AC 410 Unit 7 Homework Assignment

AC 410 Unit 7 Homework Assignment
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Questions Requiring Analysis 14-30
Early in your first audit of Star Corporation, you notice that sales and
year-end inventory are almost unchanged from the prior year.
However, cost of goods sold is less than in the preceding year, and
accounts payable also are down substantially. Gross profit has
increased, but this increase has not carried through to net income
because of increased executive salaries. Management informs you that
sales prices and purchase prices have not changed significantly during
the past year, and there have been no changes in the product line. Star
Corporation relies on the periodic inventory system. Your initial
impression of internal control is that several weaknesses may exist.
Suggest a possible explanation for the trends described, especially the
decrease in accounts payable while sales and inventory were constant
and gross profit increased. Explain fully the relationships involved.
For this question, you’ll need to look at the ratios presented and
analyze the trends. What do the trends mean?

Problem 14-38
The following are typical questions that might appear on an internal
control questionnaire for accounts payable.
1. Are monthly statements from vendors reconciled with the accounts
payable listing?
Monthly statements from vendors should be reconciled to the payables
ledger.
2. Are vendors’ invoices matched with receiving reports before they are
approved for payment?
The two procedures are test controls that provides auditors the
evidence to access control risk of financial statements.
Required:
a. Describe the purpose of each of the above internal control activities.
b. Describe the manner in which each of the above procedures might
be tested.
c. Assuming that the operating effectiveness of each of the above
procedures is found to be inadequate, describe how the auditors might
alter their substantive procedures to compensate for the increased
level of the risk of material misstatement.
Questions Requiring Analysis 15-30

You are retained by Columbia Corporation to audit its financial
statements for the fiscal year ended June 30. Your consideration of
internal control indicates a fairly satisfactory condition, although there
are not enough employees to permit an extensive separation of duties.
The company is one of the smaller units in its industry, but it has
realized net income of about $500,000 in each of the last three years.
Near the end of your fieldwork, you overhear a telephone call received
by the president of the company while you are discussing the audit with
him. The telephone conversation indicates that on May 15 of the
current year the Columbia Corporation made an accommodation
endorsement of a 60-day $430,000 note issued by a major customer,
Brill Corporation, to its bank. The purpose of the telephone call from
Brill was to inform your client that the note had been paid at the
maturity date. You had not been aware of the existence of the note
before overhearing the telephone call.
Questions Requiring Analysis 15-31
Valley Corporation established a stock option plan for its officers and
key employees this year. Because the options granted have a higher
option price than the stock’s current market price, the company has not
recognized any cost for the options in the financial statements.
However, a note to the financial statements includes all required
disclosures.
a. Do you believe that Valley’s management has appropriately
accounted for the stock option plan? Explain your answer.
b. What responsibility do the auditors have for the information in the
notes to the financial statements?

c. List the audit procedures, if any, which you believe should be applied
to the stock option plan.