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:

Audit Assessment Steps:

What is the initial audit risk? High, medium or low?

What factors made you decide on this level?

Audit Plan Assertions

What would you include in the audit plan, and why?

Would you plan a test of controls or substantive tests? Why or why not?

Would these tests make a difference in the nature, timing, and extent of audit procedures? If so, how?

Audit Plan Evidence

Would you plan to put reliance on prior-year evidence? Why, or why not?

Would your evidence come from observation, analytical procedures, or other means? Explain your reasoning.

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

1.Initial audit risk are medium.

Because after the observation of given information about the manufacturing company it can be observed that "controls" are reduced at every step by the organisation with the reason to "Reduce cost" but also controls are not completely removed .

So, the initial audit risk is observed to be " medium".

2. Test of controls will be used in audit plan instead of substantive test as the organisation has worked upon reducing cost through removal of certain controls throughout the organisation like.

• lnternal auditing has been reduced by one person to reduce costs.
• There is even lack of procedures in cash receipts of the organisation.

Therefore, test of controls will be looked upon insted of substantive test to identify material misstatement as test of controls is an audit procedure to test the effectiveness of a control used by a client entity to prevent or detect material misstatements. Depending on the results of this test, auditors may choose to rely upon a client's system of controls as part of their auditing activities. However, if the test reveals that controls are weak, the auditors will enhance their use of substantive testing, which usually increases the cost of an audit.

3. Yes, the prior-period evidence will be relied upon as the previous auditor has stated that financial statements were free from any material misstatement only after proper audit procedure is followed by the current auditor to ascertain any material misstatements.

Analytical procedures will be used to obtain evidences because analytical procedures are a type of evidence used during an audit.

• These procedures can indicate possible problems with the financial records of a client, which can then be investigated more thoroughly.
• Analytical procedures involve comparisons of different sets of financial and operational information, to see if historical relationships are continuing forward into the period under review.
• Inmost cases, these relationships should remain consistent over time. If not, it can imply that the financial records are incorrect, possibly due to errors or fraudulent reporting activity.

Reason for using analytical procedures is that there is a huge change in current year financial information and previous year statement. So, auditor has to minutely analysis each information such as inventory, sales , credit and debit period change etc.