5-52 Trend analysis, common-size financial statements, and ratios are presented for the Brody Corporation in Figure 5. 4. Assume that you are auditing Brody’s financial statements for the year ended 12/31/X8. You have performed tests of controls over the recording of gross sales and believe that the system is operating effectively and that 7 percent represents an accurate estimate of the increase in gross sales for 20X8 over the amount for 20X7. You should also assume that the financial statements for 20X6 and 20X7 are not misstated.
Required a. | | Analyze Figure 5. and identify any accounts that appear to represent significant variations from what one might expect. For each of the accounts, identify another account that might also be out of line due to the manner in which the double-entry bookkeeping system records transactions. Financial statements produced under the cash basis of accounting cover cash receipts plus receivables within a specified period from the end of the period (complementary period); cash disbursements plus payables within a specified period from the end of the period (complementary period).
Some countries that use the cash basis of accounting for their budget operations also produce financial statements under a modified accrual basis (e. g. , France, Spain). The modified accrual basis of accounting (sometimes called “expenditure basis”) recognizes transactions and events when they occur, irrespective of when cash is paid or received. However, there is no deferral of costs that will be consumed in future periods. Physical assets that will provide services in the future are “written off” (or “expensed”) in the period acquired.
Full accrual and modified accrual accounting therefore have the same accounting framework. The major difference lies in the time between the acquisition of goods and assets and their utilization. Under modified accrual accounting, supplies are considered consumed and assets are written off as soon as they are acquired. Under full accrual accounting, changes in inventories are recognized and assets are progressively depreciated according to their useful life. An overriding principle of full accrual accounting is the matching principle whereby expenses are recorded in the same period as the related revenues are recognized. b. Identify any ratios that appear to represent significant variations from what one might expect. For each ratio, identify the financial statement account or accounts that may be misstated. Analytical procedures are an important part of the audit process and consist of evaluations of financial information made by a study of plausible relationships among both financial and nonfinancial data. Analytical procedures range from simple comparisons to the use of complex models involving many relationships and elements of data.
A basic premise underlying the application of analytical procedures is that plausible relationships among data may reasonably be expected to exist and continue in the absence of known conditions to the contrary. Particular conditions that can cause variations in these relationships include, for example, specific unusual transactions or events, accounting changes, business changes, random fluctuations, or misstatements. Understanding financial relationships is essential in planning and evaluating the results of analytical procedures, and generally requires knowledge of the client and the industry or industries in which the client operates.
An understanding of the purposes of analytical procedures and the limitations of those procedures is also important. Accordingly, the identification of the relationships and types of data used, as well as conclusions reached when recorded amounts are compared to expectations, requires judgment by the auditor. | 5-57You are the partner on the audit of Datasave, Inc. , a small publicly held corporation that manufactures high-speed disk drives for the computer industry. The audit of Datasave had been progressing satisfactorily until you were about a month away from issuing your opinion.
Suddenly, and quite mysteriously, Carl Wagner, the financial vice president, resigned. John Ross, who had been a manager with a large CPA firm, was quickly hired to replace Wagner. Although the change in Datasave’s chief financial officer caused some disruption, the audit was completed on a timely basis. As the last step in the audit process, you have prepared the representation letter for signing. You wanted the letter to be signed by William Cox, the president; Robert Star, the controller; and Wagner, who occasionally came to the company’s offices to resolve matters regarding his past compensation.
The signatures of Cox and Star were obtained, and you approached Wagner for his signature. In response to your request, Wagner replied, “I no longer am employed with this crazy company. Why should I take any responsibility for the financial statements? ” Despite your attempts to persuade him, Wagner refused to sign the letter. Wagner also refused to discuss the reasons for his resignation, other than to say the reasons were personal. When you discussed the problem of Wagner’s refusal to sign with Cox, he indicated that there was no problem because Ross would sign the letter.
You see this as a possible solution, but you are aware that Ross knows very little about the financial statements for the year under audit. Also, you are still somewhat concerned about the reasons for Wagner’s resignation. Required: a. Describe fully the alternatives that are available to you in this situation. Making a decision implies that there are alternative choices to be considered, and in such a case we want not only to identify as many of these alternatives as possible but to choose the one that (1) has the highest probability of success or effectiveness and (2) best fits with our goals, desires, lifestyle, values, and so on.
Decision making is the process of sufficiently reducing uncertainty and doubt about alternatives to allow a reasonable choice to be made from among them. This definition stresses the information-gathering function of decision making. It should be noted here that uncertainty is reduced rather than eliminated. Very few decisions are made with absolute certainty because complete knowledge about all the alternatives is seldom possible. Thus, every decision involves a certain amount of risk.
If there is no uncertainty, you do not have a decision; you have an algorithm–a set of steps or a recipe that is followed to bring about a fixed result. b. Express your personal opinion as to the appropriate course of action and provide reasoning to support your opinion. Making an argument through analogy involves comparing two objects s(events, situations, people, and the like) and arguing that, because they are similar in some way, a similar action should occur in both situations.
The person making this claim begins with the premise that one situation – giving books away – is wrong, and argues that a second situation – returning them to the bookstore – is analogous to the first situation. These premises are used to justify taking a similar action in both cases. Analogies are important to one’s argument, but it is all too easy to apply one situation improperly to another. One must determine the similarity between two situations and, once this similarity is found, one must ask if this similarity is the important and relevant similarity. | | | | | | |
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