Question

The BakFirn Corporation, a publicly traded firm, has contracted with YOUCPA, your public accounting firm, for an audit. The BakFirn Corporation manufactures specialty construction tools. The tools are used in the unique construction of homes, warehouses, and multiunit dwellings. The prices range from $1,000 to $5,000 per unit.

During the audit, the audit team has determined the risk assessment of the client. Consequently, the audit has to respond to the assessed risks of material misstatement at the financial statement and assertion levels. The YOUCPA audit team has asked you, the auditor, to prepare a list of actions that you will take to assess the audit risk.

The following information is available in the year just finished:

• The BakFirn Corporation end-of-year is 12/31/20XX.
• Sales for the previous year were $10,000,000. Sales this year are coming in at $9,500,000.
• The firm is in the construction machine industry, making specialty tools.
• Account receivable days sales outstanding (DSO) has been averaging 90–120 days. The year before, it was 80–90 days.
• Inventory turns have decreased from 3 to 2 per year.
• Account receivable and inventory make up 80% of total assets.
• Internal auditing has been reduced by one person to reduce costs.
• An initial test of controls in cash receipt indicated a lack of following procedures.
• The construction industry is in the third year of a downturn. It is forecasted to last two more years.
• The audit team has defined materiality to be focused on account receivable and inventory with $3,000 being the initial threshold. Net income for last year was $1,000,000.
• Inventory at the end of the year was $2,500,000.
• Account receivable at the end of the year was $2,740,000, or 100 DSO.
• The previous auditors did not disclose any fraud or any management issues at the meeting with BakFirn and YOUCPA. The reason for the auditor change was explained as a costs reduction program.

Audit Plan Evidence

1. Would you plan to put reliance on prior-year evidence? Why, or why not?
2. Would your evidence come from observation, analytical procedures, or other means? Explain your reasoning.
3. Would the evidence prove or disprove an assertion on the reliance of a specific balance sheet account or financial statement account? Explain your reasoning

Answer 1

Case scenario :

The BakFirn Corporation, a publicly traded firm . They are engaged into manufactures specialty construction tools. The tools are used in the unique construction of homes, warehouses, and multiunit dwellings.

Auditor has to do risk assessment of the client , assessed risk of material misstatement at the financial statement

Sales movement of current year Vs previous year are almost in same line approx $ 9.5 to $ 10 Mio , which is quite good .

Firm major challenge is Account receivable + Inventory management . Account receivable + Inventory cover almost 80% of total asset and also major part of working capital

Challenge is Account receivable ( DSO) has increased in current years as compared with last year . Inventory turnover decreased but not significant

Internal audit team member reduce to save cost . This is one of the open area that the reason for remove of Internal Audit staff .

As per current scenario , company made net Income $ 1 Mio ( % wise almost 10% ) . maintain 10% Net Margin is good for this type of company but still they remove Internal auditor to sve cost is not acceptable .

Present Auditor noticed that company having good amount of Inventory as well as Accoutn receivable balance . May be movement of Inventory is mot good but still company generating / accruing revenue of approx $ 10 Mio which is need to do more compliance test . Precious auditor doe not highlight any fraud and misstatement in financial records but they removed due to cost saving purpose .

Yes Present Audit firm has to do trend analysis , do comparative statement analysis of previous year and collect all relevant audit evidence form previous auditor to get an idea about companies financial health . To understand method used by previous auditor mean level of compliance and substantive testing they have done .Present Auditor need to collect audit evidence from previous auditor on special investigation relates to Account receivable + Inventory .

Auditor need to do complete transaction analysis , Ageing analysis of debtors + Inventory to ensure that company is following proper provision policy and adjusted in financial statement , otherwise Net income must be overstated .

Present Auditor definitely review Revenue recognition process adopted by Company because company havig high Inventory days bit still managing good amount of revenue YOY , need to ensure that company following correct accounting standard whole recognising revenue and not over/ understated . Special Area already highlighted as above like Debtors + Inventory transaction analysis ( as explained above)