EMs Audit of Maxall - Case Study Example

MAXALL CASE STUDY INTRODUCTION: Auditing is a very important activity. An audit report giving a "fairly presented" opinion shows gives credence tothe assertions in terms of the assets, liabilities, capital, revenues, costs, expenses, profits and losses of the audit client. The Users of financial statements would rely on a financial statement that has been audited1. BODY: What do you think the auditors meant by the term "substantive audit' Substantive audit is the audit of balance sheet accounts that affect the income statement accounts. the external auditors, EM, will audit the cash account, the receivables accounts, the bad debts expense and the allowance for doubtful accounts because these four accounts will result to an increase or decrease in the revenues of the company. The balance sheet accounts will substantiate or given ample evidence that the revenues reported in the income statements are valid and relevant. For, an increase in cash in the balance would indicate that a cash sales transaction occurred. However, an increase in cash could also be attributed to collection of accounts receivable and not a new sales transaction. In addition, an increase in receivables account would indicate a possible sales on account transaction. On the other hand, an increase in receivables account could be due to an reinstatement or reversal of an accounts receivable that had been written off. Accounts receivable are written off if there is a probability that the a certain amount of receivables can no longer be collected because the customer may be absconded or has filed for bankruptcy in the courts2. Was the substantive approach appropriately applied in EM's audit of Maxall Yes, the substantive approach appropriately was applied in EM's audit of Maxall. First, EM determined that a violation of the auditing principle that segregation of incompatible functions occurred. Auditing principles state that incompatible functions of recording, keeping and approving should not be placed in the shoulders of one person. For, there is a stronger possibility of fraud to occur in the sales, receivables, cash accounts if one person handles two or three of the functions mentioned here. For example, the cashier can pocket the cash collected from the customer and make a fraudulent entry debiting bad debts expense of $100 and crediting accounts receivable of $100 so that the customer's account will be erased or written off. In short, there is greater audit risk in incompatible function scenes than when one person is the cashier, another person is the bookkeeper or accountant and a third person approves receivables write off. Second, the external auditors set materiality levels $35,000 in the sales/accounts receivable area in 2001. the external auditors set materiality levels of $50,000 for the year 2002. Materiality is defined as the amount that would affect the decision making activities of users of the financial statements. The financial statement users include board of directors, stock holders, suppliers, creditors, banks customers, government taxation and legal agencies, community. For example, the non recording of sales transaction amounting to $10 would surely not affect the decision of the users if the total sales reported in the income statement is $2,000,000. On the other hand, a debit to sales and accounts receivable accounts in December 2001 of $5,000 when the delivery of the inventory took place in January 2,2002 would affect the decision making activities of the users of the financial statements if the total receivables amount is $12,000. In terms of planning, the auditors, EM, were right not pinpoint that the internal control was weak and that more time must be spent to gather more evidences to substantiate that the financial statements are not fairly presented. Fairly presented is the best audit report opinion to give for it means that the financial statements are fair to everyone because only the material subsidiary accounts are examined, vouched, observed, confirmed and the like. The external auditors, EM, were right in planning to gather audit evidence based on material levels above in order to save on the audit client's audit expenses. The external auditors were right in gathering confirmation of fifty five to sixty percent of the accounts receivables amount to $4,146,591 for 2001 and $26,952,431 in 2002. Positive confirmation is a better strategy when the accounts receivable amount of each account customer is material. The negative confirmation is a better strategy when the accounts receivable of each account customer is not material. The received confirmations amounting to $1,900,036 in 2001 and $14,786,239 in2002 will is the customer's confirmation that the accounts receivable listed in the accounts receivable ledger is correct or erroneous. Likewise, the application of alternative procedures when confirmation letters were not received from the clients is in compliance with generally accepted auditing standards in the arena of audit evidence gathering. The alternative procedures include tracing the flow of transactions from inventory to sales on account to collection of accounts receivables3. Identify and discuss specific audit processes / procedures that the auditors) performed that were in accordance with Generally Accepted Auditing Standards In addition to the audit processes/ procedures discussed in the prior question above, the auditors complied with GAAS by verifying that some sales on accounts were not recorded. For example, EM noticed that The Southwestern Accounts receivable of $370,440 listed in the balance sheet as of December 31, 200s did not tally with the customer's confirmation that it had only an accounts receivable balance of $19,426. Alternative procedures done by EM proved that the $370,440 shipment from Maxall to Southwestern had arrived at the customer's destination after the cut off date of December 31, 2001. Further, Em was right in making audit adjustment of increasing the 2002 sales and receivables amounts by $48,310 because a sales transaction should only recorded in the book of original entry (Journal) on the date of the actual delivery4. CONCLUSION: The auditing firm ,EM, had complied with all facets of generally accepted auditing standards in the area of receivables, cash and sales. They complied with the auditing procedures and programs in terms of audit risk, planning, materiality and collection of evidence. Read More