You are a second-year associate and will be working on the Zoom Snowboards audit team for the 10.31.21 audit. Zoom is a public company based in Park City, Utah that sells snowboards and sno
accounting multi-part question and need the explanation and answer to help me learn.
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You are a second-year associate and will be working on the Zoom Snowboards audit team for the 10.31.21 audit. Zoom is a public company based in Park City, Utah that sells snowboards and snowboarding apparel. They sell their inventory to retailers throughout Canada and the US. They also have one corporate-owned retail store in Park City. There is a new manager assigned to the engagement but the partner has worked on the engagement for 4 years. Select financial information is provided in a separate excel document.
Zooms inventory is composed of a variety of different types of snowboards as well as snowboarding apparel. The snowboards vary from a low-end/lower priced entry-level board for novice snowboarders to very high quality, high-priced top of the line snowboards for use by expert snowboarders (prices range from $500 to $1400). Zoom snowboards are manufactured in the US, by a sub-contractor. The manufacturing of their apparel is outsourced to a manufacturer in China. Zooms inventory is stored in 1 of 5 warehouses that Zoom owns. They own the land& buildings where the warehouses are located as well as some highly specialized equipment used to brand & customize the boards when they receive them from their US manufacturer. Zoom orders their apparel inventory from China with a 6-month lead- time for the winter season, thus their warehouses are full of product in June each year, and this inventory is shipped out over the next 4-6 months as demand from retailers dictates. Zoom uses pre-numbered purchase orders and receiving reports; however, the sequential numbers are not always checked and unmatched purchase orders or receiving reports are not followed up on.
Zoom was started several years ago by two avid snowboarders, Shawn and Lindsey. They run Zooms day-to-day operations. Your firm has been the companys auditor for the past 7 years and has always had a good rapport with everyone at Zoom. Prior year audits identified material misstatements in the inventory account due to inadequate reserves for obsolescence — Zoom does not have a systematic process to consider/identify obsolescence but Zoom always makes the necessary adjustments to correct their net inventory balance, based on the auditors proposed adjustments. Shawn and Lindsey are also happy to sign a detailed management representation letter every year.
The management team is lean and mean, though Lindsey and Shawn have every confidence in their executive team (which includes a CFO, COO and CIO). They also hired an internal auditor in the past year to oversee the outsourced IA function , and a new controller (after the previous controller quit)–a senior manager from your audit firm who was tired and burnt out and decided to try the corporate world. You have worked with this individual on a few clients over the past few years and are confident in her abilities & relieved you can trust the information she produces. (Moreover, you are both avid snowboarders, so maybe shell get you a good deal on a snowboard!)
Zoom has experienced considerable growth over the past 5 years and has financed some of this growth by drawing on its considerable Line of Credit with its primary bank. The line of credit has strict debt covenants that stipulate specific current, quick and inventory turnover ratios. The past year has been difficult for Zoom as revenues have declined significantly with increased competition in the marketplace, poor snow conditions, and a tightening of consumer spending. Costs of their raw materials and apparel from China have also increased substantially. One of their major retailers is on the verge of bankruptcy and thus there is doubt as to their ability to pay the significant balance they owe Zoom, not to mention the fact that Zoom may not receive any Q4 orders from them.
Zoom performs their annual physical inventory count on September 30 each year and reconciles their book to physical at that point. Since Zoom uses a perpetual inventory system with strong internal controls over additions to and deletions from inventory, they roll-forward the inventory balance from September 30 to October 31 in order to obtain their year-end inventory numbers for the financial statements. The audit plan is for one of the firms first year associates to attend the inventory counts with you.
MAC 830 Final Exam 2023
This is an open book exam. You can access the Async material, your notes, the course textbook, or your Financial Reporting textbook. Please insert your responses below for each question. Use a different font (or italics) for your responses. Be clear and concise (no ?once upon a time lengthy discussions please). This exam is due no later than 6pm on March 20th. Please submit electronically. Late submissions will be penalized. Good luck ? youve got this.
Question 1 (20 points)
You start by working on the audit of inventories. On what date should you count the inventory? (1 point)
What is your assessment of RMM for the inventory account at Zoom? Give reasons why with specific reference to information provided in the case materials as well as relevant analytics. (6 points)
Inventory Count – Assume you encountered the following scenarios during the inventory count. Briefly explain how you would either address the issue or what you could have done to prevent the issue. Treat each scenario independently.
(i)The auditors observed the clients inventory count at 2 locations after discussions with management (management suggested which locations would be best for the auditor to count. The company falsified inventory at the other locations by including fictitious inventory in the counts. The inventory counted/observed represented less than 10% of the total inventory on hand. (2)
(ii)After the count was completed and the auditors had left the count sites, Zoom added additional, fictitious count sheets that increased the total inventory by 5%. The client notified the auditors of the inadvertent omission and explained that the additional count sheets represented legitimate inventory that had been overlooked because it represented snowboards that had been set aside for customization. (2)
Assume that your testing of the cost of the Apparel inventory proceeded without incident. In order to test the carrying cost of the snowboards you divided them by type/quality. Your testing of the low-priced boards revealed no discrepancies. As part of your testing of the carrying cost of the high-end boards, you note the following.
The total quantity per the inventory count is 1050. Zooms carrying cost of these boards is $1,187,500 (the remaining balance is related to the low-end boards). Zoom uses the FIFO method.
i.Do you agree with Zooms carrying cost for the high-end snowboard inventory? If not, what adjusting entry would you propose? Show your work. (4 points)
ii.How would you audit management?s esitmate of the Reserve for Inventory Obsolescence? Be specific as to which audit approach you would use and what you believe that inputs and significant assumptions are.(5 points)
Question 2 ? CHOOSE EITHER PART A OR PART B. Do not answer both parts.
Part A Attributes Sampling (15 points)
You have decided to use attribute sampling to test Zooms controls over their purchasing function ? the pricing of their inventory purchases in particular. In prior year audits, relatively limited reliance was placed on these internal control activities with extensive substantive testing performed instead. The new manager on this engagement has decided to evaluate the possibility of performing more tests of controls over the processing of vendor invoices in order to increase the reliance on internal controls.
Zoom has had these controls in place for several years and they have had no turnover in personnel in the purchasing and related functions. Discussions with the Controller revealed that they had not had time to remediate any control deficiencies identified in the prior year. You reviewed the prior audit documentation, which was prepared by another staff accountant who has since left the firm. Based on your review, you have the following notes:
The control activity tested by the staff accountant is the employee verification of the reasonableness of prices on the vendor invoices by placing a checkmark or other notation adjacent to the price on the invoice once the prices have been checked.
Using an expected population deviation rate of 1%, a tolerable rate of deviation of 7% and a risk of overreliance of 10%, the staff accountant selected a sample of 55 invoices to test.
Tests of controls revealed three misstatements. Based on the sample size of 55 and R.O.O. of 10%, the ULRD was 11.8%. Because this exceeded the T.R.D of 7%, the staff accountant reduced reliance on the control activity and conducted more extensive substantive procedures.
Do you agree with the conclusions from last years audit (were Sample Size and ULRD calculated correctly and was the staff accountants conclusion valid)? (3 points)
If you want to increase the reliance on the control activity this year, what two factors will be need to be modified (and in which direction) and how will this affect your sample size (increase or decrease) ? (3 points)
Assume that you establish a R.O.O. of 5%, a T.R.D of 6% and an expected population deviation rate of 1%. Using AICPA tables, determine the necessary sample size for this years audit. (2 points)
Given the parameters in part c what is the maximum number of deviations permissible for you to rely on this control activity? Is it feasible to increase the reliance on internal control this year? (4)
Do you agree with the following statement made by the manager on the audit? Why or why not? (3 points)
We really need to be careful to limit our exposure to the risk of over-reliance. At the end of the day, this risk could result in an inappropriate audit strategy where we do not perform enough substantive procedures.
Part B. Variables Sampling on the audit (15 points)
Assume that a member of the Zoom audit team who is responsible for testing the Accounts Receivable balance approaches you for some help. They have decided to use MUS to select a sample of accounts receivable for confirmation. They are a little confused and unsure of MUS and thus have asked for your assistance. They share the following with you. They decided to use MUS to select a sample of accounts receivable for confirmation because MUS uses each account in the population as a separate sampling unit. They expected to discover many overstatements but presumed that the MUS sample size still would be smaller than the corresponding sample size for classical variables sampling. They further reasoned that the MUS sample would automatically result in a stratified sample because each account would have an equal chance of being selected for confirmation.
They computed the sample size using the risk of incorrect acceptance, the total recorded book value of the receivables, and the number of misstated accounts allowed. They then divided the total book value by the sample size to determine the sampling interval and then calculated the standard deviation of the dollar amounts of the accounts selected in order to evaluate the receivables balance.
Their calculated sample size was 60 and the sampling interval was $10,000. However, only 58 different accounts were selected because two accounts were so large that the sampling interval caused each of them to be selected twice. In the end, they sent requests to 55 of the 58 customers selected by the MUS program. Three of the accounts originally selected had insignificant balances, so they substituted these for three large account balances that had not been selected by the random selection procedure.
The confirmation process revealed two differences. Once account with an audited value of $3000 had been recorded at $4000. They projected this as a $1000 misstatement. Another account with an audited value of $2000 had been recorded at $1900. They ignored the difference because it was not an overstatement.
Their conclusion was that the A/R balance was fairly stated because the projected misstatement ($1,000) was less than the allowance for sampling risk.
(i)Briefly describe 10 incorrect assumptions, statements or conclusions made by the auditor in performing this sampling procedure. (10 points)
(ii) Describe five ways that the auditor might be biased on the Zoom audit -make sure you note the type of bias. For each type, list a possible de-biasing technique. (5 points)
PART B (20 points)
You arrive at Zooms offices one day late in November to try and plow through your year-end audit work, only to learn shocking news. Zoom was the victim of a hacking incident. Management noted that they would be disclosing the breach in the next few days as well as filing an 8-K document. As you dig into the breach further, you learn that the hackers had accessed sensitive employee data (social security numbers, addresses etc) and customer data (credit card and banking details) in August 2021. Zoom only just became aware of the breach this week and immediately put their CIO to work and hired a cybersecurity specialist to investigate it. As far as Zoom is aware, the hacker was not able to access or modify any accounting records or credit card transaction processing data. Zoom was concerned, however, that they would be financially responsible to reimburse the credit card networks (Visa, Mastercard etc) for costs incurred to reissue new cards. They would also need to provide specific identity theft protection for all their employees. Estimating the relevant costs was going to be a challenge. (You recall reading that TJX Companies spent $20M just to settle claims with MasterCard.)
Shawn and Lindsey noted that luckily the breach was only a security breach and that it need not be disclosed in this years F/S since they were not aware of it until after year-end. It would be disclosed with the Q1 results. They also deemed that recording a liability due to a loss contingency would be inappropriate because it is very difficult to estimate the amount of loss that will be incurred, the amount is probably not material, and the likelihood is probably remote. (Zoom was still working on identifying which customer data and which employee data were compromised.)
Upon investigation, the cybersecurity specialist learned that the hackers used source code to circumvent the companys user access controls. In addition, they noted that Zoom might be in hot water with the credit card companies because they may not have been compliant with payment card industry data security standards.
What audit issues does this incident give rise to? (4 points)
Choose two issues you noted in (i). What audit procedures would you perform to understand and evaluate the impact of the issues on your year-end audit? (4 points)
Describe which ITGCs or ITACs failed. Do you believe the hacking incident is indicative of a possible significant deficiency or material weakness in ICFR? What specific audit evidence would you gather to support your conclusion. (4 points).
How would you audit managements estimate of the contingent liability related to the incident? (8 points).
Question 4. Auditing Investments & Other Assets (20 points)
Zooms investment account is comprised of a $100,000 face value corporate bond purchased during the year as a temporary investment (available for sale).
The bond has a term of 14 years and a bond rating of A-. The bond is not traded in an active market, so Zoom assembled the following matrix of bond price data (term and bond ratings) for actively traded bonds in order to estimate the FV of the bond at year-end.
The CFO valued the bond at $99,100 by taking the average of the A rated bonds and BBB rated bonds for the 10 year term. He reasoned that the 20-year bond information was irrelevant as the 14-year term is closer to the 10-year term than the 20-year term. In your discussions with him on his methodology/approach, he noted that he actually believes that the A rated bonds are far closer to his A- rated bonds than the BBB-rated bonds, and thus he could argue a FV of 99,600; but he has decided to be conservative. He noted the Fair Value Hierarchy level as Level 2.
Do you agree with conclusion re the FV Hierarchy Level? Explain your answer. If you disagree, what level would you assign? (2 points)
If you disagree with the CFOs FV estimate, what should the FV estimate be? (3)
What audit procedures would you perform to test the existence assertion? (3)
During your audit, you learn that Other Assets includes a 7-year license that Zoom acquired at the beginning of the year, which gives the company broadcasting rights (and ultimately earn licensing fees) for a series of extreme snowboarding videos. When they acquired the license, Zoom estimated that there would be a resultant $250,000 in cash flows/revenues annually. The risk free interest rate is 4%; however, since the receipt of the cash flows is uncertain, Zoom is using a 10% risk-adjusted rate in its DCF calculations. Zoom is unsure as to which FV hierarchy level to assign to the asset or whether FV is relevant here.
What type of asset is the license? What are the critical assertions related to this asset? (3)
How should the asset initially be recorded? (3)
Is the auditor required to test the asset for impairment? Describe the process you would follow/the steps you would perform in doing so. (6 points)
Question 5 (5 points)
As you are wrapping up the audit, CIO mentions to you that Zoom needs a SOC report because their B2B customers and vendors are increasingly requesting assurance that their online transactions & data are secure, private, and processed with integrity. He is wondering whether you could issue this report as an extension of your audit report given the extensive testing you have already performed on their ICFR.
What is your response to the CIO and what type of SOC report would you recommend? What level of assurance would the report provide?
Honor Code Statement: I pledge that I completed this exam entirely on my own and that I have neither given nor received any unauthorized assistance. I only used class notes and the textbook for reference. I did not search the internet in any capacity.
______________________________________________________________________ (Name & Date)
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