Parts III, V, and VI of this case study dealt with obtaining an understanding of internal...

Parts III, V, and VI of this case study dealt with obtaining an understanding of internal control and assessing control risk for transactions affecting accounts payable of Pinnacle Manufacturing. In Part VII, you will design analytical procedures and design and perform tests of details of balances for accounts payable.

a. List those relationships, ratios, and trends that you believe will provide useful information about the overall reasonableness of accounts payable. You should consider income statement accounts that affect accounts payable in selecting the analytical ;procedures.

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b. Study Table 1 (p. 647) containing balance-related audit objectives and tests of details of balances for accounts payable to be sure you understand each procedure and its purpose. Prepare an audit program for accounts payable in a performance format, using the audit procedures in Table 1. The format of the audit program should be similar to Table 2 (p. 541). Be sure to include a sample size for each procedure.

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c. Assume for requirement b that (1) assessed control risk had been high rather than low for each transaction-related audit objective, (2) inherent risk was high for each balance-related audit objective, and (3) analytical procedures indicated a high potential for misstatement. What would the effect have been on the audit procedures and sample sizes for requirement b?

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d. Confirmation requests were sent to a stratified sample of 51 vendors listed in Figure 1 (p. 552). Confirmation responses from 45 vendors were returned indicating no difference between the vendor’s and the company’s records. Figure 2 (pp. 553-554) presents the six replies that indicate a difference between the vendor’s balance and the company’s records. The auditor’s follow-up findings are indicated on each reply. Prepare an audit schedule similar to the one illustrated in Figure 3 (p. 555) to determine the misstatements, if any, for each difference. The audit schedule format shown in Figure 3 can be downloaded using the Pinnacle link on the textbook Web site. The exception for Fiberchem is analyzed as an illustration. Assume that Pinnacle Manufacturing took a complete physical inventory at December 31, 2011, and the auditor concluded that recorded inventory reflects all inventory on hand at the balance sheet date. Include the balances confirmed without exception as one amount on the schedule for each stratum, and total the schedule columns.

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e. Estimate the total misstatement in the income statement, not just the misstatements in the sample, based on the income statement misstatements you identified in requirement d. The total misstatement should include a projected misstatement and an estimate for sampling error.Hint: See pages 257-258 for guidance on calculating

the point estimate. Note that the misstatements should be projected separately for each stratum. You will need to determine the size of each stratum using the accounts payable listing. Use your judgment to estimate sampling error, considering the size of the population and the amounts tested.

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f. Estimate the total misstatement in accounts payable in the same way you did for the income statement in requirement e.Hint: A misstatement caused by the failure to record an FOB origin purchase is an understatement of accounts payable and inventory and has no effect on income.

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g. What is your conclusion about the fairness of the recorded balance in accounts payable for Pinnacle Manufacturing as it affects the income statement and balance sheet? How does this affect your assessment of control risk as being low for all transaction-related audit objectives? Assume you decided that tolerable misstatement for accounts payable as it affects the income statement is $250,000.

Table 1 Analytical Procedures for Income and Expense Accounts

Analytical Procedure	Possible Misstatement
Compare individual expenses with previous years.	Overstatement or understatement of a balance in an expense account.
Compare individual asset and liability balances with previous years.	Overstatement or understatement of a balance sheet account that will also affect an income statement account (for example, a misstatement of inventory affects cost of goods sold).
Compare individual expenses with budgets.	Misstatement of expenses and related balance sheet accounts.
Compare gross margin percentage with previous years.	Misstatement of cost of goods sold and inventory
Compare inventory turnover ratio with previous years.	Misstatement of cost of goods sold and inventory
Compare prepaid insurance expense with previous years.	Misstatement of insurance expense and prepaid insurance.
Compare commission expense divided by sales with previous years.	Misstatement of commission expense and accrued commissions.
Compare individual manufacturing expenses divided by total manufacturing expenses with previous years.	Misstatement of individual manufacturing expenses and related balance sheet accounts.

Table 2 Test of Details of Balances Audit Program for Hillsburg Hardware Co. – Sales and Collection Cycle (Performance Format)

1.	Review accounts receivable trial balance for large and unusual receivables.
2.	Calculate analytical procedures indicated in carry-forward audit schedules (not included) and follow up on any significant changes from prior years.
3.	Review the receivables listed on the aged trial balance for notes and related party receivables.
4.	Inquire of management whether there are any related party, notes, or long-term receivables included in the trial balance.
5.	Review the minutes of the board of directors meetings and inquire of management to determine whether any receivables are pledged or factored.
6.	Trace 10 accounts from the trial balance to the accounts receivable master file for aging and the balance.
7.	Foot two pages of the trial balance for aging columns and balance and total all pages and crossfoot the aging.
8.	Trace the balance to the general ledger.
9.	Trace five accounts from the accounts receivable master file to the aged trial balance.
10.	Confirm accounts receivable, using positive confirmations. Confirm all amounts over $100,000 and a nonstatistical sample of the remainder.
11.	Perform alternative procedures for all confirmations not returned on the first or second request.
12.	Discuss with the credit manager the likelihood of collecting older accounts. Examine subsequent cash receipts and the credit file on all larger accounts over 90 days and evaluate whether the receivables are collectible.
13.	Evaluate whether the allowance is adequate after performing other audit procedures for collectibility of receivables.
14.	Select the last 20 sales transactions from the current year's sales journal and the first 20 from the subsequent year's and trace each to the related shipping documents, checking for the date of actual shipment and the correct recording.
15.	Review large sales returns and allowances before and after the balance sheet date to determine whether they are recorded in the correct period.

FIGURE 1 Pinnacle Manufacturing Sample of Accounts Payable Selected for Confirmation – December 31, 2011

FIGURE 2 Replies to Requests for Information

FIGURE 3 Pinnacle Manufacturing Analysis of Trade Accounts Payable – December 31, 2011