Solution with answer applied auditing by cabrera chapter16

CHAPTER

17

COMPLETING THE AUDIT

17-1.

a.

(3)

b.

(1)

c.

(4)

d.

(3)

17-2.

a.

(4)

b.

(3)

c.

(1)

d.

(4)

17-3.

a.

(3)

b.

(1)

c.

(1)

d.

(2)

17-4.

Tracy Brewing Company

e.

(1)

a.

4 - The amount appeared collectible at the end of the field work.

b.

1 - The uncollectible amount was determined before end of field work.

c.

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.

d.

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.

e.

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.

f.

2 - The lawsuit originated in the current year, but the amount of the loss is
unknown.

g.

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.

h.

4 - The financial statements were believed to be fairly stated for 6-30-06 or 819-06.

i.

2 - The cause of the lawsuit occurred before the balance sheet date and the
lawsuit should be included in the 6-30-06 footnotes.


17-2

Solutions Manual to Accompany Applied Auditing, 2006 Edition

17-5.

Flowmeter, Inc.

Ite
m
No.
1.

2.

3.

Audit Procedures
Goods “in-transit” would be
detected in the course of the
auditor’s 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
company’s
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
cash disbursements for the period
between the balance sheet date and

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.

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.

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.
If the acquisition is significant
enough, it might be advisable to


Completing the Audit

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
firm’s legal counsel would
probably have revealed the
purchase.

4.

Inventory losses attributable to a
flood would be brought to the
auditor’s
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
client’s 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 committee’s
meetings, by corresponding with
the client’s attorneys and by
examining the cash receipts book
in the period subsequent to the
balance sheet date for evidence of
unusually large receipts.

17-3

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
reader’s 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 reader’s
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
such a material impact on the entity
that the auditor may wish to


17-4

Solutions Manual to Accompany Applied Auditing, 2006 Edition
include in his report an explanatory
paragraph directing the reader’s
attention to the event and its effect.

17-6.

Olars Manufacturing Corporation
1.

The government’s approval of a plan for the construction of an express

highway would have come to the CPA’s 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).

2.

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 president’s 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
officer’s personal business and has no effect upon the corporation’s financial
statements. Indeed, disclosure of the funds’ source might be construed as
detrimental to the officer.

3.

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 client’s 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}.

4.

The CPA might learn of the agreement to purchase the treasurer’s 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 CPA’s 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 treasurer’s
resignation, does not require disclosure in the financial statements. The


Completing the Audit

17-5

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.

6.

The contract with Lopez Industries would come to the CPA’s 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 corporation’s
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.