Comprehensive Problem: Monetary Unit Sampling. Zachary Mayo is a new staff accountant participating on his first audit engagement. He has been assigned to the Foley Company engagement and is examining Foley's accounts receivable. Foley maintains a computerized ledger of its accounts receivable balances, which are recorded at $5,000,000 and comprise 5,560 individual customer accounts.

Mayo established the following parameters for use in this year's audit. In so doing, he relied extensively on parameters established in prior audits:

• Expected misstatement is established at $100,000, which is the average amount of misstatement identified in the past five audits. During the past year, Foley has experienced a great deal of turnover among its sales processing personnel and has made some relatively large sales that present some unusual revenue recognition issues. In addition, accounts receivable have increased by almost 15 percent from the prior year.
• The tolerable misstatement is 10 percent of the ending accounts receivable balance, or $500,000 ($5,000,000 0.10). Compared to previous years, Foley's financial condition has slightly deteriorated. Its current and quick ratios, although still above levels necessary to satisfy its debt covenants, have deteriorated.
• The risk of incorrect acceptance is 10 percent, which is the same as that used in the previous year. In evaluating the components of the audit risk model, some of the issues related to the turnover among sales processing personnel as well as the more limited use of analytical procedures during the current audit represent important differences from previous years.

Mayo sent positive confirmations to Foley's customers. His work identified the following differences between audited balances and recorded balances.

Customer

Recorded Balance

Audited Balance

R. Gerer

$15,000

$10,000

D. Wings

25,000

20,000

L. Goss

60,000

30,000

K. David

120,000

90,000

Unfortunately, Mayo resigned from the firm shortly after identifying these differences. The only documentation you were able to locate was information related to (1) the levels of expected misstatement, tolerable misstatement, and risk of incorrect acceptance that were used in the Foley audit and (2) the four confirmations returned by customers indicating differences between their records and Foley's recorded balances.

Required:

1. Mayo decided to use MUS primarily because it had been used in previous audits of Foley. Based on the nature of this sampling application and the composition of Foley's accounts receivable, was the use of MUS appropriate?
2. Based on the parameters established by Mayo, determine the sample size and sampling interval he used in the sampling application.
3. Describe the sample selection process used by Mayo. Are you able to replicate or otherwise determine which customer balances he confirmed?
4. Based on the four overstatements identified by Mayo, calculate the upper limit on misstatements. Based on this upper limit on misstatements, what general statement can be made with respect to the extent of misstatement in the account balance?
5. What is your initial decision with respect to the fairness of Foley's accounts receivable balance?
6. Review each of the parameters established by Mayo (expected misstatement, tolerable misstatement, and risk of incorrect acceptance). Do any differences in the current engagement raise questions with respect to the level of these parameters?
7. What are the potential effect(s) of the changes in parameters noted in (f) on the sampling application?