AC 410 AC410 AC410 Unit 7 Homework Assignment

AC 410 AC410 AC410 Unit 7 Homework Assignment

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Questions Requiring Analysis 14-30

Early in your first audit of Star Corporation, you notice that sales and year-end inventory are
almost unchanged from the prior year. However, cost of goods sold is less than in the preceding
year, and accounts payable also are down substantially. Gross profit has increased, but this
increase has not carried through to net income because of increased executive salaries.
Management informs you that sales prices and purchase prices have not changed significantly
during the past year, and there have been no changes in the product line. Star Corporation relies
on the periodic inventory system. Your initial impression of internal control is that several
weaknesses may exist.

Suggest a possible explanation for the trends described, especially the decrease in accounts
payable while sales and inventory were constant and gross profit increased. Explain fully the
relationships involved.

For this question, you’ll need to look at the ratios presented and analyze the trends. What do the
trends mean?

Problem 14-38

The following are typical questions that might appear on an internal control questionnaire for
accounts payable.

1. Are monthly statements from vendors reconciled with the accounts payable listing?
Monthly statements from vendors should be reconciled to the payables ledger.

2. Are vendors’ invoices matched with receiving reports before they are approved for payment?
The two procedures are test controls that provides auditors the evidence to access control risk of
financial statements.

Required:

a. Describe the purpose of each of the above internal control activities.
b. Describe the manner in which each of the above procedures might be tested.
c. Assuming that the operating effectiveness of each of the above procedures is found to be
inadequate, describe how the auditors might alter their substantive procedures to compensate for
the increased level of the risk of material misstatement.
Questions Requiring Analysis 15-30

You are retained by Columbia Corporation to audit its financial statements for the fiscal year
ended June 30. Your consideration of internal control indicates a fairly satisfactory condition,
although there are not enough employees to permit an extensive separation of duties. The

company is one of the smaller units in its industry, but it has realized net income of about
$500,000 in each of the last three years.

Near the end of your fieldwork, you overhear a telephone call received by the president of the
company while you are discussing the audit with him. The telephone conversation indicates that
on May 15 of the current year the Columbia Corporation made an accommodation endorsement
of a 60-day $430,000 note issued by a major customer, Brill Corporation, to its bank. The
purpose of the telephone call from Brill was to inform your client that the note had been paid at
the maturity date. You had not been aware of the existence of the note before overhearing the
telephone call.

Questions Requiring Analysis 15-31

Valley Corporation established a stock option plan for its officers and key employees this year.
Because the options granted have a higher option price than the stock’s current market price, the
company has not recognized any cost for the options in the financial statements. However, a note
to the financial statements includes all required disclosures.

a. Do you believe that Valley’s management has appropriately accounted for the stock option
plan? Explain your answer.
b. What responsibility do the auditors have for the information in the notes to the financial
statements?
c. List the audit procedures, if any, which you believe should be applied to the stock option plan.