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Auditing Problem: ethical dilemma and completion procedures

Sue and John Brown are the owners of a gas and convenience store with a coffee and donut area along a busy highway near Wawa, Ontario. They have a mortgage with RBC for $650,000 and an operating line of credit for $200,000. In the past, the business has serviced the debt and produced a reasonable return on the investment.

RBC requires audited annual financial statements as part of the terms for the mortgage and line of credit. Cash flow has been tight as the highway has been under construction and traffic has reduced accordingly. Sue and John have therefore applied for an increase in their line of credit, as they feel the reduction in revenue is only short term.

George Pylie, Public Auditor has completed the audit since the Browns started in business. Some interim testing of controls was completed during August. The year end is November 30. George had a massive heart attack and died December 14. Anne Sullivan is the successor of George's practice. In working with George, she learned that he was extremely careful in obtaining evidence. She initiated the work to complete the file on January 12 for the due date at RBC of January 31. She familiarized herself with the client, noting that there are many regulations governing this industry.

Regulations over fuel sales state the fuel must be sold temperature compensated and must be reconciled daily. Since temperatures can fluctuate drastically throughout the year, it is very important that controls are in place to ensure the inventory of fuel is accurately recorded at year-end.

Anne notes that the documentation to ensure adequate fuel reconciliations is incomplete. George tested many of the reconciliations for August and found several errors as Sue often rushed through her daily reconciliations in order to complete them before the evening staff arrived. He had also recorded that further testing of the reconciliations was necessary for November 30, but there were none at, or near this date. Anne contacts Sue to obtain fuel reconciliations dated near November 30. Sue responds that she submitted all the documentation to George. She also indicates that she would like to meet with Anne very soon as John has been recently diagnosed with cancer. The prognosis is good, but Sue fears that RBC will not increase the line of credit. She would like to meet with Anne on January 25, the day after tomorrow.

Anne searches through the rest of the boxes of records and locates a handwritten note by George. It was dated December 10, and states that in carrying the boxes into the office, the lid loosened and many of the records were windswept away. Anne realizes that it will be very time consuming and costly in order to reconstruct these records.

Required:

a) Describe how this is an ethical dilemma for Anne and what she should do to resolve it.

b) Discuss 5 most important procedures that Anne must carry out in completing the final phase of this audit.

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The ethical dilemma faced is whether Anne should disclose the loss of evidence needed for testing the controls over the accuracy of inventory calculations. Yes, she should, and the reason she should is that her workpapers may not stand up to scrutiny in the future without the completion of testing. Second, she must ask the client to re-create the missing data with a valid reason for having to make the request. Honesty seems to be the best policy in this set of circumstances.

With the re-created data and having performed the additional tests, Anne will then have to decide whether she is satisfied that the internal control procedures are adequate to ensure the inventory of fuel is accurately recorded at year-end. If not, she may have to expand testing. Based upon results of testing, Anne will make a determination of whether the inventory amounts are reasonable and within tolerable materiality guidelines.

As a result, she may have a decision regarding the ...

Solution Summary

The 600 word solution comments on Anne's ethical problem and how it might be solved including two reasons for the conclusion. Then the procedures for completing the audit are discussed in detail as they relate to this particular situation. The entire response is couched in terms of US auditing procedures which are presumed to be very similar to Canadian auditing.

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