Question

EZ Furniture Wholesalers, Inc.

You are a staff auditor with BLB CPAs. BLB CPAs has been retained to perform the audit of the fiscal year 2019 by EZ Furniture Wholesalers, Inc. EZ Furniture Wholesalers, Inc. has been a client of BLB CPAs for several years. You are auditing the allowance for doubtful accounts and have concerns about some contradictory evidence. Background Information EZ Furniture Wholesalers, Inc. reserves for its allowance for doubtful accounts based on standard reserve percentages supported by historical collection experience. Management uses the same process for estimating the allowance for doubtful accounts (the “reserve”), as it did in the prior year. As part of its risk assessment procedures, the engagement team identified the following risk of material misstatement related to the valuation assertion:

• The entity may not appropriately update its reserve policy (including updates to reserve percentages) for changes in circumstances.

Note that the engagement team may have identified additional risks of material misstatement related to the valuation assertion identified as part of its risk assessment procedures; however, you must focus on this specific risk of material misstatement.

In addition, this risk was not identified as a fraud risk. You obtained the following evidence from the audit procedures performed to address this risk:

• The current-year reserve as a percentage of gross receivables is consistent with prior years, although there was an increase in revenues, gross receivables, and the related reserve.

• Bad debt expense has remained consistent as a percentage of gross revenue over the past several years. • Retrospective review of receivable collections indicates that management’s reserves have historically been accurate.

• Economic conditions have been fairly stable and are predicted to remain stable.

• Revenues increased substantially year over year as a result of the introduction of a new product line.

• The new product line is marketed toward customers in the restaurant industry, in which the entity does not currently have an established customer base.

• The restaurant industry generally has a higher rate of business failure than other customer segments.

• The entity’s collections experience has primarily been with customers in the retail and professional services industries; the entity has very little collections experience with the new product line, given the recent launch.

• Approved sales terms have not changed year to year (e.g., sales personnel may offer an extension of credit of up to 100 percent of the purchase price consistent with prior year, creditworthiness is determined in the same manner, payment terms are consistent with prior year).

• Sales of the new product line are more frequently 100 percent financed versus sales of the existing product lines, resulting in an increase in gross receivables.

• Competitors who manufacture similar restaurant furniture products have higher reserves as a percentage of their trade receivables.

Required: Your manager has asked you to prepare a document (Titled EZ Furniture Wholesalers Summary of Contradictory Evidence) answering the following questions. The format of the document should first state the question; second, provide the relevant PCAOB AS Standard(s), and AICPA AU Standard(s) (you may cut and past the applicable sections of the standard); and third, your interpretation of how the standards applies to the case. Each question should follow this format. Save the document as YourLastNameEZ.

1. Identify and summarize the corroborative and contradictory audit evidence.

2. Determine what additional information, if any, is needed to reach a conclusion regarding management’s assertion.

3. On the basis of the case facts, determine whether management’s assertion is supportable and how additional information obtained might change your conclusion.

Answer 1

• AS PER 1101: AUDIT RISK

  THE RISK OF MATERIAL MISSTATEMENT REFERS TO THE RISK THAT THE FINANCIAL STATEMENTS ARE MATERIALLY MISSTATED. AS 2110, IDENTIFYING AND ASSESSING RISKS OF MATERIAL MISSTATEMENT, INDICATES THAT THE AUDITOR SHOULD ASSESS THE RISKS OF MATERIAL MISSTATEMENT AT TWO LEVELS: (1) AT THE FINANCIAL STATEMENT LEVEL AND (2) AT THE ASSERTIONLEVEL.

RISKS OF MATERIAL MISSTATEMENT AT THE FINANCIAL STATEMENT LEVEL RELATE PERVASIVELY TO THE FINANCIAL STATEMENTS AS A WHOLE AND POTENTIALLY AFFECT MANY ASSERTIONS. RISKS OF MATERIAL MISSTATEMENT AT THE FINANCIAL STATEMENT LEVEL MAY BE ESPECIALLY RELEVANT TO THE AUDITOR'S CONSIDERATION OF THE RISK OF MATERIAL MISSTATEMENT DUE TO FRAUD. FOR EXAMPLE, AN INEFFECTIVE CONTROL ENVIRONMENT, A LACK OF SUFFICIENT CAPITAL TO CONTINUE OPERATIONS, AND DECLINING CONDITIONS AFFECTING THE COMPANY'S INDUSTRY MIGHT CREATE PRESSURES OR OPPORTUNITIES FOR MANAGEMENT TO MANIPULATE THE FINANCIAL STATEMENTS, LEADING TO HIGHER RISK OF MATERIAL MISSTATEMENT.

RISK OF MATERIAL MISSTATEMENT AT THE ASSERTION LEVEL CONSISTS OF THE FOLLOWING COMPONENTS:

1. INHERENT RISK, WHICH REFERS TO THE SUSCEPTIBILITY OF AN ASSERTION TO A MISSTATEMENT, DUE TO ERROR OR FRAUD, THAT COULD BE MATERIAL, INDIVIDUALLY OR IN COMBINATION WITH OTHER MISSTATEMENTS, BEFORE CONSIDERATION OF ANY RELATED CONTROLS.
2. CONTROL RISK, WHICH IS THE RISK THAT A MISSTATEMENT DUE TO ERROR OR FRAUD THAT COULD OCCUR IN AN ASSERTION AND THAT COULD BE MATERIAL, INDIVIDUALLY OR IN COMBINATION WITH OTHER MISSTATEMENTS, WILL NOT BE PREVENTED OR DETECTED ON A TIMELY BASIS BY THE COMPANY'S INTERNAL CONTROL. CONTROL RISK IS A FUNCTION OF THE EFFECTIVENESS OF THE DESIGN AND OPERATION OF INTERNAL CONTROL.