Worksheet for You Decide Questions: Q1:Discuss how the SEC has influence (if any) over the audit of Smackey Dog Foods, Inc. Solution: Since Smackey is a private company, the SEC regulations are not required. The SEC requires only public companies to offer full disclosure on their financial statements. Private companies are not bound to such strict disclosure requirements. Q2: Discuss the essential activities involved in the initial planning of an audit. How do these all specifically to the Smackey Dog Food client? Solution: There are four things that an auditor needs to assess prior to performing an audit: 1.

The auditor must decide whether or not to accept the audit 2. The auditor must understand the client’s needs for the audit which will aid the auditor in planning out the audit 3. The auditor and client must come to an agreement about “the terms of the engagement” (Arens, etal, 2010) 4. The auditor must develop a strategy and gather all auditors and specialists When it comes to Smackey: 1. The auditor accepted Smackey as a client 2. The auditor was informed that Smackey needs the audit to obtain more financing from the bank – the bank required an audit 3.

The auditor and Smackey need to talk and come to an agreement about the “terms of the engagement” (Arens, etal. , 2010) as it does not appear that has yet occurred 4. Since the auditor has never audited a dog food manufacturer before, aside from Peter, Ben and Maureen (the auditors assigned to this audit), they may want to hire a specialist who has audited this type of business in the past Q3:Discuss the 4 stages of the audit and the major activities performed by the auditor in each phase. Give an example of how each of these specifically applies to the Smackey Dog Food, Inc audit.

For instance, examine the apparent internal control weaknesses and possible negative outcome of each. Solution: I: Plan and design. The auditor must know what the client is seeking to gain from the audit. In this case, Smackey needs the audit to get another loan from the bank. The auditor must assess all risk prior to committing to the engagement. They also need to be sure they are able to provide due care and adhere to GAAS (Chapt 7 – Accepting the Engagement and Planning the Audit) II: “Perform tests of controls and substantive tests of transactions” (Arens, etal. , 2010). The auditors need an understanding of the client’s operations.

With Smackey, the auditors should walk through the plant to see what the operation entails and see any/all physical controls that exist. It appears that this had been performed as Ben and Maureen have observed returned dog food eventually being loaded into an employee’s car. The auditors must also get an understanding of how the sisters work together and how they deal with their financials and employees. As related parties their actions could significantly alter or cause issues with financial statements. III: “Perform analytical procedures and tests of details of balances” (Arens, etal. 2010). Here the auditors will perform tests that fulfill transaction related and balance related audit objectives. They will also use “tests of details of balance” (Arens, etal. , 2010) that will test for misstatements. At Smackey, the auditors would want to concentrate on the accuracy of accounts receivable since this is the collateral they wish to put up for the bank loan. They would also need to concentrate on the tests of details for accounts receivable as it appears that misstatements are likely as the receivables are adding up/increasing and Sarah is unwilling to write any of them off.

IV: “Complete the audit and issue an audit report (Arens, etal. , 2010). Once the auditor completes phases I-III, they would compile all the information to complete their report and issue an opinion. Q4:Describe Keller CPAs’ responsibilities related to communications regarding internal control matters. What internal controls issues do you identify? Solution: Keller CPAs are responsible to communicate, in writing, any problems they discover with internal control. This communication would be addressed to the owners/management. The issues with internal control at Smackey include: 1.

Smackey uses Henry exclusively for all their shipping and production needs. He prepares and approves all inventory records. Since he is the only one recording this information, there is no control. He has the potential to misstate the inventory taken in, shipped out and what truly remains in inventory. 2. Due to lack of segregation of duties in the shipping and production department, auditors have observed a great deal of waste that ends up in Henry’s vehicle for him to take home. 3. The sales department is getting advances on their commissions based on each sales person’s estimation.

However there are no apparent controls on how advances that are higher than actual earned commissions are returned to the company. 4. There are control issues when it comes to accounts receivable. Sarah refuses to write off any of them and many are aging. Also their biggest client may not be paying what they owe in the near future and they also may be scaling back the amount of food they purchase. Since the accounts receivable is what Smackey is using as collateral to get a bank loan, what is currently reported may be very inaccurate and misleading to the bank. Q5:You decide that you will address Smackey Dog Food, Inc. s accounts receivables through confirmations. Discuss the various types of confirmations and what forms you will implement and why. Solution: There are three types of confirmations: 1. An invoice confirmation is a positive confirmation in which a customer confirms that a specific invoice is accurate 2. A positive confirmation is a document sent to a customer requesting their response. They are asked to confirm their account balance. 3. A negative confirmation is a document sent to a customer requesting only a reply if the stated account balance is incorrect.

With Smackey, I would take a sampling from the accounts receivable and request positive confirmation. I would especially do this with their biggest client. If customers do not respond, auditors need to examine documents to verify shipments and recording of payments. Q6:What are the major factors affecting sample size for confirming accounts receivable? Solution: “Tolerable misstatement, inherent risk, control risk, achieved detection risk from other procedures, type of confirmation” (Chapter 16 Completing the Test in the Sales and Collection Cycle)

Q7:A major issue in verifying the ending balance in property, plant and equipment is the possibility of legal encumbrances. Discuss what specific concern do you have. Describe the procedures your firm will perform to obtain evidence about existing legal encumbrances. Solution: Some of the concerns I would have include: 1. Any liens against the property due to judgments filed against Smackey for unpaid debts to suppliers. These judgments would attach to the property. 2. The possibility of a judgment filed against Smackey from the employee suing.

This judgment could also attach to the property. To discover any liens or encumbrances, as an auditor any lease agreements, mortgages and liabilities need to be looked into. A search of public records would not hurt either. Q8:The client wants to know if you will be present at the year-end inventory. What is your decision and why? What role or actions will you take at the inventory if you decide to attend the inventory. Why? Solution: It is essential that the audit team be physically present for the inventory count.

I read the case earlier in this course where the audit team was present for the inventory count but the count was done on different days at each facility instead of all at the same time. This window allowed the client to transfer inventory from one location to another and so the inventory count was grossly misstated. An auditor needs to oversee the count and ensure that an appropriate/accurate count is taken Q9:Considering the general six functions that make up the inventory and warehousing cycle for Smackey Dog Foods, Inc. , identify the related documents and/or records that would be used.

From your analysis of the internal controls related to the inventory and warehousing cycle of Smackey Dog Foods, Inc. , what internal control weaknesses exist? Solution: The six general functions of Smackey’s inventory and warehouse cycle include: 1. Process purchase orders: employee Henry takes in all purchase orders 2. Receive raw materials: Kim orders and accounts for all raw materials 3. Store raw materials: Henry stores all raw materials and decides when they are needed for production 4. Process the goods: Henry is also responsible for the production 5.

Store finished goods: Henry stores all the finished goods and is responsible to keep a record of them 6. Ship finished goods: Henry is also responsible for shipping Since Henry has his hand in five of the six functions of inventory and warehousing, there is a strong potential for fraud. He has too much access and too much control. Kim needs to strengthen the internal control in her department. There also seems to be no procedures established for returns. This is probably why it has been so easy for Henry to steal returned dog food on a regular basis.

Q10:Discuss if Keller CPAs or its auditors are breaching any Professional Rules of Conduct and why or why not? Solution: SAS99 requires auditor independence. None of the auditors have any financial or related connection to Smackey in any way. However Pete has been discussing the engagement with his friend, Alan. Depending on the content of their conversations, Pete could be breaching confidentiality. But if he has been merely discussing general auditing procedures not specific to Smackey, there would be no breach.

Q11:Discuss the CPA firm’s legal liability concerns for this audit if they make a material unintentional or intentional mistake. Include any other legal liability concerns regarding possible Professional Rule violations. Solution: There are “four sources of auditor’s legal liability: 1. Liability to clients 2. Liability to third parties under common law 3. Civil liability under the Federal Securities laws 4. Criminal liability” (Arens, etal. , 2010) In the situation with Smackey, I believe the greatest concern regarding liability would be liability to third parties under common law.

Since the audit engagement was needed by Smackey, due to the bank’s demand, if the audit does not find material misstatements present, the bank can sue the auditors. This would fall under the Ultramares Doctrine. If this happens, the client can also sue. References A Arens, R. Elder, M. Beasley (2010). Auditing & Assurance Services and Integrated Approach. NJ: Prentice Hall. Chapter 7–Accepting the Engagement and Planning the Audit. http://ruby. fgcu. edu/courses/cpacini/courses/acg4632/ch7audnotes. pdf Chapter 16 Completeing the Tests in the Sales and Collection Cycle. ccba. jsu. edu/ccba/… /jzanzig_Auditing%20Ch%2016%20Lecture. ppt