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.

Assignment Guidelines:

1. Audit Assessment Steps:
   1. What is the initial audit risk? High, medium or low?
   2. What factors made you decide on this level?
2. Audit Plan Assertions
   1. What would you include in the audit plan, and why?
   2. Would you plan a test of controls or substantive tests? Why or why not?
   3. Would these tests make a difference in the nature, timing, and extent of audit procedures? If so, how?
3. 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

Answer:

A) AUDIT ASSESSMENT STEPS

a) Intial audit risk is high as firms nearly 80% of assets constitute Accounts receivable and inventory. The firm is always at risk if its assets are mainly based on just two factors.

b) Increased DSO period and inventory as compared to earliers years is alarming sign as these are 80% of total assets.