TASK
The Kowal Manufacturing Company employs about 50 production workers and has the following payroll procedures.
The factory foreman interviews applicants and on the basis of the interview either hires or rejects them. When applicants are hired, they prepare a W-4 form (Employee’s Withholding Exemption Certificate) and give it to the foreman. The foreman writes the the new employee in the corner of the W-4 form and then gives the form to a payroll clerk as notice that the worker has been employed. The foreman verbally advises the payroll department of rate adjustments.
A supply of blank time cards is kept in a box near the time clock at the entrance to the factory. Each worker takes a time card on Monday morning, fills in his or her name, and punches the time clock upon their daily arrival and departure. At the end of the week, the workers drop the time cards in a box near the door to the factory.
On Monday morning, the completed time cards are taken from the box by a payroll clerk. One of the payroll clerks then enters the payroll transactions into the computer, which records all information for the payroll journal that was calculated by the clerk and automatically updates the employees’ earnings records and general ledger. Employees are automatically removed from the payroll when they fail to turn in a time card.
The payroll checks that are not directly deposited into employees’ bank accounts are manually signed by the chief accountant and given to the foreman. The foreman distributes the checks to the workers in the factory and arranges for the delivery of the checks to the workers who are absent. The payroll bank account is reconciled by the chief accountant, who also prepares the various quarterly and annual payroll tax reports.
a. List the most important weaknesses in their processes and state the misstatements that are likely to result from the weakness.
b. For each weakness that increases the likelihood of fraud, identify whether the likely fraud is misappropriation of assets or fraudulent financial reporting.*
This problem requires you to access PCAOB Auditing Standards (pcaobus.org) to answer each of the following questions. You can access those standards by viewing content found under the link “Standards.” Review PCAOB auditing standards related to the auditor’s consideration of fraud in a financial statement audit (AS 2401) and related to the auditor’s responses to the risks of material misstatement (AS 2301) to answer parts a. through f. below. For each answer, document the paragraph(s) in the relevant standard supporting your answer.
a. You have determined that there is a fraud risk related to the existence and accuracy of inventory. Review the guidance in PCAOB auditing standards to provide examples of auditor responses involving changes to the nature, timing, and extent of audit procedures related to this assessed fraud risk for inventory.
b. What do PCAOB auditing standards say about how the auditor should assess risk related to revenue recognition?
Required
Required
Required
Based on AICPA question paper, American Institute of Certified Public Accountants.
c. What examples of auditor responses to fraud risk related to revenue recognition are provided in PCAOB auditing standards?
d. What kind of documentation is required for the auditor’s consideration of fraud?
e. What kinds of inquiries about fraud risks are required by PCAOB AS 2301?
f. How does PCAOB AS 2301 define “fraud risk factors”? Do all conditions have to be present for fraud risk to exist?
The following audit procedures are included in the audit program of Holland Equipment, Inc.
1. Use audit software to examine journal entries in the sales, cash receipts, purchases,
cash disbursements, payroll, and general journals for any amounts exceeding $1 mil-
lion and for any entries with unusual account codings. Review related supporting
documentation for reasonableness.
2. Examine the estimate for the Allowance for Doubtful Accounts recorded in the
prior-year audited financial statements. Obtain information about receivable write-
offs recorded during the current fiscal year for receivables included in the prior-year
audited financial statements and obtain other information to perform a hindsight
evaluation of the reasonableness of the allowance account included in the prior-year
audited financial statements.
3. Continue to observe inventories at Holland’s two main distribution centers, but for
this year examine inventories at its two smaller warehouses not examined in prior
years. Management does not expect you to examine those additional warehouses.
4. During the current year, Holland has entered into a joint venture partnership with a
company that serves similar customers but makes an entirely different product than
Holland. Inquire of management about the business rationale for this transaction.
5. Review for reasonableness any manual journal entries made by management to ad-
just the computer-generated accounting records.
a. What is the overarching purpose for performing all of these procedures?
b. How might each audit procedure in 1 through 5 help the auditor identify fraud risk?
