Question

In: Accounting

You have reviewed the work performed by your assistant, Raymond Snow, on the audit of Tin...

You have reviewed the work performed by your assistant, Raymond Snow, on the audit of Tin Ltd for the year ended 30 June 20X8 and you have noted the following two independent matters: (i) In testing investments in listed securities, Raymond selected all shareholdings with a market value above $200,000 and checked them to the closing market value reported by the Australian Stock Exchange (ASX) to determine the net realisable value of each shareholding. The items tested totaled $5,500,000 or 60% of the total balance. Of the items tested, only one error of $110,000 was discovered. Raymond concluded that the error was not itself material, as it was only 2% of the balance tested. He extrapolated this error to the total population and estimated that the error for the total population would be $185,000, which was also immaterial. Therefore, he concluded that the investments in listed securities were fairly stated at the lower of cost or net realisable value. (ii) Tin Ltd has 1,000 stock lines that are maintained on a perpetual inventory system. Stock is counted on a cyclical basis so that all lines are covered at least once per year. Raymond attended the March stocktake to observe the counting procedures and conducted 20 test counts from the floor to the client’s count sheets and 20 from the client’s count sheets to the floor. He uncovered two minor discrepancies of one item each, which he considered to be immaterial. The client also uncovered five minor discrepancies between the perpetual records and the actual quantity on hand. None of these discrepancies were adjusted on the perpetual records, as the amounts involved only totaled $50,000 and were considered to be immaterial. Raymond concluded that no further work was considered necessary on stock quantities at year end. Required: (a) In your own words, explain what is meant by sufficient appropriate audit evidence. (b) Explain whether sufficient appropriate audit evidence has been obtained for each of the above situations. Give reasons for your answer.

Solutions

Expert Solution

Audit evidences are the evidences obtained during an audit relevant to a specific area that form part of the working papers. This evidence acts as a justification to the company’s recording of the financial transactions. The auditors normally determines the amount of audit evidence that may be required considering the risk of material misstatement. The overall quality of audit evidence is also judged based on the evidences received. Sufficient appropriate audit evidence can be interpreted as an indication of the measure of the quality of the evidence in terms of its relevance and reliability. Sufficient appropriate evidence is obtained by applying audit procedures keeping in mind the risk assessment.

(i)

In the given situation, in the testing for investment in listed securities Raymond has tested about 60% of the holdings and extrapolated the findings of 2% error in the sample to the entire population. The total error was identified as $185000 and Raymond concluded that this is not a material value and stated that the securities were fairly stated at lower of cost or fair value.

Normally when testing of investment is carried on it would be better if the following steps are followed with reference to audit evidences

If your company maintains custody of its investments by itself. It’s a good idea to check the minutes of the corporate meetings to confirm the authorization to purchase each investment.

Confirm that all investment-related interest and dividend income is reflected in the income statement as revenue. On the flip side, if you see any investment income in the income statement cannot be matched to an investment, that situation indicates a completeness issue — that all investments are not reflecting on the balance sheet.

To test a client’s investments, you mostly look at how a security is categorized and whether it’s presented on the client’s income statement or balance sheet. The three categories of debt and equity securities are held-to-maturity, trading, and available-for-sale. During this process, you also audit the value of an investment and how that value is determined.

It is assumed that in the given case the testing is being done for traded and available for sale securities.

Trading : Debt and equity securities that your client purchases to sell in the short term to make a profit are recorded on the balance sheet initially at cost. Then, as their value fluctuates, they’re recorded at fair market value with any gain or loss going to the income statement.

Available-for-sale: These initially recorded at their cost, and then your client should be recording them at fair market value with any gains or losses reported in shareholder’s equity.

Hence the testing of 60% may not be sufficient evidence to conclude that the investments are fairly valued. The evidences should also look into the areas that have been listed above in addition to checking the rates adopted to value each secutiry.

(ii)

Perpetual Inventory system

In the given situation, Raymond performs 20 test counts between floor to client count sheet and vice versa. He finds minor discripencies that were not adjusted in the perpetual inventory records since the amount involved was on $500000 and not considered material.

Inventory is one of the primary areas of importance of any organization. Sufficient controls have to be in place to prevent pilferage and losses.

As a practice auditors performing test counts, for example, by tracing items selected from management’s count records to the physical inventory and tracing items selected from the physical inventory to management’s count records, provides audit evidence about the completeness and the accuracy of those records.

In addition to recording the auditor’s test counts, obtaining copies of management’s completed physical inventory count records assists the auditor in performing subsequent audit procedures to determine whether the entity’s final inventory records accurately reflect actual inventory count results.

Where a perpetual inventory system is maintained, management may perform physical counts or other tests to ascertain the reliability of inventory quantity information included in the entity’s perpetual inventory records. In some cases, management or the auditor may identify differences between the perpetual inventory records and actual physical inventory quantities on hand; this may indicate that the controls over changes in inventory are not operating effectively

Matters for consideration when designing audit procedures to obtain audit evidence about whether changes in inventory amounts between the count date, or dates, and the final inventory records are properly recorded include: Check   whether the perpetual inventory records are properly adjusted. This also gives an indication on the reliability of the entity’s perpetual inventory records. It is important to identify the reasons for significant differences between the information obtained during the physical count and the perpetual inventory records.

Hence based on the testing 20 test counts may not be a sufficient sample test considering the 1000 stock lines that the company maintains. In addition it would be ideal to consider the areas listed above to obtain sufficient and appropriate audit evidence before concluding on the controls with respect to the inventory.


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