Using the relevant audit risk and materiality concepts from the text, address th
ID: 2564146 • Letter: U
Question
Using the relevant audit risk and materiality concepts from the text, address the following scenarios regarding Tucker & Company’s audits of the financial statements of Foursquare Industries, Inc.
BACKGROUND
1. Tucker & Company auditors are planning their audit of Foursquare Industries, Inc.’s 2018 financial statements. The Company manufactures and sells industrial pumps and related plumbing equipment. Early in 2018, Foursquare introduced a new product, a complex computerized control mechanism that can be added on to certain of its other products. It eliminates the need for Foursquare’s customers to manually monitor and adjust certain settings. The product can be purchased together with its other products or purchased separately and added to its other products that have already been purchased by its customers. Despite its high cost, the new product has been a success and accounts for approximately 30 percent of 2018 revenues. Because of the nature of the new product, however, the sales price includes mechanical maintenance and software updates for three years from the date of purchase. Foursquare’s other products include only a 90-day warranty.
Question: How does the introduction of the new product affect the amount of audit evidence the Tucker & Company auditors will need to obtain about the occurrence and accuracy of the recorded revenue, as compared to the previous year, and why?
2. Because of its growing success, Foursquare attracted the interest of a venture capital firm, which offered to make a significant investment in the company. Up to that time, Foursquare had been owned and operated by a single family. The company decided to accept the offer, and sold 40 percent of the company’s common stock to the investors before the end of 2018. With the agreement of the new investors, Foursquare used the proceeds of the investment to pay off the substantial bank loans the company had incurred in connection with the development of its new product. The company’s patents related to its new product and certain manufacturing equipment had fully collateralized the bank loans.
Questions: Does this change in Foursquare’s capital structure affect the overall amount of audit evidence the Tucker & Company auditors will obtain in its audit of Foursquare’s 2018 financial statements, as compared to the prior year? Why or why not?
3. In past audits, the Tucker & Company auditors found few, if any, errors in its substantive audit procedures for the existence of Foursquare’s accounts receivable. For the 2018 audit, Tucker & Company decided to change its audit strategy for the existence of accounts receivable by identifying controls and testing their design and operating effectiveness. In the past, Tucker & Company did not test controls. The results of the tests of controls indicated that Foursquare’s controls were designed and operated effectively. After performing their substantive tests of details of balances, however, the auditors discovered numerous errors in the accounts receivable balances.
Questions: What effect did the change in strategy have on the planned nature and extent of auditing procedures performed regarding the existence of Foursquare’s accounts receivable as compared to the previous audit and why? What do the results of the substantive tests of details of balances indicate, how should the auditors respond, and why?
Explanation / Answer
Answer to Question.1.
The Introduction of the new product increases the total sales of Foursquare Industries Ltd. by 30%. This indicate that the new product plays a material role in overall sales. Thus, while selecting the sales sample, Trucker and Company should consider the materiality of new product and should select the sample from the same. Further, the product is new the Trucker & Co. should also need to consider the manner of deciding the price of the product. They need to analyze the mechanism for computing cost and should understand the profit margin computation. They should verify whether all expense incurred are correctly recorded for deriving the selling price of the product. The new product is supplied along with other product also. Thus, in case of such supply the auditor needs to verify the additional revenue collected in respect of such sales.
In the previous year, the auditor is selecting samples on the basis of existing product. Thus, it is not essential to put major importance on a particular product as every product plays the same role. Only sales materiality is the relevant factor for the audit purpose. However, in the current year the auditor should put special emphasis on the new introduced product and should verify all necessary documentation and computation involved with regards to fixation of selling price and derivation of cost for new product
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