Auditing Practice - Key Considerations and Procedures

Actions and Discussions for Auditing Chateaubriand Ltd

1. Juliet B a partner in Stamp & Hoppit, Registered Auditors, receives a telephone call from the  Managing Director of Chateaubriand Ltd which runs a chain of restaurants and bars. They wish to  appoint Stamp & Hoppit as auditors as they have a disagreement with the existing auditors. A  meeting was arranged to discuss the audit which would be due to commence in about two months’ time. The Managing Director tells her that Chateaubriand runs a chain of 12 restaurants and 10 bars  situated in the Northern region. It also sells ready meals under the ‘Chateaubriand’ name which are manufactured by another independent company; Chateaubriand buys them in, adds a margin and  sells them on through supermarkets and smaller food retailers. This is becoming an increasingly  significant part of the business. Juliet B carries out some further research and discovers that  Chateaubriand is a private company wholly owned by the Staples family. The managing director is  R. A. Staples, his son is the sales director and his wife is responsible for ‘Product Design’. The  finance director has been with the company for eighteen months and there have been three other  finance director appointments in the last five years. The company turns over some £15m and made  a profit of some £800 000 before tax in the last financial year.

Required

List five actions Juliet B should take before accepting the appointment.

List five matters that Juliet B should discuss at the meeting with the Managing Director of  Chateaubriand Ltd.

State Two Purposes of an engagement letter.

List TEN items that will be included in an Audit Engagement Letter.  

2. As auditor of the Star Manufacturing Company, you have obtained the following balances from the  books of Star Manufacturing Company a month before year-end.

Star Manufacturing Company, Account Balances one month before year-end

Cash in bank (Dr) 87,000.00  

Trade accounts receivables (Dr) 345,000.00  

Notes receivables (Dr) 125,000.00  

Inventories (Dr) 317,000.00  

Trade accounts payables (Cr) 235,000.00

Mortgages payable (Cr) 400,000.00  

Legal and professional fees (Dr) 3,000.00  

Interest expense (Dr) 35,000.00  

Equity Share Capital (Cr) 575,000.00  

There are no inventories consigned either in or out. All notes receivable are due from outsiders and  held by Star.

Required

State Five account balances that should be confirmed with outside sources and the source of  confirmation.

For each of the account balances stated in (a) list four information that should be confirmed.  

Audit Engagement Letter for Chateaubriand Ltd

3. Convoluted Ltd is a company dealing in rare metals internationally. It has 40 employees (25 in the  UK). It is owned by Joe King Ltd, a company registered in the Cayman Islands and is known to  deal with several other UK and overseas companies also owned by that company. The company has  four directors who are all UK residents and who do not own any shares in the company.

The company has a pension scheme with employee and employer trustees and is heavily indebted to  its bankers. The auditors are Sew & Sew, who are newly appointed.

Required

Define what constitutes a “related party.”

List five possible related parties of Convoluted Ltd.

From the auditor’s point of view list four likely related party issues Convoluted Ltd may not  disclosed.

List ten audit procedures Sew & Sew should carried out to ascertain related party transactions in  Convoluted Limited.

4. In the audit of the Worldwide Wholesale Company, you did extensive ratio and trend analysis as  part of preliminary audit planning. Your analytical procedures identified the following: 1. Commission expense as a percent of sales was constant for several years but has increased  significantly in the current year. Commission rates have not changed.

The rate of inventory turnover has steadily decreased for three years.

Inventory as a percent of current assets has steadily increased for four years. 4. The number of days’ sales in accounts receivable has steadily increased for three years. 5. Allowance for uncollectible accounts as a percent of accounts receivable has steadily decreased  for three years.

The absolute amounts of depreciation expense and depreciation expense as a percent of gross  fixed assets are significantly smaller than in the preceding year.

Required

Evaluate how each of the above ratios or trends could affect the fair presentation of the  financial statements.  

For each item, state the follow-up procedures you would perform to determine whether a  material misstatement exists.

5. The following table contains calculations of several key ratios for a fictional company, Indianola  Pharmaceutical Company, a maker of proprietary and prescription drugs. Indianola Pharmaceutical  Company is a small-to medium-sized publicly held pharmaceutical company. Approximately 80%  of its sales has been in prescription drugs; the remaining 20% is in medical supplies normally found  in a drugstore. The primary purpose of the auditor’s calculations is to identify potential risk areas  for the upcoming audit. The auditor recognizes that some of the data might signal the need to gather  other industry- or company-specific data. A number of the company’s drugs are patented. Its best selling drug, Anecillin, which will come off patent in two years, has accounted for approximately  20% of the company’s sales during the past five years. The auditor’s expectation is that the  company’s own trends from the past few years should be relatively consistent with this year’s  trends, and that the company will not have significant deviations from industry norms.

Confirmation of Account Balances for Star Manufacturing Company

Indianola Pharmaceutical Ratio Analysis

Required

Identify five account balances that have a high risk of material misstatements.

State the potential risks in each of the account balances identified in (a) above.  

Explain how you would address each risk stated in (b) when planning the audit.

State five other critical background information you will want to obtain when planning  the audit.

Explain two major actions the company take during the immediate preceding year.

6 . The following are partial descriptions of internal controls for companies engaged in the  manufacturing business:

Company 1.  

When Mr. Clark orders materials, an electronic copy of the purchase order is sent to the receiving  department. During the delivery of materials, Mr. Smith, the receiving clerk, records the receipt of  shipment on this purchase order and then sends the purchase order to the accounting department,  where it is used to record materials purchased and accounts payable. The materials are transported  to the storage area by forklifts. The additional purchased quantities are recorded on storage records.

Company 2.  

Every day, hundreds of employees clock in using their employee identification cards at Generous  Motors Corporation. The data on these time records is used in the preparation of the labor cost  distribution records, the payroll journal, and the electronic payments and payroll checks. The treasurer, Angela Lee, compares the payroll journal with the payroll records, signs the checks, and  returns the payroll notifications and checks to Charles Strode, the supervisor of the computer  department. The payroll checks and payment notices are distributed to the employees by Strode.

Company 3.  

The smallest branch of Connor Cosmetics employs Mary Cooper, the branch manager, and her sales  assistant, Janet Hendrix. The branch uses a bank account to pay expenses.

The account is kept in the name of “Connor Cosmetics—Special Account.” To pay expenses,  checks must be signed by Cooper or by the treasurer, John Winters. Cooper receives the cancelled  checks and bank statements. She reconciles the branch account herself and files cancelled checks  and bank statements in her records. She also periodically prepares reports of cash disbursements  and sends them to the home office.

Required

List two deficiencies in internal control for each Company.

For each deficiency, state the type(s) of misstatement(s) that is (are) likely to result. Be as  specific as possible.

How would you improve internal controls for each of the three companies?