ACCT 611 Seminar in Auditing and Assurance Services Final Exam

Hello, dear friend, you can consult us at any time if you have any questions, add WeChat: daixieit

ACCT 611 Seminar in Auditing and Assurance Services

Final Exam, Version 1

Questions ONLY

I. A comprehensive audit case (adapted CICA question, INDIVIDUAL Report only)

You are a partner at London and Paris LLP, a renowned CPA firm in the Midwestern United States. As part of the firm's quality control program, you are tasked with conducting an independent review of completed audits.

Currently, you are examining the audit working papers and a draft of the financial statements for Wallis Electronics Inc. for the fiscal year ending September 30, 2023. These documents include the suggested auditor's report—an unqualified opinion—prepared by the engagement partner. Wallis Electronics designs and manufactures components for various consumer electronics, such as radios and televisions. The company, a family-owned business since its founding by Frank Wallis, who passed away several years ago, primarily supplies large consumer electronics manufacturers. Notably, a major portion of its sales—approximately 40%—is to a leading South Korean conglomerate.

Wallis Electronics has been a client of your firm for three years. The audit, which lasted about five weeks, was conducted by a team comprising two senior auditors—Tony, the Senior Accountant I and team leader, and Leslie, the Senior Accountant II—along with three junior auditors, Mary, Jack, and Tom. The engagement partner had already reviewed the working papers prior to your evaluation. The financial statements indicate that at year-end, the company had total assets of $250,000,000, revenues of $300,000,000, and pre-tax income of $10,000,000.

During your review of the working papers, various memoranda, and review notes prepared by the staff and engagement partner, you identified several issues that arose during the audit and the approaches taken by the audit team to resolve them.

Issue #1. Inventory Audit

While testing the client's finished goods inventory, Mary noted a significant quantity of older, dust-covered parts. The perpetual inventory records revealed these parts, manufactured two years earlier for a South Korean client—a major business partner—had been left unshipped following the cancellation of the order. The recorded inventory value of these components stood at approximately $1,500,000. When Mary inquired about these parts, the production manager indicated that the company had chosen to retain the inventory, hoping to eventually find another buyer.

Upon reviewing Mary's findings, Senior Auditor Tony concluded that no adjustments were necessary, deeming the amount to be immaterial. This assessment was later affirmed by the engagement partner, who added their concurrence with a note: "I agree."

Issue #2. Cutoff Test

Wallis uses “FOB Shipping Point” as the standard trade term when selling its components to domestic and international customers. Since its products are all standardized industry components, contractual obligations under contracts usually end after Wallis ships out its products.

Leslie, the SA II, conducted FY 2023 revenue cut off test for Wallis Inc. Below is an excerpt from her working papers. She pointed out that Wallis made a small error: Accounting for consignment transaction as a real sale. She proposed to reverse the $80,000 revenue and $46,000 COGs (Transaction #4 below. Her proposed adjustments have been accepted by the client) and concluded her cutoff audit. The engagement partner approved her working paper on the cutoff test with two words, “well done”. A snapshot of the working paper is provided below,

Sales Sales Cost of Shipping

Invoice Invoice Goods Document

Amount Date Sold Date

Sep

1)      $42,000 9/28 $38,000 9/29

2)        18,000    9/29   14,000 9/22

3)        20,000   9/30   12,000    10/2

4)        80,000 9/30   46,000        9/30(shipped to consignee)

Oct

1)      $30,000 10/1 $22,000 10/1

2)      20,000 10/2   13,000 10/1

3)        40,000 10/3   29,000 9/30

Issue #3. A/R and A/P Audit

Tony (SA-I) and Jack (junior) were tasked by their audit manager to conduct an audit of the accounts receivable (A/R) and accounts payable (A/P) accounts. During the first two days of the audit, Jack, under Tony’s supervision, efficiently completed the A/R audit work, and then moved on to the A/P audit. To Tony’s delight, Jack completed all the A/P audit work in just 6 hours and then sat idle for further instructions.

Jack explained to Tony how he performed the A/P audit. First, he classified the A/P accounts into three categories: A, B, and C.

Category A accounts were those with balances over $50,000, and Jack's confirmation procedures covered 100% of those accounts. He obtained the A/P balance for each account from the A/P sub-ledgers and then requested confirmation from the vendor of the audit client.

Category B accounts were those accounts with balances between $3,000 and $50,000, and Jack's confirmation procedures covered 20% of those accounts.

For the remaining A/P accounts with balances under $3,000, they all belonged to Category C, and Jack only took a 5% sample (in terms of the number of sub-ledger accounts) and sent confirmations.

As a star graduate of Catalina State University, Short Colina (CSUSC), Jack proudly reminded Tony that he still remembered the concept of materiality from Prof. Zheng's class. Jack's approach effectively covered 94% of the total dollar value of A/P accounts, impressing Tony again, who is also a CSUSC alumnus.

Tony was pleased to have such an excellent colleague.

Required

After careful consideration of all the facts above, you decide to compose a memorandum addressed to the engagement partner. A copy of the memo will also be forwarded to the managing partner of the CPA firm to communicate your opinions regarding this audit engagement. In the memo, you will detail your stance on the issues at hand and what must be done before you are comfortable giving your approval to the engagement. To accomplish this, you will conduct a thorough evaluation of the three audit issues presented, giving credits to some excellent audit team members, and highlighting any flaws or errors. Please do not forget to provide your professional recommendations.

II. Deluxe Chicken Inc. (INDIVIDUAL Report only, 70 points)

Founded in 1989 by Sebastian Bony, Deluxe Chicken (DC) specializes in rotisserie-cooked chicken accompanied by fresh vegetables and other side dishes. DC operates its own stores and franchises in a manner similar to Kentucky Fried Chicken (KFC). Sebastian describes DC’s mission as providing "a home meal replacement" across the New England and Mid-Atlantic regions.

DC went through an impressive expansion. At the end of 1991, the firm operated only 34 stores, with no franchisee stores. But by the end of 1994, the total of stores (company-owned stores and franchise stores) had increased to 534 (491 were franchise stores). It was estimated that DC’s franchise store can easily break even if its weekly average revenue per store exceeds $23,000. According to Reuters, its stock price had risen steadily from $8 in November 1993 to $23 in March 1997.

DC’s auditor is a prestigious Big-8 accounting firm, Firehouse Young LLP. The 1994 and 1995 fiscal year financial statements below were all audited numbers, but the 1996 numbers were unaudited.

DC’s excellent performance also impressed Wall Street. Stock analyst Mike Foster of Silverman Sterling forecasted that DC’s EPS would grow at an annual rate of around 35% between 1997 and 2001 and gave a “strong buy” rating. It was rumored that the wealth management division of Mohan Stoney took a passive 3% stake in this firm. Many hedge funds followed the rumor and added DC’s shares to their portfolios.

Table 1. CONSOLIDATED INCOME STATEMENTS

                                                                 Fiscal Years Ended

                                               ------------------------------------------------

                                               December 25,      December 31,      December 29,

                                                   1994               1995              1996

      (in thousands)  (in thousands)    (in thousands)

Revenue:

  Royalties and franchise related fees...........   $43,603          $ 74,662           $115,510

  Company stores sales........................ ..    40,916            51,566             83,950

  Interest income................................    11,632            33,251             65,048

     Total revenue...............................    96,151           159,479            264,508

Costs and Expenses:

  Cost of products sold..........................    15,876            19,737             31,160

  Salaries and benefits..........................    22,637            31,137             42,172

  General and administrative.....................    27,930            41,367             99,847

  Relocation expense      .......................     5,097                 -                  -

     Total costs and expenses....................    71,540            92,241            173,179

Income From Operations..........................     24,611            67,238            91,329

Other Income (Expense):

  Interest expense, net.........................    (4,235)          (13,179)           (14,446)

  Gain on issuances of subsidiary's stock........         -                 -             38,163

  Other income, net..............................        74               314                137

     Total other income (expense)................    (4,161)          (12,865)            23,854

Income Before Income Taxes

   and Minority Interest.........................    20,450            54,373            115,183

Income Taxes.....................................     4,277            20,814             42,990

Minority Interest in (Earnings)

   of Subsidiary................................         -                 -             (5,235)

Net Income......................................   $16,173          $ 33,559           $ 66,958

                                                    =======          ========           ======== 

TABLE 1. CONSOLIDATED INCOME STATEMENTS (to continue)

                                                                 Fiscal Years Ended

                                                ------------------------------------------------

                                                December 25,      December 31,      December 29,

                                                   1994               1995              1996

       (in thousands)  (in thousands)    (in thousands)

Net Income Per Common and

 Equivalent Share......                 $  0.38         $ 0.66           $ 1.01

                                    ======      ========       ========

Shares outstanding at year end

(in thousands)........                   44,700     59,129             64,246

                                    ======      ========       ========

TABLE 2. CONSOLIDATED BALANCE SHEETS

                                                                   December 31,     December 29,

                                                                        1995           1996

                         (in thousands)  (in thousands)

Current Assets:                                                                                     

  Cash and cash equivalents......................................      $ 310,436      $  100,800

  Accounts receivable, net.......................................         13,445          22,438

  Due from area developers, royalty and interest ................          9,614          10,246

  Notes receivable from area developers, due in 12 months.........         5,462               -

  Prepayment and other current assets.....................                 4,858          12,979

    Total current assets.......................................          343,815        146,462

Property and Equipment, net.....................................         258,550         334,748

Long-term Notes Receivable from area developers.................         450,572         800,519

Goodwill, net...................................................               -         190,439

Other Assets, net...............................................          20,940          71,448

    Total assets...............................................       $1,073,877     $1,543,616

Current Liabilities:                                                                                

  Accounts payable..............................................      $   12,292      $   40,430

  Accrued expenses..............................................           9,095          36,547

  Deferred franchise revenue....................................           8,945          10,656

Total current liabilities...................................         30,332          87,633

Deferred Franchise Revenue......................................           2,072           7,740

Convertible Subordinated Debt...................................         129,872         129,841

Zero coupon bond         .......................................         177,306         182,613

Deferred Income Taxes...........................................          16,631          40,216

Other Noncurrent Liabilities....................................             833           6,292

Minority Interest...............................................               -         153,441

Stockholders' Equity:                                                                               

    Common stock...............................................              591             642

    Additional paid-in capital..................................         675,611         827,611

    Retained earnings...........................................          40,629         107,587

                                                                         716,831         935,840

          Total liabilities and stockholders' equity............     $1,073,877      $1,543,616

Shares outstanding at year end(in thousands)........        59,129       64,246 

TABLE 3. CONSOLIDATED CASH FLOW STATEMENTS

                                       December 25, 1994   December 31, 1995  December 29, 1996

  (In thousands)     (In thousands)     (In thousands)

Cash Flows from Operating Activities:      

Net income................................    $  16,173          $  33,559          $    66,958

Adjustments:

  Depreciation and amortization...........        6,074             11,442               22,887

  Interest expense on zero coupon bond...             -              8,075               13,793

  Gain on issuances of subsidiary's stock             -                  -              (38,163)

  Deferred income taxes...................         4,277             12,133              14,059

  Minority interest.......................            -                  -                5,235

  Provision for write-down of assets......            -                  -               14,550

  Loss (gain) on disposal of assets.......         (368)               231                   68

  Changes in assets and liabilities

    A/R & due from area developers               (7,800)           (10,057)              (7,193)

    Accounts payable and accrued expenses....     13,724              3,661               48,674

    Deferred franchise revenue.............        5,926               (303)               3,174

    Other assets and liabilities......... .       (2,088)            (3,265)                 868

      Net cash provided by operating activities   35,918             55,476              144,910

Cash Flows from Investing Activities:

  Purchase of PPE and other assets  ......      (168,797)          (149,231)           (137,432)

  Proceeds from the sale of PPE assets.           62,342             80,910               86,320

  Loans (notes receivable) to area developers   (225,282)          (661,033)         (1,467,065)

  Repayment of notes receivable by area developers 68,498           407,499              993,151

      Net cash used in investing activities..    (263,239)         (321,855)           (525,026)

Cash Flows from Financing Activities:

  Proceeds from issuance of common stock          125,703           385,360              112,863

  Proceeds from issuance of subsidiary's stock         -                  -              135,422

  Proceeds from issuance of convertible bond      130,000                 -                    -

  Proceeds from issuance of zero coupon bond           -            172,464                    -

  Increase in deferred financing cost.......      (7,615)            (6,313)             (3,799)

  Proceeds from revolving bank credit line....    96,130            229,240               43,250

  Repayments of revolving bank credit lin......  (96,130)          (229,240)           (117,256)

      Net cash provided by financing activiti..  248,088            551,511              170,480

Net Increase (Decrease).                          20,767            285,132            (209,636)

 in Cash and Cash Equivalents

Below is some info from footnotes for your reference:

1. Principles of Consolidation. The consolidated financial statements include the accounts of the Company and its subsidiaries.

2. Revenue Recognition. Revenue from Company stores is recognized when food is sold. Royalties are recognized when related franchise store revenue is generated. It is 5% of the franchise revenue. Initial franchise fees and area development fees are recognized as DC’s revenue when the franchised store opens. Franchise store also pays 5.75% of its revenue for system-wide marketing use.

3. Franchise store performance is not included in the consolidated financial statements since DC has no equity investment larger than 50% in any franchise store.

4. Area developers are large regional franchises which focus on major U.S. metropolitan markets. The initial investment consists of 25% equity (contributed by independent business owners) and 75% loan made from Deluxe Chickens. Area developers have no other sources for investment. DC believes that it is difficult for small franchises to get bank loans, therefore, DC always loans the money to support those area developers. DC loans are recorded at historical cost. The average interest rate is around 8.2% in 1996.  

Below are some disclosed info about all area developers   1995 1996

Total number of area developers 15 14

Total number of stores open by those developers 627                841

Gross Revenue (in thousands)                                       $491,341           $865,082

Total gross assets aggregated for those developers (in thousands)  $513,926           $640,534

Debt to Deluxe Chicken Inc. (in thousands)                         $372,071           $555,105

Total stockholder’s equity (or deficit) (in thousands)              (9,891)          (102,754)

TABLE 4. Net Income vs. OCF

                                                                 Fiscal Years Ended

                                               ------------------------------------------------

                                                December 25,      December 31,      December 29,

                                                  1994               1995              1996

               (in thousands)  (in thousands)    (in thousands)

Net Income......................................  $16,173          $ 33,559           $ 66,958

Net cash provided by operating activities          35,918            55,476            144,910

As a senior auditor at Firehouse Young LLP, you are tasked with auditing Deluxe Chicken's (DC) financial statements for 1996. John is the manager in charge and Kelvin Collins, a straight-A graduate from CSU Short Colina, is your junior. Below is some conversation between you (Y) and Kelvin (K).  

You (Y): DC is not a difficult account, but audit fee is never fat. So watch out when filling time sheets. BTW, have you ever tried AP (analytical procedures) by now?

Kelvin (K): Got it, AP is not done yet. But I had a quick scan of the numbers and compared net income and OCF in the last 3 years. I learned this trick from Professor Zheng’s class. Net income looks healthy as it is well-supported by operating cash flow.  Look at the numbers below, NI/OCF ratios vary between 0.45 and 0.60. No negative OCF and no “kiss of death” in 1995 and 1996. It should not be a tough audit this year.

Required:

Turn your clock back to February 1997. As a senior auditor, you are expected to perform analytical procedures and then write a memo to your manager. In your memo, you must highlight those accounts that might be subject to material misstatements and support your conclusions with solid evidence, calculation, GAAP knowledge, and your professional judgment.