Mattel Inc., a manufacturer of toys, failed to write off obsolete inventory, thereby overstating inventory and improperly deferred tooling costs, both of which understated cost of goods sold and overstated income. “Excess” inventory was identified by comparing types of toys (wheels, general toys, dolls, and games), parts, and raw materials with the forecasted sales or usage; lower-of-castor-market (LCM) determinations then were made to calculate the obsolescence write-off. Obsolescence was expected and the target for the year was $700,000. The first comparison computer run showed $21 million “excess” inventory! The company “adjusted” the forecast by increasing the quantities of expected sales for many toy lines. (Forty percent of items had forecasted sales more than their actual recent sales.) Another “adjustment” was to forecast toy closeout sales not at reduced prices but at regular prices. In addition, certain parts were labeled “interchangeable” without the normal reference to a new toy product. These adjustments to the forecast reduced the excess inventory exposed to LCM valuation and write-off. The cost of setting up machines, preparing dies, and other preparations for manufacture are tooling costs. They benefit the lifetime run of the toy manufactured. The company capitalized them as prepaid expenses and amortized them in the ratio of current-year sales to expected product lifetime sales (much like a natural resource depletion calculation). To lower the amortization cost, the company transferred unamortized tooling costs from toys with low forecasted sales to ones with high forecasted sales. This caused the year’s amortization ratio to be lower, the calculated cost write-off lower, and the cost of goods sold lower than it should have been. The computerized forecast runs of expected usage of interchangeable parts provided a space for a reference to the code number of the new toy where the part would be used. Some of these references contained the code number of the part itself, not a new toy. In other business cases, the forecast of toy sales and parts usage contained the quantity on hand, not a forecast number. In the tooling cost detailed records, unamortized cost was classified by lines of toys (similar to classifying asset cost by asset name or description). Unamortized balances were carried forward to the next year. The company changed the classifications shown at the prior year-end to other toy lines that had no balances or different balances. In other words, the balances of unamortized cost at the end of the prior year did not match the beginning balances of the current year except for the total prepaid expense amount. For lack of obsolescence write-offs, inventory was overstated at $4 million. The company recorded a $700,000 obsolescence write-off. It should have been about $4.7 million, as later determined. The tooling cost manipulations overstated the prepaid expense by $3.6 million. The company reported net income (after taxes) of $12.1 million in the year before the manipulations took place. If pretax income were in the $20 to $28 million range in the year of the misstatements, the obsolescence and tooling misstatements alone amounted to about 32 percent income overstatement.
> Briefly describe the options and information provided by auditors when engaged to report on (a) summary financial statements and (b) supplementary information?
> What reporting options are available if predecessor auditors examined prior years’ financial statements presented in comparative form?
> Which of the following is ordinarily performed last in the audit examination? a. Securing a signed engagement letter from the client. b. Performing tests of controls. c. Performing a review for subsequent events. d. Obtaining signed written representatio
> If auditors wish to express a different opinion on prior years’ financial statements in the current report than in a previously issued report, how should their current report be modified?
> What is the auditors’ reporting responsibility for (a) other information accompanying the audited financial statements and (b) required supplementary information?
> What is an uncorrected misstatement? What is the auditors’ responsibility for communicating misstatements detected during the audit?
> What are going-concern uncertainties? What is the auditors’ responsibility for evaluating going concern uncertainties?
> What types of matters would result in the auditors’ report being modified for consistency?
> Define emphasis-of-matter and other-matter paragraphs. What type of information do auditors provide in these paragraphs?
> What options are available to group auditors when component auditors are involved in the examination of group financial statements?
> When a scope limitation exists, how would the standard (unmodified) report be modified to express (a) a qualified opinion and (b) a disclaimer of opinion?
> If a scope limitation exists and auditors cannot perform alternative procedures, what are the auditors’ reporting options?
> What are the major differences in wording for qualified opinions and adverse opinions issued as a result of departures from GAAP?
> Explain the effect of pervasiveness on the auditors’ report when the entity uses an accounting method that departs from GAAP.
> Which of these persons generally does not participate in writing the management letter? a. Client’s outside attorneys. b. Client’s accounting and production managers. c. Public accounting firm’s audit team on the engagement. d. Public accounting firm’s c
> What are the types of opinions and the conclusion of each type of opinion?
> Define group auditors and component auditors. What issues are introduced when component auditors examine a division, subsidiary, or segment of group financial statements?
> Which of the following normally occurs earliest in the audit examination? a. Discovery of an omitted audit procedure. b. Dual dating the auditor’s report on the entity’s financial statements for subsequent events that exist at the date of the financial s
> A major objective of written representations is to a. Shift responsibility for financial statements from the management to auditors. b. Provide a substitute source of audit evidence for substantive procedures that auditors would otherwise perform. c. Pro
> Follow the instructions preceding Problem 9.61. Write the audit approach section following the cases in the chapter. The following is an excerpt from an article, “Memory Chip Trader Gets 14 Years for Bank Fraud,” The Straits Times (Singapore), February 1
> The auditor tests the quantity of materials charged to work-in-process by vouching these quantities to a. Cost ledgers. b. Perpetual inventory records. c. Receiving reports. d. Material requisitions.
> When testing a company’s cost accounting system, the auditor uses procedures that are primarily designed to determine that a. Quantities on hand have been computed based on acceptable cost accounting techniques that reasonably approximate actual quantiti
> When evaluating inventory controls, an auditor would be least likely to a. Inspect documents. b. Make inquiries. c. Observe procedures. d. Consider policy and procedure manuals.
> An auditor would vouch inventory on the inventory status report to the vendor’s invoice to obtain evidence concerning management’s balance assertions about a. Existence. b. Rights and obligations. c. Completeness. d. Valuation.
> An auditor most likely would analyze inventory turnover rates to obtain evidence concerning management’s balance assertions about a. Existence. b. Rights and obligations. c. Completeness. d. Valuation and allocation.
> Which of the following auditing procedures probably would provide the most reliable evidence concerning the entity’s assertion of rights and obligations related to inventories? a. Trace test counts noted during the entity’s physical count to the entity’s
> Explain dual-direction sampling in the context of inventory test counts.
> What characteristics should be considered in reviewing a client’s inventory-taking instructions?
> ABC Company has 100 shares of IBM stock that it holds as an investment. The stock was purchased three years ago and has been in the client’s safe deposit box along with other investment securities. During an inspection of securities held by the client, t
> Why should receiving reports be prenumbered? What assertion would an auditor test using the receiving reports, and how would the auditor do this?
> To determine the client’s planned amount and timing of production of a product, the auditor reviews the a. Sales forecast. b. Inventory reports. c. Production plan. d. Purchases journal.
> The purpose of tracing a sample of inventory tags to a client’s computerized listing of inventory items is to determine whether the inventory items a. Represented by tags were included on the listing. b. Included on the listing were properly counted. c.
> Which of the following approaches is most suitable for auditing the finance and investment cycle? a. Perform extensive tests of controls and limit substantive procedures to analytical procedures. b. Ignore internal controls and perform extensive substant
> A portion of a client’s inventory is in public warehouses. Evidence of the existence of this merchandise can most efficiently be acquired through which of the following methods? a. Observation. b. Confirmation. c. Calculation. d. Inspection.
> Which of the following management assertions is an auditor most likely testing if the audit objective states that all inventory on hand is reflected in the ending inventory balance? a. The entity has rights to the inventory. b. Inventory is properly valu
> An auditor is examining a nonpublic company’s inventory procurement system and has decided to perform tests of controls. Under which of the following conditions do GAAS require tests of controls be performed by an auditor? a. Significant weaknesses were
> Your client counts inventory three months before the end of the fiscal year because controls over inventory are excellent. Which procedure is not necessary for the roll-forward? a. Check that shipping documents for the last three months agree with perpet
> What is a compensating control? Give some examples for finance and investment cycle accounts.
> What procedures do auditors employ to audit inventory when the physical inventory is taken on a cycle basis or on a statistical plan but never a complete count on a single date?
> An auditor selected items for test counts while observing a client’s physical inventory. The auditor then traced the test counts to the client’s inventory listing. This procedure most likely obtained evidence concerning management’s balance assertion of
> Describe the activities a company should perform to ensure appropriate reconciliation of marketable securities.
> A client maintains perpetual inventory records in quantities and in dollars. If the assessed control risk is high, an auditor would probably a. Apply gross profit tests to ascertain the reasonableness of the physical counts. b. Increase the extent of tes
> You have been assigned to trace the results of the observation of Brightware China’s physical inventory count to its pricing and compilation. You note the following conditions. 1. The last inventory tag documented by Mark Hulse, the auditor who observed
> Which of the following internal control activities most likely addresses the completeness assertion for inventory? a. The work-in-process account is periodically reconciled with subsidiary inventory records. b. Employees responsible for custody of finish
> Follow the instructions preceding Problem 9.61. Write the audit approach section following the case in the chapter. SueCan Corporation manufactured electronic and other equipment for private customers and government defense contracts. It deferred costs u
> From the auditors’ point of view, inventory counts are more acceptable prior to the year-end when a. Internal control is weak. b. Accurate perpetual inventory records are maintained. c. Inventory is slow moving. d. Significant amounts of inventory are he
> A retailer’s physical count of inventory was higher than that shown by the perpetual records. Which of the following could explain the difference? a. Inventory items had been counted, but the tags placed on the items had not been taken off and added to t
> An auditor usually traces the details of the test counts made during the observation of physical inventory counts to a final inventory compilation. This audit procedure is undertaken to provide evidence that items physically present and observed by the a
> The diagram in Exhibit 9.51.1 describes several cost accounting tests of controls. It shows the direction of the tests, leading from samples of cost accounting analyses, management reports, and the general ledger to blank squares. Required: For each bla
> The list of vouchers payable for Potter’s Magic Shoppe at December 31 is as follows: Checks written in the following January are: Required a. Prepare an audit plan for the audit of unrecorded liabilities for Potter’
> What documents would a company need to correctly account for its investment securities, and what information would they obtain from these documents?
> You are supervising the audit fieldwork of Sparta Springs Company and need certain information from Sparta’s equipment records, which are maintained on a computer file. The particular information is (1) net book value of assets so that your assistant can
> Each of the following tests of controls could be performed during the audit of the controls in the production cycle. Required: For each procedure, identify (a) the internal control activity (strength) being tested and (b) the assertion(s) being addresse
> A client has a large and active investment portfolio that is kept in a bank safe deposit box. If the auditors are unable to count securities at the balance sheet date, they most likely will a. Request the bank to confirm to the auditors the contents of t
> Following are the four assertions about account balances that can be applied to the audit of a company’s PP&E, including assets the company has constructed itself: existence, rights and obligations, completeness, and valuation and allocation. Required:
> This question contains three items that are management assertions about property and equipment. Following them are several substantive procedures for obtaining evidence about management’s assertions. Assertions 1. The entity has legal right to property
> Bart’s Company has prepared the PP&E and depreciation schedule shown in Exhibit 8.50.1. The following information is available. (Assume the beginning balance has been audited :) The land was purchased eight years ago whe
> This case is designed like the ones in the chapter. Your assignment is to write the “audit approach” portion of the case organized around these sections: Objective. Express the objective in terms of the facts supposedly asserted in financial records, acc
> Maine Construction builds office buildings. The buildings generally cost between $5 million and $8 million to build, and the plumbing can cost between $300,000 and $600,000 depending on the building requirements. Therefore, Maine always sends the plumb
> The following case is designed like the ones in the chapter. Your assignment is to write the audit approach portion of the cases organized around these sections: Objective. Express the objective in terms of the facts supposedly asserted in financial rec
> C. Marsh, CPA, is the independent auditor for Compufast Corporation, which sells personal computers, peripheral equipment (printers, data storage), and a wide variety of programs for business and games. From experience on Compufast’s previous audits, Mar
> Who is normally responsible for the authorization of investment activities? Why is the authorization normally performed at this level?
> An audit plan to examine long-term debt most likely would include steps that require a. Comparing the carrying amount of held-to-maturity securities with their year-end market values. b. Correlating interest expense recorded for the period with outstandi
> Partners Clark and Kent, both CPAs, are preparing their audit plan for the audit of accounts payable on Marlboro Corporation’s annual audit. Saturday afternoon they reviewed the thick file of last year’s documentation, and they both remembered too well t
> You are in the final stages of your audit of the financial statements of Ozine Corporation for the year ended December 31, 2017, when the corporation’s president consults you. The president believes there is no point to your examining the 2015 voucher re
> What assertions found in PP&E, investments, and intangibles accounts are of interest to an auditor during the examination of the expenditure and acquisition cycle?
> Refer to the internal control questionnaire for the production cycle (Appendix Exhibit 9A.1) and assume that the answer to each question is “no.” Prepare a table matching questions to errors or frauds that could occur
> Following is a selection of items from internal control questionnaires. 1. Are purchase orders above a certain level approved by an officer? 2. Are the quantity and quality of goods received determined at the time of receipt by receiving personnel indepe
> Which of the following tests of details most likely would help an auditor determine whether accounts payable have been misstated? a. Examining reported purchase returns that appear too low. b. Examining vendor statements for amounts not reported as purch
> A company employs three accounts payable clerks and one treasurer. Their responsibilities are as follows: Which of the following would indicate a weakness in the company’s internal control? a. Clerk 1 opens all of the incoming mail. b
> In a test of controls, auditors may trace receiving reports to vouchers recorded in the voucher register. This is a test for a. Occurrence. b. Completeness. c. Classification. d. Cutoff.
> When auditing account balances of liabilities, auditors are most concerned with management’s assertion about a. Existence. b. Rights and obligations. c. Completeness. d. Valuation and allocation.
> You are conducting an audit of the financial statements of a wholesale cosmetics distributor with an inventory consisting of thousands of individual items. The distributor keeps its inventory in its own distribution center and in two public warehouses. A
> Which of the following accounts would most likely be audited in connection with a related balance-sheet account? a. Property Tax Expense. b. Payroll Expense. c. Research and Development. d. Legal Expense.
> An audit team would most likely examine the detail support for charges to which of the following accounts? a. Payroll expense. b. Cost of goods sold. c. Supplies expense. d. Legal expense.
> Curtis, a maintenance supervisor, submitted maintenance invoices from a phony repair company and received the checks at a post office box. This should have been prevented by a. Comparison of the company name to the approved vendor list by the check signe
> In auditing for unrecorded long-term bonds payable, an audit team most likely will a. Perform analytical procedures on the bond premium and discount accounts. b. Examine documentation of assets purchased with bond proceeds for liens. c. Compare interest
> How do audit procedures for prepaid expenses and accrued liabilities also provide audit evidence about related expense accounts?
> A furniture company ordered 84 tables from a supplier. The supplier accidentally sent only 48 tables, but the receiving department at the furniture company accepted the tables. The invoice was eventually received but was for the original 84 tables. The f
> You are auditing Martha’s Prison Clothes Inc. as of December 31, 2014. The inventory for orange jumpsuits shows 1,263 suits at $782 for a total of $987,666. When you look at the invoices for the jumpsuits, you see the following: Requi
> When verifying debits to the perpetual inventory records of a nonmanufacturing company, auditors would be most interested in examining a sample of purchase a. Approvals. b. Requisitions. c. Invoices. d. Orders.
> To determine whether accounts payable are complete, auditors perform a test to verify that all merchandise received has been recorded. The population for this test consists of all a. Vendors’ invoices. b. Purchase orders. c. Receiving reports. d. Cancele
> Which of the following procedures is least likely to be performed before the balance-sheet date? a. Observation of inventory. b. Review of internal control over cash disbursements. c. Search for unrecorded liabilities. d. Confirmation of receivables.
> How should an audit team assess the reasonableness of a film studio’s estimate of film revenues? (Refer to the No Treasure in This Treasure Planet case.)
> Which of the following is the best audit procedure for determining the existence of unrecorded liabilities? a. Examine confirmation requests returned by creditors whose accounts are on a subsidiary trial balance of accounts payable. b. Examine a sample o
> Budd, the purchasing agent of Lake Hardware Wholesalers, has a relative who owns a retail hardware store. Budd arranged for hardware to be delivered by manufacturers to the retail store on a cash-on-delivery (C.O.D.) basis, thereby enabling his relative
> When auditing inventories, an auditor would least likely verify that a. All inventory owned by the client is on hand at the time of the count. b. The client has used proper inventory pricing. c. The financial statement presentation of inventories is appr
> A client’s purchasing system ends with the recording of a liability and its eventual payment. Which of the following best describes auditors’ primary concern with respect to liabilities resulting from the purchasing system? a. Accounts payable are not ma
> Which of the following would not overstate current-period net income? a. Capitalizing an expenditure that should be expensed. b. Failing to record a liability as an expense. c. Failing to record a check paying an item in Vouchers Payable. d. All of the a
> Why is it important for auditors to obtain control information over inventory count sheets or tickets?
> For which of the following accounts would the matching concept be the most appropriate? a. Cost of goods sold. b. Research and development. c. Depreciation expense. d. Sales.
> An audit team testing long-term investments would ordinarily use analytical procedures to ascertain the reasonableness of the a. Existence of unrealized gains or losses. b. Completeness of recorded investment income. c. Classification as available-for-sa
> Which of the following audit procedures would not likely be performed for audits of investments? a. Read board of directors’ minutes for authorization of investment strategies. b. Confirm investments with registrar. c. Confirm investments with broker or
> Which of the following accounts does not appear in the acquisition and expenditure cycle? a. Cash. b. Purchases returns. c. Sales returns. d. Prepaid insurance.
> How could auditors have discovered the off-balance-sheet financing described in the Off-Balance-Sheet Inventory Financing case?
> Which of the following procedures would best prevent or detect the theft of valuable items from an inventory that consists of hundreds of different items selling for $1 to $10 and a few items selling for hundreds of dollars? a. Maintain a perpetual inven
> What features of the cost accounting system would be expected to prevent the omission of recording materials used in production?
> An audit team would most likely verify the interest earned on bond investments by a. Vouching the receipt and deposit of interest checks. b. Confirming the bond interest rate with the issuer of the bonds. c. Recomputing the interest earned on the basis o
> What primary functions should be separated in the acquisition and expenditure cycle?
> What makes the recording of inventory at its proper amount difficult on the financial statements?
