Maxall company audit solution

Answer 1

Meaning of Substantive Audit and the approach applied in EM's Audit of Maxall.

What do you think the auditors meant by the term "Substantive Audit"? Was the substantive approach appropriately applied in EM's audit of Maxall?

Here the term substantive Audit refers to the test of account balances with respect to the transactions relating to it.

Yes the substantive approach was appropriately applied in this audit which was confined to Accounts Receivables, in relation to sales.

Comparison of Audit Procedures that are in accordance with Generally Accepted Auditing Standards.

Identify and discuss specific audit process/procedures that the auditor(s) performed that were in accordance with Generally Accepted Auditing Standards.

We have got three types of tests performed under substantive audits, as per the Generally Accepted Auditing Standards, namely

(I) Test of Transactions,

(II) Test of balances

(III) Analytical review procedures.

(I) Test of transaction: It is an auditing procedure related to examining specified transactions and supporting documentation. It is part of the testing process used by the auditor to check internal-controls reliability. It is undertaken to gather evidence so that an audit opinion can be rendered as to the fairness of financial statement presentation. Included in such a test is verifying transaction amounts and tracing transactions to accounts in the financial statements.

Here this test was confined to Accounts receivable, sales and inventory.

(II) Test of Balances When EM compares the book balance of cash to the book balance, it is a test of balances. This is the step in which the Auditor seeks to obtain sufficient evidence to make a final judgment on the extent of losses or account misstatements that have occurred or might occur.

Here, in this audit, the CPA's obtained evidence relating to the Accounts receivables with respect to the sales made during the year. They found out that 6 invoices made at the year end and confirmed those with the concerned customers.

(III) Analytical review is an auditing process that tests relationships among accounts and identifies material changes. It involves analyzing significant ratios and trends for unusual changes and questionable items. Included in the analytical review process are: (1) reading important documents and analyzing their accounting and financial effects; (2) reviewing the activity in an account between interim and year-end, especially noting entries out of the ordinary; and (3) comparing current period account balances to prior periods as well as to budgeted amounts, noting reasonableness of account balances by evaluating logical relationships among them (i.e., relating payables to expenses, accounts receivable to sales).

Only a part of Analytical review was made by EM for this company. They made certain adjustments relating to sales and Provision for doubtful debts.

Identification of Audit Errors made by EM and Precautionary measures to be taken.

Identify the specific audit errors made by EM and discuss what the auditor

should have done to avoid the errors.

Inherent risk is the susceptibility of EM audit area to error which could be material, individually or in combination with other errors, as there were no related internal controls. Here we can see a possible error relating to Material. The material level was fixed at $35000 for 20x1 and $50000 for 20x2 which was not substantiated. There is no proper evidence to set these levels for the Material. As per the CPA standards the Material Level should be

Under single Rule

1. 5% of pre-tax income
2. 0.5% of total assets
3. 1% of equity
4. 0.5% of total revenues

Or

Under Variable rule

1. 2 to 5% of gross profit, if less than $20,000
2. 1 to 2% of gross profit, if between $20,000 and $1 million
3. 0.5 to 1% of gross profit, if between $1 and $100 million
4. 0.5% of gross profit, if more than $100 million.

These rules have not been followed here.

Comparison of audit in compliance with latest professional guidance.

The scope of a forensic audit is to fix blame or answer a question. A forensic audit seeks proof, not reasonable assurance. Here the auditors have conducted a normal audit. When they found out the sales made in late December 20x1 and 20x2 to Balco limited, was given 90 to 120 days credit limit, they should have enquired into the reasons behind it and should have gathered enough evidence for evaluating the credibility of the customer. But they accepted the Mary Maxwell assurance for this customer. This evidence clearly shows that this audit was not conducted entirely in compliance with the professional guidance regarding the forensic-type phase of audit.