You have been requested by the management of J. L. Lockwood Co. to issue a debt compliance letter as a part of the audit of Taylor Fruit Farms, Inc. J. L. Lockwood Co. is a supplier of irrigation equipment. Much of the equipment, including that supplied to Taylor, is sold on a secured contract basis. Taylor Fruit Farms is an audit client of yours, but Lockwood is not. In addition to the present equipment, Lockwood informs you they are evaluating whether they should sell another $500,000 of equipment to Taylor Fruit Farms. You have been requested to send Lockwood a debt compliance letter concerning the following matters: 1. The current ratio has exceeded 2.0 in each quarter of the unaudited statements prepared by management and in the annual audited statements. 2. Total owners' equity is more than $800,000. 3. The company has not violated any of the legal requirements of California fruit-growing regulations. 4. Management is competent and has made reasonable business decisions in the past 3 years. 5. Management owns an option to buy additional fruit land adjacent to the company's present property. Required a. Define the purpose of a debt compliance letter. b. Why is it necessary to conduct an audit of a company before it is acceptable to issue a debt compliance letter? c. For which of the five requested items is it acceptable for a CPA firm to issue a debt compliance letter? Give reasons for your answer.
> In verifying accounts payable, it is common to restrict the audit sample to a small portion of the population items, whereas in auditing accrued property taxes, it is common to verify all transactions for the year. Explain the reason for the difference.
> Explain the relationship between accrued rent and substantive tests of transactions for the acquisition and payment cycle. Which aspects of accrued rent are not verified as part of the substantive tests of transactions?
> Evaluate the following statement by an auditor concerning tests of acquisitions and cash disbursements: “In selecting the acquisitions and cash disbursements sample for testing, the best approach is to select a random month and test every transaction for
> What are the major differences between the audit of prepaid expenses and other asset accounts such as accounts receivable or property, plant, and equipment?
> Distinguish between the evaluation of the adequacy of insurance coverage and the verification of prepaid insurance. Explain which is more important in a typical audit.
> Explain why the audit of prepaid insurance should ordinarily take a relatively small amount of audit time if the client’s assessed control risk for acquisitions is low.
> Explain the relationship between substantive tests of transactions for the acquisition and payment cycle and tests of details of balances for the verification of prepaid insurance.
> In auditing depreciation expense, what major considerations should the auditor keep in mind? Explain how each can be verified.
> List and briefly state the purpose of all audit procedures that might reasonably be applied by an auditor to determine that all property, plant, and equipment retirements have been recorded in the accounting system.
> What is the relationship between the audit of property, plant, and equipment accounts and the audit of repair and maintenance accounts? Explain how the auditor organizes the audit to take this relationship into consideration.
> As a part of your clerical tests of inventory for Martin Manufacturing, you have tested about 20% of the dollar items and have found the following exceptions: 1. Extension errors: 2. Differences located in comparing last year’s costs wi
> 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 inhere
> The physical inventory for Ajak Manufacturing was taken on December 30, 2011, rather than December 31, because the client had to operate the plant for a special order the last day of the year. At the time of the client’s physical count,
> As part of the June 30, 2011, audit of accounts payable of Milner Products Company, the auditor sent 22 confirmations of accounts payable to vendors in the form of requests for statements. Four of the statements were not returned by the vendors, and five
> List one possible control for each of the six transaction-related audit objectives for acquisitions. For each control, list a test of control to test its effectiveness.
> Even though Bergeron Wholesale Company is privately held, management has decided that it is worthwhile to have effective internal controls to the extent it is practical in a small company, as a way to reduce the likelihood of error and fraud. They have i
> You were in the final stages of your audit of the financial statements of Ozine Corporation for the year ended December 31, 2011, when you were consulted by the corporation’s president, who believes there is no point to your examining the year 2012 acqui
> The Broughton Cap Company requires that prenumbered receiving reports be completed when purchased inventory items arrive in the receiving department. At the time of receipt, the receiving clerk writes the date of receipt on the receiving document. The la
> Lecimore Company has a centralized purchasing department that is managed by Joan Jones. Jones has established policies and procedures to guide the clerical staff and purchasing agents in the day-to-day operation of the department. She is satisfied that t
> Haskin Company was founded 40 years ago and now has several manufacturing plants in the Northeast and Midwest. The evaluation of proposed capital expenditures became increasingly difficult for management as the company became geographically dispersed and
> Weston Corporation has an internal audit department operating out of the corporate headquarters. Various types of audit assignments are performed by the department for the eight divisions of the company. The following findings resulted from recent audits
> In an annual audit at December 31, 2011, you find the following transactions near the closing date: 1. Merchandise costing $1,822 was received on January 3, 2012, and the related acquisition invoice recorded January 5. The invoice showed the shipment was
> In testing cash disbursements for the Jay Klein Company, you obtained an understanding of internal control. The controls are reasonably good, and no unusual audit problems arose in previous years.Although there are not many individuals in the accounting
> Lajod Company has an internal audit department consisting of a manager and three staff auditors. The manager of internal audits, in turn, reports to the corporate controller. Copies of audit reports are routinely sent to the audit committee of the board
> What are the major differences between reporting for operational and financial auditing?
> Explain how planning for operational auditing is similar to and different from financial auditing.
> Identify the three phases of an operational audit.
> Explain what is meant by the criteria for evaluating efficiency and effectiveness. Provide five possible specific criteria for evaluating effectiveness of an IT system for payroll.
> Under what circumstances are external auditors likely to be involved in operational auditing? Give one example of operational auditing by a CPA firm.
> Explain the role of government auditors in operational auditing. How is this similar to and different from the role of internal auditors?
> Distinguish among the following types of operational audits: functional, organizational, and special assignment. State an example of each for a not-for-profit hospital.
> Distinguish between efficiency and effectiveness in operational audits. State one example of an operational audit explaining efficiency and another explaining effectiveness.
> The following are sales, cost of sales, and inventory data for Aladdin Products Supply Company, a wholesale distributor of cleaning supplies. Dollar amounts are in millions. Required a. Calculate the following ratios, using an electronic spreadsheet prog
> Identify the three major differences between financial and operational auditing.
> The following auditing procedures were performed in the audit of accounts payable: 1. Obtain a list of accounts payable. Re-add and compare with the general ledger. 2. Trace from the general ledger trial balance and supporting documentation to determine
> Identify the key required reports of the Single Audit Act and OMB Circular A-133.
> Identify the primary specific objectives that must be incorporated into the design of audit tests under the Single Audit Act.
> In what ways is the Yellow Book consistent with generally accepted auditing standards, and what are some additions and modifications?
> Explain what is meant by the Single Audit Act. What is its purpose?
> Explain how governmental financial auditing is similar to and different from audits of commercial companies. Who does governmental auditing?
> Explain the difference between the independence of internal auditors and external auditors in the audit of historical financial statements. How can internal auditor’s best achieve independence?
> What is the nature of the two categories of standards in the IIA International Standards for the Professional Practice of Auditing?
> Explain the role of internal auditors for financial auditing. How is it similar to and different from the role of external auditors?
> In connection with his audit of the financial statements of Knutson Products Co., an assembler of home appliances, for the year ended May 31, 2011, Ray Abel, CPA, is reviewing with Knutson's controller the plans for a physical inventory at the company wa
> Superior Co. manufactures automobile parts for sale to the major U.S. automakers. Superior's internal audit staff is to review the internal controls over machinery and equipment and make recommendations for improvements when appropriate. The internal aud
> The Institute of Internal Auditors (IIA) is an international professional association of more than 170,000 members with global headquarters in Altamonte Springs, Florida. Throughout the world, The IIA is recognized as the internal audit profession's lead
> The following misstatements are included in the accounting records of Westgate Manufacturing Company. 1. The accounts payable clerk prepares a monthly check to Story Supply Company for the amount of an invoice owed and submits the unsigned check to the t
> Jones, CPA, has completed the audit of Sarack Lumber Supply Co. and has issued a standard unqualified report. In addition to a report on the overall financial statements, the company needs a special audited report on three specific accounts: sales, net f
> Bengston, CPA, is conducting the audit of Pollution Control Devices, Inc. In addition, a supplemental negative assurance report is required to a major mortgage holder. The supplemental report concerns indenture agreements to keep the client from defaulti
> Carl Monson, the owner of Major Products Manufacturing Company, a small, successful, longtime audit client of your firm, has requested you to work with his company in preparing 3-year forecasted information for the year ending December 31, 2012, and two
> Each of the following represents different client requests for engagements related to WebTrust and SysTrust assurance services. a. Ware Hospital Systems, Inc. is in the process of developing a new patient records system. Management has approached a licen
> Lucia Johnson, of Johnson and Lecy, CPAs, has completed the first-year audit of Tidwell Publishing Co., a publicly held company, for the year ended December 31, 2011. She is now working on a review of interim financial statements for the quarter ended Ma
> In an engagement to review the financial statements of a nonpublic company, SSARS require the accountant to obtain review evidence that is primarily based on inquiries and analytical procedures. The nature of the accountant's inquiries is a matter of jud
> You encountered the following situations during the December 31, 2011, physical inventory of Latner Shoe Distributor Company: Required a. Latner maintains a large portion of the shoe merchandise in 10 warehouses through-out the eastern United States. Th
> SSARS contain several procedures that are required when engaged to perform a compilation or review engagement. Below are ten statements that may or may not be relevant to a compilation or review engagement. For each of the ten statements, indicate whethe
> You are doing a review services and related tax work engagement for Murphy Construction Company. You have made extensive inquiries of management about their financial statements and have concluded that management has an excellent understanding of its bus
> Evaluate the following comments about compiled financial statements: "When CPAs associate their name with compiled financial statements, their only responsibility is to the client and that is limited to the proper summarization and presentation on the fi
> Donnen Designs, Inc. is a small manufacturer of women’s casual-wear jewelry, including bracelets, necklaces, earrings, and other moderately priced accessory items. Most of their products are made from silver, various low-cost stones, beads, and other dec
> The following questions concern reports issued by auditors, other than those on historical financial statements. Choose the best response. a. An auditor is reporting on cash basis financial statements. These statements are best referred to in the opinion
> The following questions concern attestation engagements. Choose the best response. a. Which of the following professional services is considered an attestation engagement? (1) A management consulting engagement to provide IT advice to a client. (2) An in
> The following are miscellaneous questions about compilation and review services. Choose the best response. a. It is acceptable for a CPA to be associated with financial statements when not independent with respect to the client and still issue a substant
> The Absco Corporation has requested that Herb Germany, CPA, provide a report to the Northern State Bank as to the existence or nonexistence of certain loan conditions. The conditions to be reported on are the working capital ratio, dividends paid on pref
> State the reporting requirements for statements prepared on a basis other than GAAP.
> Explain what is meant by prospective financial statements and distinguish between forecasts and projections. What four things are involved in an examination of prospective financial statements?
> Your client, Ridgewood Heating and Cooling, specializes in residential air conditioning and heating installations. The company maintains an inventory of air conditioning units, furnaces, and air handling ductwork. The client has provided the following se
> An audit client has engaged a third party service organization to host its payroll software package on servers located at the service organization. What options do you have to obtain assurance about the controls embedded in the payroll application?
> Describe the purpose of a SysTrust assurance services engagement.
> List the five Trust Services principles and explain whether a WebTrust licensed CPA can report on an entity's compliance with those principles individually or in combination.
> Define what is meant by attestation standards. Distinguish between attestation standards and auditing standards.
> Following are some of the tests of controls and substantive tests of transactions procedures commonly performed in the acquisition and payment cycle. Each is to be done on a sample basis. 1. Trace transactions recorded in the acquisitions journal to supp
> Explain why a review of interim financial statements for a public company may provide a greater level of assurance than an SSARS review.
> What are the differences between the review reports for a private company under SSARS and for the interim financial statements of a public company?
> What should auditors do if during a review of financial statements they discover that applicable accounting standards are not being followed?
> What procedures should the auditor use to obtain the information necessary to give the level of assurance required of reviews of financial statements?
> What steps should auditors take if during a compilation engagement they become aware that the financial statements are misleading?
> Explain the relationship between tests of the acquisition and payment cycle and tests of accounts payable. Give specific examples of how these two types of tests affect each other
> List five things that are required of an auditor by SSARS for a compilation.
> Distinguish the three forms of compilation reports that a CPA can provide to clients.
> Distinguish between compilation and review of financial statements. What is the level of assurance for each?
> What is negative assurance? Why is it used in a review engagement report?
> What is meant by the term level of assurance? How does the level of assurance differ for an audit of historical financial statements, a review, and a compilation?
> Questions 1 through 8 are typically found in questionnaires used by auditors to obtain an understanding of internal control in the acquisition and payment cycle. In using the questionnaire for a client, a “yes” response to a question indicates a possible
> The Accounting and Review Services Committee (ARSC) is responsible for issuing standards for compilations and reviews of financial statement issued by nonpublic companies. Visit the AICPA website (www.aicpa.org) and answer the following questions about t
> In a letter to the audit committee of the Cline Wholesale Company, Jerry Schwartz, CPA, informed them of material weaknesses in the control of inventory. In a separate letter to senior management, he elaborated on how the material weaknesses could result
> The following items were discovered during the December 31, 2011 audit of the financial statements of Westmoreland Corporation: 1. The company's financial statements did not include an accrual for bonuses earned by senior management in 2011 but payable i
> As a part of the audit of Ren Gold Manufacturing Company, a nonpublic company, management requests basic financial statements and separately, the same basic financial statements accompanied by additional information. Management informs you that the inten
> You are responsible for the audit of inventory for Honey Best Grocery Wholesales, Inc., a closely held grocery wholesaler that sells to independent grocery stores. Inventory is by far the largest account on their balance sheet. Honey Best operates in ten
> Leslie Morgan, CPA, has prepared a letter of representation for the president and controller to sign. It contains references to the following items: 1. Inventory is fairly stated at the lower of cost or market and includes no obsolete items. 2. All actua
> The field work for the June 30, 2011, audit of Tracy Brewing Company was finished August 19, 2011, and the completed financial statements, accompanied by the signed audit reports, were mailed September 6, 2011. In each of the highly material independent
> The following unrelated events occurred after the balance sheet date but before the audit report was prepared: 1. The granting of a retroactive pay increase 2. Declaration of a stock dividend 3. Sale of a fixed asset at a substantial profit 4. Determinat
> In analyzing legal expense for the Boastman Bottle Company, Mary Little, CPA, observes that the company has paid legal fees to three different law firms during the current year. In accordance with her CPA firm's normal operating practice, Little requests
> In an audit of the Marco Corporation as of December 31, 2011, the following situations exist. No entries have been made in the accounting records in relation to these items. 1. During the year 2011, the Marco Corporation was named as a defendant in a sui
> Elizabeth Johnson, CPA, has completed the audit of notes payable and other liabilities for Valley River Electrical Services and now plans to audit contingent liabilities and commitments. Required a. Distinguish between contingent liabilities and commitm
> Explain why the emphasis in auditing property, plant, and equipment is on the current period acquisitions and disposals rather than on the balances in the account carried forward from the preceding year. Under what circumstances will the emphasis be on t
> List one possible internal control for each of the six transaction related audit objectives for cash disbursements. For each control, list a test of control to test its effectiveness.
> The following questions concern information accompanying basic financial statements. Choose the best response. a. The Form 10-K filed by management of a public company includes a section on management's discussion and analysis (MD&A) in addition to the a
> The following questions concern communications between management, those charged with governance, and the auditor. Choose the best response. a. A principal purpose of a letter of representation from management is to (1) Serve as an introduction to compa
> The following misstatements are included in the inventory and related records of Westbox Manufacturing Company: 1. An inventory item was priced at $12 each instead of at the correct cost of $12 per dozen. 2. In taking the physical inventory, the last shi
> Describe matters that the auditor must communicate to audit committees of public companies.
> Distinguish between regular audit documentation review and independent review and state the purpose of each. Give two examples of potential findings in each of these two types of review.
