Smackey Dog Foods, Inc.: Case Study
Neal Williams 4-7-2015 ACCT 555 You Decide Assignment
Smackey Dog Foods, Inc. has approached Keller CPAs to conduct an audit of the financial statements. The purpose of this summary is to describe the expectations that Keller CPAs has regarding how the audit of Smackey Dog Foods, Inc. will be conducted. Smackey Dog Foods, Inc. is a privately held corporation and is not …show more content…
required to follow the rules set forth by the Securities and Exchange Commission (SEC) for audit of public companies. Keller CPAs must follow the guidelines set forth by the American Institute of Certified Public Accountants (AICPA) no matter if the client being audited is privately or publicly held. The Auditing Standards Board of the AICPA issues statements on Auditing Standards. The pronouncements are the standards by which audits of non-public companies must be conducted. These statements offer guidance on the implementation of Generally Accepted Auditing Standards (GAAS) and do apply to privately held companies. The audit of Smackey Dog Foods, Inc. will be conducted under these standards.
The SEC does not require an audit of a privately held company but the bank that Smackey is requesting a loan from would like them to provide audited financial statements before the loan process goes any further. The bank requires that the financial statements comply with Generally Accepted Accounting Principles (GAAP) and Keller CPAs will be auditing the financial statements to verify the bank’s expectations and to provide assurance that the statements are not materially misstated.
Pete, Ben, and Maureen will be responsible for conducting the audit of Smackey Dog Foods, Inc. They will plan the audit by developing an audit strategy, identifying problem areas, and specific areas where material misstatements might occur. They will need to analyze the lawsuit to get a feel for the risk associated with it. Pete, Ben, and Maureen will need to include the nature of the industry Smackey Dog Foods, Inc. as in, what a manufacturer does, and how their business operations are run.
Before issuing our opinion of the financial statements, we will carefully answer the following questions to ensure that the correct opinion is issued.
The Securities and Exchange Commission (SEC) has a significant influence on the audit of Smackey Dog Foods, Inc. by Keller CPAs. This influence can be observed in the audit standards that have to be followed in establishing the independence of auditors involved in the audit of Smackey. In the audit of publicly held companies including Smackey, auditors need to observe six ethical principles. “Independence is one of the six ethical principles of the American Institute of Certified Public Accountants (AICPA) Code of Professional Conduct” (Arens, Elder, & Beasley, 2012, p. 85). The other principles are responsibilities, the public interest, integrity, objectivity and independence, due care, and scope and nature of services. More specifically, audit team members are required to be objective and independent with regard to the audit by maintaining objectivity and being free of conflicts of interest in discharging professional responsibilities and by being independent in fact and appearance when providing auditing and other attestation services. In here the influence of the SEC is very obvious. Under the Sarbanes-Oxley Act (SOX), auditors have to be objective and independent otherwise legal sanctions can be incurred. Although the above standards are enforceable for the audit of public companies, it can also be applied to the audit of non-public companies like Smackey Dog Foods, Inc. “The following are five of the essential activities involved in the initial planning of an audit as they relate to Smackey Dog Foods, Inc.” (Arens, Elder, & Beasley, 2012, pp. 215-220). The first essential activity is to understand the client’s business and industry. The audit firm can capitalize on its experience in auditing other food manufacturers in planning and doing the audit for Smackey. So far, members of the audit team, the audit manager, Pete, and two audit staffers, Ben and Maureen, have to understand the client’s business and industry.
The second essential activity is to assess client business risk. Business risk is the risk that Smackey will fail to achieve its objectives. In this activity, the audit team assesses the risk of material misstatements arising from Smackey’s business risk. For example, the high amount of waste in Smackey’s Best Dog division presents a lot of business risk, and therefore material misstatement risk.
The third essential activity is to perform preliminary analytical procedures. Keller CPAs needs to compare the performance of Smackey’s with the industry to further support its initial assessment of business risk. These analytical procedures help the audit team identify areas where the risks of misstatements are very high.
The fourth essential activity is to set materiality and assess acceptable audit risk and inherent risk. The Smackey audit team now has to set the acceptable level of materiality. The circumstances of Smackey have to be taken into account in setting materiality level as this level is purely relative and subject to the auditor’s judgment.
The fifth and final essential activity is to develop an overall audit plan and audit program. The audit plan and program aims to achieve the audit risk objectives of the audit team and to provide reasonable assurance and basis for the audit report and opinion. There are four stages in an audit with major activities that are performed by the auditor in each phase.
The first stage that specifically applies to the audit of Smackey Dog Foods, Inc. is the planning and risk assessment stage. For Smackey, the risks can initially be assessed by obtaining understanding of Smackey’s business and its industry. More specifically, the design and implementation of the client’s internal control procedures, processes and systems are studied and analyzed for the audit team to be able to assess the control risk for each of the transaction-related audit objectives- occurrence, completeness, accuracy, classification, timing and posting and …show more content…
summarization. The second stage that specifically applies to the audit of Smackey Dog Foods, Inc. is test of internal controls. The audit team can perform tests of controls by making inquiries of appropriate client personnel, examining documents, records, and reports maintained by Smackey. This team can also perform tests of controls by observing control-related activities such as the one done for the inventory procedures for returned Best Boy Gourmet dog food, and reperforming client procedures. The third stage that specifically applies to the audit of Smackey Dog Foods, Inc. is substantive tests. The Smackey audit team needs to perform substantive tests on the balances of the accounts receivables and inventory accounts. Moreover, substantive tests can be done through performing substantive tests of transactions, analytical procedures, and test of details of balances. The fourth and final stage that specifically applies to the audit of Smackey Dog Foods, Inc. is audit finalization. At this stage, the audit team compiles a report to Smackey’s management as regards to matters that came to the team’s attention during the audit, evaluates and reviews the audit evidence obtained in the audit, and considers the audit opinion to be issued based on the evidence obtained. “Generally Accepted Auditing Standards (GAAS) and professional conduct requires that the auditor communicate, in writing, to management and those charged with governance, significant deficiencies and material weaknesses identified in an audit” (Arens, Elder, & Beasley, 2012, pp. 295-296). The following four internal control issues were identified in regards to the audit for Smackey Dog Foods, Inc. and thus have to be communicated to appropriate people within Smackey. The first issue was granting of commissions to sales people based on estimated sales. This internal control issue presents risk as regards to the company’s financial resourced as sales people might be paid for sales not made, and there is no refund process for commissions paid for this type of sale. The next internal control issue is segregation of duties in regards to the handling of inventory. With a single person assigned with the preparation and approving all inventory records, the changes of material misstatements are high. Another issue with the internal controls of Smackey Dog Foods, Inc. is a lack of control procedures and guidelines in handling returned dog foods which presented opportunities wherein employees take home returned items. The final issue is a lack of control procedures and guidelines in handling and recording accounts receivable. This is much more important now since a major client which represents 31 percent of total sales experience financial difficulty. Moreover, the urgency of these procedures and guidelines is in light of the magnitude of receivables (29 percent of total assets). “There are two general classifications of accounts receivable confirmation” (Arens, Elder, & Beasley, 2012, p. 533). These classifications are positive and negative confirmations. Positive confirmations are confirmations that ask debtors to confirm directly to the auditors whether the balance of the accounts receivable from the debtors is correct or not. Examples of positive confirmation are blank and invoice confirmation forms. A negative confirmation requests debtors to respond only when they disagree with the stated amount in the confirmation form. As to the audit of Smackey Dog Foods, Inc’s accounts receivables, I will implement an invoice confirmation form under the positive confirmation approach because a positive confirmation is more reliable and the auditor can follow up easier if a response is not received from the debtor. The following are major factors that affect the sample size for confirming accounts receivable. The first major factor is tolerable accounts receivable and financial statement misstatement. The second major factor is inherent risk. Inherent risk is dependent on the size of total accounts receivable, the number of accounts, prior-year results, and expected misstatements. The third major factor is control risk. The fourth major factor is achieved detection risk. Achieved detection risk is based on other substantive tests. The last major factor is type of confirmation. Generally a positive confirmation requires a smaller number of sample size. Keller CPAs will need to perform the following to obtain evidence about existing legal encumbrances. These six procedures are inquiry with property, plant and equipment custodians, review of minutes of meetings, review of items noted during property, plant and equipment inventory observations, confirmation of the client’s liabilities, reading and reviewing lease agreements, and reading and reviewing property, plant and equipment purchase contracts and agreements. These procedures aim to assess whether encumbrances and liens to the property, plant and equipment have been identified and whether property currently pledged as collateral on a loan has not been sold or damaged. The presence of the audit team during the year-end inventory taking is necessary. The representation of the audit team provides assurance that the physical count was carried out carefully and systematically by persons fully informed of the duties involved. Thus the auditor’s responsibility is to ascertain whether the client’s employees are carrying out their instructions properly during the count. During the count, the auditor needs to test the efficiency of the counting by arranging for a count or a recount of selected items in the audit team’s presence. Moreover, the auditor will be taking notes considered necessary to be followed up. These can include details of items of inventory selected so that the particulars may be checked to the final count sheets; list of items actually counted in the auditor’s presence; details of any inventory noted by the auditor as being obviously defective, damaged, or slow-moving; and details of instances where the client’s physical count procedures were not carried out. There are six general functions that make up the client’s inventory and warehousing cycle.
“The first function is processing of purchase orders. This includes purchase requisitions, quotations from suppliers, and purchase orders” (Arens, Elder, & Beasley, 2012, p. 683). The second function is receipt of purchased materials. This includes the receiving report. The third function is storage of materials or inventory. This includes the materials requisition form. The fourth function is processing raw materials. This includes the job cost sheet, and process cost sheets. The fifth function is storage of finished goods. This includes the sales invoice, and the sales order form. The final function is shipping finished goods. This includes the shipping form and
invoices. Two internal control weaknesses were observed in regards to Smackey’s inventory and warehousing cycles. The first weakness that was identified was no procedures for the receipt, storage, and disposal of returned dog foods. The second weakness that was observed was processing purchase orders, receipt of purchased materials, storage of raw materials and finished goods, particularly the documents supporting these functions, are handled by a single person. Breaches in the internal control in this case are very high. Yes, unfortunately the members of the audit team assigned to Smackey’s are breaching any Professional Rules of Conduct. One violation is under confidentiality. In the case, Pete, a member of the audit team, has been discussing details of the audit to Alan over a few beers. Ethical conduct and principles require that auditors maintain integrity in performing all responsibilities in regards to the audit with the highest sense of integrity. Not disclosing and discussing details of the audit with people not members of the audit team is part of this responsibility. The audit profession agrees that the failure of an audit to uncover material misstatements which then resulted to the issuance of an incorrect audit opinion makes the auditor’s discharge of his audit responsibility and services questionable, particularly on whether such were exercised with due care. However, how the auditor performed his responsibility in regards to the audit and the extent of the damage incurred by third parties relying on the financial statements will determine his legal liability. Smackey Dog Foods, Inc. approached Keller CPAs to conduct an audit of the financial statements. The purpose of this summary is to describe the expectations that Keller CPAs has regarding how the audit of Smackey Dog Foods, Inc. will be conducted. Smackey Dog Foods, Inc. is a privately held corporation and is not required to follow the rules set forth by the Securities and Exchange Commission (SEC) for audit of public companies. Keller CPAs must follow the guidelines set forth by the American Institute of Certified Public Accountants (AICPA) no matter if the client being audited is privately or publicly held. The Auditing Standards Board of the AICPA issues statements on Auditing Standards. The pronouncements are the standards by which audits of non-public companies must be conducted. These statements offer guidance on the implementation of Generally Accepted Auditing Standards (GAAS) and do apply to privately held companies. The audit of Smackey Dog Foods, Inc. was conducted under these standards.
References
Arens, A. A., Elder, R. J., & Beasley, M. S. (2012). Auditing and Assurance Services: An Integrated Approach. Boston: Pearson Learning Solutions.
Smackey Dog Foods, Inc. has approached Keller CPAs to conduct an audit of the financial statements. The purpose of this summary is to describe the expectations that Keller CPAs has regarding how the audit of Smackey Dog Foods, Inc. will be conducted. Smackey Dog Foods, Inc. is a privately held corporation and is not …show more content…
required to follow the rules set forth by the Securities and Exchange Commission (SEC) for audit of public companies. Keller CPAs must follow the guidelines set forth by the American Institute of Certified Public Accountants (AICPA) no matter if the client being audited is privately or publicly held. The Auditing Standards Board of the AICPA issues statements on Auditing Standards. The pronouncements are the standards by which audits of non-public companies must be conducted. These statements offer guidance on the implementation of Generally Accepted Auditing Standards (GAAS) and do apply to privately held companies. The audit of Smackey Dog Foods, Inc. will be conducted under these standards.
The SEC does not require an audit of a privately held company but the bank that Smackey is requesting a loan from would like them to provide audited financial statements before the loan process goes any further. The bank requires that the financial statements comply with Generally Accepted Accounting Principles (GAAP) and Keller CPAs will be auditing the financial statements to verify the bank’s expectations and to provide assurance that the statements are not materially misstated.
Pete, Ben, and Maureen will be responsible for conducting the audit of Smackey Dog Foods, Inc. They will plan the audit by developing an audit strategy, identifying problem areas, and specific areas where material misstatements might occur. They will need to analyze the lawsuit to get a feel for the risk associated with it. Pete, Ben, and Maureen will need to include the nature of the industry Smackey Dog Foods, Inc. as in, what a manufacturer does, and how their business operations are run.
Before issuing our opinion of the financial statements, we will carefully answer the following questions to ensure that the correct opinion is issued.
The Securities and Exchange Commission (SEC) has a significant influence on the audit of Smackey Dog Foods, Inc. by Keller CPAs. This influence can be observed in the audit standards that have to be followed in establishing the independence of auditors involved in the audit of Smackey. In the audit of publicly held companies including Smackey, auditors need to observe six ethical principles. “Independence is one of the six ethical principles of the American Institute of Certified Public Accountants (AICPA) Code of Professional Conduct” (Arens, Elder, & Beasley, 2012, p. 85). The other principles are responsibilities, the public interest, integrity, objectivity and independence, due care, and scope and nature of services. More specifically, audit team members are required to be objective and independent with regard to the audit by maintaining objectivity and being free of conflicts of interest in discharging professional responsibilities and by being independent in fact and appearance when providing auditing and other attestation services. In here the influence of the SEC is very obvious. Under the Sarbanes-Oxley Act (SOX), auditors have to be objective and independent otherwise legal sanctions can be incurred. Although the above standards are enforceable for the audit of public companies, it can also be applied to the audit of non-public companies like Smackey Dog Foods, Inc. “The following are five of the essential activities involved in the initial planning of an audit as they relate to Smackey Dog Foods, Inc.” (Arens, Elder, & Beasley, 2012, pp. 215-220). The first essential activity is to understand the client’s business and industry. The audit firm can capitalize on its experience in auditing other food manufacturers in planning and doing the audit for Smackey. So far, members of the audit team, the audit manager, Pete, and two audit staffers, Ben and Maureen, have to understand the client’s business and industry.
The second essential activity is to assess client business risk. Business risk is the risk that Smackey will fail to achieve its objectives. In this activity, the audit team assesses the risk of material misstatements arising from Smackey’s business risk. For example, the high amount of waste in Smackey’s Best Dog division presents a lot of business risk, and therefore material misstatement risk.
The third essential activity is to perform preliminary analytical procedures. Keller CPAs needs to compare the performance of Smackey’s with the industry to further support its initial assessment of business risk. These analytical procedures help the audit team identify areas where the risks of misstatements are very high.
The fourth essential activity is to set materiality and assess acceptable audit risk and inherent risk. The Smackey audit team now has to set the acceptable level of materiality. The circumstances of Smackey have to be taken into account in setting materiality level as this level is purely relative and subject to the auditor’s judgment.
The fifth and final essential activity is to develop an overall audit plan and audit program. The audit plan and program aims to achieve the audit risk objectives of the audit team and to provide reasonable assurance and basis for the audit report and opinion. There are four stages in an audit with major activities that are performed by the auditor in each phase.
The first stage that specifically applies to the audit of Smackey Dog Foods, Inc. is the planning and risk assessment stage. For Smackey, the risks can initially be assessed by obtaining understanding of Smackey’s business and its industry. More specifically, the design and implementation of the client’s internal control procedures, processes and systems are studied and analyzed for the audit team to be able to assess the control risk for each of the transaction-related audit objectives- occurrence, completeness, accuracy, classification, timing and posting and …show more content…
summarization. The second stage that specifically applies to the audit of Smackey Dog Foods, Inc. is test of internal controls. The audit team can perform tests of controls by making inquiries of appropriate client personnel, examining documents, records, and reports maintained by Smackey. This team can also perform tests of controls by observing control-related activities such as the one done for the inventory procedures for returned Best Boy Gourmet dog food, and reperforming client procedures. The third stage that specifically applies to the audit of Smackey Dog Foods, Inc. is substantive tests. The Smackey audit team needs to perform substantive tests on the balances of the accounts receivables and inventory accounts. Moreover, substantive tests can be done through performing substantive tests of transactions, analytical procedures, and test of details of balances. The fourth and final stage that specifically applies to the audit of Smackey Dog Foods, Inc. is audit finalization. At this stage, the audit team compiles a report to Smackey’s management as regards to matters that came to the team’s attention during the audit, evaluates and reviews the audit evidence obtained in the audit, and considers the audit opinion to be issued based on the evidence obtained. “Generally Accepted Auditing Standards (GAAS) and professional conduct requires that the auditor communicate, in writing, to management and those charged with governance, significant deficiencies and material weaknesses identified in an audit” (Arens, Elder, & Beasley, 2012, pp. 295-296). The following four internal control issues were identified in regards to the audit for Smackey Dog Foods, Inc. and thus have to be communicated to appropriate people within Smackey. The first issue was granting of commissions to sales people based on estimated sales. This internal control issue presents risk as regards to the company’s financial resourced as sales people might be paid for sales not made, and there is no refund process for commissions paid for this type of sale. The next internal control issue is segregation of duties in regards to the handling of inventory. With a single person assigned with the preparation and approving all inventory records, the changes of material misstatements are high. Another issue with the internal controls of Smackey Dog Foods, Inc. is a lack of control procedures and guidelines in handling returned dog foods which presented opportunities wherein employees take home returned items. The final issue is a lack of control procedures and guidelines in handling and recording accounts receivable. This is much more important now since a major client which represents 31 percent of total sales experience financial difficulty. Moreover, the urgency of these procedures and guidelines is in light of the magnitude of receivables (29 percent of total assets). “There are two general classifications of accounts receivable confirmation” (Arens, Elder, & Beasley, 2012, p. 533). These classifications are positive and negative confirmations. Positive confirmations are confirmations that ask debtors to confirm directly to the auditors whether the balance of the accounts receivable from the debtors is correct or not. Examples of positive confirmation are blank and invoice confirmation forms. A negative confirmation requests debtors to respond only when they disagree with the stated amount in the confirmation form. As to the audit of Smackey Dog Foods, Inc’s accounts receivables, I will implement an invoice confirmation form under the positive confirmation approach because a positive confirmation is more reliable and the auditor can follow up easier if a response is not received from the debtor. The following are major factors that affect the sample size for confirming accounts receivable. The first major factor is tolerable accounts receivable and financial statement misstatement. The second major factor is inherent risk. Inherent risk is dependent on the size of total accounts receivable, the number of accounts, prior-year results, and expected misstatements. The third major factor is control risk. The fourth major factor is achieved detection risk. Achieved detection risk is based on other substantive tests. The last major factor is type of confirmation. Generally a positive confirmation requires a smaller number of sample size. Keller CPAs will need to perform the following to obtain evidence about existing legal encumbrances. These six procedures are inquiry with property, plant and equipment custodians, review of minutes of meetings, review of items noted during property, plant and equipment inventory observations, confirmation of the client’s liabilities, reading and reviewing lease agreements, and reading and reviewing property, plant and equipment purchase contracts and agreements. These procedures aim to assess whether encumbrances and liens to the property, plant and equipment have been identified and whether property currently pledged as collateral on a loan has not been sold or damaged. The presence of the audit team during the year-end inventory taking is necessary. The representation of the audit team provides assurance that the physical count was carried out carefully and systematically by persons fully informed of the duties involved. Thus the auditor’s responsibility is to ascertain whether the client’s employees are carrying out their instructions properly during the count. During the count, the auditor needs to test the efficiency of the counting by arranging for a count or a recount of selected items in the audit team’s presence. Moreover, the auditor will be taking notes considered necessary to be followed up. These can include details of items of inventory selected so that the particulars may be checked to the final count sheets; list of items actually counted in the auditor’s presence; details of any inventory noted by the auditor as being obviously defective, damaged, or slow-moving; and details of instances where the client’s physical count procedures were not carried out. There are six general functions that make up the client’s inventory and warehousing cycle.
“The first function is processing of purchase orders. This includes purchase requisitions, quotations from suppliers, and purchase orders” (Arens, Elder, & Beasley, 2012, p. 683). The second function is receipt of purchased materials. This includes the receiving report. The third function is storage of materials or inventory. This includes the materials requisition form. The fourth function is processing raw materials. This includes the job cost sheet, and process cost sheets. The fifth function is storage of finished goods. This includes the sales invoice, and the sales order form. The final function is shipping finished goods. This includes the shipping form and
invoices. Two internal control weaknesses were observed in regards to Smackey’s inventory and warehousing cycles. The first weakness that was identified was no procedures for the receipt, storage, and disposal of returned dog foods. The second weakness that was observed was processing purchase orders, receipt of purchased materials, storage of raw materials and finished goods, particularly the documents supporting these functions, are handled by a single person. Breaches in the internal control in this case are very high. Yes, unfortunately the members of the audit team assigned to Smackey’s are breaching any Professional Rules of Conduct. One violation is under confidentiality. In the case, Pete, a member of the audit team, has been discussing details of the audit to Alan over a few beers. Ethical conduct and principles require that auditors maintain integrity in performing all responsibilities in regards to the audit with the highest sense of integrity. Not disclosing and discussing details of the audit with people not members of the audit team is part of this responsibility. The audit profession agrees that the failure of an audit to uncover material misstatements which then resulted to the issuance of an incorrect audit opinion makes the auditor’s discharge of his audit responsibility and services questionable, particularly on whether such were exercised with due care. However, how the auditor performed his responsibility in regards to the audit and the extent of the damage incurred by third parties relying on the financial statements will determine his legal liability. Smackey Dog Foods, Inc. approached Keller CPAs to conduct an audit of the financial statements. The purpose of this summary is to describe the expectations that Keller CPAs has regarding how the audit of Smackey Dog Foods, Inc. will be conducted. Smackey Dog Foods, Inc. is a privately held corporation and is not required to follow the rules set forth by the Securities and Exchange Commission (SEC) for audit of public companies. Keller CPAs must follow the guidelines set forth by the American Institute of Certified Public Accountants (AICPA) no matter if the client being audited is privately or publicly held. The Auditing Standards Board of the AICPA issues statements on Auditing Standards. The pronouncements are the standards by which audits of non-public companies must be conducted. These statements offer guidance on the implementation of Generally Accepted Auditing Standards (GAAS) and do apply to privately held companies. The audit of Smackey Dog Foods, Inc. was conducted under these standards.
References
Arens, A. A., Elder, R. J., & Beasley, M. S. (2012). Auditing and Assurance Services: An Integrated Approach. Boston: Pearson Learning Solutions.