one Potential Significances and one follow up only 8 34 (Objective 8 4) In the audit of the Worldwide Wholesale Company, you did extensive ratio and trend analysis as part of preliminary audit planning Your analytical procedures identified the following 1 Commission expense as a percent of sales was constant for several years but has increased significantly in the current year Commission rates have not changed 2 The rate of inventory turnover has steadily decreased for three years 3 Inventory as a percent of current assets has steadily increased for four years 4 The number of days sales in accounts receivable has steadily increased for three years 5 Allowance for uncollectible accounts as a percent of accounts receivable has steadily decreased for three years 6 The absolute amounts of depreciation expense and depreciation expense as a percent of gross fixed assets are significantly smaller than in the preceding year Required a) Evaluate the potential significance of each of the changes in ratios or trends identified in your analysis on the fair presentation of financial statements b) State the follow up procedures you would perform for each fluctuation to determine whether a material misstatement exists Potential Significances a Inventory appears to be maintained at a higher level than is necessary for the company b Depreciation expenses may be understated for the year c The allowance for uncollectible accounts may be understated d Collection of accounts receivable appears to be a problem e Depreciation expenses may be overstated for the year f The allowance for uncollectible accounts may be overstated g Obsolete or unsalable inventory may be present and may require markdown to the lower of cost or market h Commission expense could be overstated during the current year or could have been understated during each of the past several years Or, sales may have been understated during the current year or could have been overstated in each of the past several years i Inventory appears to be maintained at a lower level than is necessary for the company j The cost of inventory appears to be less than market Inventory might be understated k Commission expense could be understated during the current year or could have been overstated during each of the past several years Or, sales may have been overstated during the current year or could have been understated in each of the past several years Follow up Procedures 1 Discuss the reason for the reduced depreciation expense with the client personnel responsible for the fixed assets accounts If they indicate that the change resulted from a preponderance of fully depreciated assets, test the detail records to determine that the explanation is reasonable If no satisfactory explanation isgiven, expand the tests of depreciation until satisfied that the provision is reasonable for the year 2 Make an estimated calculation of total commission expense by multiplying the commission expense as a percent of sales salaries for each of the last two years For whichever year appears to be out of line, select a sample of individual sales and recompute the base salaries for the period 3 Select a sample of large invoices from the beginning of the subsequent period Examine documents supporting the sales and make sure the sales is recorded in the correct period 4 Discuss the reason for the increase depreciation expense with the client personnel responsible for the fixed assets accounts If they indicate that the change resulted from a significant purchase during the period, test the detail records to determine that the explanation is reasonable If no satisfactory explanation isgiven, expand the tests of depreciation until satisfied that the provision is reasonable for the year 5 Make an estimated calculation of total commission expense by multiplying the standard commission rate times commission sales for each of the last two years Compare the resulting amount to the commission expense for that year For whichever year appears to be out of line, select a sample of individual sales and recompute the commission, comparing it to the commission recorded 6 Select a sample of the larger inventory items (by dollarvalue) and have the client schedule subsequent transactions affecting these items Note the ability of the company to sell the items and the selling prices obtained by the client For any items that the client is selling below cost plus a reasonable markup to cover selling expenses, or for items that the client has been unable to sell, propose that the client mark down the inventory to market value 7 Select a sample of the larger inventory items (by dollarvalue) and examine the invoices supporting the purchase Make sure that the inventory is properly stated at cost 8 Select a sample of the larger and older accounts receivable and have the client schedule subsequent payments and credits for each of these accounts For the larger accounts that show no substantial payments, examine credit reports and recent financial statements to determine the customers' ability to pay Discuss each account for which substantial payment has not been received with the credit manager and determine the need for additional allowance for uncollectible accounts

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one Potential Significances and one follow up only! 8-34 (Objective 8-4) In the audit of the Worldwide Wholesale Company, you did extensive ratio and trend

one Potential Significances and one follow up only!

8-34 (Objective 8-4) In the audit of the Worldwide Wholesale Company, you did extensive ratio and trend analysis as part of preliminary audit planning. Your analytical procedures identified the following:

1. Commission expense as a percent of sales was constant for several years but has increased significantly in the current year. Commission rates have not changed.

2. The rate of inventory turnover has steadily decreased for three years.

3. Inventory as a percent of current assets has steadily increased for four years.

4. The number of days sales in accounts receivable has steadily increased for three years.

5. Allowance for uncollectible accounts as a percent of accounts receivable has steadily decreased for three years.

6. The absolute amounts of depreciation expense and depreciation expense as a percent of gross fixed assets are significantly smaller than in the preceding year.

Required

a) Evaluate the potential significance of each of the changes in ratios or trends identified in your analysis on the fair presentation of financial statements.

b) State the follow-up procedures you would perform for each fluctuation to determine whether a material misstatement exists.

Potential Significances

Inventory appears to be maintained at a higher level than is necessary for the company.

Depreciation expenses may be understated for the year.

The allowance for uncollectible accounts may be understated.

Collection of accounts receivable appears to be a problem.

Depreciation expenses may be overstated for the year.

The allowance for uncollectible accounts may be overstated.

Obsolete or unsalable inventory may be present and may require markdown to the lower of cost or market.

Commission expense could be overstated during the current year or could have been understated during each of the past several years. Or, sales may have been understated during the current year or could have been overstated in each of the past several years.

Inventory appears to be maintained at a lower level than is necessary for the company.

The cost of inventory appears to be less than market. Inventory might be understated.

Commission expense could be understated during the current year or could have been overstated during each of the past several years. Or, sales may have been overstated during the current year or could have been understated in each of the past several years.

Follow-up Procedures

1.	Discuss the reason for the reduced depreciation expense with the client personnel responsible for the fixed assets accounts. If they indicate that the change resulted from a preponderance of fully depreciated assets, test the detail records to determine that the explanation is reasonable. If no satisfactory explanation isgiven, expand the tests of depreciation until satisfied that the provision is reasonable for the year.
2.	Make an estimated calculation of total commission expense by multiplying the commission expense as a percent of sales salaries for each of the last two years. For whichever year appears to be out of line, select a sample of individual sales and recompute the base salaries for the period.
3.	Select a sample of large invoices from the beginning of the subsequent period. Examine documents supporting the sales and make sure the sales is recorded in the correct period.
4.	Discuss the reason for the increase depreciation expense with the client personnel responsible for the fixed assets accounts. If they indicate that the change resulted from a significant purchase during the period, test the detail records to determine that the explanation is reasonable. If no satisfactory explanation isgiven, expand the tests of depreciation until satisfied that the provision is reasonable for the year.
5.	Make an estimated calculation of total commission expense by multiplying the standard commission rate times commission sales for each of the last two years. Compare the resulting amount to the commission expense for that year. For whichever year appears to be out of line, select a sample of individual sales and recompute the commission, comparing it to the commission recorded.
6.	Select a sample of the larger inventory items (by dollarvalue) and have the client schedule subsequent transactions affecting these items. Note the ability of the company to sell the items and the selling prices obtained by the client. For any items that the client is selling below cost plus a reasonable markup to cover selling expenses, or for items that the client has been unable to sell, propose that the client mark down the inventory to market value.
7.	Select a sample of the larger inventory items (by dollarvalue) and examine the invoices supporting the purchase. Make sure that the inventory is properly stated at cost.
8.	Select a sample of the larger and older accounts receivable and have the client schedule subsequent payments and credits for each of these accounts. For the larger accounts that show no substantial payments, examine credit reports and recent financial statements to determine the customers' ability to pay. Discuss each account for which substantial payment has not been received with the credit manager and determine the need for additional allowance for uncollectible accounts.