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Auditing Group Project Final Paper

Words: 2166, Paragraphs: 90, Pages: 8

Paper type: Project , Subject: Business

Auditing Group Project

Course Name: Auditing 1

Course Code: ACCT 3043

Lecturer: Carol-lyn Edgehill

Due Date: Monday 7th October 2019

Group Members: Danesha Griffith – 400000106

Naquia Murrell – 417001975

Shanice Quintyne – 400001246

Sharica Wilkinson – 416000434

Shara Trotman – 417002109

Tamisha Bryan – 400000085

Sharise Hoyte – 417000661

Linda Austin – 410000491

Question 1

When determining whether to accept a new client, an auditor must perform these five procedures;

Establish quality control procedures to determine whether a client should be accepted.

Doing this will determine its acceptability. It would also assist in gaining greater knowledge of the extent to which the company stands in the marketplace and their financial stability.

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Communicate with the predecessor auditor after obtaining permission from the prospective client to discuss confidential matters.

Contact with the previous auditor further assists the auditing firm in deciding whether they should accept the engagement. This will confirm whether the company lacks integrity or if there are any disagreements in relation to accounting principles, procedures or fees. The previous auditor must obtain the permission from the company to communicate with the successor auditor.

Evaluate its ability to adequately service the prospective client.

If the auditors do not have the knowledge or understanding of that industry, they should not accept the client. As it relates to rule 201 regarding General standards, which states that you should possess the competence to do the job, if not do not accept.

Assess whether the management lacks integrity.

As an auditor, you do not want to engage in business with someone who’s not trustworthy or whose management ethical background is of concern. Some of these things deal with the turnover of management and any lawsuits that they have.

Determine the firm’s independence with respect to the prospective client.

Of the five procedures listed only three are required by auditing standards:

Assess whether the management lacks integrity.

Attempt to communicate with the predecessor auditor after obtaining permission from the prospective client to discuss confidential matters.

Determine firm’s independence with respect to the prospective client.

QUESTION 2

Nonfinancial matters deal with the company’s social and environmental information. This helps the auditor to understand the company’s accountability and responsibility. The nonfinancial matters that should be considered before accepting Home Goods Manufacturing Inc are:

The Illegal gambling incident.

Even though the incident has little to do with the business, it is still concerning, and it raises an issue about management’s integrity. As this relates to independence in appearance, others interpretation can affect the company’s reputation as well as the auditor’s faith in the client. It is likely that if a member of management is dishonest in this type of situation, they will be dishonest in other situations. The incident however was 5 years ago and there have not been any other known incidents.

Recent management turnover.

This may not have a direct negative impact on the audit, but it may cause the work of the auditor to move significantly slower. A more seasonal manager would have more significant knowledge of the company and experience in dealing with auditors, whereas new management would lack the relevant knowledge which would impact poorly on the audit causing it to move a lot slower. This can also be a sign of other problems that should be investigated

High auditor turnover rate.

The company has changed auditors three times over the past 12 years. Professional Skepticism should alert the auditor to a red flag. Although, the auditors’ turnover rate was not significantly high, the current auditors should investigate why Home Goods had so many auditors.

Transition into new system.

The transition to the new system was not smooth and employees being frustrated poses a red flag. This can be an issue for the auditors because they may have difficulty retrieving the relevant information they need from the system and conventional audit trails were not kept intact due to system failures and errors made by untrained personnel throughout 2018.

Hesitance of the client allowing the new auditor to speak to the previous auditor.

It is required by auditing standards for the new auditor to contact the predecessor auditor. Whenever a client is unwilling to allow the new auditor to communicate with the predecessor auditor, professional skepticism should alert the auditor of a red flag.

Initial Public Offering

Home Good’s has plans to go public and aggressively expand into the national market. If successful, these plans will make Home Goods a more attractive client for the auditors, however, this could also serve to increase the auditor’s business risk.

Management’s aggressiveness.

It was indicated that management is willing to manipulate year end accruals and revenue in order to meet creditors’ requirements. This poses a management integrity issue which the successor auditor should investigate.

Before accepting a new client, the auditing firm must determine whether acceptance would create or pose any threats to compliance with the fundamental principles.

Question 3

Comparison of Home Goods and the Industry Ratios

Home Goods 2017 Industry 2017 Home Goods 2018 Industry 2018

Return on Equity 7.11% 28.50% 8.94% 22.10%

Return on Assets 3.77% 8.80% 4.54% 7.20%

Assets on Equity 1.88 3.06 1.96 3.59

Accounts Receivables Turnover 13.10 7.57 11.68 8.14

Average Collection Period 27.85 48.21 31.23 44.84

Inventory turnover 4.51 7.5 6.09 8.8

Days in Inventory 80.89 47.67 59.98 41.48

Debt to Equity 0.88 2.06 0.97 2.58

Times Interest Earned 4.23 2.2 4.70 1.5

Current Ratio 1.92 1.3 1.85 1.2

Profit Margin 6.0% 10.00% 5.50% 9.80%

Major Differences:

Return on Equity – Home goods’ return on equity is less than half of the industry percentage, which shows that they are not generating enough retains for their stakeholders.

Return on Assets – Home Goods are way below the industry levels on how much returns on assets they are making.

Accounts Receivables Turnover – Home Goods is doing better than the Industry in terms of this ratio, which shows that they are settling their receivables quickly and obtaining cash quicker.

Average Collection Period – Homes Goods shows a lower number of days in which they can get money on a receivable balance, even though is not significantly low it is still doing less than the industry.

Inventory Turnover – Home Goods needs to make a faster turnover of inventory in order to make more sales. They are performing very low when compared to the industry.

Days in Inventory – Home goods days in inventory ratio is higher than the industry which implies that it takes a while to get their inventory to move out of stock, this can also mean that sales are slower than the industry.

Debt to Equity – This ratio shows that Home Goods does not deal with their long-term debt obligations properly, which states they cannot operate 100% in the long term.

Profit Margin – Homes Goods profit for each sale they make is not exceptionally low, however they are still performing lower that the industry.

Overall Home Goods is performing lower than the Industry which raises concerns especially in their Profitability Ratios and Asset Ratios.

Question 4

Having the same CPA firm provide both auditing and consulting services is the high level of efficiency. The auditor would have a level of understanding of the client’s business and can provide substantial advice. Providing both services will also assist the auditor in detecting weaknesses or observations during the audit. However, this can affect the auditor’s independence in appearance and objectivity due to the lack of duties not being segregated and the auditor’s opinion may be influenced causing other opinions to be biased.

Given the auditor independence rules the audit firm will be able to help Home Goods with the IT systems and still provide a financial statement audit because Home Goods Manufacturing Inc. is not a publicly trading company and those rules only relates to those who are. However, the auditors cannot help design and provide any managerial decisions relating to the IT system.

As Home Goods Manufacturing is not a public trading company, CPA can offer its’ services in the aid of developing and improving the IT system as they have had success in the building of this service for the past few years. CPA members must not perform managerial functions or make managerial decisions. A member should always be independent in the performance of professional services as required by standards set by bodies designated by council.

Question 5

This situation does not constitute a violation of independence according to the AICPA Code of Professional Conduct Rule 101. A violation comes about when there’s a direct financial interest, for example, if the auditor’s spouse has a direct financial interest such as ownership of stock, the auditor is prohibited to perform an audit for that company and materiality is not considered. However, in this case it is an indirect financial interest and materiality is considered.

This means that there is no close relationship present between the auditor and one of the persons in the firm who has invested venture capital and owns shares in Home Goods. Therefore, once it is not the partner who is in charge of Home Good’s audit or the partner’s spouse who has shares in the company it is not a violation, and any individual who doesn’t hold the titles listed can have a direct financial interest in the firm.

According to the AICPA Code of Professional conduct, a staff member of a CPA firm could own stock in a client’s corporation and not violate Rule 101 if the member is not involved in the engagement. As one of the partners in the firm has invested in a venture capital fund that owns shares of Home Goods common stock and is not assigned to the engagement, this would not be a violation.

Question 6

Memorandum

To: Audit Partner

From: Audit Firm

Date: October 7th, 2019

Re: Acceptance of Home Goods Manufacturing Inc.With the decision in deciding whether to accept Home Goods as an audit client, all factors of the business must be considered. These factors include:

Managerial Integrity

Aggressively changing accounts too match

Low performance comparing to Industry

Not wanting to connect predecessor auditor

Frequent management turnover

Initial Public Offering

Some of The Ratios have improved from the previous year such as the Average Collection Period, however some have declined such as the Accounts Receivable Turnover.

I do believe that you should not accept Home Goods Manufacturing Inc. as an audit client.

Question 7

*Choose a set of figures 2017

Prior Year audited figures $ (000)

Accounts Receivable 7936

Inventory 10487

Accounts Payable & Accrued Expenses 9652

Long Term Debt 17234

*Choose a Benchmark

Accounts Receivable – Turnover

Inventory – Turnover

Accounts Payable & Accrued Expenses – Operating Profit before tax

Long Term Debt – Operating Profit before tax

*Calculate the Range

Accounts Receivable

Seeing that this account is one where the risk of material maintenance is high, it would be high risk. Therefore 0.5% would be used

$7,936,000 * 5% = $396,800

Inventory

This is affected by the new IT system and will also be seen as high risk.

$10,487,000 * 5% = $524,350

Accounts Payable

High Risk

$9,652,000 * 5% = $482,600

Long Term Debt

High Risk

$17,234,000 * 5% = $861,70

The Figures previously calculated are called Original Materiality

*Calculate Performance Materiality

– This is calculating the level of acceptable misstatements in the account balance. The percentage being used is 10%. This is calculated based on the Original Materiality.

– Accounts Receivable

$396,800 * 75% = $297,600

Inventory

$524,350 * 75% = $393,262.50

Accounts Payable

$482,600 * 75% = $361,950

Long Term Debt

$861,700 * 75% = $646,275

The range in which materiality can be accounted from

Accounts Receivable range would be 0.29766. Anything above, the client must answer for.

75% Performance materiality is used because it is

*Clearly Trivial

3.5% is being used so any errors or omissions below this level can be ignored or written off.

– Accounts Receivable

$396,800 * 3.5% = $13,888

Accounts Payable

$482,600 * 3.5% = $16,891

Inventory

$524,350 * 3.5% = $18,352.25

Long Term Debt

$861,700 * 3.5% = $30,159.50

Question 8

MemorandumTo: Audit Partner

From: Audit Firm

Date: October 7th, 2019

Re: Important factors likely to affect the audit

After analysing and assessing Home Goods’ financially statements, I have discovered important factors and potential risk areas that will most likely affect how the audit is conducted if we do accept Home Goods as a client. Below is the list of factors and risk areas I have gathered:

The Accounts Receivable Turnover is above the industry’s average, which is good, but it is declining. This will raise a concern for the auditor, and they will need to pay special attention to the valuation of receivables.

There is a high risk of material misstatement that is present in the inventory tracking and cost accumulation, payroll deductions, receivables billing and aging, balance sheet account calculations and payable balances due to Home Goods’ new IT implementation. The auditor should conduct substantive procedures with large sample sizes, and with emphasis on tests of details of balances.

Home Goods’ Inventory Turnover has improved tremendously, even though it is still poor compared to the industry’s ratios. The reason for this can be that there is an effective inventory management in placed, or there are misstatements present in the inventory account.

The return on equity and the profit margin for Home Goods are low when set side by side to the Industry’s ratios. It is suggested that the auditor should ‘dig deeper’ into the situation to determine the contributing factor or an explanation for this low performance. These factors can be potentially linked to the competitiveness in the industry and in the region or product set. This raises red flags for fraud risk.

Within the Home Good’s organization, there seems to be a lack of internal controls. Therefore, the auditor will need to heavily rely on substantive procedures, which will be very costly and have implications for staffing budgets.

About the author

This paper is written by Sebastian He is a student at the University of Pennsylvania, Philadelphia, PA; his major is Business. All the content of this paper is his perspective on Auditing Group Project Final and should be used only as a possible source of ideas.

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