Question 16-11, page 529

1. Question 16-11, page 529 Explain why it is common for auditors to send confirmation requests to vendors with “zero balances” on the client’s accounts payable listing but uncommon to follow the same approach in verifying accounts receivable.

2. Solution, Question 16-11 Auditors traditionally follow a conservative approach in selecting vendors for accounts payable confirmations and customers for accounts receivable confirmations. The auditor assumes that the client is more likely to understate accounts payable and therefore concentrates on the vendors with whom the client deals actively, especially if that vendor’s balance appears to be lower than normal on the client’s accounts payable listing at the confirmation date. In verifying accounts receivable the auditor assumes that the client is more likely to overstate account balances and for that reason he concentrates more on the higher balances and is not particularly concerned with “zero balances.”

3. Problem 16-21, Page 530 Because of the small size of the company and the limited number of accounting personnel, Dry Goods Wholesale Company Ltd. initially records all acquisitions of goods and services at the time that cash disbursements are made. At the end of each quarter when financial statements for internal purposes are prepared, accounts payable are recorded by adjusting journal entries. The entries are reversed at the beginning of the subsequent period. Except for the lack of a purchasing system, the controls over acquisitions are excellent for a small company. (There are adequate prenumbered documents for all receipt of goods, proper approvals, and adequate internal verification wherever possible.) Before the auditor arrives for the year-end audit, the bookkeeper prepares adjusting entries to record the accounts payable as of the balance sheet date. The aged trial balance is listed as of the year end, and a manual schedule is prepared adding amounts that were entered in the following month. Thus, the accounts payable balance equals the aged trial balance plus the following month's journal entry for invoices received after year end. All vendors’ invoices supporting the journal entry are retained in a separate file for the auditor’s use. In the current year, the accounts payable balance has increased dramatically because of a severe cash shortage. (The cash shortage apparently arose from expansion of inventory and facilities rather than a lack of sales.) Many accounts have remain unpaid for several months, and the client is getting pressure from several vendors to pay the bills. Since the company had a relatively profitable year, management is anxious to complete the audit as early as possible so that the audited statements can be used to obtain a larger bank. loan. REQUIRED Explain how the lack of a complete aged accounts payable trial balance will affect the auditor’s tests of controls for acquisitions and cash disbursements. What should the auditor use as a sampling unit in performing tests of acquisitions? Assume that no misstatements are discovered in the auditor’s tests of controls for acquisitions and disbursements. How will that assumption affect the verification of accounts payable? Discuss the reasonableness of the client’s request for an early completion of the audit and the implications of the request from the auditor’s point of view. List the audit procedures that should be performed in the year-end audit of accounts payable to meet the cutoff objective. State your opinion as to whether it is possible to conduct an adequate audit in these circumstances.

4. Problem 16-21 , Solution An aged accounts payable trial balance: • represents a good source of information on transactions. • Select items from this trial balance for testing. • Also review documents for potential cut-off errors. Sampling unit: • use prenumbered receiving documents as the sampling unit for tests of missing documents • cash disbursement entries for other tests (e.g., existence and classification). No misstatements discovered in the auditor’s tests of controls: • the auditor may be able to reduce the scope of his or her tests for existence, accuracy, and classification of accounts payable. The client’s request for early completion of the audit: • This will present a problem for the auditor to evaluate the propriety of the purchase cutoff. – not enough time. • Since no acquisitions journal exists, this means there could be an important weakness in internal controls for the recording of accounts payable. • To compensate, perform an extensive search for unrecorded liabilities at the end of the year. Audit procedures to satisfy cutoff objective: • Reconciliation of vendors’ statements as of the year-end date. • Examination of invoices that are paid subsequent to year end to determine whether or not they should have been included in accounts payable at year end. If these invoices indicate that the purchases were received prior to year-end, the auditor should search the accounts payable listing for these items. If they do not appear on the accounts payable listing, they represent unrecorded liabilities and should be recorded by the client at year-end. • Examine all invoices that are unpaid at the end of the audit to determine whether or not they should have been recorded at year-end. For any of these items that were liabilities at year-end, the auditor should follow the same procedures followedabove. The auditor must satisfy himself or herself that this examination has been sufficient to determine that the financial statements are reasonably stated. If the auditor is able to achieve this and complete his or her engagement by the date requested by the client, then it is possible to conduct an adequate audit in these circumstances. Otherwise, it is not possible.

5. Problem 16-22, p. 531 You were in the final stages of your examination of the financial statements of Ozine corporation for the year ended December 31, 2011, when the corporation’s president came to talk to you. He believed that there was no point to your examining the 2012 acquisitions data files and testing data in support of 2012 entries. He stated that (1) bills pertaining to 2011 that were received too late to be included in the December acquisitions data files were recorded by the corporation as of the year end by journal entry, (2) the internal auditor made tests after the year end, and (3) he would furnish you with a letter confirming that here were no unrecorded liabilities. REQUIRED • Should a public accountant’s test for unrecorded liabilities be affected by the fact that the client made a journal entry to record 2011 bills that were received late? Explain. • Should a public accountant’s test for unrecorded liabilities be affected by the fact that a letter is obtained in which a responsible management official confirms that, to the best of his or her knowledge, all liabilities have been recorded? Explain. • Should a public accountant’s test for unrecorded liabilities be eliminated or reduced because of the internal audit tests? Explain. • Assume that the corporation, which handled some government contracts, had no internal auditor but that the Auditor General’s office spent three weeks auditing the records and was just completing her work at this time. How would the public accountant’s unrecorded liability test be affected by the work of the auditor from the Auditor General's office? • What sources in addition to the 2011 acquisitions data files should the public accountant consider to locate possible unrecorded liabilities?

6. Solution, Problem 16-22 The fact that the client made a journal entry to record vendors’ invoices that were received late should simplify the public accountant’s test for unrecorded liabilities and reduce the possibility of a need for a further adjustment: • But the public accountant’s test is nevertheless required. • Clients normally are expected to make necessary adjustments to their books so that the public accountant may examine statements that the client believes are complete and correct. • If the client has not journalized late invoices, the public accountant is compelled in his or her testing to substantiate what will ultimately be recorded as an adjusting entry. • In this examination, the public accountant should test entries in the 2012 data files to be sure that all items which according to dates of receiving reports or vendor’s invoices were applicable to 2011 have been included in the journal entry recorded by the client.  No. The public accountant should obtain a letter in which responsible executives of the client’s organization represent that to the best of their knowledge all liabilities have been recognized. • However, this is done as a normal audit procedure to remind the client of his responsibilities and the statements that have been made. • It does not relieve the public accountant of the responsibility for making his or her own tests. Whenever a public accountant is justified in relying on work done by an internal auditor the public accountant can curtail (but not eliminate) his or her own audit work. • In this case, the public accountant should have ascertained early in his or her examination that Ozine’s internal auditor is qualified by being both technically competent and reasonably independent. • Once satisfied as to these points, the public accountant should discuss the nature and scope of the internal audit program with the internal auditor and review his or her working papers in order that the public accountant may properly coordinate his or her own program with that of the internal auditor. • If the Ozine internal auditor is qualified and has made tests for unrecorded liabilities, the public accountant may limit his or her work to a less extensive test in this audit area. • Should also consider the level of internal independence of the internal auditor. (i.e. best to report to the audit committee.)

7. Solution, Problem 16-22 Work done by an auditor for the Auditor General’s office will normally have no effect on the scope of the public accountant’s audit • The concern of government auditors is usually limited to matters that are likely to be unrelated to the financial statements. • Nevertheless, the public accountant should discuss the government auditor’s work program with him/her, as there are isolated situations where specific procedures followed to a satisfactory conclusion by an auditor from the Auditor General’s office will furnish the public accountant with added assurance and therefore permit him/her to curtail certain work in a particular area. • Another reason for discussing the Auditor General’s office’s auditor’s results with him or her is that his or her findings may affect the financial statements in other ways. e. In addition to the 2011 acquisitions data, the public accountant should consider the following sources for possible unrecorded liabilities: vendors’ invoices that have not been entered in the purchases journal. status of tax returns for prior years still open. discussions with employees. representations from management. comparison of account balances with preceding year. examination of individual accounts during the audit. existing contracts and agreements. minutes of meetings. lawyers’ bills and letters of representation. status of renegotiable business. correspondence with principal suppliers. audit testing of cutoff date for reciprocal accounts, e.g., inventory and capital assets.