2. The following papers are in the Preliminary section. They should look familiar to you. (See step 3 below). Beside each paper is a brief description of what you should do: i. Engagement Letter - read it, note the bolded points ii. Client Description-read it, highlight the parts about RMC, City bank iii. Org chart - audit team read it, highlight your place on the team. Write in your instructor's name beside the Manager line iv. Client Financial Statements - Briefly review them V. Planning Memo - ARP: fill in the blanks (use the WTB), choose the correct responses. Risk Assessment: Assess IR in the blank space, choose the correct response for the CR section. Ignore the DR section for now. Materiality: Calculate materiality on the WP worksheet attached, check with your manager on which guideline to use and which level to choose once you have done the calculations. Planning Factors: Calculate (from the WTB) last year's AFDA%. Time Budget: read vi. Internal Control Analyses - Descriptions and flowcharts. Pick the correct level of CR for each of the systems based on your study of the flowcharts for Sales and Purchases. Use the control responses in the cash section. vii. Audit Programs - Examine them. Note that they are indexed as "Ad" items which means they are part of the administrative papers of the audit even though they will be used to do the current year "number crunch" audit later. viii. WTB and Adjusting Entries - Examine them. Use the WTB to do your ARP and AFDA calculation above. Note these are indexed as A & B even though they are part of the Admin Papers. They are the bridge from the financial statements and GL to the audit working papers. Examine the indexing on the WTB. 1. Preliminary Audit Procedures a. Analytical Review Procedures - When scanning changes on Working Paper A, the Analytic Review Procedure (ARP) % Change, note that the change in Cash is NOT an issue and Retained Earnings should not be chosen (we test components that flow into Retained Earnings, so we wouldn't consider misstatement potential in RE, but the sources that feed RE would be more relevant). When determining the accounts with potential misstatements, consider the accounts we will be testing. Use your accounting knowledge regarding items like depreciation and when assets were purchased. Look for the average percentage change, and then it will be easier to determine what might be an unusual change. b. Assess Overall Inherent Risk (IR) as either high or low; a calculated number/percentage is not required. c. Sales - use the sales figure of $3,110,000 from the Income Statement in Quantitative Factors and Materiality Considerations. d. Expenses - use the expenses figure of $624,700 from the Income Statement in Quantitative Factors. e. Normalized Pre-tax income is the same as Income before Tax. f. As your manager, I advise that because this is a new audit and there are analytical procedure concerns, use the low end of the materiality guidelines factor for calculating possible materiality. g. Once possible materiality is calculated, I advise you to use the materiality you calculated for Gross Profit as the overall materiality for this audit. Index AdA-2 Poly Distributors Ltd. Balance Sheet December 31, 2019 $ 83,000 Assets: Current assets: Cash Accounts receivable. Less: Allowance for Doubtful Merchandise inventory. Prepaid expenses.... Total current assets. $112,000 3,000 109,000 213,000 11.000 $416,000 $28,000 Plant and equipment: Office equipment. Less: Accumulated depreciation Store equipment... Less: Accumulated depreciation Total plant and equipment.. Total Assets $42,000 14,000 $330,000 63.000 267,000 295.000 $711,000 $80,000 5.000 $85,000 80,000 Liabilities: Current liabilities: Accounts payable. Salaries payable Total Current liabilities Long term Liabilities: Bank Note Payable (Store Equipment). Total Liabilities Equity: Common shares, unlimited authorized, 8,000 issued and Outstanding Retained earnings Total liabilities and equity. $165,000 $41,200 504800 546,000 $ 711.000 d Poly Distributors Ltd. Income Statement For the Year Ended December 31, 2019 $3,110,000 $ 43,000 20,400 63,400 $3,046,600 2,332,800 $ 713,800 $187,000 115,500 45,000 36,000 33,000 9,200 3,000 $428,700 Sales Less: Sales discounts. Sales returns and allowances. Net sales. Cost of goods sold. Gross profit from sales. Operating expenses: Selling expenses: Sales salaries expense Advertising expense Rent expense: selling space. Utilities expense: selling space.... Depreciation expense, store equipment Store supplies expense. Bad debt expense..... Total selling expenses.. General and administrative expenses: Office salaries expense....... Utilities expense office space. Office supplies expense Rent expense, office space Maintenance Expense, vehicles. Depreciation expense, office equipment. Insurance expense..... Total general and administrative expenses. Total operating expenses Income from operations... Other revenue and expenses: Rent revenue.... Interest expense. Profit $156,000 12,000 2,000 9,000 4,000 7,000 6,000 196,000 624,700 $ 89,100 $26,000 3,600 22,400 $ 111,500 Index AdB Initials Date Poly Distributors Ltd. December 31, 2019 PLANNING MEMORANDUM 1. Analytic Review Procedures (ARP) Per the horizontal analysis on WP A, the following unexpected or unusual changes occurred in 2019 accounts (circle increase or decrease): Account -% (Increase/decrease) Account % (Increase/decrease) Account _% (Increase/decrease) Recommendation: Therefore, potential misstatements could exist in three accounts: Expanded/Reduced/Normal (circle choice) tests of controls and if necessary more/lessormal (circle choice) substantive tests should be planned in these areas. 2. Risk Assessment i) Inherent Risk Most of the client staff and management are well educated, trained, and experienced they enjoy a fair compensation package and are well motivated. The only exception is the accounting technician performing the Sales Journal function who has less than one year experience. Overall IR is ii) Control Risk (Initial Lead Sheet AdC) Internal Controls should be assessed based on: (1) Cash WP Add-1 (2) Revenue/Receivables WP AdC-1 (3) Purchases/Payable WP AdC-2 Based on these initial descriptions CR appears Low/High (circle choice). Recommend that tests of controls be performed/omitted (circle choice). iii) Detection Risk Should be set at a high/low (circle choice) level and more/less (circle choice) substantive testing is done in the following areas: (To be determined after Control Testing is performed.) Index AdB.1 Initials Date 3. Materiality Prior year materiality was set at $3,800. Primary Financial Statement Users are: PDL Shareholders, City Bank of Moose Jaw Financial Statement user expectations: PDL is expected to have profitable operations with reasonable growth and low business risk. 2019 current audit materiality is set at (Do Calculation on WP AdB-1) 4. Planning Factors i) Tolerable Deviation Rate - TDR for all controls is set at 7% ii) AFDA Industry Average is 2.3% Prior year AFDA was % of accounts receivable. iii) Upper Error Limit - UELs will be determined using the text book tables for 90% confidence 2 hours 3 5. Time Budget (After Year End) Specifically for U. Student (you): Preliminary Procedures Tests of controls of Revenue/Rec Substantive Tests of Acct Receivable Substantive Tests of Cash Tests of controls of Purchases/Payables Substantive tests of Acct Payable 4 4 3 3 NOTE: It is STRONGLY suggested that before starting the audit of each section you review the related text and content. Auditee: Poly Distributors Ltd Year end: 2019 Index Adel Prepared Reviewed Date & Initials Materiality Assessment Comments 1. Qualitative Factors a) Identify the specific users of the financial statements for this engagement. b) Identify what expectations the users may have for the financial statements for this engagement c) Identify any possible situations or misstatements that would affect a user now or at some future point, regardless of the materiality level. (e.g. Consider environmental matters, policies, statues, safety issues, etc.) 2. Quantitative Factors a) Planning Data This Year Actual Last Year Assets Liabilities Equity Sales/Revenue Gross Profit Expenses Income before tax Previous materiality b) Normalized pre-tax (net) income This Year Actual Last Year $ Estimated pre-tax income Index AdB-11 Prepared Reviewe Date & Initials 3. Materiality Considerations Profit-oriented enterprises Factor Applied Possible Materiality Comments Measurement Base Normalized pre-tax income Assets Equity Revenue Gross profit Other $ $ $ $ $ $ Materiality guidelines Normalized pre-tax income Assets Equity Revenue Gross profit 5-10% -1% %-5% %-1% %-5% These materiality factors are provided as guidelines only and should be used as an aid in the development of your professional judgement. The materiality level should represent the largest amount of a misstatement or group of misstatements that would not, in your judgement, influence or change a decision based on the financial statements. See CAS 320, paragraphs A3-A9 for more guidance. 4. Overall Materiality Assessment for Financial Statements as a whole Based on the anticipated financial statement amounts and on the other factors described above, overall materiality for this engagement is as follows: Misstatements below this threshold, if not corrected, will be accumulated on the Possible Adjustments Sheet unless such misstatements are deemed trivial (below 5 1. Note: The auditor may designate an amount below which misstatements are deemed trivial and need not be accumulated because the auditor expects that the accumulation of such amounts clearly will not have a material effect on the financial statements. In so doing, the auditor considers the fact that the determination of materiality involves qualitative as well as quantitative considerations and that misstatements or a relatively small amount could nevertheless have a material effect on the financial statements. The summary of uncorrected misstatements included in or attached to the management representation letter need not include trivial misstatements. 2. The following papers are in the Preliminary section. They should look familiar to you. (See step 3 below). Beside each paper is a brief description of what you should do: i. Engagement Letter - read it, note the bolded points ii. Client Description-read it, highlight the parts about RMC, City bank iii. Org chart - audit team read it, highlight your place on the team. Write in your instructor's name beside the Manager line iv. Client Financial Statements - Briefly review them V. Planning Memo - ARP: fill in the blanks (use the WTB), choose the correct responses. Risk Assessment: Assess IR in the blank space, choose the correct response for the CR section. Ignore the DR section for now. Materiality: Calculate materiality on the WP worksheet attached, check with your manager on which guideline to use and which level to choose once you have done the calculations. Planning Factors: Calculate (from the WTB) last year's AFDA%. Time Budget: read vi. Internal Control Analyses - Descriptions and flowcharts. Pick the correct level of CR for each of the systems based on your study of the flowcharts for Sales and Purchases. Use the control responses in the cash section. vii. Audit Programs - Examine them. Note that they are indexed as "Ad" items which means they are part of the administrative papers of the audit even though they will be used to do the current year "number crunch" audit later. viii. WTB and Adjusting Entries - Examine them. Use the WTB to do your ARP and AFDA calculation above. Note these are indexed as A & B even though they are part of the Admin Papers. They are the bridge from the financial statements and GL to the audit working papers. Examine the indexing on the WTB. 1. Preliminary Audit Procedures a. Analytical Review Procedures - When scanning changes on Working Paper A, the Analytic Review Procedure (ARP) % Change, note that the change in Cash is NOT an issue and Retained Earnings should not be chosen (we test components that flow into Retained Earnings, so we wouldn't consider misstatement potential in RE, but the sources that feed RE would be more relevant). When determining the accounts with potential misstatements, consider the accounts we will be testing. Use your accounting knowledge regarding items like depreciation and when assets were purchased. Look for the average percentage change, and then it will be easier to determine what might be an unusual change. b. Assess Overall Inherent Risk (IR) as either high or low; a calculated number/percentage is not required. c. Sales - use the sales figure of $3,110,000 from the Income Statement in Quantitative Factors and Materiality Considerations. d. Expenses - use the expenses figure of $624,700 from the Income Statement in Quantitative Factors. e. Normalized Pre-tax income is the same as Income before Tax. f. As your manager, I advise that because this is a new audit and there are analytical procedure concerns, use the low end of the materiality guidelines factor for calculating possible materiality. g. Once possible materiality is calculated, I advise you to use the materiality you calculated for Gross Profit as the overall materiality for this audit. Index AdA-2 Poly Distributors Ltd. Balance Sheet December 31, 2019 $ 83,000 Assets: Current assets: Cash Accounts receivable. Less: Allowance for Doubtful Merchandise inventory. Prepaid expenses.... Total current assets. $112,000 3,000 109,000 213,000 11.000 $416,000 $28,000 Plant and equipment: Office equipment. Less: Accumulated depreciation Store equipment... Less: Accumulated depreciation Total plant and equipment.. Total Assets $42,000 14,000 $330,000 63.000 267,000 295.000 $711,000 $80,000 5.000 $85,000 80,000 Liabilities: Current liabilities: Accounts payable. Salaries payable Total Current liabilities Long term Liabilities: Bank Note Payable (Store Equipment). Total Liabilities Equity: Common shares, unlimited authorized, 8,000 issued and Outstanding Retained earnings Total liabilities and equity. $165,000 $41,200 504800 546,000 $ 711.000 d Poly Distributors Ltd. Income Statement For the Year Ended December 31, 2019 $3,110,000 $ 43,000 20,400 63,400 $3,046,600 2,332,800 $ 713,800 $187,000 115,500 45,000 36,000 33,000 9,200 3,000 $428,700 Sales Less: Sales discounts. Sales returns and allowances. Net sales. Cost of goods sold. Gross profit from sales. Operating expenses: Selling expenses: Sales salaries expense Advertising expense Rent expense: selling space. Utilities expense: selling space.... Depreciation expense, store equipment Store supplies expense. Bad debt expense..... Total selling expenses.. General and administrative expenses: Office salaries expense....... Utilities expense office space. Office supplies expense Rent expense, office space Maintenance Expense, vehicles. Depreciation expense, office equipment. Insurance expense..... Total general and administrative expenses. Total operating expenses Income from operations... Other revenue and expenses: Rent revenue.... Interest expense. Profit $156,000 12,000 2,000 9,000 4,000 7,000 6,000 196,000 624,700 $ 89,100 $26,000 3,600 22,400 $ 111,500 Index AdB Initials Date Poly Distributors Ltd. December 31, 2019 PLANNING MEMORANDUM 1. Analytic Review Procedures (ARP) Per the horizontal analysis on WP A, the following unexpected or unusual changes occurred in 2019 accounts (circle increase or decrease): Account -% (Increase/decrease) Account % (Increase/decrease) Account _% (Increase/decrease) Recommendation: Therefore, potential misstatements could exist in three accounts: Expanded/Reduced/Normal (circle choice) tests of controls and if necessary more/lessormal (circle choice) substantive tests should be planned in these areas. 2. Risk Assessment i) Inherent Risk Most of the client staff and management are well educated, trained, and experienced they enjoy a fair compensation package and are well motivated. The only exception is the accounting technician performing the Sales Journal function who has less than one year experience. Overall IR is ii) Control Risk (Initial Lead Sheet AdC) Internal Controls should be assessed based on: (1) Cash WP Add-1 (2) Revenue/Receivables WP AdC-1 (3) Purchases/Payable WP AdC-2 Based on these initial descriptions CR appears Low/High (circle choice). Recommend that tests of controls be performed/omitted (circle choice). iii) Detection Risk Should be set at a high/low (circle choice) level and more/less (circle choice) substantive testing is done in the following areas: (To be determined after Control Testing is performed.) Index AdB.1 Initials Date 3. Materiality Prior year materiality was set at $3,800. Primary Financial Statement Users are: PDL Shareholders, City Bank of Moose Jaw Financial Statement user expectations: PDL is expected to have profitable operations with reasonable growth and low business risk. 2019 current audit materiality is set at (Do Calculation on WP AdB-1) 4. Planning Factors i) Tolerable Deviation Rate - TDR for all controls is set at 7% ii) AFDA Industry Average is 2.3% Prior year AFDA was % of accounts receivable. iii) Upper Error Limit - UELs will be determined using the text book tables for 90% confidence 2 hours 3 5. Time Budget (After Year End) Specifically for U. Student (you): Preliminary Procedures Tests of controls of Revenue/Rec Substantive Tests of Acct Receivable Substantive Tests of Cash Tests of controls of Purchases/Payables Substantive tests of Acct Payable 4 4 3 3 NOTE: It is STRONGLY suggested that before starting the audit of each section you review the related text and content. Auditee: Poly Distributors Ltd Year end: 2019 Index Adel Prepared Reviewed Date & Initials Materiality Assessment Comments 1. Qualitative Factors a) Identify the specific users of the financial statements for this engagement. b) Identify what expectations the users may have for the financial statements for this engagement c) Identify any possible situations or misstatements that would affect a user now or at some future point, regardless of the materiality level. (e.g. Consider environmental matters, policies, statues, safety issues, etc.) 2. Quantitative Factors a) Planning Data This Year Actual Last Year Assets Liabilities Equity Sales/Revenue Gross Profit Expenses Income before tax Previous materiality b) Normalized pre-tax (net) income This Year Actual Last Year $ Estimated pre-tax income Index AdB-11 Prepared Reviewe Date & Initials 3. Materiality Considerations Profit-oriented enterprises Factor Applied Possible Materiality Comments Measurement Base Normalized pre-tax income Assets Equity Revenue Gross profit Other $ $ $ $ $ $ Materiality guidelines Normalized pre-tax income Assets Equity Revenue Gross profit 5-10% -1% %-5% %-1% %-5% These materiality factors are provided as guidelines only and should be used as an aid in the development of your professional judgement. The materiality level should represent the largest amount of a misstatement or group of misstatements that would not, in your judgement, influence or change a decision based on the financial statements. See CAS 320, paragraphs A3-A9 for more guidance. 4. Overall Materiality Assessment for Financial Statements as a whole Based on the anticipated financial statement amounts and on the other factors described above, overall materiality for this engagement is as follows: Misstatements below this threshold, if not corrected, will be accumulated on the Possible Adjustments Sheet unless such misstatements are deemed trivial (below 5 1. Note: The auditor may designate an amount below which misstatements are deemed trivial and need not be accumulated because the auditor expects that the accumulation of such amounts clearly will not have a material effect on the financial statements. In so doing, the auditor considers the fact that the determination of materiality involves qualitative as well as quantitative considerations and that misstatements or a relatively small amount could nevertheless have a material effect on the financial statements. The summary of uncorrected misstatements included in or attached to the management representation letter need not include trivial misstatements