Read the information on “Tonker Toy Company Ltd”. Tonker Toy Company Ltd. The To
ID: 2585078 • Letter: R
Question
Read the information on “Tonker Toy Company Ltd”.
Tonker Toy Company Ltd.
The Tonker Toy Company Ltd. (Tonker) has experienced considerable success and steadily increasing profits over the past few years. However, the economic decline coupled with increasingly severe price competition have decreased Tonker’s profits and liquidity significantly during the current fiscal year ending on 30 June 2014. In fact, most of Tonker’s competitors have reported losses for the current year. Management believes that unless additional financing can be obtained, Tonker will face a possible cash flow crisis and loan defaults.
To obtain additional financing on the most favourable terms, management feels that the income statement for the current year would have to show increased profits relative to the prior year. Therefore, Tonker’s financial controller, in collusion with the marketing Vice President, made up a substantial amount of fictitious June sales. Sales orders, shipping orders, bills of lading and invoices were prepared for nonexistent sales. The customers were real, but the sales and shipments were not. As a result, Tonker reported sales of about $2 million in the last three days of June, which is a traditionally slow sales month for the toy industry.
You have been the Manager in charge of the audit of Tonker for about five years now. In your past association with senior management at Tonker, you have noticed from past actions that they are willing to compromise their integrity in order to achieve their goal.
Answer the following questions.
(a) In general, describe four benefits or purposes auditors can obtain from audit planning. (6 marks)
(b) In Tonka’s case, discuss how proper planning of the audit should lead to the discovery of this fraud. (6 marks)
(c) Describe the three components of audit risk in the audit risk model. Briefly explain the nature of each of the components of audit risk. (5 marks)
(d) Discuss four specific factors in Tonker’s case that should affect the auditor’s assessed level of inherent risk. For each factor, comment on whether the factor would increase or decrease inherent risk. (8 marks)
Explanation / Answer
A)Audit Planning Benefits :
Audit Planning is addressed by planning an audit of Financial Statements.it states that palnning benefits the audit of financial statements several ways :
- Helping the auditors to devote appropriate attention to important areas of the audit.
- Helping the auditor to identify and resolve potential problems on a timely basis.
- Helping the auditor to properly organise and manage the audit engagement so that it is performed in an effective and effecient manner.
- Assisting in the selection of engagement team members with appropriate levels of capabilities and competence to respond to anticipated risks and the proper assignment of work to them.
- Facilitating the direction and supervision of engagement team members and the review of their work.
- Assisting where applicable in condition of work done by experts.
B. DISCOVERY OF SALES FRAUD :
- The two sides of a sale transcation record the money coming in and the inventory going out. In false sale fraud as there is no sale to record only the inventory going out is recorded. as the levels of inventory are reduced to reflect the stolen item being sold, it can simply be taken without being missed in a stock take.
- The inventory records are updated from the false source documents as if there had been a legitimate sale. now the inventory records will match the physical level of inventory . However as there is no sale recorded money is not expected to be collected and will not missed.
- False collection schemes are an adaptation of the sales frauds based on a manufacturing process . the target of the fraud can be inventory on hand , material or parts on hand , or items being purchased . the fraud is based on the false allocation of inventory to work in progress in a manufacturing process . The inventory is recorded as allocated to a particular job. This fraud relies on an explanation for the use of material inventory.The rest of the scheme is the same.
C.COMPONENTS OF AUDIT RISK :
- INHERENT RISK :
1)Inherent risk is the susceptibility of an account balance or class of transcations to a material misstatement , assuming that there were no internal controls.
2) Factors effecting the inherent risk
- at financial statements level : integrity of management , management experience and knowledge , unusual pressure on management , nature of entitys business
- at transcations level : Accounts prone to misstatement , complex transcations Assets prone to misappropriation , unusual transcations at or near period end.
- CONTROL RISK :
1) Control risk is the risk that material misstatements will not be prevented or detected and corrected on a timely basis by the internal control system.
- DETECTION RISK :
1) Detection risk is the risk that an auditor substantive procedures will not detect a material misstatement.
D. FACTORS :
- Nature of clients business : Value of obsolescent inventory in highly technology industry .
- Results of previous audits : misstatements found in previous year audit is more likely to occur again .
Misstatements are systematic in nature.
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