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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
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
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.
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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.
- Fall '13