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Determining the Extent of TODBDetermining the Extent of TODB
Risk model factorsRisk model factors• Acceptable audit riskAcceptable audit risk
• Inherent riskInherent risk
• Control riskControl risk
MaterialityMateriality (partially depends on (partially depends on AAR)AAR)
Determining the Extent of TODBDetermining the Extent of TODB
Risk model factorsRisk model factors
MaterialityMateriality
Results of other testsResults of other tests• Tests of controlsTests of controls
• Substantive tests of Substantive tests of transactionstransactions
• Analytical proceduresAnalytical procedures
Analytical ProceduresAnalytical Procedures
2007 Gross 2007 Gross 2006 Gross 2006 Gross Margin Margin Margin Margin
GW INDGW IND GW IND GW IND
HardwoodHardwood 36.3 32.4 36.4 32.5 36.3 32.4 36.4 32.5SoftwoodSoftwood 23.9 22.0 20.3 22.123.9 22.0 20.3 22.1
PlywoodPlywood 40.3 50.1 44.2 54.3 40.3 50.1 44.2 54.3
Analytical ProceduresAnalytical Procedures
Softwood increased 3.9%, industry Softwood increased 3.9%, industry stablestable
Changes Changes usually most informativeusually most informative (also want to understand (also want to understand differences from industry)differences from industry)
Easier to spot errors in Easier to spot errors in disaggregated datadisaggregated data
Analytical Procedure Follow-upAnalytical Procedure Follow-up
Client will be able to suggest likely Client will be able to suggest likely non-error causes, which you will non-error causes, which you will evaluate.evaluate.
Consider error causesConsider error causes
What errors would cause gross What errors would cause gross profit to increase?profit to increase?
Error Causes of Gross Profit IncreaseError Causes of Gross Profit Increase
Sales overstatedSales overstated• Fictitious salesFictitious sales
• Cutoff error - January sale recorded in Cutoff error - January sale recorded in December (COS not matched)December (COS not matched)
Cost of sales understatedCost of sales understated• Inventory overstatedInventory overstated
• Purchases understated or cutoff error - Purchases understated or cutoff error - December purchase recorded in JanuaryDecember purchase recorded in January
Extent of TestsExtent of Tests
Amount of testing for TODB objectives Amount of testing for TODB objectives will depend upon results of TOT for will depend upon results of TOT for related transaction objectives:related transaction objectives:
– see following slide for related see following slide for related objectives (from Ch. 6)objectives (from Ch. 6)
– see table in notes for specific testssee table in notes for specific tests
–main sampling application in main sampling application in TODB for AR is confirmationsTODB for AR is confirmations
Assertion Trans. Obj. Balance Obj.Assertion Trans. Obj. Balance Obj.
ExistenceExistence OccurrenceOccurrence Existence Existence
Completeness Completeness CompletenessCompleteness Completeness Completeness
Accuracy Accuracy AccuracyAccuracy
ValuationValuation Classific. Classific. Classific. Classific.
oror Timing Cutoff Timing Cutoff
AllocationAllocation Post. & Summ. Detail tie-in Post. & Summ. Detail tie-in
None NRVNone NRV
Rights & Obl. N/A Rights & Obl.Rights & Obl. N/A Rights & Obl.
Pres. & Disc. N/A Pres. & DisclPres. & Disc. N/A Pres. & Discl
ConfirmationsConfirmations
Key ObjectivesKey Objectivesexistenceexistence
accuracy (valuation)accuracy (valuation)
Weak evidence for completeness Weak evidence for completeness - why?- why?
Confirmation are required unless Confirmation are required unless (SAS # 67):(SAS # 67):
• Accounts receivable are Accounts receivable are immaterial.immaterial.
• Confirmations are expected to be Confirmations are expected to be ineffective.ineffective.
• Combined IR and CR are lowCombined IR and CR are low, and , and other evidence reduces audit risk to other evidence reduces audit risk to an acceptably low level.an acceptably low level.
ConfirmationsConfirmations
Why would auditors like to Why would auditors like to minimize confirmations?minimize confirmations?
What is the alternative to What is the alternative to confirmations?confirmations?
Positive ConfirmationsPositive Confirmations
• Emphasis in testing is usually larger, and Emphasis in testing is usually larger, and older accountsolder accounts• Testing may be balance or individual Testing may be balance or individual
invoiceinvoice– Invoice may increase response rateInvoice may increase response rate
–Reduces extent of reconciling itemsReduces extent of reconciling items
–However, provides less assuranceHowever, provides less assurance
Negative ConfirmationsNegative Confirmations
Used whenUsed when
• Internal control effectiveInternal control effective
• Many small balancesMany small balances
• Customers expected to give Customers expected to give adequate considerationadequate consideration
Alternative ProceduresAlternative Procedures
1. Subsequent cash receipts1. Subsequent cash receipts
2. Shipping document2. Shipping document
Any untested portion should be Any untested portion should be treated as an error for projection treated as an error for projection purposes.purposes.
95% of returned confirmations indicated 95% of returned confirmations indicated the customer owed a smaller balance. the customer owed a smaller balance. This may be explained by:This may be explained by:
a. a. Cash receipts journal was held open after Cash receipts journal was held open after year-end.year-end.
b. There are a large number of unrecordedb. There are a large number of unrecorded liabilities.liabilities.
c. Sales journal was closed prior to y/e.c. Sales journal was closed prior to y/e.
d. Sales journal was held open after year-d. Sales journal was held open after year- end.end.
FIGURE 16 - 3FIGURE 16 - 3FIGURE 16 - 3FIGURE 16 - 3Aged Trial Balance forAged Trial Balance for
Hillsburg Hardware Co.Hillsburg Hardware Co.Aged Trial Balance forAged Trial Balance for
Hillsburg Hardware Co.Hillsburg Hardware Co.
FIGURE 16 -4FIGURE 16 -4FIGURE 16 -4FIGURE 16 -4
AnalysisAnalysisof Allowanceof Allowance
for Uncollectiblefor UncollectibleAccounts forAccounts for
Hillsburg Hardware Hillsburg Hardware Co.Co.
AnalysisAnalysisof Allowanceof Allowance
for Uncollectiblefor UncollectibleAccounts forAccounts for
Hillsburg Hardware Hillsburg Hardware Co.Co.
Estimated EstimatedEstimated EstimatedAgeAge Percentage Percentage
PercentagePercentage(days)(days) Amount Amount Uncollectible Uncollectible Uncollectible Uncollectible
Less thanLess than
3030 14,217,15614,217,156 3 3 426,515 426,515
31-6031-60 2,869,366 2,869,366 6 6 172,162 172,162
61-9061-90 1,408,642 1,408,642 1515 211,296 211,296
91-12091-120 1,038,926 1,038,926 2525 259,732 259,732
> than> than
120120 662,710 662,710 4040 265,084 265,084
TotalsTotals 20,196,80020,196,800 1,334,789 1,334,789
Auditing AllowanceAuditing Allowance
Beginning BalanceBeginning Balance from prior yearfrom prior year
Less: write-offsLess: write-offs tested tested
Plus: current provisionPlus: current provision
(bad debt expense)(bad debt expense) residualresidual
Ending balanceEnding balance tested TODBtested TODB
Cutoff TestingCutoff Testing
Sales Cutoff - Sales Cutoff - Primary focus is on sales Primary focus is on sales recorded just recorded just beforebefore year-endyear-end
Cash receipts cutoff -Cash receipts cutoff - Primary focus is Primary focus is on receipts recorded on receipts recorded beforebefore year-endyear-end
Purchases Cutoff -Purchases Cutoff - Primary focus is on Primary focus is on purchases recorded purchases recorded afterafter year-endyear-end
( does not affect A/R)( does not affect A/R)
Sales Cutoff ErrorsSales Cutoff Errors
Key issue is whether COS is matched. Key issue is whether COS is matched. Determining factor is whether good Determining factor is whether good are included or excluded from are included or excluded from inventory.inventory.
Y/E physicalY/E physical - inventory normally - inventory normally correctcorrect
Sales Cutoff ErrorsSales Cutoff Errors
Shipped 1/2Shipped 1/2 Sale - $10,000Sale - $10,000
Recorded 12/31Recorded 12/31 COS - $7,000COS - $7,000
Counted inCounted in Income Effect Income Effect
inventory?inventory? of Error of Error___ ___
YesYes $10,000$10,000
No $3,000No $3,000
Cutoff AdjustmentsCutoff Adjustments
Error 1 - inventory correctError 1 - inventory correct
Sales 10,000Sales 10,000 Accounts receivable 10,000Accounts receivable 10,000
Error 2 - inventory not correctError 2 - inventory not correct
Sales 10,000Sales 10,000Inventory 7,000Inventory 7,000 Accounts receivable 10,000Accounts receivable 10,000 Cost of sales 7,000Cost of sales 7,000