(Assertions) In planning the audit of a client’s financial statements, an auditor identified
the following issues that need audit attention.
1. The allowance for doubtful accounts is fairly presented in amount.
2. All accounts payable owed as of the balance sheet date are included in the financial
statements.
3. All purchase returns recorded in the general ledger are valid.
4. There is a risk that purchases made in the last week of the month might be recorded in
the following period.
5. The client may have factored accounts receivable.
6. The client has used special-purpose entities to finance a building. Neither the building
nor the debt is included in the financial statements.
7. A retail client values its inventory using the retail method of accounting.
8. A construction client uses the percentage of completion method for recognizing revenues.
9. A client has a defined benefit pension plan and does not have competent employees to
write footnote disclosures.
10. A client acquired a subsidiary company and paid a high amount of goodwill when the
stock market, and resulting values, were at all-time highs.
11. A client financed the acquisition of assets using preferred stock that pays a 3 percent
dividend and must be redeemed from the shareholders next year.
Required
Identify the assertion for items 1 through 11 above.
(Audit evidence) During the course of an audit, the auditor examines a wide variety of
documentation. Listed below are some forms of documentary evidence and the sources
from which they are obtained.
1. Bank statement sent directly to the auditor by the bank.
2. Creditor monthly statement obtained from client’s files.
3. Vouchers in client’s unpaid voucher file.
4. Duplicate sales invoices in filled order file.
5. Time tickets filed in payroll department.
6. Credit memo in customer’s file.
7. Material requisitions filed in storeroom.
8. Bank statement in client’s files.
9. Management working papers in making accounting estimates.
10. Paid checks returned with bank statement in (1) above.
11. Letter in customer file from collection agency on collectibility of balance.
12. Memo in customer file from treasurer authorizing the write-off of the account.
Required
a. Classify the evidence by source into one of four categories: (1) directly from outsiders, (2)
indirectly from outsiders, (3) internal but validated externally, and (4) entirely internal.
b. Comment on the reliability of the four sources of documentary evidence.
(Understanding the entity and its environment) You have just been assigned as in-charge
accountant on HipStar, Inc. a new audit client in the recording industry. HipStar is an
emerging growth company that finds new recording artists, records their music, and distributes
the music directly to consumers exclusively over the Internet. The company does
not produce CDs or tapes and does not distribute the artist’s music through traditional distribution
channels. In order to better understand HipStar, you have set out to understand
the following:
1. Industry conditions
2. The regulatory environment
3. Other external factors affecting the business
4. The entity’s business operations
5. The entity’s investing activities and financing activities
6. The entity’s financial reporting activities
7. The entity’s objectives, strategies, and related business risks
8. How the entity measures and reviews its financial performance.
Required
For each of these eight categories (1) describe the knowledge and understanding you want
to obtain about HipStar to develop a knowledgeable perspective about the entity and (2)
identify how this knowledge might assist in assessing the risk of material misstatement.