Increases acceptable audit risk 3 the companys stock

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Unformatted text preview: everal accounting estimates that are based on management assumptions. Increases Inherent risk 8. The company has struggled in tracking property, plant & equipment. Increases Control risk 9. Henderson acquired a regional electric company. Increases Inherent risk 10. The audit engagement staff have experience in auditing energy and public companies. Decreases Planned detection risk 11. Partner review of key accounts will be extensive. Decreases Planned detection risk. 9-36 Computer prepared Excel worksheets (P936a.xls and P936b.xls) are contained on the Companion Website. a. See Worksheet 9-36A on pages 9-19 and 9-20. It is important to recognize that there is no one solution to this requirement. The determination of materiality and allocation to the accounts is always arbitrary. In this illustration, the auditor makes estimated adjustments for problems noted by analytical procedures. This is an important step as the potential adjustments reduce income before taxes, and thus materiality. The illustrated solution recognizes that with downward adjustments, actual income may be much closer to the contractual amount required for an additional contribution to the employee's pension plan. This creates a sensitivity that will need to be watched carefully as the audit progresses. The allocation to the accounts is particularly arbitrary. It is noteworthy that the sum of allocated amounts equals 1.5 times materiality. It is assumed that this is consistent with the audit firm's internal policies. b. The level of acceptable audit risk is based on an evaluation of three factors: 1. 2. 3. The degree to which external users rely on the statements. The likelihood that the client will have financial difficulties after the audit report is issued. The auditor's evaluation of management's integrity. 9-68 9-36 (continued) Stanton Enterprise is a public company and therefore has a high degree of reliance by external users on its financial statements. The Company's operating results and financial condition indicate that there is very little likelihood of financial difficulty in the immediate future. With regard to management's integrity, although there has been some concern with Leonard Stanton's past bankruptcy, the carefully monitored relationship has been good for the four years Stanton has been a client. On that basis, it appears management integrity is good. Overall, then, an acceptable audit risk level of medium would seem appropriate. c. See Worksheet 9-36B on pages 9-21 and 9-22 that shows both horizontal and vertical analysis of the 2008 audited and the 2009 unaudited financial statements, as well as computation of applicable ratios. Following are the key observations to be made: Overall Results Stanton Enterprises apparently had an extremely successful year in 2009. Sales increased by 36.4 percent, gross margin increased by 4 absolute percentage points, and income before taxes increased by 138.5 percent. Return on total assets and return on equity increased and are at admirable levels. These results allowed the Company to increase its dividends by 25 percent (recognizing that more shares were outstanding) and total stockholder's equity by 101.9 percent. Furthermore, the Company's current, quick, cash and times interest earned ratios are up, and its debt to equity ratio is down, indicating that the Company is extremely sound from a liquidity standpoint. Trade Accounts Receivable In the face of such growth, trade accounts receivable increased by 59.3 percent, and at the same time, accounts receivable turnover slowed and days to collect increased somewhat. However, the allowance for uncollectible accounts was only .3 percent of gross receivables at the end of 2009, down from 1.0 percent at the end of 2008. This implies that the allowance may be significantly understated for 2009 and must be looked at very carefully during the current audit. This review would include considering whether a liberalization of credit policies was used to help increase sales. Property, Plant and Equipment The Company made a significant additional investment in property, plant and equipment, increasing them by 30.5 percent. These new assets will need to be verified during the current audit. It is noteworthy that accumulated depreciation 9-69 9-70 9-36 (continued) increased by only 16.1 percent. This could indicate that depreciation on the new assets was not recorded, but may not, depending on dates of acquisition and depreciation method used. Depreciation must be tested considering these facts as determined. Goodwill Goodwill also increased significantly, by $855,000. This implies that the Company made an acquisition during the year. This could explain the increase in operating assets, and any such transaction must be examined in detail as part of the audit. Also, the goodwill from prior transactions must be considered during each audit as to its amortization and recoverability. Accounts Payable Accounts payable went down from 2008 to 2009. This do...
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This note was uploaded on 02/04/2014 for the course ACCOUNTING 211 taught by Professor Alikapur during the Fall '13 term at American University of Sharjah.

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