Lambert Skull recently graduated from an accounting program at a local university and accepted a position on the audit staff of Look and Look, CPAs. He was assigned to the audit of Grand Toys, a manufacturer of innovative children's toys, including a plastic gun that shoots rubber arrows at other children.

Lambert's senior auditor was Christine Bore, who had extensive experience auditing Grand Toys and companies that made similar products. Christine assigned Lambert to perform analytical procedures. Lambert's first task was to compare administrative expenses for the year under audit with the previous year. Lambert secured the following schedule of comparative Administrative Expenses.

Lambert did not wish to appear dumb in the eyes of Christine. Therefore, he went directly to the controller, who did not like the auditors and gave them as litle time as possible. Lambert received these answers to the variations in administrative expenses.
1. The increase in office salaries was caused by the replacement of an unskilled worker with one who could work with the various computer software programs used in the office.
2. The increase in legal expense resulted from a retainer fee increase by the law firm retained by the company. The controller did not like the increase, but he could do nothing about it because the head of the legal firm was a friend of the chairman of the board of directors of Grand Toys.
3. The increase in miscellaneous expense was nothing the auditor should be concerned with because this category represented expenditures that could not be classified in one of the other accounts.
Lambert did not conduct any further investigation of these variances. He wrote a memo describing the controller's explanations and indicating that they appeared reasonable.

Required:

a. Describe at least one auditing procedure that Lambert could have performed to confirm the controller's explanations for each of the three variances.
Meanwhile Christine was engaged in a discussion with Grand Toys' legal counsel concerning two events.
1. The settlement of a major lawsuit filed by parents of a child whose eye was damaged severely by a rubber arrow fired from a toy gun manufactured by Grand Toys. The settlement was for an amount materially in excess of the recorded liability.
2. The filing of a lawsuit in early \(19 \times 5\) by parents of another child who had suffered the same eye damage from one of Grand Toys' guns. The lawsuit was in an early stage, but the amount asked by the parents was material to the financial statements of Grand Toys.
Required:

b. Describe at least one auditing procedure Christine Bore used to discover the settlement of the first described lawsuit.

c. Describe at least one auditing procedure Christine Bore used to discover the existence of the second described lawsuit.

d. What actions should the auditor take in regard to each of the described lawsuits? Why?

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Administrative expenses 12-31-X4 12-31-X3 Over (under) Officer salaries $800,000 $800,000 $ Office salaries 600,000 550,000 50,000 Office supplies 10,000 9,000 1,000 Legal expense 80,000 40,000 40,000 Office lease 20,000 20,000 Miscellaneous expense 70,000 60,000 10,000