Shoe Zoo Solution

ISSUES IN ACCOUNTING EDUCATION - TEACHING NOTES Vol. 27, No. 4 2012 pp. 11–22

American Accounting Association

TEACHING NOTES

Shoe Zoo, Inc.: A Practice in Electronic Work Papers, Tick Mark Preparation, and Client Communication through the Audit of Property, Plant, and Equipment Penelope L. Bagley and Nancy L. Harp IMPLEMENTATION TOOLS

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he Teaching Notes are accompanied by three additional files students will not receive: a Word document titled Prior Year Property Additions Listing and two Excel files titled Updated Property Lead Sheet and Solutions—Excel Work Papers. 1 See Appendix A for solutions to the Case Critical-Thinking Questions. See Appendix B for suggested solutions to the Optional Background Reading Quiz/Assessment. For implementation ease, we have provided a sample transcript of the questions students should ask the client’s controller, J. M. Perkins (played by the instructor) and suggested answers to those questions (see Appendix C). In particular, the students should ask the controller about the following issues related to Task 1, Substantive Detail Testing of Gross PPE Additions: 

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The student should ask why the 2011 building balance on the Property Lead Sheet (created from a previously obtained trial balance) does not match the building balance on the Property Roll Forward.

Penelope L. Bagley is an Assistant Professor at Appalachian State University, and Nancy L. Harp is an Assistant Professor at Clemson University. We gratefully acknowledge Michael Bamber, Beau Barnes, Allen Blay, Brian Daugherty, Matt Hart, Marc Ortegren, Tracy Trac y Reed Reed,, Shan Shanee Stin Stinson, son, and Ralp Ralph h Viat Viator or for thei theirr valu valuable able assistance assistance and comm comments ents.. We furt further her thank Bill Pasewark, an anonymous associate editor, and two anonymous reviewers for helping to improve our case. Supplemental materials can be accessed by clicking the links in Appendix D. Please do not make the Teaching Notes available to students or post them on websites.

Published Online: November 2012

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During a financial statement audit, auditors keep track of immaterial errors on a separate work paper. We did not include this as a requirement of the case, and therefore there is no such work paper in the accompanying solutions. Instructors can choose to add this requirement at their own discretion. See Appendix D for the links to the downloadable supplemental materials.

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The student should request an updated trial balance (i.e., the Updated Property Lead Sheet Excel file). The stu studen dentt sho should uld ask abo about ut a rep repair airs/m s/main ainten tenanc ancee exp expense ense imp improp roperl erly y cap capital italize ized d as property, plant, and equipment. The student should ask for you to arrange for him/her to physically observe the assets selected for additions testing (Apple computers and office expansion). Regarding Task 2, Substantive Analytical Procedures for Testing Depreciation Expense, the student should explain to the controller his/her method for calculating an expectation for 2011 Depreciation Expense and then ask for potential explanations of why the actual recorded balance is lower than the calculated expectation. The student should also ask for corroborative evidence that can be examined to verify all explanations provided by the client. The instructor can choose to be a helpful controller or a difficult controller to work with. In addition, we recommend the instructor keep a tally of the number of times the auditor asks things of the client. One point to reiterate to the students before completing the case is that the client’s time is valuable and they should try to group questions together if possible. The questions students will ask the senior will be much less formal than the questions they will ask the client client.. Based on the implementation implementation experiences, experiences, we antic anticipate ipate that the students’ questions questions for the senior will be primarily clarifying questions on how they should best complete their tasks and document that they have done so. For example, students might notify the senior of balances that did not properly agree and ask what they should do about them, students students might ask the senior what they should do about the physical asset that could not be observed, or students might simply want reassurance reassur ance that they are headin heading g in the right direction with their docum documentati entation. on. The studen students ts will also likely ask the senior about the misclassification error and its implications for internal controls, in whi which ch case the sen senior ior should should dir direct ect the stu studen dents ts to exa examin minee the completed completed work pap papers ers documenting controls testing and to find out more information regarding the error to determine what impact the error has on using the control-reliance strategy for the financial statement audit. 2 We recommend that the person playing the senior role become familiar with the case materi materials als and the suggested solutions so that he/she will be able to point the student in the right direction, without simply giving away the suggested answers. Overall, the role of the senior is to help guide the students when they have questions as they complete their audit program, much like a true audit senior would. 

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Solutions

Students should turn in their completed work papers and their responses to the Case CriticalThinking Questions. The work papers should include all the tabs within the file called Excel Work Papers Pap ers.. See Sol Soluti utions ons—Ex —Excel cel Wor Work k Pap Papers ers for the sol soluti utions ons to the abo above ve wor work k pap papers. ers. The solutions are thorough; instructors should recognize that student responses will not likely be as in depth dep th and detailed. detailed. Also, the students students may have mor moree or les lesss tic tick k mar marks ks tha than n the solution solutions. s. Instructors can take this opportunity to provide feedback to the students regarding appropriate information to include (and exclude) from the work papers. We recommend the student be grade graded d separa separately tely for his/h his/her er interaction interaction with the clien client, t, his/h his/her er work papers, and his/her solutions to the critical-thinking questions. Keeping in consideration the lack lac k of kno knowle wledge dge and exp experi erienc encee the student student has in com commun munica icatin ting g wit with h cli client ents, s, as wel welll as 2

For simplicity, students are instructed in the case materials to document the impact of found errors on controls in a tick mark on the work paper where the error is discovered. We recognize and encourage instructors to inform students that the implications of an error on controls would be investigated and documented more thoroughly in a true audit setting.

Issues in Accounting Education - Teaching Notes Volume 27, No. 4, 2012

Shoe Zoo, Inc.: A Practice in Electronic Work Papers, Tick Mark Prep, Client Communication

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information provided previously during class lecture(s), we recommend the student be graded in the following five categories for interactions with the client: F: Overall, the student was unprofessional and rude in interactions with the client. D: Overall, the student was cordial with the client, but there were a few instances when the student was rude or unprofessional with the client. C: Overall, the student was friendly with the client, however, there were several instances when the stu studen dentt was abr abrupt upt and not cle clear ar wit with h the cli client ent reg regard arding ing inf inform ormatio ation n nee needed ded.. Examples include: 

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Not properly greeting the client when asking for information, i.e., giving the impression of barging into the client’s office. Referring to documents using auditor terms that the client would not be familiar with, such as lead sheet. When asking for additional information regarding additions, instead of referring to the asset names, the student asks to physically observe this asset. ‘‘

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B: Overall, the student was friendly with the client and had only a few instances when he/she was not clear with the client. With few exceptions, the student properly greeted the client when asking for additi additional onal information. information. A: Overall, the student interacted very well with the client. The student was aware of the value of the client’s time and tried to group questions together to limit the number of times he/ she needed to speak with the client. When he/she did speak with the client, the student greeted the client appropriately and would ask if it was an okay time to talk. We recommend the following five grading categories for the work papers, again keeping in mind the student’s inexperience with work papers and tick marks, as well as information previously provided in class lecture: ‘‘

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F: Overall, the work papers displayed a complete lack of effort by the student. Most of the audit step st epss ei eith ther er we were re no nott pe perf rfor orme med d an and/ d/or or we were re no nott do docu cume ment nted ed in th thee wo work rk pa pape pers. rs. Docume Doc umentat ntation ion in the wor work k pap papers ers was inc incoher oherent ent,, and ins instru tructio ctions ns wer weree not cle clearl arly y followed. D: Overall, the evidence displaying that the audit program steps were performed is unclear or incomplete. Several ste steps ps of the aud audit it pro progra gram m wer weree eit either her not com complet pleted ed and and/or /or not docu do cumen mente ted d in th thee wo work rk pa pape pers rs.. Th Thee st stud uden entt fa fail iled ed to us usee co comp mplet letee se sent nten ence cess in explanations, rendering it difficult to follow how the student addressed several of the steps in the audit program. C: Overall, the work papers displayed that most of the audit steps were performed. However, there are several insta instances nces of uncle unclear ar docum documentati entation, on, missin missing g infor informatio mation, n, and/o and/orr error errors. s. Examples include: 

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The student signed off on the particular audit program step, but the work papers do not show any evidence that the step was performed. For example, in the Property Roll Forward testing, the student signed off on Step 3 in the audit program, but there was no documentati docume ntation on that the mathematical mathematical accur accuracy acy was tested in the Property Roll Forward work paper (i.e., a tick mark or footing symbol was missing next to the balances that were supposed to be footed or cross-footed). There are instances of missing information, such as the student failing to complete the asset addition information in the table on the Additions Testing work paper. There are errors such as documenting that a numerical balance agrees to the lead sheet when it does not. Other errors include incorrect work paper references, missing crossreferences, and failure to explain a difference when needed.


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B: Overall, the work papers are fairly clear, and each step of the audit program was performed. Specifically, the audit program was properly completed, including the student’s sign-off on each step and the appropriate reference to where that step was performed. There are some errors as described in the C grade portion above, but primarily an outside reviewer could follow within the work papers how each step was performed. A: Ove Overal rall, l, the student’ student’ss wor work k pap papers ers provided provided clear evi eviden dence ce tha thatt eac each h ste step p of the audit progra pro gram m was per perfor formed med.. Spe Specifi cificall cally, y, the aud audit it pro progra gram m was pro proper perly ly com comple pleted, ted, including the student’s sign-off on each step and the appropriate reference to where that step was performed. Additionally, the student usually made use of standardized tick marks when appropriate (e.g., f was used to indicate that the balance properly footed, and PY was used to indicate the balance agreed to the prior year). Overall, unusual items requiring additional explanation were clearly explained in complete sentences in a separate tick mark (e.g., documenting that the asset addition that could not be physically verified was verified through discussion with the Florida branch operations manager). There are only a few of the errors described in the C grade description. We rec recomm ommend end the ins instru tructo ctors rs use the their ir own dis discre cretio tion n whe when n gra gradin ding g the Cas Casee Cri Critic ticalalThinking Questions, keeping in mind the depth of the question-related topics discussed in the textbook as well as in previous class lectures. ‘‘

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APPENDIX A SOLUTIONS FOR CASE CRITICAL-THINKING QUESTIONS

This assignment is designed to help you make connections between the work you performed in the audit of Shoe Zoo, Inc. and key concepts discussed in class. You should write a few sentences to address each question below. Task 1

1. Steps 3 and 4 of the Audit Program Program for Testing Gross PPE (WP #5600 #5600)) required you to: a. obtain obtain a roll forward forward of activity in the PPE accounts from last year to the curre current nt year, b. test the mathematical mathematical accuracy accuracy of the schedu schedule, le, and c. agree the beginning beginning and ending balances balances per the roll forward forward to the amounts per the lead sheet. Why is a roll forward important in testing PPE for the year December 31, 2011? Why are steps b and c above necessary? (Hint: how would your subsequent audit procedures be affected if there were errors in b and c above, but you did not realize that because you did not perform those steps?) A roll forward is important to test the year-end balance of gross PPE because the auditor needs to gain assurance about the December 31, 2011 amount on the balance sheet, but a great deal of those dollars would have been subject to testing last year. It would be extremely inefficient for the auditor to perform testing each year on the entire PPE ending balance. In PPE, a roll forward provides an auditor with the activity (additions and disposals) that has occurred since the last balance. Thus, the returning auditor can save time and simply test the PPE activity that occurred since the last audit. The auditor must ensure that the beginning balance per the roll forward agrees to the audited balance from the prior year. If the beginning balance does not agree, then the auditor cannot be sure that he/she will subject all the changes to PPE that occurred during 2011 to testing. The ending balance balan ce must also agree to the lead sheet (i.e., the trial balance) balance) because that is the balance that will Issues in Accounting Education - Teaching Notes Volume 27, No. 4, 2012


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ultimately be reported in the financial statements and/or footnotes. If the auditor does not ensure that the roll forward is mathematically accurate, he/she may be testing PPE additions or disposals information that is not complete or accurate. In short, the roll forward allows a returning auditor to more efficiently test the PPE balance. He/ she can rely on the prior year audited beginning beginning balance as a starti starting ng point, then simply subject the chan ch ange gess to te test stin ing g to fo form rm an op opin inio ion n on wh wheth ether er th thee en endin ding g ba bala lance nce is fr free ee of ma mate teri rial al misstatement. This approach is only effective if the beginning balance agrees to the prior year, the ending balance agrees to the trial balance, and the schedule is mathematically accurate. 2. In class we have learned that that audit evidence evidence should be both sufficient and appropriate. Appropriate Appro priate evidence evidence must be both relevant and reliable. Discuss the reliability of the evidence you collected in Steps 7 and 8. Which pieces were more or less reliable and why? In Step 7, we vouched asset additions by obtaining invoices and checks. The invoices appeared to be ori origin ginal al doc docume uments nts that wer weree cre create ated d out outsid sidee of Sho Shoee Zoo Zoo,, Inc Inc.. In gen genera eral, l, ins inspect pecting ing docume doc uments nts is con conside sidered red to pro provid videe rel reliab iable le evi eviden dence. ce. Ins Inspec pectin ting g ori origin ginal al doc docume uments nts is mor moree reliable than copies. Also, inspecting external documents (i.e., the invoices) is more reliable than internally created documents (check copies). If the auditor were concerned about the reliability of the check copies that are internally generated, he/she could also request that the client provide cleared check copies from the bank or show where the check cleared the bank statement. In Step 8, we attemp attempted ted to physic physically ally inspect the asset additions. additions. Audit evidence evidence is consid considered ered to be extremely reliable when the auditor physically inspects a tangible asset himself. This evidence is even more reliable than inspecting documents (as in Step 7) because it involves the auditor persona per sonally lly inspecti inspecting ng a rea reall asse asset. t. In one case, we wer weree abl ablee to phy physica sically lly inspect inspect the asset (computers), whereas in another case we had to rely on inquiry of a person in the Florida office who was knowledgeable about the addition and was outside of the accounting department. The auditor persona per sonally lly ins inspec pectin ting g the asse assett pro provid vides es mor moree rel reliab iable le evi eviden dence ce com compar pared ed to dis discus cussing sing the existence with a person within the company. An auditor can never fully rely on client inquiry for evidence, but the combination of inquiring of the Florida person and the examination of invoices/ checks was deemed sufficient in this case. If there was a high risk in the PPE account or suspicion of fra fraud, ud, the auditor auditor may have mad madee a dif differ ferent ent dec decisi ision on (i.e. (i.e.,, he/ he/she she wou would ld hav havee phy physic sicall ally y inspected the addition by personally visiting the Florida office). ‘‘

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3. Discus Discusss the imp implic licati ations ons of the err error or fou found nd dur during ing pro proper perty ty add additi itions ons tes testin ting g (i.e. (i.e.,, the computer repair that was incorrectly capitalized instead of immediately expensed). Write your answer as if it were a recommendation to your senior about how to deal with the error and how it impacts the audit. Consider in your discussion all of the following: a. the dollar amount amount of the error, b. the PPE acquisition process internal internal control implications implications of the error, c. entit entity-wid y-widee inter internal nal control implications implications of the error, d. how the audit plan may need to be revis revised ed (recall the Audit Risk Model), and e. any additional additional risks signaled signaled by the error and how to address them. The error found in additions testing was extremely small (less than the $1,000 materiality threshold). However, it is important to remember that we are sampling, and thus there is a risk that errors beyond the ones we find in our sample selections exist. While individually immaterial, the auditor would want to extrapolate the error to try to estimate the maximum impact of the error. Additionally, in talking with the client about why and how the error occurred, we were able to determine that a breakdown in internal controls led to the error. The property accountant was out on sick leave for the entire month of April, during which time an accounting clerk took over her responsibilities. Control PPE104, which appeared to be operating effectively in our control testing Issues in Accounting Education - Teaching Notes Volume 27, No. 4, 2012

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working paper #4001, failed to operate effectively in April (which was not selected in our initial control testing). I recommend that we carefully evaluate the other responsibilities that the accounting clerk took over during the month of April to see if there are other internal controls that failed in that month. I also recommend that we make additional selections of PPE additions that were made in the month of April, since it seems there are control problems in April when the property accountant was out. We should also more carefully examine the repairs and maintenance expense account detail and perhaps perform additional testing in the month of April. We should also reconsider whether there are internal control problems at Shoe Zoo at more of an entity-wide level. The client should have controls in place for properly training personnel, overseeing personnel, and ensuring that qualified employees are available to backup people who are on leave. We may want to inquire about other key employees who were out during the year and how their responsibiliti responsibilities es were covered. In my opinion, the control failures in April mean that control risk is actually higher than we initially assessed during our planning and control testing of working paper #4001. The audit risk model tells us that Audit Risk ¼ Inherent Risk 3 Control Risk 3 Detection Risk. Thus, to keep audit risk constant in the face of higher than expected control risk, we must lower detection risk. This means that we would want to make more selections in PPE testing. I recommend specifically focusing those selections in April, the month in which controls were not operating effectively. The error signals additional control risks in PPE and repairs and maintenance accounts. These can be addressed as discussed above. The error also signals potential risks in other areas. If the company does not have adequate personnel to step in when a key employee is out, there could be other areas where errors exist when key client personnel were absent. I recommend we also inquire of the client about compensating controls that exist at the company (e.g., budget-to-actual reviews, reconciliat recon ciliation ion reviews) to minim minimize ize the likelihood likelihood that material errors will go undetected. undetected. We should test those controls as well. ‘‘

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4. Assume Assume the cli client ent cor correc rects ts the err error or fou found nd dur during ing pro proper perty ty add additi itions ons tes testin ting g (i.e. (i.e.,, the computer repair that was incorrectly capitalized instead of immediately expensed). Given the correction, is no further testing necessary? Discuss the reasons supporting your answer. The auditor should perform additional testing even if the client corrects the error detected in the sample. Simply correcting the identified immaterial error is not sufficient because the underlying problem may be pervasive. If the problem is pervasive and the auditor does not look into it, then there could be material misstatements in the financial statements that go undetected. Therefore, the auditor should gain an understanding of why the error occurred and perform additional testing as needed. In this case, the error occurred because of a failure in internal controls when an accounting clerk took over the duties of the property accountant during the month of April. To determine what additional additi onal testing is neede needed, d, the auditor should carefu carefully lly evalu evaluate ate the other responsibilit responsibilities ies that the accounting clerk took over during the month of April to see if there are other internal controls that failed in that month. The auditor should also reconsider whether there are internal control problems at Shoe Zoo at more of an entity-wide level. The client should have controls in place for properly training personnel, overseeing personnel, and ensuring that qualified employees are available to backup people who are on leave. The auditor should inquire about other key employees who were out during the year and how their responsibilities were covered, to determine if additional testing is needed in other areas. Additionally, the auditor should inquire of the client about compensating contro con trols ls tha thatt exi exist st at the com compan pany y (e. (e.g., g., bud budget get-to -to-ac -actua tuall rev reviews iews,, rec reconc oncili iliati ation on rev review iews) s) to minimize minim ize the likel likelihood ihood that materi material al errors will go undet undetected. ected. Those compensating compensating contr controls ols should also be tested. ‘‘

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5. Examine Examine the control testing of PPE101 and PPE102 provided provided with your case materi materials als and your own testing of PPE additions. Can you think of any ways the efficiency of the audit can be increased for next year? Next year the auditor could perform dual-purpose testing. Instead of making selections for control testing and then different selections for additions testing, the auditor should use the same selections made for substantive PPE additions testing to test whether controls PPE101 and PPE102 are operating effectively. ‘‘

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TASK 2

1. Why do yo you u th thin ink k th thee au audi ditt te team am de deci cide ded d to pe perf rfor orm m ana analy lyti tica call pr proc oced edur ures es to te test st deprec dep reciat iation ion exp expens ense? e? Wha Whatt fac factor torss wer weree (an (and/o d/orr sho should uld be) con consid sidere ered d to det determ ermine ine whetherr an analy whethe analytical tical approach (versus substantive substantive tests of detail detailss appro approach) ach) is appro appropriate priate for testing depreciation expense at Shoe Zoo, Inc.? Anal An alyti ytical cal pr proc ocedu edure ress ar aree pa part rticu icular larly ly us usef eful ul fo forr in incom comee sta statem tement ent acc accou ount nts, s, su such ch as depreciation expense where an auditor can determine an expectation in a fairly precise manner. In this case, expected depreciation depreciation expense can be easily estimated estimated based on audited balances (i.e., using the ratio of the audited depreciation expense from the prior year to the audited gross PPE balance from the prior year). In deciding to perform analytical procedures, the auditor also should consider the depreciation process proce ss (i.e., whethe whetherr it is a manual process process or an automated automated process process within the the company’s company’s fixed asset system sys tem). ). Man Manual ual pro process cesses es are mor moree lik likely ely to con contai tain n hum human an erro error, r, whe whereas reas aut automa omated ted pro process cesses es may be more stable and reliable. The auditor should also consider whether changes to the depreciation policies occurred since the last year (i.e., changes in depreciable lives). Finally, the auditor should cons co nsid ider er wh whet ethe herr it is mo more re ef effic ficie ient nt to per perfo form rm te test stss of de deta tail ilss or an an anal alyt ytic ical al pr proc oced edur ure. e. In th this is cas case, e, I think the auditor decided to use an analytical approach approach since there were no major major changes within PPE or depreciation policies and it is probably more efficient than making sample selections. 2. Do you think the error (resulting from a failure of controls while the fixed asset accountant accountant was on lea leave) ve) you fou found nd in you yourr PPE addition additionss test testing ing has any implicati implications ons for the depreciation expense testing? Discuss. It is possible that the accounting clerk who replaced the fixed asset accountant also made errors when whe n ent enteri ering ng fixe fixed d asse assett inf inform ormati ation on in the com compan pany’s y’s fixe fixed d asse assett acco account unting ing sys system tem.. For example, if she incorrectly set up an asset account, then the system could be calculating too much or too little depreciation expense. The PPE Additions Listing shows only three PPE additions in April, so the effect of any error is probably small for 2011. However, it is also possible that the PPE Additi Add itions ons Lis Listin ting g for Apr April il add additi itions ons is inc incomp omplet letee if the acc accoun ountin ting g cle clerk rk did not pro proper perly ly capitalize capita lize all April PPE additions. The auditor should discuss these poten potential tial implications implications with the audit team and the client to determine the next audit steps. 3. In tes testin ting g dep deprec reciat iation ion exp expens ense, e, you per perfor formed med cli client ent inq inquir uiries ies to det determ ermine ine why the expected balance was not closer to the balance recorded by Shoe Zoo, Inc. Why is inquiry alone not enough for a high-quality audit? What else did you do (or what should you have done) instead of relying only on the client’s explanation? Client inquiry alone does not provide persuasive audit evidence. This is because it is very easy for client personnel to say things that are either accidentally inaccurate or purposely false if they do not have to back up their statements with additional documentation. An important part of being an auditor is to maintain an attitude of professional skepticism. Thus, an auditor should be skeptical of client explanations explanations until they are corro corroborat borated ed with additional evidence. In the case of testing depreciation expense, instead of simply relying on the client’s claim that there were large end-of-year additions skewing our expectation, we ensured that was true by ‘‘

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examining the PBC Additions Listing (which was subject to testing in our PPE additions working papers). We also ensured that what the client told us about the depreciation policy matched the actual depreciation policy documentation we were provided. We also did not rely on the client’s claim that no large end-of-year additions happened last year. Instead we obtained the prior year additions listing from our prior year working papers and ensured that there were no such additions occurring after December 15 in the prior year. ‘‘

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APPENDIX B OPTIONAL BACKGROUND READING QUIZ/ASSIGNMENT SOLUTIONS

1. Wha Whatt is the name name of you yourr audit firm? firm? Answer: Kerzman and Lee, LLP 2. Task 1 of the case is primarily about about auditing which account? account? Answer:: Prope Answer Property, rty, Plant Plant,, and Equip Equipment ment 3. Task 2 of the case is primarily about about auditing which account? account? Answer: Depreciation Expense 4. What documents documents have been provided provided by the clien clientt in the PBC documents? documents? Answer: 2011 Property Additions Listing Invoice from Computer Supplies, Inc. Invoice from Florida Builders, Inc. Invoice from Granny Smith Computer Repair Check copy to Computer Supplies, Inc. Check copy to Florida Builders, Inc. Check copy to Granny Smith Computer Repair Fixed Asset Deprec Depreciatio iation n Polic Policy y 5. At what amount has materiali materiality ty been set for Task 1? Answer: $1,000 6. What is the prede predetermin termined ed threshold threshold for tolerable tolerable difference difference in Task 2? Answer: $1,000 7. In what work paper(s) would you find prior year and current year gross property property balance? Answer: Property Lead Sheet and Property Roll Forward 8.

Task 2 involv involves es performin performing g what type type of audit audit testing? testing? Answer: Substantive Analytical Procedures

APPENDIX C SAMPLE TRANSCRIPT OF STUDENT QUESTIONS AND SUGGESTED RESPONSES

Note: Students’ questions will likely vary from those listed below. However, the basic content should remain the same. In addition, below are suggested responses, which can also vary greatly.


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Student Questions (italicized) and Suggested Answers: Task 1: Substantive Detail Testing of Gross PPE Additions

1. Why doesn’t doesn’t the amount on the trial balance (i.e., the lead sheet) you gave us earlier match the amount on the roll forward sheet you gave us?

Oh, that trial balance I originally gave you was just a preliminary trial balance. There was a journal entry for an addition that didn’t get booked until later. (Note: The term lead sheet is common among auditors, but not to the client. If the student references lead sheet instead of trial balance, we recommend recommend that as the client, you act is if you are not familiar with such terminology.) ‘‘

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Potential follow up question the student should ask: Can you provide me with a few more details detai ls about this addit addition? ion? Sure. The Florida branch manager neglected to notify and turn in the paperwork for an addition addit ion to the corporate corporate branch until after the company books were closed for December 31, 2011, and the preli preliminar minary y trial balance was created created.. The property accountant accountant detected the error and properly entered the addition into the general ledger as of December 31, 2011. So, the entry was made to increase the building account of $78,097 for the Florida branch addition that occurred late in the year 2011. It is properly included in the roll forward and is also reflected in the new trial balance. Potential follow up question the student should ask: Can I have the updated trial balance? Sure, here it is. (Provide student with the file, Updated Property Lead Sheet. Inform the student that he/she can assume this is the lead sheet created from the updated trial balance.) (Note to instructors regarding Question 1: We recommend you tell the students to replace the original lead sheet with the updated lead sheet in the working papers. The student should number the updated lead sheet the same as the original lead sheet [5610], and should foot and agree the updated lead sheet to the roll forward and the prior year balances. At the instructor’s discretion, the students may also be required to turn in the original lead sheet with tick marks discussing the differences they noted. The original lead sheet with the incorrect balances serves as an opportunity for the students to practice documenting a discrepancy and how it was resolved.) 2. Could you help me understand why there appears to be a computer repair capitalized with the purchase of Apple Computers for the Marketing Department? (Shows the client the addition selected from the additions listing, and the two invoices and checks.)

Hmmm. Let me take a closer look at those invoices. invoices. Yes, I see what you are talkin talking g about. It does look like $972 of the total amount should not have been capitalized. I do remember Sarah from Marketing spilling a soda on her Apple laptop. That must have been when Sarah’s computer got fixed. I’m not sure how that did not get recorded as a repair, but don’t worry about it. I’m sure an amount that small is well below your materiality, right? Please don’t tell me we need to make a big deal out of such a small error. Potential student follow-up question: I would just like to understand a bit more about how the error occurred. Even though this particular error is very small, I need to understand if there is some kind of systematic problem in your internal controls around capitalizing assets versus recording repairs and maintenance expense . Issues in Accounting Education - Teaching Notes Volume 27, No. 4, 2012

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Other mem Other member berss of the aud audit it tea team m alr alread eady y tes tested ted our con contro trols. ls. The They y did not find any problems in our controls around capitalizing assets. I think this was just an isolated slip-up in a tiny amount. Are you sure your senior wants you to keep digging into this and wasting time? Please go talk to your senior, and meanwhile I’ll start looking into what might have gone wrong in this one littl littlee error. If you still need to know more about this, come back in a little while and I should know more by then. (Note: The student should go to talk with the audit senior at this point. The senior will advise the student to look at the controls working papers provided with the case materials to get more familiar with what has already been done in that area. The senior will also advise the student to continue investigating how this error took place because the team may need to do more testing if controls are not reliable in this area. The student should go back to the client to find out more details after looking through the controls materials included with the case materials.) Student follow-up question: I looked at our control testing working papers around recording fixed assets. Our team randomly selected February and September to test the monthly detailed review of property additions. We saw sign-offs on the February and September detail det ailed ed pro proper perty ty add additi itions ons rep report ort ind indicat icating ing tha thatt it was pre prepar pared ed by the pro propert pertyy accoun acc ountan tant. t. We als also o saw sig signn-off offss by the app approp ropria riate te dep depart artmen mentt hea heads ds who whose se departments had property added in those particular months. It looks like the controls were working at least in February and September. Did you find out any more information information about how this error occurred? Yes. I shoul should d have thoug thought ht of this earlier, earlier, but I think I know what happened. happened. The invoi invoices ces and checks are dated in early April. Our property accountant, Mary Swanson, was on a medical leave for the entire month of April. She had an emergency unplanned surgery. She is very particular and would never have made this error if she was working. We had an accounting clerk, who normally assists our treasury manager, take over the process for inputting property into our fixed asset system. I was overseeing her work, but I guess I just didn’t look closely enough to notice that a $972 repair invoice somehow got into the property additions. Potential student follow-up question: So was there a detailed review of property additions performed for April, while Mary Swanson was out? Could we see that document? No, I was behind in my work since Mary was out and the accounting clerk who took some of her responsibilities did not know she was supposed to prepare that report and coordinate getting department heads to review the listing if their department got any new property. I guess this just slipped through the cracks. The good news is that Mary was back in her position by May, so only April should have potential errors. I doubt there are any other problems though. 3. I would like to verify the physical existence of the Apple computers, could you arrange for that to happen?

Sure. I arranged for you to go with our operations manager, John Smith, on February 15, at 2:15 p.m. to view the computers. You examined the asset and found it to match the description given in the property listing, and to be in good condition and use. (Note: Inform the student that he/she is to assume they did observe the asset under the above conditions condit ions and shoul should d docum document ent that accordingly.) accordingly.) 4. I would like to observe the office expansion. Could you arrange that for me? Issues in Accounting Education - Teaching Notes Volume 27, No. 4, 2012


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Well, it’s out of state (i.e., in Florida) so I am not sure how you are going to do that. Potential student follow-up question: Is it possible for me to verify with someone in the Florida office that the addition exists? Sure. You called Florida branch operations manager Melissa Watson, and she verified that they recently expanded the office and the addition is valid. (Note: Inform the student that he/s he /she he is to ass assum umee th thee ab abov ovee co conv nver ersat satio ion n di did d oc occu curr an and d sh shou ould ld do docu cume ment nt th that at accordingly.) (Note to the instructors: The student may ask you, the client, about a $1 difference between the property lead sheet and the roll forward in the computer balance. In addition, the student may ask about the $215 difference between the additions listing and the additions amount on the roll forward. Both amounts are immaterial and should not be of concern to the student. As the client, feel free to become annoyed if asked about such trivial differences.) ‘‘

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Task 2: Substantive Analytical Procedures for Testing Depreciation Expense

Note to instructors: It is possible for students to complete the Analytical Procedures satisfactorily without talking to the client. The students are given the depreciation policy and additions listing, theref the refore ore with car carefu efull ana analys lysis is som somee stu studen dents ts may be abl ablee to ide identi ntify fy on the their ir own that the Warehouse Expansion and Office Building addition should not be included in the calculation of depreciatio depre ciation n expen expense se and adjust their calcul calculations ations accordingly. accordingly. 1. I am testing depreciation depreciation expense and am having a little trouble. trouble. We are testin testing g the account just like last year, with substantive analytical procedures. I came up with an expectation for deprec dep reciat iation ion exp expense ense,, and when I com compar pared ed it to the rec recorde orded d bal balanc ance, e, the rec record orded ed balance was much less than expected. Could you help me figure out why the recorded balance is lower than my expectation?

Sure, I can try to help. How did you calculate your expectation? Potential student follow-up: Well, we used the relationship between last year’s depreciation expe ex pens nsee an and d th thee av aver erag agee gr gros osss PPE fr from om la last st ye year ar to co come me up wi with th ou ourr ex expe pect cted ed depreciation expense. We figured out that last year, depreciation expense represented 3.55 percent of the average gross PPE balance from last year. Since we don’t think there were any changes to your depreciation methodology, we figured that a reasonable expectation for this year’s depreciation expense would be 3.55 percent of this year’s average gross PPE balance. Does this expectation make sense based on your knowledge of depreciation, any changes in depreciation methods, and changes to PPE this year? Hmmm. Yes, I would expect that the relationship between last year’s depreciation expense and gross average PPE would would be the same as this year. However, However, now that I think about about it, we did make two pretty big acquisitions really late in the year. Let me check something. (Here, the controller pulls out his copy of the 2011 Additions Listing.) Yes, se Yes, seee th these ese tw two o ad addi diti tion onss to th thee bu buil ildi ding ng ac acco coun unt? t? No Noti tice ce th that at th thee Wa Ware reho hous usee Expans Exp ansion ion for $107,653 $107,653 was mad madee on Dec Decemb ember er 28, 201 2011, 1, and the Offi Office ce Bui Buildin lding g Addition for $78,097 was made on December 30, 2011. I think that explains why your expectation was higher than the recorded balance. I’m m st stil illl no nott su sure re I un unde derst rstan and d ho how w th this is ma makes kes my Potential studen Potential studentt follo follow-up w-up questi question: on: I’ expectation too high. Can you clarify for me? Issues in Accounting Education - Teaching Notes Volume 27, No. 4, 2012

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Well, our Fixed Asset Depreciation Expense Policy (which we gave you in the PBC documents) clearly states that assets acquired after the 15th day of a given month shall begin depreciation expense in the following month. These two big balances are included in gross PPE at year-end, but since they were acquired on December 28, 2011, and December 30, 2011, they did not get any depreciation expense for 2011. I think you should remove those two addit additions ions from your ending balance of gross PPE for purposes of calculating an expectation for depreciation expense. I suggest that you re-run your calculations after taking away those two big acquisitions on December 28, 2011, and December 30, 2011, from the gross PPE balance at December 31, 2011. Last year, we didn’t have any big acquisitions at the end of December, so I guess this problem didn’t happen last year. ‘‘

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Potential student follow-up: OK. That makes sense. Do you have a copy of last year’s additions listing so that I may verify that there were not any large additions at the end of December last year for which I would need to adjust my 2011 expectation? Well, your team audited property last year as well. Isn’t last year’s property additions listing with your prior year working papers? I guess I can dig one up if you can’t find it. Potential student follow-up: Sorry, you are right. I will ask my senior to help me find it in last year’s working papers. Thank you for your help. I will verify what you have told me with the dep deprec reciat iation ion pol policy icy and las lastt yea year’s r’s add additi ition on lis listin ting. g. The Then n I wil willl rere-cal calcul culate ate my expected depreciation expense, compare it to recorded depreciation expense, and let you know if I have any other questions . (Note to the instructors: We recommend that the student ask the senior for the prior year additions additi ons listing [i.e., Prior Year Prope Property rty Additions Listing]. Listing]. Alter Alternative natively, ly, the prior year additions listing could be included with other files from the prior year (i.e., the prior year audited financials and prior year depreciation expense lead sheet) that were provided to the student at the beginning of the case.)

APPENDIX D

Prior Year Property Additions Listing: http://dx.doi.org/10.2308/iace-50251tn.s1 Updated Update d Prope Property rty Lead Sheet: http://dx.doi.org/10.2308/iace-50251tn.s2 Solutions—Excel Work Papers: http://dx.doi.org/10.2308/iace-50251tn.s3


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