Your audit firm, Garrett and Schulzke LLP, is engaged to perform the annual audit of Hooplah, Inc., for the year ending December 31, 2017. Hooplah is a privately-held company that sells electronics components to companies that manufacture various appliances. The company hires a public accounting firm to provide an audit of its financial statements in order to get favorable terms on its bank loans. Your firm has audited Hooplah for the past three years. For the current audit engagement, your team has already performed most of the audit work; however, there are a few loose ends for you to tie up. Portions of Garrett and Schulzke’s audit policy relating to audit sampling are provided to assist you in completing the procedures.

REQUIRED 

Part A

[1] Evaluate the appropriateness of Darrell’s conclusions relating to the first two controls: 

[a] Is it acceptable to use the same set of transactions and the same sample size to test two different controls? 

[b] Do you agree with Darrell’s conclusions with respect to these first two controls? If not, why not? In evaluating Darrell’s conclusions, you may wish to refer to the attribute sampling evaluation table available in Appendix A. 

[c] What additional work, if any, is necessary to support his assessment that both controls are operating effectively? 

[2] Evaluate each of the following questions independently: 

[a] Referring to Garrett and Schulzke’s sample size table (Appendix A), determine an appropriate sample size for the test of the control relating to authorization of credit memos. 

[b] Regardless of your answer to question [a], assume that Darrell randomly selected a sample of 75 credit memo packages, each of which contains a credit memo with a matching receiving report and inventory warehouse receipt, and has reviewed all but the last five credit memo packages and found no exceptions. Each credit memo authorizing a customer refund or reduction in the amount owed due to the return of goods should be authorized by Brian Thompson, the accounting supervisor over accounts receivable. When a customer wants to return unwanted or defective product, they go to Hooplah’s website and download a “Customer Return Report” and fill in their information as well as a description and quantity of goods being returned. Chris Jacobs in the receiving department at Hooplah uses the Customer Return Report as the receiving report when the shipment comes in, and Felix Katt counts and inspects the goods to make sure they’re all in good condition. The goods are then transferred back to Jed Baxter in the warehouse, who issues an “Inventory Receipt.” Once the Inventory Receipt is attached to the Customer Return Report, the documents are forwarded to Brian so that he can approve a credit memo. Brian examines the Customer Return Report and the Inventory Receipt to ensure that credit is only authorized when goods have been received and for the quantity actually received. He then documents his authorization by marking his initials on the credit memo. You have agreed to help Darrell by examining the remaining five credit memo packages. You will find the last five credit memo packages at www.pearsonhighered.com/beasley. Examine these documents for Brian Thompson’s initials indicating the memos were approved (for this question, just focus on his initials for audit evidence that the control is operating effectively) and then evaluate the test results for the full sample. Provide support for your assessment on the effectiveness of the control based on testing performed.

[3] In question 2[b] you gathered evidence on the operation of the control by examining the five credit memos for Brian’s initials. While this provides some evidence of control, higher quality evidence that the control is actually operating effectively can be obtained by reperforming Brian’s control procedure. This would be done by verifying that each credit memo is supported by a Customer Return Report and Inventory Receipt and that the quantity and description of goods on the credit memo is supported by the quantity and description on the supporting documents. If Brian’s initials are on the credit memo, but the quantity or description of goods on the memo is not consistent with the quantity and description on the supporting documents, this would be considered a control deviation. Assume Darrell reperformed the control for the first 70 credit memo packages and found no exceptions. 

[a] Reperform the control for the remaining five credit memo packages and evaluate the test results for the full sample. Provide support for your assessment on the effectiveness of the control based on testing performed. 

[b] If you came to a different conclusion in 2[b] and 3[a], which conclusion is more supportable and why? 

[4] Assuming the controls testing is not expanded to provide additional support regarding the effectiveness of the controls tested, what are the implications of the controls testing in question 3[a] with respect to the nature, timing, and extent of substantive evidence that must be gathered to support the fairness of the accounts receivable balance?

Part B

REQUIRED

[1] In selecting which customer balances to detail test via accounts receivable confirmations, assume that you have decided to direct test only the minimum number of customer accounts required; that is, you will direct test only customer accounts that are greater than tolerable misstatement, and you will use audit sampling to test the remainder of the population. You can find the accounts receivable detail listing at www.pearsonhighered.com/beasley. As noted there, Hooplah has a total of 357 customers, with an accounts receivable balance totaling $12,881,551. Based on the engagement team’s knowledge of Hooplah’s accounts receivable processes and policies, experience in prior year’s audits, and the results of tests of controls and substantive analytical procedures, the assessment of risk of material misstatement for accounts receivable has been set at “moderate.” Prepare a schedule that includes the following 

[a] List the customer number and related balance for all customers you plan to direct test. 

[b] Indicate your computed sample size (using the sample size formula provided on prior page). Provide supporting calculations and justification for your sample size, including justification for the confidence factor and the level of expected misstatement you used to compute your sample size. 

[2] Based on the same background information as was used for question 1, but assuming that in selecting which customer balances to detail test you want to expand directed testing by selecting additional items based on risk and size, reevaluate the mix of directed testing and audit sampling. If you believe it would be efficient and effective to increase your directed testing, prepare a schedule that includes the following: 

[a] Identify what characteristic can be used to select riskier items. 

[b] List the customer numbers and related balances you would select for directed testing based on risk and provide the characteristics you used. 

[c] List the additional customer accounts you would select for directed testing based on size and “coverage.” 

[d] Determine whether it would be necessary to test the remaining population using audit sampling; if so, compute your sample size for testing the remaining population through audit sampling and justify the inputs you used in the sample size formula. 

[3] Which detail testing approach seems most appropriate in this situation: the minimum level of directed testing together with a larger audit sample, expanded directed testing with no audit sampling, or both expanded directed testing and audit sampling? Be sure to consider the effectiveness and efficiency of the approach, as well as the level of assurance needed in view of the evidence already obtained from controls testing, substantive analytical procedures, etc. 

[4] Independent of your responses to prior questions, assume that you direct tested customer balances greater than tolerable misstatement and randomly selected a sample of 40 additional customer balances for confirmation. The total book value of the 40 items sampled is $761,030. No differences were noted in the directed testing, and the sample yielded a combined overstatement in Hooplah’s records of $4,215. Brian Thompson, the accounts receivable supervisor agrees that the differences noted are misstatements due to pricing errors. Please answer the following questions: 

[a] How much is the known misstatement in the accounts receivable balance? 

[b] How much is the projected misstatement in the population (i.e., the total accounts receivable account) using ratio projection? 

[c] How much is the projected misstatement in the population using difference projection?

[d] Explain why the two projections produce different results and describe the circumstances under which one projection approach might be more appropriate than the other. 

[e] Based on the results of the detail testing outlined in this requirement, as well as the assurance obtained from controls testing and substantive analytical procedures, do the audit procedures support the assertion that the accounts receivable account is fairly stated? Why or why not? 

PROFESSIONAL JUDGMENT QUESTIONS 

It is recommended that you read the Professional Judgment Introduction found at the beginning of this book prior to responding to the following questions. 

[5] How might the availability tendency contribute to less than optimal auditor judgment in the sampling process? How might an auditor mitigate the effects of this tendency? 

[6] How might the confirmation tendency contribute to less than optimal auditor judgment in the sampling process? How might an auditor mitigate the effects of this tendency?