Question

Answer the following questions based on the following financial information taken from the trial balance for New Day, Inc:

                                                Year 2                                    Year 1

Account title                       Debit (Credit)                    Debit(Credit)

Cash                                      281,000                              297,000

Accounts receivable            12,000                                   14,000

Prepaid expenses                  2,000                                     8,000

Inventory                            581,000                              321,000

PPE                                        926,000                              926,000

Accumulated Deprn        (581,000)                             (581,000)

Patents                                   19,000                                    19,000

Accounts Payable             (11,000)                             (17,000)

Interest Payable                  (3,000)                                  (4,000)

Bonds Payable                   (750,000)                             (750,000)

Common Stock                  (50,000)                               (50,000)

Retained Earnings            (426,000)                             (183,000)

1. Select the two account categories that you feel are the most significant for your audit of year 2 and indicate why you chose them.
2. Identify the auditor’s objectives for the account categories you selected.
3. For each of the two categories, discuss the internal control issues the auditor should consider.
4. Provide at least 5 substantive test the auditor would likely want to perform in your audit and indicate which auditor’s objective the test would help satisfy.
5. Is this company financed with debt equity or capital equity? Give some audit procedures relevant an audit of this category.

Answer 1

Account categories significant for audit of year 2

Inventory and PPE

Reason - (i)Closing balance of inventory for year 2 is substantially more when compared with closing balance of year 1

(ii) PPE and accumulated depreciation is remaining the same year on year so it is important to know the reason behind it to rule out possible misstatements.

Auditor's Objective

Inventory - Verifying the existence, Ascertaining ownership rights, Examining accuracy in the valuation of items that constitute Inventory, Evaluation of the realizable value, Ensuring apt presentation and disclosure.

PPE - Determining the existence, Establishing the organization's right, Determining valuation,Ensuring proper charge to Income statement, Ensuring proper presentation and disclosure.

Internal control issues to be considered by auditor

Inventory - Ensuring accuracy and reliability of the reports generated by the management, Ensuring there exists a system that prevents the company from loss of inventory by theft, fire, etc, Ensuring the integrity of members doing Physical inventory count at the end of the year, etc.

PPE - Checking proposals and authorization made for acquisition and disposal of assets, Ensuring there exists a proper document for recording fixed asset (commonly known as Fixed asset register), Whether there exists adequate safeguards for protecting the Fixed asset, etc.

Substantive test

Particulars	Substantive Test	Objectives the test would satisfy
Inventory	Observing Period ending inventory count	Verifying existence
Obtaining schedule of charges created against inventory	Ascertaining ownership rights
Performing analytical procedures and cut-off procedures	Examining accuracy in the valuation
Confirming the value with experts or by conducting market research	Evaluation of realizable value
Review of Financial statements, comparing it with the standard presentation and disclosure norms	Ensuring apt presentation and disclosure
PPE	Inspecting the Assets	Determining the existence
Examination of Supporting documents (Study of loan proposal, study of agreement with the supplier, etc)	Establishing the organization's right
Vouching of Purchase,transfer and disposal transactions	Determining valuation
Recomputation of depreciation to check whether the depreciation norms are being followed	Ensuring proper charge to Income statement
Verifying apt disclosure of historical cost,depreciation methods, classification in financial statements	Determining presentation and disclosure

Financing

This company is financed with Debt instruments,Since there is a huge outstanding of bonds payable

Audit procedures for audit of debt - Review of the board meeting minutes to know the terms and conditions of debt, Ensuring completeness and proper classification of Debt instruments, Performing a walkthrough of debt to see if any internal control issues exist, Vouching bank statement to ensure proper interest payments, etc.