examine the voucher; determine that the documents exists and are in agreement. Review the voucher for charge to the proper account. Trace the voucher to the voucher register to determine that the account is proper. All items are classified as EXCEPTION or NO EXCEPTION for evaluating Control Risk. Other comment as appropriate. EVALUATION [*] SUMMARY EXCEPTION No validity problem. NO EXCEPTION NO EXCEPTION EXCEPTION No validity problem. EXCEPTION No adjustment proposed. EXCEPTION See memo. Audit procedure to satisfy that this is a single exception. AJE #1 proposed. SEE T-3. NOT APPLICABLE See Inventory, 0-1, for adjustment. 3 — 8 Assignment #1 — SOLUTION VALLEY PUBLISHING COMPANY Tests of Purchases 12/31/20x2 SUMMARY OF EXCEPTIONS FROM T-2 SUMMARY OF EXCEPTIONS TOTAL ERRORS Existence 30 2 Posting & summarization 1 Classification ( 1 ) 330 Printing Equipment 18,760 811 Newsprint Consumed 18,760 To capitalize freight on new printing equipment per...
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