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Final Exam Fall 2015

ACCT 612 Auditing


Instructions
Name:

After you have downloaded this document from the Final Exam item in the Course
Content section, please save a copy of this document and rename it using your own name
as the file name so that I can keep them separate on my machine (i.e., "Jim Peters
Final.doc").

Type all your answers in this document.

Once you have completed the exam, submit your completed Word files by midnight
Saturday, 8/6. The exam is worth 20% of your final grade.

If you need clarification on the wording of any question on the exam, you can e-mail me or
call me at (505) 425-9999.

I will deduct percentage points for not following these instructions. For example, I will
deduct percentage points if you do not type your answers in this document and submit
some other type of file or if you do not attached your file to the assignment.

I have attached a spreadsheet file to the Final Exam assignment, which I refer to as a grading
checklist, with this exam. That spreadsheet file shows you how I have allocated percentage
points to questions. When grading your exams, I will fill in a copy of this file for each student
and return it with your graded exam. When I grade exams, I embed comments in the Word
documents to explain why I am deducting points, which is why I need you to submit your exams
as Word document.
Course Policy on Collaboration and Individual Work
This is an individual assignment and you are not to seek help from anyone else other than me.
I have engineered the test around the text and so you should not need to do any outside research.
However, if you chose use any outside sources, cite them to avoid a charge of plagiarism. By
cite, I mean be clear about exactly what material you took from what source and don't just
include a "Works Cited" section at the end of the test. This is inadequate. The text doesn't
qualify as an outside source and so you don't need to cite it nor do you need to cite any of my
solutions. Finally, I want all your answer to be stated in your own words. You are not allowed to
quote the text, my solutions, or any outside sources. Paraphrasing in your own words is fine, but
direct quoting is not allowed. Also, direct quoting even the text or my solutions without citation
is plagiarism.
Questions
1)

Joe Zebrowski was an internal auditor for a retail drug chain. He detected a computer
programmer who worked on the firm's accounts payable system stealing from the firm.
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The programmer had miss-programmed the portion of the program to truncate all cash
discounts instead of rounding them. That is, when the firm paid a bill within the vendor's
cash discount period, the program calculated the amount of the discount and then deducted
that amount from the amount of the check written to the vendor. These calculations rarely
came out to an even penny and the program should have rounded any amount for a half a
penny up to the next highest penny and dropped any amounts less than a half a penny from
the discount amount to round down to the next lowest penny. Instead, the programmer
programmed the system to always drop any partial penny from the amount and always
lower the discount amount to lower full penny.
Instead of being discarded, the programmer also had the program put them is a secret
storage location and let them accumulate. Once the amounts in the secret location reached
a certain level, the programmer would have the program write him an expense
reimbursement check for the accumulated amounts. He was able to access the program to
write himself a check because when he developed the program, he left a secret back door
into the program that bypass the account/password access control of the program.
Programmers worked in the home office and rarely had any reason to travel or incur
significant reimbursable expenses.
a)

b)

1)

Describe two internal control(s) that should have prevented this fraud and how each
control should have worked. Also discuss how the programmer might have been
able to circumvent the control even if it were in place and working properly. You
answer needs to be specific to the case. For example, if you believe segregation of
duties should have prevented the theft, you need to describe the segregation of
specific duties and how segregating those specific duties should have prevented the
fraud.
i)

Control #1 -

ii)

Control #2 -

Describe an audit test that the internal audit department might have used to detect the
fraud and explain how it would have detected the fraud.

Stephanie is auditing a major consumer products manufacturer. She is building her audit
plan and trying to determine her approach to auditing their ending inventory balance as
well as the long-term debt balance. Their inventory consists of a large number of items
that are similar in value. For a variety of reasons, she has assessed the inherent risk of the
inventory account as moderate to high. Her assessment of the design of internal controls
over inventory recording and valuation is that these controls are well designed and haven't
changed since she audited them last year and found they were working properly. However,
she has not retested the controls yet for this year.

Stephanie's auditee only has three major bond issues that make up the long-term debt
account balance. Each bond issue contains complex provisions like conversion features
and debt covenants. The three bonds differ in size and one of them alone makes up 50% of
the total balance.
The following questions cover all possible alternatives for testing the inventory and longterm debt balances and I have asked you to makes assumptions in them. Some of these
assumptions may be extreme and I realize that. I just want you to apply the basic
principles for testing to each question even if the assumptions involved are extreme.

2)

a)

Should Stephanie use a sampling technique to test their inventory balance? Why or
why not?

b)

Assuming she decided to sample the inventory, should she use statistical or nonstatistical sampling? Explain your answer.

c)

Assuming she decided to use statistical sampling to test the inventory, should she use
Monetary Unit Sampling or Variables Sampling?. Explain your answer.

d)

Should she use a sampling technique to test their long-term balance? Why or why
not?

e)

Assuming she decided to sample the long-term debt account, should she use
statistical or non-statistical sampling? Explain your answer.

f)

Assuming she decided to use statistical sampling for the long-term debt account,
would she use Monetary Unit Sampling or Variables Sampling? Explain your
answers.

Jake Jones is auditing an ending inventory balance. He obtained a complete listing of


every item that made up the ending inventory balance from the auditee's subsidiary
inventory ledger. The listing included the number of items is inventory, the cost per unit
assigned to each item, and the extended cost (cost times quantity). At the same time that
the auditee took its physical count of the items in ending inventory, he selected a sample of
items from the listing and performed his own count of the number of that item in ending
inventory. He then compared his count to the auditee's count and noted any differences in
his working papers.
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Then he obtained he used the costs in the listing and verified those cost to purchase
invoices from the vendors. Finally, he multiplied the number in his count by the invoice
costs and compared the resulting amount to a listing that the client had provided that
included their totals for each item. He traced the total of their listing to their general ledger
account.
a)

b)

c)

3)

For each of the following tests he performed, describe the purpose of the test to
include all the audit objective(s) involved. Be sure to explain how the test supports
each objective.
i)

Counting the items in inventory

ii)

Verifying the costs per item

iii)

Tracing the total to the general ledger

When Jake ran his inventory tests as described above using a statistical sampling
technique, he found differences in the inventory recorded cost that totaled to more
than your tolerable misstatement. Discuss what alternatives he has to address this
difference and how each alternative might compensate for or correct the sample
results he found.
i)

Alternative 1

ii)

Alternative 2

iii)

Alternative 3

iv)

Alternative 4

Discuss which how Jake should order these alternatives and why. That is, which
alternative should he try first, second, third, and fourth and why?

The following is a list of misstatements that might be found in a year-end account balance.
For each:

state the audit objective(s) that was violated because of the error and why;
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describe one control activity that might have detected or prevented the misstatement;

and describe a test of balance audit procedure that auditors might use to find it.
Make sure you answers are sufficiently detailed to be clear about how the error violated the
audit objective and how each internal control or testing procedure would detect the error.
Assume in all cases that the auditee's controller prepares regular bank reconditions.
a)

b)

c)

An accounting clerk omitted a check from the outstanding checklist on the year-end
bank reconciliation. The check cleared a week after year-end.
i)

Audit objective(s) violated -

ii)

Internal control -

iii)

Test of balance -

The auditee's bank credited the auditee's bank account four days before year-end
with cash received from a loan the auditee had secured. However, the loan was not
shown as outstanding on the year-end financial statements and the cash proceeds
from the loan were not included firm's ending cash balance.
i)

Audit Objective(s) violated -

ii)

Internal control -

iii)

Test of balance -

The auditee had factored without recourse a little over 50% of their ending accounts
year-end accounts receivable balance. "Factoring" is when a firm sells its accounts
receivable to another firm, usually a financial institution. "Without recourse" means
that the purchasing firm cannot return the receivables to the selling firm if they can't
collect them. Thus, full title to the receivables has passed to the purchasing firm.
However, these accounts still showed in the auditee's ending accounts receivable
balance. Note that auditee does not notify the customer who owed the account to the
auditee that their account has been factored and the selling firm merely forwards
receipts on factored accounts to the purchasing company.
i)

Audit Objective(s) violated -

d)

4)

ii)

Internal control -

iii)

Test of balance -

The auditee's ending accounts payable balance excluded a significant number of


amounts due vendors that created a materially understated in accounts payable.
i)

Audit Objective(s) violated -

ii)

Internal control -

iii)

Test of balance -

Your audit of AJAX, Inc., a public company registered with the SEC, followed the
following timeline of events. Assume that all events are material to the financial
statements taken as a whole.

AJAX's fiscal year ended 12/31/2013.

Event 1 - On 1/15/14 AJAX's management informed you that a major competitor had just
introduced a new product that made a substantial portion of their inventory obsolete and
only resalable for a fraction of the cost shown on the balance sheet as of 12/31/13.

Event 2 - On 2/25/14 AJAX sold the line of business that produced that obsolete inventory
items to another firm. The sale represented approximately 25% of AJAX's product line.

You completed your fieldwork and dated you audit report as of 3/1/14.

AJAX distributed their financial statements and your report on 3/15/14.

Event 3 - On 4/1/14 AJAX's internal audit department contacted you to tell you that they
had discovered massive fraud that their CFO had perpetrated during 2013 that led to a
material overstatement of the firm's accounts receivable and sales as of 12/31/2013. These
errors were clearly material to the financial statements taken as a whole.
Describe what actions you would need to take, if any, based on each of the three labeled
events. Be complete and describe any changes you would require in AJAX's financial
statements for 2013, your audit report for 2013, and any additional actions, if any, required
by GAAS. Also, justify your selections by stating why you would take them based on the
type of each event.
a)

Event 1 6

5)

b)

Event 2 -

c)

Event 3 -

One of the final audit procedures for any audit is to obtain letters from the auditee's
attorneys.
a)

Why do auditors require attorney's letters? What potential financial reporting issue
are they testing?

b)

Who requests the letters from the attorney and why?

c)

Why might attorneys resist providing the information needed by the auditor?