Review Note 1
The first review note required the change of dates in the entire work paper from X3 and X2 to the years in which the auditing was done. The present analysis was conducted for the financial years 2016 and 2017. To ensure that the requirements of the review note were met, the change from the first year in the work paper was changed with the first year in the actual analyze year. Similar process was done for the second year. In this case, all entries marked for X2 were changed to 2016 and those marked for X3 were changed X3 to fully close the review note. The closure to the review note was conducted on the assumption that auditing is done after one year from the closure of previous books of accounting.
Review Note 2
The second review required the correction of lack of equality in the value of gross account receivable amounts in the first and the second sheets, that is, AR – 100 and AR – 101 respectively. Wrong value for gross account receivables were entered in the second sheet which could be an error during the translation of entries. To fully close this review note, there was need to ensure that an efficient method is used to avoid errors in the transfer of values. The use of excel formulas was found the most efficient method to apply in this situation. In this regard, the gross account receivables in AR – 101 sheet was equated to the value in AR – 100 sheet. The method resulted in equal gross account receivable values in both sheets.
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Review Note 3
The objective of the review note was to perform additional substantive tests in order to confirm the values of the unconfirmed accounts receivable balances. The tests already performed involved tracing of the balances to the aging subsidiary journal. In order to successfully close the note, a review of the firm’s audit procedures was necessary. It was noted that the balances were unconfirmed due to the fact that their existence was not verified with original documents (Andiola, et al., 2018). In order to achieve the objective, the shipping addresses of the identified customers were requested from the account managers. Thereafter, confirmation requests were sent to the respective customers. The confirmations were then vouched against the current balances. The verification of the customer balance confirmations and the balances completed the existence tests and hence closed the review note.
Review Note 4
The review note request was to ensure that the sample selected for test of detail and control on the write-offs was correct. In order to achieve the objectives of the review note, the firm's procedures on sample selection were reviewed and used to determine whether the sample size selected was correct. From the review of procedures, it was observed that the sample for the test of detail was correct while that for the test of control required an additional ten samples owing to the population size (Andiola, et al., 2018). The additional sample participants were taken through the test of control to ensure that their existence was authorized and accurately calculated. Representation is based on the level of risk of a population. Higher levels of risk require larger sample sizes in order to identify. In this case, the increased population size noted an increase in risk level and hence requirement for larger sample representation. The verification of test of detail sample size and addition of samples to the test of control sample closed the review note.
Review Note 5
The objective of review note 5 was to ascertain the accuracy, completeness, and authorization of the write-offs. In order to achieve this, substantive tests on the written off amounts were conducted. This involved the determination of accuracy by verification of write off amounts against vouchers, determination of authorization by tracing the write-off memos to the respective section heads, and determination of completeness by tracing the write-offs from the write-off memos to the entry in the general ledger. The note was closed by ensuring the selected samples were vouched for accuracy, authorization, and completeness of record.
Review Note 6
The objective of review note 6 was to conduct additional tests in order to prevent misstatement of the written-off amount where the amount was considered immaterial. In order to close the review note, there was need to review the audit firm procedures which indicated that additional sampling tests to be conducted in cases of misstatement in order to ascertain the probability of misstatement recurring in the given area of misstatement (Andiola, et al., 2018). In order to achieve this, the goods returned accounts were identified as high risk of misstatement area and hence additional tests were ordered on the account. The objective was to determine whether the misstatement was as a result of error or a problem in the existing system. A sample was selected, from the goods returned journal, this were vouched for accuracy, completeness, and authorization. Accuracy determined whether the amounts returned reflected the value of the goods returned net of profits with which they were sold. Completeness investigated whether the items were properly and completely documented and ownership transferred properly, back to the client. Authorization determined whether the returns and refunds for goods returned were properly authorized by the personnel in charge of the activity.
Additional Audit Steps and Identification of Revision Issues
The procedures noted in the work papers present a complete audit experience which allow for the accurate completion of audit tasks while minimizing the likelihood of audit risks. However, absent from the process is the calculation of materiality and acceptable levels of risk. Each account and line item in the balance sheet has individual risks and materiality in relation to the nature of the business and the nature of the item within the financial system. As such, it is often prudent to calculate acceptable risk and materiality levels for individual financial statement line items (Moroney & Trotman, 2016) . This allows for the determination of specific sampling requirements which increase the effectiveness of sampling. As opposed to the generic automated sampling process used in the case, the use of specified risk and vulnerability assessments in sample size determination would more effectively reduce the likelihood of audit risks in the process. As a next step, the client’s policy regarding payment and credit days should be reviewed in order to determine whether there are proper controls that would reduce the risk of liquidity based on misalignment between the AR and AP cash flows. This would increase auditor’s confidence regarding the going concern nature of the business.
Critical Thinking Questions
Confirmation requires the auditor to ensure that the values of line items in the financial statements are free of error of misstatement and that ownership is with the client. In order to achieve this, PCAOB recommends the use of external evidence in order to ascertain existence of accounts receivable (PCAOB, 2018AS 2310). In this case, the recommendation is that the auditor should, with the consent of the client; communicate with the debtor in order to determine whether the amount stated at on the debtors end as the amount receivable is similar to the amount reported by the clients in their books of account. The PCAOB assumes this to provide a higher value of audit evidence than other sources of evidence in the confirmation process (PCAOB, 2018AS 2310). This is because, the nature of transactions is such that the, documentation of communication is transferred from a supplier to a purchaser. Accounting information reflects the nature of interaction between the business organization and the external business environment. In this case, the existence of an element represented in the internal environment, with similar representation in the external environment would offer material evidence on its existence. The assumption is that, the external party is less likely to benefit from failure of the audit process and hence their objectivity in presenting evidence is unquestionable (Islam, et al., 2018). As such, where confirmation is obtained from the external environment it is more likely reliable and objective than if it would originate from the internal financial environment.
Despite the heavy reliance on external evidence by PCAOB, there are instances where nonresponses results in the absence of external confirmation. In this case, the auditor has to rely on the internal evidence only. In order to reduce the level of audit risks, the alternative procedure requires the validation of internal evidence and application of such evidence to ensure that any discrepancy would not result in the reversal of the auditor’s report regarding the completeness and accuracy of the records (PCAOB, 2018 AS 2310). In the case study, reference to the documents of original entry was used to determine the existence of the amounts. The documents of original entry refer to communication between the client and the customer. This, were compared to other documents of original entry referring to similar transactions with different clients. The similarity between those documents and those of other responsive customers with similar transactions was assumed as evidence of validity of the internal evidence (Andiola, et al., 2018). Despite the strength of this evidence with respect to validity, the fact that they were internally generated and could have been altered to reflect other documents reduces the validity of the evidence. Additionally, in some cases, similarity is as a result of duplication errors which may still result in audit risks. However, of the different methods used, the application of customer correspondence bore the highest risk in the process. This is because; the termination of customer correspondence prior to finalization of the transaction may be an indication of failure of the transaction which increases the risk of existence assertion.
The financial statement assertions to which internal controls relate most closely to is are rights and obligations of the client. This is because they determine whether proper authority to create a right or obligation was applied (PCAOB, 2018 AS 2310). The revision of the audit plan recommended is the determination of disclosure of interests for the material items. This reduces the risk of misrepresentation of material amounts and the risk of internal fraud. Conflict of interest would occur where the authorizing personnel has a stake in the write-off of accounts and represents a fraud where such authority is issued by the same authority (Islam, et al., 2018). As such, the risk of misstatement of company receivables would increase if such measures are not put in place in the internal control system. The response to the changes in the risk would require the review of the company policy as regards conflict of interest disclosure, and the process of authorization of write-offs.
The financial statement assertions that the verification of returns most relates to is existence and completeness. Existence concerns with the presence of assets, while completeness concerns the expenses and liabilities (Andiola, et al., 2018). Sales returns create an obligation on the part of the company to refund payment where such payment has already been made and a reduction of profits where such goods were sold previously at a profit. As such, verification of the returns write-off is a verification of a loss to the company hence its existence and completeness must be verified. The testing performed was on the value at which the merchandize was sold to the customer inclusive of taxes and profits (Andiola, et al.,, 2018). This amount is different from the cost of merchandize returned to the client. As such, the total dollar amount of the exception would be the actual price of the merchandize less the cost of merchandize. This would give a representation on the amount of taxes reported and the profits. The effect of the exceptions on the amounts of receivable balance would be to reduce the accounts receivable balance by the value at which the merchandize was sold. The appropriate auditor’s response was to trace the returns of merchandize back to the inventory and to ascertain correctness of treatment of profits and taxes on the sale of the merchandize.
Following the collection of evidence, a report is written from the auditor’s representations of facts and findings. The auditor is required to document significant information and information of significant findings (PCAOB, 2018AS 1215). The responsibility of the auditor with regards to documentation is to offer evidence of significant issues that have either been concluded and how they were concluded, as well as evidence of issues that would result in the reversal of the auditor’s representation when they are clarified or concluded. The factors that would result in the characterization of findings or issues as significant include; the effect of materiality of the issue on the audit representations, issues that significantly affect or cause modification of audit procedure to accumulate, and issues that cause significant changes to risk materiality evaluations (PCAOB, 2018 AS 1215). Of the issues presented in the case, the one significant issue is the exception of sales returns write-off. This is because, while the value of the issue is not material, the issue resulted in modification of the audit procedures, and inferred an audit risk of misrepresentation which would result in changing of the audit report if such issue is concluded. As such, the issue is significant and additional documentation responsibility emerges.
References
Andiola, L. M., Lambert, T. A., & Lynch, E. J. (2018). Sprandel, Inc.: Electronic Workpapers, Audit Documentation, and Closing Review Notes in the Audit of Accounts Receivable. Issues in Accounting Education, 33(2) , 43-55.
Islam, M. A., Deegan, C., & Gray, R. (2018). Social compliance audits and multinational corporation supply chain: evidence from a study of the rituals of social audits. Accounting and Business Research, 48(2) , 190-224.
Moroney, R., & Trotman, K. T. (2016). Differences in Auditors' Materiality Assessments When Auditing Financial Statements and Sustainability Reports. Contemporary Accounting Research, 33(2) , 551-575.
PCAOB. (2018). AS 1215: Audit Documentation . Retrieved August 2018, from Public Company Accounting Oversight Board: https://pcaobus.org/Standards/Auditing/Pages/AS1215.aspx
PCAOB. (2018). AS 2310: The Confirmation Process . Retrieved August 2018, from Public Company Accounting Oversight Board: https://pcaobus.org/Standards/Auditing/Pages/AS2310.aspx
