Audit and Assurance
Audit and Assurance
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This 6 page Class Notes was uploaded by priyanshi on Friday February 27, 2015. The Class Notes belongs to a course at a university taught by a professor in Fall. Since its upload, it has received 1332 views.
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Date Created: 02/27/15
a Part II of Pinnacle case External users reliance on financial statements External users rely heavily on the financial statement of Pinnacle Manufacturing AlthoughPinnacle manufacturing is a privately held company it incurs a large amount of debt As a result potential users rely heavily on financial statements Pinnacle is selling the machine tech division to focus on engine manufacturing the company39s core operations This causes buyers to also rely heavily on financial statements In point 6 the board chooses to finance the construction project mentioned in point 4 by raising more debt Again bringing focus to the Financial statements Likelihood of financial difficulties The Solar Power engine business is focused on habitual transformation of technology which makes the business riskier than other business and brings about a greater chance of bankruptcy Item 1 in the planning issues raises a concern about the viability of the SolarElectro division but not necessarily the entire company The conclusion in Part I of the case was that the likelihood of financial failure is low even considering the issue with SolarElectro In point 9 the planning phase shows there is a debt covenant requiring a current ratio above 20 and a debttoequity ratio below 10 The current ratio has fallen below 20 This could result in the loan being called unless a waiver of the loan covenant is granted Manaaem ent intearitv No major issue exists that would cause the auditor to question management integrity but the auditor should have done extensive client acceptance procedures before accepting the client It is possible that Item 8 in the planning phase turnover of internal audit personnel could be intentional and increases the risk of fraudulent financial reporting Acceptable audit risk is likely to be medium to low because of the factors listed previously especially the planned increase in financing and the potential violation of the debt covenant agreement Some might prefer an even lower acceptable risk because it is a first year audit C Inherent Risk Account or Accounts Affected Relevant Audit Objectives No Risk NA NA Possibility of Obsolete Inventory Inventory and Cost of Goods Sold Might affect the valuation of inventory at the lower of cost or market No Risk NA NA Nonroutine transaction Property accounts inventory and cost of sales There is a risk that materials labor andor overhead are incorrectly applied to the property accounts 5 A receivable outstanding for Accounts receivable bad debt expense May indicate a major collection several months from a allowance for uncollectible accounts problem customer making up 15 of the company s outstanding accounts receivable balance 6 Potential related party Construction Manufacturing Equipment Could affect the valuation of the transaction and Footnote transaction and may require disclosure as a related party transaction 7 Potential related party Repairs and maintenance expense and Could affect the valuation of the transaction Accounts Payable transaction and may require disclosure as a related party transaction 8 Although this does not All accounts The turnover may also affect the directly affect inherent risk auditor s assessment of control risk it is possible that turnover of internal audit personnel could be intentional and increases the risk of fraudulent financial reporting 9 In addition to affecting All accounts The auditor should be concerned acceptable audit risk about the risk of fraudulent financial reporting due to the incentive to make certain that all debt covenants have been met 10 An ongoing dispute with the Income tax expense and income taxes May require an adjustment to income Internal Revenue Service payable tax liability or a disclosure in footnotes for a contingency depending on the status of the dispute 11 Related party transaction Notes payable notes receivable Because this transaction was not SolarElectro borrowed money from the Welburn division interest expense and interest income conducted with an outside party it is possible that the related receivable and payable might not have been properly eliminated on Pinnacle s consolidated financial statements PINNACLE MANUFACTURING Part III Control Risk Matrix Acquisitions TransactionRelated Recorded Existing Recorded Acquisition Acquisition Recorded Audit Objective acquisitions acquisition acquisition transactions transactions acquisition are for trans transactions are properly are recorded transactions are goods and actions are are stated at classified on the properly included services recorded the correct classifica correct dates in the master received complete amounts tion timing files and are existence ness accuracy properly Internal summarized Controls posting and summarization 1 Required use of PO and receiving report with check of completeness C 2 Proper approval C C 3 Segregation of functions C 4 Cancellation of documents C 5 Prenumbering of documents with accounting for sequence C 6 Internal verification of documentsrecords C C C C 7 Use of chart of accounts 8 Procedures requiring prompt processing C 9 Monthly reconciliation of NP master file with general ledger C Assessed control risk Low Low Low Low Low Low Control Matrix Cash Disbursements TransactionRelated Audit Objectives Internal Controls Recorded cash disbursements are for goods and services actually received existence Existing cash disbursement transactions are recorded complete ness Recorded cash disbursement transactions are stated at the correct amounts accuracy Cash disbursement transactions are properly classified classification Cash disbursement transactions are recorded on the correct dates timing Recorded cash disbursement transactions are properly included in the master file and are properly summarized posting and summarization 1 Segregation of functions 2 Review of support signing of checks by authorized person 3 Prenumbered checks accounted for 4 Use of chart of accounts 5 Procedures for prompt recording C C 6 Monthly reconciliation of NP master file with GL Deficiencies 1 Lack of an independent bank reconciliation Done by Treasurer 2 Lack of internal verification of documentation package by cash disbursements clerk 3 Lack of internal verification of key entry into cash disbursements file Assessed control risk Medium Medium High Low Low Low Part IV of Pinnacle case a IncentivesPressures Pinnacle s board is considering selling the MachineTechdivision and the president of the division is committed to making it profitable Part I Pinnacle is in danger of violating its debt covenants the current ratio has fallen from 219 to 175 Part II Opportunities Pinnacle engages in a number of related party transactions Part I Realizable value issues exist with inventory and receivables Part land ll There has been turnover in internal audit personnel Part II AttitudesRationalizations Pinnacle has had disputes with the IRS Part II b The company is in the engine manufacturing business and has recently expanded into solar engines The engine manufacturing business is competitive and increasingly outsourced The solar business depends on developing technology These characteristics are most likely to affect Inventory and to a lesser extent accounts receivable and xed assets c Pinnacle could overstate revenues in several ways The auditor would especially focus on the MachineTech division because of the incentives identified in part a Tehniqu tn Ina mind Eganum ipping amounts for REESE su year aunt a l Hahn Elia 7 ti L t F 1 Emmim rm5 11131 null lardamid Erratum E nnllrrri quot a There is a major change in Operating expenses and Income from operations If this change was not expected it could suggest revenue recognition fraud The decline in bad debt expense and increase in depreciation expense which are management estimates could suggest the use of estimates to overstate income Fraud Risk Fraud Triangle Element if yes 1 Yes Motivation Justify commitment to solar 2 Yes Opportunity 3 Yes Opportunity related party transaction 4 No 5 Yes Opportunity related party transaction 6 Yes Incentives 7 Yes Opportunity related party transaction 8 Yes AttitudeRationalization 9 Yes Opportunity 10 Yes Opportunity 11 Yes Opportunity related party transaction
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