The following are three situations, all involving nonpublic companies, in which the auditor is required to develop an audit strategy:

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Part 1

Requirement a. For Audit 1, recommend an evidence mix for the five types of tests for the audit of inventory and cost of goods sold. Justify your answer. Include in your recommendations both tests of controls and substantive tests. (Abbreviations used: E = Extensive amount of testing; M = Medium amount of testing; S = Small amount of testing; N = No testing; S, E = Small amount of testing for gross balance and extensive testing done for other concerns.)

First, recommend an evidence mix for this audit.

Audit

Procedures to Obtain an Understanding of Internal Control

Tests of Controls

Substantive Tests of Transactions

Analytical Procedures

Tests of Details of Balances

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1.

The client has inventory at approximately 50 locations in a three-state region. The inventory is difficult to count and can be observed only by traveling by automobile. The internal controls over acquisitions, cash disbursements, and perpetual records are considered effective. This is the fifth year that you have done the audit, and audit results in past years have always been excellent. The client is in excellent financial condition.

2.

This is the first year of an audit of a medium-sized company that is considering selling its business because of severe underfinancing. A review of the acquisition and payment cycle indicates that controls over cash disbursements are excellent but controls over acquisitions cannot be considered effective. The client lacks receiving reports and a policy as to the proper timing to record acquisitions. When you review the general ledger, you observe that there are many large adjusting entries to correct accounts payable.

3.

You are doing the audit of a small loan company with extensive receivables from customers. Controls over granting loans, collections, and loans outstanding are considered effective, and there is extensive follow-up of all outstanding loans weekly. You have recommended a new computer system for the past two years, but management believes the cost is too great, given their low profitability. Collections are an ongoing problem because many of the customers have severe financial problems. Because of adverse economic conditions, loans receivable have significantly increased and collections are less than normal. In previous years, you have had relatively few adjusting entries.

a.

For Audit 1, recommend an evidence mix for the five types of tests for the audit of inventory and cost of goods sold. Justify your answer. Include in your recommendations both tests of controls and substantive tests.

b.

For Audit 2, recommend an evidence mix for the audit of the acquisition and payment cycle, including accounts payable. Justify your answer.

c.

For Audit 3, recommend an evidence mix for the audit of outstanding loans. Justify your answer.