CHAPTER

17
17-1. 17-2. 17-3. 17-4. a. a. a. (3) (4) (3) b. b. b.

COMPLETING THE AUDIT

(1) (3) (1) c. c. c. (4) (1) (1) d. d. d. (3) (4) (2) e. (1)

Tracy Brewing Company a. b. c. 4 - The amount appeared collectible at the end of the field work. 1 - The uncollectible amount was determined before end of field work. 3 - Amount should have been determined to be uncollectible before end of field work, but it was discovered after the issuance of the statements. The financial statements should have been known to be in error on 8-20-06. 2 - The cause of the bankruptcy took place after the balance sheet date, therefore the balance sheet was fairly stated. Account may be written off as uncollectible at 6-30-06, but they are not required to do so. Footnote disclosure is necessary because the subsequent event is material. 2 - The sale took place after the balance sheet date but, since the loss was material and will affect future profits, footnote disclosure is necessary. 2 - The lawsuit originated in the current year, but the amount of the loss is unknown. 1 - The settlement should be reflected in the 6-30-06 financial statements as an adjustment of current period income and not a prior period adjustment. 4 - The financial statements were believed to be fairly stated for 6-30-06 or 819-06. 2 - The cause of the lawsuit occurred before the balance sheet date and the lawsuit should be included in the 6-30-06 footnotes.

d.

e. f. g. h. i.

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Solutions Manual to Accompany Applied Auditing, 2006 Edition

17-5.

Flowmeter, Inc. Ite m No. 1. Audit Procedures Goods in-transit would be detected in the course of the auditors review of the year-end cutoff of purchases. The auditor would examine receiving reports and purchase invoices to make certain that the liability to suppliers had been recorded for all goods included in inventory, and that all goods for which the client was liable at year-end were recorded in inventory. Settlements of litigation would be revealed by requesting from the companys legal counsel a description and evaluation of any litigation, impending litigation, claims, and contingent liabilities of which he has knowledge that existed at the date of the balance sheet being reported upon, together with a description and evaluation up to the date the information is furnished. A review of cash disbursements for the period between the balance sheet date and completion of field work may also reveal evidence of the settlement. The purchase would normally be revealed in general conversations with the client and would further be detected by reading the minutes of meetings of stockholders, directors, and appropriate committees. In addition, because the amount paid is likely to be unusually large in relation to other cash disbursements, a review of Required Disclosure and Reasons The receipt of the goods provides additional evidence with respect to conditions that existed at the date of the balance sheet and hence the financial statements should be adjusted to take into account such additional information.

2.

The settlement of litigation would require an adjustment of the financial statements since the events that gave rise to the litigation had taken place prior to the balance sheet date.

3.

The purchase of a new business is not an event that provides evidence with respect to conditions existing at the balance sheet date; hence, it does not require adjustment in the financial statements. However, such an event would normally be of such importance that disclosure of it is required to keep the financial statements from being misleading.

Completing the Audit cash disbursements for the period between the balance sheet date and completion of field work is likely to reveal such an extraordinary transaction. Moreover, because a purchase of a business usually requires a formal purchase agreement, the letter from the firms legal counsel would probably have revealed the purchase.

17-3

4.

Inventory losses attributable to a flood would be brought to the auditors attention through inquiries and discussions with corporate officers and executives. Moreover, the auditor would know the location of the plants and warehouses of his client and upon becoming aware of any major floods in such a location, he would investigate to determine if his clients facilities had suffered any damage.

5.

The sale of bonds or other securities would require a filing with the SEC in which the auditor would presumably be involved. In addition, the sale would be revealed by reading the minutes of directors and finance committees meetings, by corresponding with the clients attorneys and by examining the cash receipts book in the period subsequent to the

If the acquisition is significant enough, it might be advisable to supplement the historical statements with pro forma statements indicating the financial results if the two firms had been consolidated for the year ending December 31, 2005. Otherwise, disclosure in footnotes to the statements would be adequate. Occasionally, a situation of this type may have such a material impact on the entity that the auditor may wish to include in his report an explanatory paragraph directing the readers attention to the event and its effect. Losses attributable to floods subsequent to the balance sheet date do not provide information with respect to conditions that existed at the balance sheet date; hence, it does not require an adjustment in the financial statements. However, such an incident may be of sufficient importance to require footnote disclosure. Occasionally, a situation of this type may have such a material impact on the entity that the auditor may wish to include in his report an explanatory paragraph directing the readers attention to the event and its effect. Sales of bonds or capital stock are transactions of the type that do not provide information with respect to conditions that existed at the balance sheet date; hence, adjustment of the financial statement is not required. However, such sales may be of sufficient importance to require footnote disclosure. Occasionally, a situation of this type may have

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Solutions Manual to Accompany Applied Auditing, 2006 Edition balance sheet date for evidence of unusually large receipts. such a material impact on the entity that the auditor may wish to include in his report an explanatory paragraph directing the readers attention to the event and its effect.

17-6.

Olars Manufacturing Corporation 1. The governments approval of a plan for the construction of an express highway would have come to the CPAs attention through his inquiries of officers and key personnel, his examination of the minutes of the meetings of the board of directors and stockholders, and his reading of local newspapers. The details of the item would not have to be disclosed as a separate footnote because all fixed assets of the corporation, including the right to the condemnation award, were to be sold as of March 1, 2006 (see item 6). It is improbable that the CPA would learn the source of the P25,000 unless it were revealed in a discussion with the president or his personal accountant, or unless the auditor prepared the presidents personal income tax return, in which case the interest charges would have lead to his investigation of the use to which the funds were put. Setting out the loan in the balance sheet as a loan from an officer would be sufficient disclosure. The source from which the officer obtained the funds would not be disclosed because it is the officers personal business and has no effect upon the corporations financial statements. Indeed, disclosure of the funds source might be construed as detrimental to the officer. The additional liability for the ore shipment would have been revealed to the CPA in his scanning of January transactions. His regular examination of 2001 transactions and related documents such as purchase contracts would have caused him to note the time for subsequent follow up to determine the final liability. In addition the clients letter of representation might have mentioned the potential liability. The item would not require separate disclosure by footnote or otherwise and would be handled by adjusting the financial statement amounts for purchases, ending raw materials inventory, and accounts payable by the amount of the additional charge, P9,064 {[(72 50) / 50] = 0.44; 0.44 x P20,600 = P9,064}. The CPA might learn of the agreement to purchase the treasurers stock ownership through his inquiries of management and legal counsel, examination of the minutes of the meetings of the board of directors and stockholders and subsequent reading of the agreement. The absence of the treasurer might also arouse the CPAs curiosity. The details of the agreement would be disclosed in a footnote because the use of company cash for the repurchase of stock and the change in the amount of stock held by stockholders might have a heavy impact on subsequent years financial statements. Usually, a management change, such as the treasurers

2.

3.

4.

Completing the Audit

17-5

resignation, does not require disclosure in the financial statements. The details underlying the separation (personal disagreements and divorce) should not be disclosed because they are personal matters. 5. Through inquiries of management, review of financial statements for January, scanning of transactions, and observations, the CPA would learn of the reduced sales and of the strike. Disclosure would not be made in the financial statements of these conditions because such disclosure might create doubt as to the reasons therefore and misleading inferences might be drawn. The contract with Lopez Industries would come to the CPAs attention through his inquiries of management and legal counsel, his reading of the minutes of the meetings of the board of directors and stockholders, and his examination of the contract. All important details of the contract should be disclosed in a footnote because of the great effect upon the corporations future. The factors contributing to the entry into the contract need not be disclosed in statements; while they might be of interest to readers, they are by no means essential to make the statements not misleading.

6.