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Audit Risk/Plan

Use the information below to answer the following questions:

A. Audit Assessment Steps:
a. What is the initial audit risk? High, medium or low?
b. What factors made you decide on this level?
B. Audit Plan Assertions
a. What would you include in the audit plan, and why?
b. Would you plan a test of controls or substantive tests? Why or why not?
c. Would these tests make a difference in the nature, timing, and extent of audit procedures? If so, how?
C. Audit Plan Evidence
a. Would you plan to put reliance on prior-year evidence? Why, or why not?
b. Would your evidence come from observation, analytical procedures, or other means? Explain your reasoning.
c. Would the evidence prove or disprove an assertion on the reliance of a specific balance sheet account or financial statement account? Explain your reasoning.

The BakFirn Corporation, a publicly traded firm, has contracted with YOUCPA, your public accounting firm, for an audit. The BakFirn Corporation manufactures specialty construction tools. The tools are used in the unique construction of homes, warehouses, and multiunit dwellings. The prices range from $1,000 to $5,000 per unit.

During the audit, the audit team has determined the risk assessment of the client. Consequently, the audit has to respond to the assessed risks of material misstatement at the financial statement and assertion levels. The YOUCPA audit team has asked you, the auditor, to prepare a list of actions that you will take to assess the audit risk.

The following information is available in the year just finished:

-The BakFirn Corporation end-of-year is 12/31/20XX.
-Sales for the previous year were $10,000,000. Sales this year are coming in at $9,500,000.
-The firm is in the construction machine industry, making specialty tools.
-Account receivable days sales outstanding (DSO) has been averaging 90-120 days. The year before, it was 80-90 days.
-Inventory turns have decreased from 3 to 2 per year.
-Account receivable and inventory make up 80% of total assets.
-Internal auditing has been reduced by one person to reduce costs.
-An initial test of controls in cash receipt indicated a lack of following procedures.
The construction industry is in the third year of a downturn. It is forecasted to last two more years.
-The audit team has defined materiality to be focused on account receivable and inventory with $3,000 being the initial threshold. Net income for last year was $1,000,000.
-Inventory at the end of the year was $2,500,000.
-Account receivable at the end of the year was $2,740,000, or 100 DSO.
-The previous auditors did not disclose any fraud or any management issues at the meeting with BakFirn and YOUCPA. The reason for the auditor change was explained as a costs reduction program.

Solution Preview

The following points are significant:
1. Account receivable days sales outstanding (DSO) has been averaging 90-120 days. The year before, it was 80-90 days.
2. Inventory turns have decreased from 3 to 2 per year.
3. Account receivable and inventory make up 80% of total assets.
4. Internal auditing has been reduced by one person to reduce costs.
5. An initial test of controls in cash receipt indicated a lack of following procedures.
6. The construction industry is in the third year of a downturn. It is forecasted to last two more years.

While the other factors are important, the above listed are crucial to this audit. #5 is the biggest problem, right from the start.

A. Audit Assessment Steps:
a. What is the initial audit risk? High, medium or low?

This is definitely a high risk audit. An auditor would never be able to justify this as being a low or medium risk audit. There are too many high risk indicators in the scenario. (see B)

b. What factors made you decide on this level?

#5 is a big problem. Based on #5 alone, an auditor can set the audit risk as high because a test of controls already indicated that proper procedures aren't being followed. In addition to this, we have several additional indicators that make this a high risk audit. A/R are taking longer to collect, which means that the company still needs to look good to banks and investors, giving an incentive to manipulate transactions, even though they're taking longer to collect on AR. Sales are slightly lower and this is coupled by the fact that sales in the industry are declining in general and this company makes specialty goods, which means they have a select, specialty market. Their goods can't be sold in wholesale or widely distributed, so their market is smaller, which means there is even a greater likelihood that their sales will decline further, making it an even higher risk audit. AR at the end of the year was 100 DSO; they're taking over three months to collect. This shows really inefficient credit and/or management practices. They're taking way too long to collect their money. This would concern us as auditors because it shows a lack of good, sound managerial practices. All of these points combined would definitely justify this as a high risk audit.

B. Audit Plan Assertions
a. What would you include in the audit plan, and why?

We would definitely want to test several ...

Solution Summary

A. Audit Assessment Steps:
a. What is the initial audit risk? High, medium or low?
b. What factors made you decide on this level?
B. Audit Plan Assertions
a. What would you include in the audit plan, and why?
b. Would you plan a test of controls or substantive tests? Why or why not?
c. Would these tests make a difference in the nature, timing, and extent of audit procedures? If so, how?
C. Audit Plan Evidence
a. Would you plan to put reliance on prior-year evidence? Why, or why not?
b. Would your evidence come from observation, analytical procedures, or other means? Explain your reasoning.
c. Would the evidence prove or disprove an assertion on the reliance of a specific balance sheet account or financial statement account? Explain your reasoning.

The BakFirn Corporation, a publicly traded firm, has contracted with YOUCPA, your public accounting firm, for an audit. The BakFirn Corporation manufactures specialty construction tools. The tools are used in the unique construction of homes, warehouses, and multiunit dwellings. The prices range from $1,000 to $5,000 per unit.

During the audit, the audit team has determined the risk assessment of the client. Consequently, the audit has to respond to the assessed risks of material misstatement at the financial statement and assertion levels. The YOUCPA audit team has asked you, the auditor, to prepare a list of actions that you will take to assess the audit risk.

The following information is available in the year just finished:

-The BakFirn Corporation end-of-year is 12/31/20XX.
-Sales for the previous year were $10,000,000. Sales this year are coming in at $9,500,000.
-The firm is in the construction machine industry, making specialty tools.
-Account receivable days sales outstanding (DSO) has been averaging 90-120 days. The year before, it was 80-90 days.
-Inventory turns have decreased from 3 to 2 per year.
-Account receivable and inventory make up 80% of total assets.
-Internal auditing has been reduced by one person to reduce costs.
-An initial test of controls in cash receipt indicated a lack of following procedures.
The construction industry is in the third year of a downturn. It is forecasted to last two more years.
-The audit team has defined materiality to be focused on account receivable and inventory with $3,000 being the initial threshold. Net income for last year was $1,000,000.
-Inventory at the end of the year was $2,500,000.
-Account receivable at the end of the year was $2,740,000, or 100 DSO.
-The previous auditors did not disclose any fraud or any management issues at the meeting with BakFirn and YOUCPA. The reason for the auditor change was explained as a costs reduction program.

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