19-28 (Objective 19-5 ) You are the manager in the audit of Vernal Manufacturing

ID: 2578301 • Letter: 1

Question

19-28 (Objective 19-5 ) You are the manager in the audit of Vernal Manufacturing Company and are turning your attention to the income statement accounts. The in-charge auditor assessed control risk for all cycles as low, supported by tests of controls. There are no major inherent risks affecting income and expense accounts. Accordingly, you decide that the major emphasis in auditing the income statement accounts will be to use substantive analytical procedures. The client prepared a schedule of the key income statement accounts that compares the prior-year totals with the current year totals. The in-charge auditor completed the last column of the audit schedule, which includes explanations of variances obtained from discussions with client personnel. The audit schedule is included.

Required

a.Examine the schedule prepared by the client and your staff and write a memorandum to the in-charge that includes criticisms and concerns about the audit procedures performed and questions for the in-charge auditor to resolve.

b.Evaluate the explanations for variances provided by client personnel. List any alternative explanation to those given.

c.Indicate which variances are of special significance to the audit and how you believe they should be responded to in terms of additional audit procedures.

* There isn't any more info provided in the textbook this is the entire question.

Home Insert Page Layout Formulas Data ReviewView General Formatting as Table Styles ) Format Sort & Find & Filter Select Styles Vernal Manufacturing Co. Income Statement Accounts 12/31/16 Change Account 2/31/1 2/31/16 AmountPercent Explanations by Client $9.845.231 $1.377.919 16.3 Sales increase due to two new customers who (243.561 ) ( 178.666) 275.3 account for 20% of volume. Larger returns 43,200 (186.422) 431.3 d to need to cement relations with these $8.467.312 (64.895) 43,222 Sales returns and allowances Gain on sale of assets Interest income Miscellaneous income customers 6,365 8.452,247 300.3 1031,924 2.2 19.113 Trade-in of several sales cars that needed replacement. Cost of goods sold: Beginning inventory 1,389,034 3.430,865 65,782 (57.643) ,145.467 201.343 490.765 (98.632 6.6 866.41433.8 20.450 . 8,667-24.5 158,712 6. 1,487,666 2,564.45I 45.332 Increase in these accounts due to increased volume th new customers as indicated above. ases Purchase returns 986,755 97,652 478.659 es 2.106 ation Ending inventory 55.2 Inventory being held for new customers. 2.156.003) 4.639.2834824.169 (766.969) 84.880 ( 1.389.034) Selling, general, and administrative: 103 2,167 4.2 Normal salary increases. 167,459 32,32 95.675 9,888 56,845 30.878 34,880 38,221 4,657 36.55 3.644 15.607 Executive salaries Executive benefits Office salaries 74,562 98,540 1,890 18,738 25,802 9.7 an attempt to obtain new major customers. ts 75,583 156.680 42,334 21,554 8.756 67,822 4,522 15.607 33.0 Sales and promotional expenses increased in Travel and entertainment Advertising Other sales expense Sta 7.454 24 Two obtained and (16,667) -43.6 Probably a misclassification; will investigate. tionery and supplies 4.099 28.0 Normal increase. 31,27 85.6 Normal increase. Dues and memberships Rent 878 24.1 Normal increase. l fees 21306 50.5 Timing of billing for fees. 6,700 1,950 7 Normal increase. Accounting Depreciation, S Bad debt expense Insurance 69,500 143.871 45.702 (3.950 (22.583 5.4 Normal change. -13.6 Haven't reviewed yet for the current year 44,32 20.432 1,381 3. Normal change. 137,922 17,4904.5 Normal change. Other expense 28.762 23.307 427.3 Amount not material. ,087,592 5,726,875 2.725,372 .212.093 6.036.256011.4 3.447.915 1,020.600 309,381 722.543 26.5 Income before taxes Income taxes Net income 926,626 1.798,746 0. Increase due to increased income before tax. 2,427,3157.3740 628,569 34.9

Explanation / Answer

Answer (a)

Memorandum

To: In charge Auditor

From: Audit Manager

Subject: Concerns about the schedule prepared by the client and the staff in the audit of Vernal Manufacturing Company

Date: …………………….

CC: …………………….

The schedule of analytical procedures for the audit of Vernal Manufacturing Company is quite insufficient and requires rework for enhancing its precision. There are numerous flaws:

1. The audit schedule was unfinished in terms of headings, references, and indexing.

2. An organized income statement would furnish more constructive information rather than one liner.

3. The schedule should contain additional columns depicting the percentage of net sales for 12/31/15 and 12/31/16. Net sales are required while performing financial analysis (specifically ratio analysis). If this information is missing, the relative change in each account would not be evaluated effectively.

4. There is no information regarding comparison of journal, ledger totals and journal ledger balances or if, that calculations were tested or not.

5. There is no recognition of such accounts that we are bothered may be substantially wrongly stated. For example, the $1,381 (or 3.1%) change in insurance expense appears immaterial but the change of 427% in other expense may be significant but that was considered as amount not material (in explanation given in schedule).

6. No specific accounts were identified that might call for additional analysis or investigation and the nature of such investigation.

7. Nothing was mentioned about evaluation of the client's explanations and evidence support. Inquiry by management or internal parties is fragile form of evidence and insufficient and unacceptable by itself.

Answer (b)

For each and every explanation presented by client, an alternative possibility is a misrepresentation or distortion in the financial statements. The following are a few examples of probable misstatement:

Particular (Account Names)

Probable Misstatement

Sales

Halt mistake for sales

Sales returns and allowances

Returns because of deficiencies in technology of products that may show obsolete stock or inventory

Miscellaneous income

Includes proceeds from the sale of assets rather than reducing the balance of asset account

Cost of goods sold

Little increase in cost of goods sold compared to net sales may depict an overstated ending inventory or understated balance of any other account contributing to cost of goods sold

Answer (c)

The following are variances of special significance to the audit that have been identified from the rework of analytical procedures included in the solution to part a. After examining management's justifications, the following additional audit procedures may be suitable:

Account

Potential additional audit procedures

1. Sales

Execute extensive cutoff tests and other tests for probable overstatements.

2. Sales returns and allowances

Inspect documents for the largest sales returns and allowances and examine the effect of returns on inventory valuation.

3. Cost of goods sold

Tests should be conducted regarding physical counts, costing, inventory levels and obsolescence.

4. Travel and entertainment

Identify and inspect supporting documents for huge amount travel and entertainment expenses.

5. Telephone

Monthly comparison of telephone bills to determine the chances of a misclassification.

6. Legal fees

Evaluate legal fees to ascertain the possibility of court cases or other legal actions that might impact financial statements unfavorably.

7. Depreciation expense

Month wise comparison of depreciation to ensure proper recording of asset value in financial statement.

8. Bad debt expense

Carry out detailed analytical procedures and tests to assess the capability of the allowance for uncollectible accounts.

9. Other expense

Investigate other expenses to find out mistaken accounting.