Fellowes and Associates Chartered Accountants is a successful mid-tier accounting firm with a large range of clients across Canada. During 2011, Fellowes and Associates gained a new client, Health Care Holdings Group (HCHG), which owns 100 percent of the following entities:
• Shady Oaks Centre, a private treatment centre
• Gardens Nursing Home Ltd., a private nursing home
• Total Laser Care Ltd. (TLCL), a private clinic that specializes in the laser treatment of skin defects. Year end for all HCHG entities is June 30.
You are a senior auditor working on the Shady Oaks Centre engagement for 2011 and are currently in the planning stage of the audit. In discussions with management, you discover that Shady Oaks has recently acquired two new full-body scanning machines. These machines use the latest technology and cost the company more than $10 million each. Although they are more than 50 percent more likely to detect abnormalities, new academic studies suggest there may be potential long-term side effects for patients scanned by these machines. However, because the machines are new, the evidence about long-term effects will not be known for many more years. Despite this, there has been some bad press for Shady Oaks highlighting the potential risks to patients.
Shady Oaks charges a premium price for patients using the scanning machines, and there is extremely high demand. To manage the demand, Shady Oaks requires that all patients pay for their scans in full at the time of booking, and the payments are immediately recognized as revenue by the centre. Shady Oaks has taken bookings for four months in advance-although it is only April 2011, the centre has bookings for July and August 2011.
The Canadian Medical Association is currently reviewing the use of the scanning machines and is considering banning their use within Canada until the issue is resolved. A decision is expected on August 1, 2011, and managers tell you that they believe there is an 80 percent chance the scanners will be approved.
Inventory of various medical supplies and drugs is a material account on the Shady Oaks Centre audit engagement. You are planning to adopt a combined audit approach for existence of inventory and rely heavily on preventative control procedures (for example, access to the dispensary and the store room being limited to a few authorized staff) to ensure the physical security of inventory.
You have just completed your tests of controls in relation to physical security procedures. Your projected error rate, based on the results of your already large sample size, is higher than the tolerable error. You are satisfied that the sample is representative and the errors occurred throughout the period audited.
Required
(a) Briefly outline the impact of the projected error rate on your planned substantive audit procedures.
(b) Assume that all of the deviations from the internal control procedures tested (that is, all the errors in the sample) relate to a three-week period when a senior staff member was on annual vacation. Discuss how this would affect your planned substantive tests of detail.