2 a Overstates inventory, reduces cost of goods sold, increases profit. Major account balance/class of transaction and assertion at risk of material misstatement is existence of inventory. 3 b Overstates sales and receivables, increases profit. Major account balance/class of transaction and assertion at risk of material misstatement is cut-off of sales. c Understates liabilities and expenses/inventory, increases profit. Major account balance/class of transaction and assertion at risk of material misstatement is completeness of accounts payable. d Understates cost of goods sold and liabilities (accounts payable), increases profit. a b c d Major account balance/class of transaction and assertion at risk of material misstatement is occurrence of purchase returns. Check the pre-numbered stock count sheets. ii Observe the physical stocktake and compare from the perpetual inventory records to the count sheets. List the sales transactions of a few days before and after the financial year-end, and check that the accounting entries associated with them are recorded in the correct period. ii Check the debtors' confirmations. Examine the subsequent payments to suppliers. ii Examine the orders not matched with vendor invoices. Examine the creditors' confirmations. ii Examine the subsequent payments to suppliers. ('
ADVANCED AUDIT AND ASSURANCE SUGGESTED ANSWERS 4.7 .~ Case Study 4.6: South Ltd 1 There are two assertions of major concern for building improvements based on the information provided in the case study. Valuation and allocation Management has the incentive to misstate the carrying value of building improvements. Their bonus is tied to the return on total assets ratio. The draft financial statements show that the ratio is very close to the critiCal level at which this bonus is paid. Therefore, they have an incentive to overstate net profit or understate total assets. Building improvements, where there is work undertaken by employees and an overhead rate calculated, are areas of managerial discretion. These discretions would include exactly what hours to capitalise rather than expense, and how the overhead rate is calculated. Thus, it is the monetary value, or valuation and allocation of the improvements, whiCh is of major concern. A related concern is that management has revised some of its depreciation rates during the year. This also relates to the assertion of valuation and allocation of non-current assets, as this revision may be done to again achieve target returns rather than for any sound business or economiC reason. Existence The second assertion of concern is the existence of non-current assets. At the extreme, it is possible that the company is capitalising, under non-current assets, items that should rather be expensed (possibly through repairs and maintenance). The existence of building improvements is questionable if these items have no future economiC benefit, or otherwise do not meet the definition of an asset.