Risk identified Classification of risk

Solution to Question 1

1. a) Risk identified Classification of risk
2. Accounting for work-in-process inventory is complex. Inherent risk (account specific)
3. Management rarely intervenes in the estimate and allocation process done by Ellen. Control risk
4. The accounting information system used by TDA is out of date. Control risk
5. The cost of Aluminum can fluctuate. Inherent risk (business)

1. b) Potential misstatements of the financial statements due to risks identified above: The work-in-process inventory could be incorrectly valued as an incorrect amount of labour and overhead was allocated to it. • An error in valuation of the work-in-process (WIP) and finished goods inventory would result in incorrect balances of the various inventories and would also translate to an error in the gross margin and COGS for a given period.  o The error could be due to the complexity in understanding the accounting standard and understanding what is an eligible cost to capitalize as part of WIP; OR o There could be an error (intentional or not) made by Ellen. As no one currently appears to be reviewing her work, this error would likely be undetected.  • The outdated accounting system not only poses a risk that the inventory is reported incorrectly but it also poses a risk that all balances reported from the system contain a misstatement. • The volatile aluminum price poses a risk on the valuation of all inventory balances (raw material, WIP, and finished goods). If the aluminum price drops significantly, a possible impairment of raw material could exist. This would then affect WIP and finished goods as well.

Solution to Question 2

If the sample error is $75,000, it would not be appropriate to conclude that sales are misstated by the same amount, because this error was discovered in a sample of sales invoices. In this case, the total number of sales invoices in the sample and the total number of sales invoices in the population are not disclosed, so an estimate of the projected error cannot be made. However, to make the estimate, the auditor would consider the size of the error in relation to the sample size (sample error/sample size), and then the sample error rate in relation to the population size (by multiplying sample error/sample size by the population size). The auditor would also consider whether the population was stratified before sampling.    The auditor must consider whether an error is likely to be unique/isolated and thus not likely to be repeated throughout the population being tested.

Solution to Question 3

• Setting the audit risk helps plan how much effort needs to be placed in collecting evidence and providing due diligence.
• Audit risk also guides and shows how much risk the auditor is willing to accept that even after the audit and providing a standard unmodified opinion, the financial statements may contain material misstatements.
• The lower the audit risk is set at (per the audit risk model), the more evidence will need to be gathered and evaluated. It assists in setting the tone for the entire audit as well. Therefore, it needs to be set before the audit can begin. • Setting materiality establishes the amount that the auditor considers material. Therefore any error equalling and/or totalling up to the material amount must be adjusted before an unmodified opinion can be issued. This amount helps the team to plan how many transactions to test and the amounts to test for.
• Materiality also helps plan the types of tests, amounts, and sampling criteria. Setting the tolerable misstatement helps the audit team decide whether to accept a tested sample as acceptable or not. Therefore, it needs to be set before the audit can begin.
• Reviewing the prior year’s audit files to determine changes assists the audit team in determining any new risks that could exist because of the changes. By assessing new risks, the audit team can plan the tests that will help determine if they exist and need to be corrected in any way.
• If the audit team is not aware of changes and the new risks that may be introduced to the company are not identified, it could cause material misstatements in the financial statements and/or risk the future of the organization under audit. Therefore, the review needs to take place before the audit can begin.

Solution to Question 4

The auditor is responsible for maintaining professional skepticism throughout the audit, for considering the potential for management override of controls, and for recognizing that audit procedures that are effective for detecting errors may not be effective for detecting fraud.

The auditor is responsible for responding appropriately to fraud or suspected fraud identified during the audit by communicating to those charged with governance.  Two types of fraud are misappropriation of assets and fraudulent financial reporting.

Solution to Question 5

In general, the auditor would want to include the following points in her discussion with Bill and John:

• ASI is experiencing fast and unprecedented growth that Bill cannot keep up with in the credit process; therefore, change is required to accommodate the growth.
• Bill is getting to retirement age, and ASI needs to redesign the credit process to a stage where it does not depend so much on Bill’s or any other individual staff member’s involvement. • Bill is also responsible for job costing and purchasing office supplies, which occupies his time and reduces the amount of time he can devote to credit. Therefore, errors may be occurring in multiple areas.
• Automating the credit process will speed up the credit approval and activation activities, provide immediate detection of orders that exceed the current credit limit and provide immediate feedback to the credit manager for attention, eliminate tedious manual filling out of paper documents that must be routed around the office and then filed, and provide instant and up-to-date information on any customer in the system. • Automating the credit process will eliminate human error that creeps into any manual system and ensure continuity of process and results. • Automating the credit process will allow continuity of the process and will avoid any opportunity for the company to be impacted by the absence of one individual.

Solution to Question 6

1. a)

A three-party relationship exists Yes Accountable party: Lauren and Nook Practitioner: Independent auditor User: Government grant program officials

Appropriate subject matter exists An appropriate subject matter exists. The operations of Nook for the past year would constitute a subject matter.

A suitable criteria exists Yes, a suitable criteria exists. The government guidelines would be used as the suitable criteria.

A conclusion can be provided Yes, the auditor could provide a conclusion that Nook has complied / not complied with the government guidelines for a given year.

1. b) A review would provide negative assurance and confirm that it is plausible that Nook has complied with the government guidelines.

This would require less work and be less costly for Nook; however, the extent of the work done would be less than an audit.

An audit would provide a higher level of assurance than a review and conclude that it is reasonable to conclude that Nook has complied with the government guidelines.

As the outcome of the assurance report will result in a large sum of money being disbursed by the government, it would be preferable to conduct an audit in order to provide a higher level of assurance.

1. c) Examples of procedures include: •

Obtain a list of all children enrolled in Nook’s preschool for the year. Verify the enrolment form of each child to confirm that the child is aged between 2.5 and 5 years.

• Verify the attendance records and enrolment form for each child claiming the grant and verify that the child attended Nook’s preschool program for a 10-month consecutive period. • Obtain and observe an original document (tax return, driving licence, health card) for the guardian of each child claiming the grant and verify that the principal address is a Canadian address to confirm the permanent residence status.
• To confirm the 6:1 ratio of students to educators, obtain the enrolment records and payroll summary for the past year. Calculate the number of kids attending the preschool and compare to the number of educators working in the same period.
• To confirm that each educator has the relevant ECE degree, examine employment records of each educator to confirm their education and background contains an ECE degree from a university or college.

Solution to Question 7

Control 1  Category: Authorization  Purpose: To ensure orders and purchases are properly authorized by staff with the appropriate level of seniority.  Test: Select a sample of expenses from the general ledger, trace to the PR documents, and examine them to verify they have been signed by the designated individual.

Control 2  Category: Physical controls  Purpose: To safeguard the physical security of the company’s documents and records.  Test: Select a sample of expenses from the general ledger, trace to the PR and PO documents, and examine them to verify they match.    Control 3  Category: Segregation of duties  Purpose: Segregation of the authorization function helps prevent and detect errors and fraud, as a different individual is responsible for ensuring PRs are authorized.  Test: Select a sample of expenses from the general ledger, trace to the PR documents, and examine them to verify that the purchasing manager has approved them.

Control 4  Category: Authorization  Purpose: To ensure buyers are not buying from vendors that do not operate at arm’s length from the buyer and to ensure that the vendor exists.  Test: Select a sample of expenses exceeding $10,000 from the general ledger and trace to the PO documents. Examine the POs to verify that those over $10,000 are sent to a preauthorized vendor.

Control 5  Purpose: To ensure all capital assets owned by the company are tracked and that depreciation is consistently and accurately recorded.  Test: Recalculate depreciation based on the company’s depreciation policy. Trace a sample of tagged numbers to the actual asset (Existence) and a sample of assets to the ledger (Completeness). Computer-assisted auditing techniques may also be used to efficiently check the depreciation calculation.