In evaluating the audit approach for McClain for the current year's audit, Sessions believed that a substantive


In evaluating the audit approach for McClain for the current year's audit, Sessions believed that a substantive approach was really only appropriate for the audits of small nonpublic companies. In his judgment, McClain Plastics, with sales of $200 million and 146 employees, had reached the size where it was not economical, and probably not wise, to concentrate all the tests on the balance sheet. Furthermore, although McClain is not a public company, Sessions recognized that similar public companies are required by Section 404 of the Sarbanes-Oxley Act and related PCAOB standards to have an integrated audit of the financial statements and internal control over financial reporting. Therefore, he designed an audit program that emphasized identifying internal controls in all major transaction cycles and included tests of controls. The intended economic benefit of this "reducing control risk" approach was that the time spent testing controls will be more than offset by reduced tests of details of the balance sheet accounts. In planning tests of inventories, Sessions used the audit risk model included in auditing standards to determine the number of inventory items BRS&B will test at year-end. Because of the number of different products, features, sizes, and colors, McClain's inventory consisted of 2,450 different items. These were maintained on a perpetual inventory management system that used a relational database. In using the audit risk model for inventories, Sessions believed that an audit risk of 5% was acceptable. He assessed inherent risk as high (100%) because inventory, by its nature, is subject to many types of misstatements. Based on his understanding of the relevant transaction cycles, Sessions believed that internal controls were good. He therefore assessed control risk as low (50%) before performing tests of controls. Sessions also planned to use analytical procedures for tests of inventory. These planned tests included comparing gross profit margins by month and reviewing for slow-moving items.
Sessions believed that these tests will provide assurance of 40%. Substantive tests of details will include tests of inventory quantities, costs, and net realizable values at an interim date 2 months before year-end. Cutoff tests will be done at year-end. Inquiries and analytical procedures will be relied on for assurance about events between the interim audit date and fiscal year-end.

a. Decide which of the following will likely be done under both a reducing control risk approach and a substantive approach:
(1) Assess inherent risk.
(2) Obtain an understanding of internal control.
(3) Perform tests of controls.
(4) Perform analytical procedures.
(5) Assess planned detection risk.
b. What advantages does the reducing control risk approach Sessions plans to use have over the substantive approach previously used in the audit of McClain Plastics?
c. What advantages did the substantive approach have over the reducing control risk approach?

Financial Statements
Financial statements are the standardized formats to present the financial information related to a business or an organization for its users. Financial statements contain the historical information as well as current period’s financial...
Balance Sheet
Balance sheet is a statement of the financial position of a business that list all the assets, liabilities, and owner’s equity and shareholder’s equity at a particular point of time. A balance sheet is also called as a “statement of financial...
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Auditing and Assurance services an integrated approach

ISBN: 978-0132575959

14th Edition

Authors: Alvin a. arens, Randal j. elder, Mark s. Beasley

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