This could indicate that depreciation on the new

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Unformatted text preview: esn't seem reasonable at all given an increase in business activity. It is very possible there are unrecorded liabilities at the end of 2009, and this must be an area of major emphasis during the audit. Bank Loan Payable It seems somewhat strange for the Company to have an outstanding balance on its bank loan payable at the end of 2009 given its excellent operating results. It is possible this was the result of an acquisition, or they simply haven't paid it off. In any case, verifying this balance is a relatively easy audit procedure. Federal Income Taxes Payable and Income Tax Expense The Company's effective tax rate for 2006 was 34 percent. Income tax expense is only 22.5 percent of income before taxes. Federal income taxes payable on the balance sheet is significantly lower at 12-31-09 than would be expected based on 2008. These both indicate that the Company has not made its final tax accrual for 2008, and this area will require careful attention during the audit. Common Stock Common stock increased by 25 percent. It is possible that this occurred in connection with an acquisition (see Goodwill), or in some other way. The issuance of new shares and surrounding circumstances will need to be understood and examined. Sales Whenever there is a drastic increase in business activity, there is an increased risk of problems. It is possible that controls will lapse or not be carefully observed. It is possible that transactions will not be carefully accounted for. Therefore, in a situation such as Stanton's it is important to understand the nature of the changes that took place and to do a careful review of controls. It will be especially important to thoroughly test cutoffs if both sales and purchase transactions. 9-71 9-36 (continued) Cost of Goods Sold and Gross Profit Consistent with the comments under sales, the auditors must determine why the gross profit percent has made such a significant improvement. Tests of costs and inventories will be more extensive than in more stable circumstances. Pension Cost It appears that the Company exceeded the contractual amount for additional pension contribution. Yet, pension cost is a lesser percent of sales in 2009 than in 2008. This may indicate that an accrual for additional pension cost was not made. As pension cost is a complex and important area, it will be verified in detail during the audit. d. ACCEPTABLE AUDIT RISK INHERENT RISK ANALYTICAL PROCEDURES Detail tie-in Medium Medium See Note 5 Existence Medium Medium See Note 5 Completeness Medium Medium See Note 5 Accuracy Medium Medium See Note 5 Classification Medium Medium See Note 5 Cutoff Medium High High Realizable value Medium High High Rights Medium Medium See Note 5 Tolerable misstatement: Trade accounts receivable Allowance for uncollectible accounts Total $80,000 15,000 $95,000 RATIONALE 1. 2. Acceptable audit risk is medium for the engagement, therefore, it is medium for accounts receivable and all of its related objectives. Inherent risk for the engagement would be considered medium for the following reasons: 9-72 9-36 (continued) a. b. c. 3. 4. 5. Stanton's background problems. Stanton's autocratic management style. Some indication of deficiencies in the control environment, particularly rejection of recommendation to establish an internal audit function. Inherent risk for cutoff is considered high due to the Company's rapid growth in 2009 and the general frequency of cutoff errors. Inherent risk for realizable value is considered high because of the Company's rapid growth and the amount of judgment involved in establishing the allowance for uncollectible accounts. The analytical procedures performed are preliminary only, and don't provide substantive evidence. However, they can indicate areas where possible problems exist. In other words, they can't lower risk, but can increase it. In this case, they corroborate the high inherent risk level specified for cutoff and realizable value. Stanton Enterprises Worksheet 9-36A Determination of Materiality and Allocation to the Accounts 12/31/2009 DETERMINATION OF MATERIALITY: Income before taxes Possible adjustments - estimated. See Worksheet 9-36b: Increase allowance for uncollectible accounts $8,004,277 Increase accounts payable (1,069,997) (60,248) Pension cost NA Adjusted net income before taxes $6,874,032 5 percent $ 343,702 Round down to $ 340,000 Note: A key consideration is whether the Company will be required to make its additional pension contribution. As more information is obtained, the amount considered material may be reduced to assure any possible misstatements in earnings are considered in light of that contractual obligation. 9-73 Increase to 1.7% of trade accounts receivable. Reflect same increase as cost of goods sold. Can't estimate. May or may not be required. 9-36 (continued) Stanton Enterprises Worksheet 9-36A, cont. ALLOCATION TO THE ACCOUNTS: Prelim. 12/31/09 Tolerable Misstatement Cash $243,689 10000 Easy to audit at low cost. Trade accounts receivable 3,544,009 80000 Large tolerable misstatement (TM) because account is large and requires extensive sampling to audit. Allowance for uncollectible accounts Inventories (120,000) 15000 Fairly low TM beca...
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