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Auditing: Analytical procedures, assessing internal control

8-15 (Analytical procedures)
In audit planning the audit of Construction Industry Resources, Inc., a building supply company. You have completed analytic procedures relevant to purchases and inventory. The results of these procedures are included in Figure 8.13.

Figure 8.13. Selected Financial Information ($000)
(see attachment for figure)

Analytical procedures show that inventory turnover decreased from 31-34 days to 27 days, and gross margins declined to the lowest level in five years. What might this indicate about the risk of misstatement with respect to inventory and inventory purchases?

8-16 (Analytical procedures)
In audit planning the audit of Circuits Technology, Inc. (CTI). CTI resells, installs, and provides computer networking products (client software, gateway hardware and software, and twinax hardware) to other businesses. Figure 8.14 provides some summary information from CTI's financial statements.

Figure 8.14. CTI Selected Financial Information ($000)
(see attachment for figure)

1. Calculate purchases, gross margin, inventory turn days, accounts receivable turn days, and accounts payable turn days for the years ended 20x2, 20x3, 20x4, 20x5.
2. Describe the trends identified by performing analytical procedures in the gross operating cycle, the net operating cycle, and gross margin.
3. If tolerable misstatement is $45,000 for inventory, develop an expectation range for inventory turn days.
4. With respect to inventory, what might these trends indicate about the potential misstatement in inventory?

10-31 (Components of internal control)
The chapter identified five components of internal control. Listed below are specific control policies and procedures prescribed by Suntron Company.

Management gives careful consideration to the requisite knowledge and skills personnel need at all levels of the organization.
General controls and application controls are established in the electronic data processing department.
Management acts to reduce or eliminate incentives and temptations that might lead individuals to engage in dishonest or illegal acts.
Management is alert to complaints received from customers about billing errors.
Management gives special consideration to the risks that can arise from the use of information technology in the accounting system.
Employees' responsibilities are assigned so as to avoid any individual's being in a position to both commit an error or irregularity and then conceal it.
IT management has designed controls to prevent unauthorized use of IT equipment, data files, and computer programs.
The processing of payroll includes a check on the total number of hours submitted. If more than 65 hours are reported in a weekly pay period, the transaction is printed on an exception report and put in a suspense file for additional review or additional authorization.
Suntron's internal audit staff periodically assesses the effectiveness of various ICS components.
Policy manuals, accounting and financial reporting manuals, and a chart of accounts have been developed and implemented.

Identify the components of internal control to which each policy or procedure relates.
For each item, identify one other policy or procedure for that internal control component that is not on the preceding list.

10-32 (Components of internal control)
Internal controls can be categorized using the following framework.

Control environment
Risk assessment
Information and communication
Control activities
4.1. Authorization
4.2. Segregation of duties
4.3. Information processing controls
4.3.1. Computer general controls
4.3.2. Computer application controls
4.3.3. Controls over the financial reporting process
4.4. Physical controls
4.5. Performance reviews
4.6. Controls over management discretion in financial reporting

Monitoring
Antifraud programs and controls

Following is a list of controls prescribed by Waterfront, Inc.

Management has established a code of conduct that includes rules regarding conflicts of interest for purchasing agents.
Waterfront has established a disclosure committee to review the selection of new accounting policies.
Any computer program revision must be approved by user departments after testing the entire program with test data.
The managers of each of Waterfront's manufacturing departments must review all expenditures charged to their responsibility center weekly.
The CEO, CFO, and controller review the financial consequences of business risks annually to ensure that controls are in place to address significant business risks.
Human resources focuses on ensuring that accounting personnel have adequate qualifications for work performed in billing and accounts receivable.
Security software limits access to programs and data files, and keeps a log of programs and files that have been accessed, which is then reviewed by the security manager daily.
A computer program prints a daily report of all shipments that have not yet been billed to customers.
The controller reviews sales and collections bimonthly.
The computer compares the information on the sales invoice with underlying shipping information.
Customer billing complaints are directed to internal audit for follow-up and resolution.
The documentary transaction trail for all credit sales is documented in company policy manuals.
A committee of the board of directors evaluates and monitors business risks.
Access to spreadsheets used in the financial reporting process is limited and spreadsheets are tested with test data on a quarterly basis.

Indicate the category of internal control applicable to each procedure using the framework above.
Identify an assertion to which each procedure pertains (some procedures may have a pervasive impact on multiple assertions).

11-21 (Assessing control risk)
An auditor is required to obtain a sufficient understanding of each of the components of an entity's system of internal control to plan the audit of the entity's financial statements and to assess control risk for the assertions embodied in the account balance, transaction class, and disclosure components of the financial statements.

1. Explain the reasons an auditor may assess control risk at the maximum level for one or more assertions embodied in an account balance.
2. What must an auditor do to support assessing control risk at less than the maximum level when the auditor has determined that controls have been placed in operation?
3. What should an auditor consider when seeking a further reduction in the planned assessed level of control risk?
4. What are an auditor's documentation requirements concerning an entity's system of internal control and the assessed level of control risk?

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8-15
(Analytical procedures) In audit planning the audit of Construction Industry Resources, Inc., a building supply company. You have completed analytic procedures relevant to purchases and inventory. The results of these procedures are included in Figure 8.13.

Figure 8.13. Selected Financial Information ($000)

X1 X2 X3 X4 X5
Building supply revenues $ 90,100 $ 99,380 $ 117,468 $ 137,085 $ 160,800
Lumber brokerage revenues $ $ — $ 45,021 $ 63,480 $ 90,141
$ 90,100 $ 99,380 $ 162,489 $ 200,564 $ 250,941
Inventory turn days
Building supplies 32 34 31 33 27
Lumber brokerage 7 6 6
Gross margin
Building supplies 20.1% 18.5% 18.6% 19.1% 18.0%
Lumber brokerage 3.9% 4.1% 4.2%

Required
Analytical procedures show that inventory turnover decreased from 31-34 days to 27 days, and gross margins declined to the lowest level in five years. What might this indicate about the risk of misstatement with respect to inventory and inventory purchases?

Turnover is COGS / average inventory = turns (convert to days with 365/turns). So, anything that increases COGS higher will increase days in inventory. Anything that decreases inventory will also increase days in inventory.

Examples:
COGS of $100 / Inventory of 10 = turns of 10 or 365/10 = 36.5 days
COGS of $200 / Inventory of 10 = turns of 20 or 365/20 = 18.25 days
COGS of $100 / Inventory of 5 = turns of 20 or 365/20 = 18.25 days

So, inventory might be understated and the COGS may be overstated.
Another risk is that sales have dropped over the year and so COGS is higher for the full year compared to lower sales/inventory at year end.

With respect to purchases, it is possible that purchases are double counted, leading to both lower days in inventory and higher COGS (lower margins).

Inventory may also be stolen causing lower inventory and higher COGS.

Your discussion is 155 words and shows you how to interpret the inventory days and gives several ideas of misstatement risks in inventory and purchases. 
8-16
(Analytical procedures) In audit planning the audit of Circuits Technology, Inc. (CTI). CTI resells, installs, and provides computer networking products (client software, gateway hardware and software, and twinax hardware) to other businesses. Figure 8.14 provides some summary information from CTI's financial statements.

Figure 8.14. CTI Selected Financial Information ($000)

20x1 20x2 20x3 20x4 20x5
Accounts receivable, net $ 837 $ 1,335 $ 1,121 $ 962 $ 822
Inventory $ 1,025 $ 1,327 $ 1,099 $ 1,003 $ 1,027
Accounts payable $ 164 $ 380 $ 225 $ 201 $ 175
Sales $ 3,780 $ 5,638 $ 4,623 $ 4,022 $ 3,905
Cost of sales $ 1,812 $ 2,691 $ 2,399 $ 2,095 ...

Solution Summary

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