CASE 13
SUGGESTED ANSWERS TO DISCUSSION QUESTIONS
(1)
The authoritative auditing literature describes a material internal control
weakness as a condition where a company’s systems fail to reduce to a relatively
low level the risk that a material error or irregularity will both occur and avoid
being detected within a timely period by employees in the normal course of
performing their assigned duties. If any such weakness does exist, the company
is exposed to the danger that an error or irregularity will occur, go undetected,
and then directly affect reported financial figures.
The auditor’s role is to accumulate sufficient, competent evidence on which to
form an opinion as to the fair presentation of the client’s financial statements.
(2)
Management prefers to understand how the information is accumulated,
manipulated and reported. The old manual/paper systems provided an easy to
(3)
Many individuals in business are skilled in one particular industry: audio
equipment, car sales, fashion design, etc. Others are trained in one general
aspect of business such as marketing, personnel, shipping, etc. Although these
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(4)
Public accounting firms come into contact with numerous business organizations,
their operations, and their accounting systems. Since the client’s systems and
(5)
A fully computerized accounting system has two major impacts on the work of
the independent auditor. First, the traditional audit trail is changed significantly.
The series of paper documents that could be followed from the inception of a
transaction to its final recording is often unnecessary in an automated system.
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procedures, the audit firm must adapt its examination to new circumstances.
Increased emphasis is placed on developing tests of the computer controls to
ensure that all of the data being processed is reliable. The auditor would expect
the computer installation, for example, to have restricted access to limit the
(5) and (6)
Public accounting firms have long held that a distinction is maintained between
consulting and audit services, a separation that protects them from any possibility
of a conflict of interest. In many organizations, the two services are offered
through relatively autonomous divisions. Furthermore, the client is free to
discuss possible improvements with any other business enterprise providing
these services. Many large companies, for example, use one firm for auditing
and a different organization for advisory services to avoid becoming too
dependent on any one group.
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“Happily, accounting remains for now at least one of the nation‘s most
admired professions, as shown by a recent Louis Harris poll of
shareholders and business leaders who believed accounting to have the
highest moral practices of any major profession – better than college
professors, lawyers, congressmen, journalists. Yet if something
happens to that credibility, there is more at risk than simply the fortunes
SUGGESTED ANSWERS TO EXERCISES
(1)
The cases in this book have described several of the accounting systems in use
by the Lakeside Company. Because of the lack of complete computerization,
these various functions are mechanical in design, relying on the skills of the
company‘s employees. Therefore, Abernethy and Chapman can recommend to
Rogers a number of specific functions to be modernized through the installation
of a new accounting information system. Listed below are a few examples of the
types of suggestions that students may provide:
– Payroll
The names and pay rates for all employees are programmed into the
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– Credit File
Information is accumulated about all of the customers to whom credit sales
are made. A review board is established by Lakeside to approve or reject
– Perpetual Inventory
All inventory balances are monitored by a computer program. At the time
merchandise is transferred to a customer, the identity of the specific items is
– Accounts Receivable Subsidiary Ledger
A listing of all customers is maintained within the database as well as the
(2)
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General controls relate to all EDP activities and include:
A plan of organization and operation of the EDP function.
Procedures for documenting, reviewing, testing, and approving systems or
Applications controls relate to specific tasks performed by the EDP department,
such as preparing payroll. These controls are intended to provide assurance that
the recording, processing, and reporting of data are properly performed.
Applications controls can be further divided into “input,” “processing,” and
“output” controls.
Input controls ensure that input data is authorized, converted into machine–
sensible form, verified, and not lost, duplicated, or altered.
Processing controls provide assurance that transactions are processed, as
authorized, and that none were added or omitted.
Output controls ensure that output data are accurate and received only by
authorized personnel.
In Lakeside‘s situation, specific controls would include the following:
– All programs should be purchased from reputable software firms or written by
employees with an appropriate background in software development. The
– Proper documentation should be furnished with all programs to indicate the
controls that have been established within the various functions. This
– Testing of all programs should be performed before the client relies on them.
For a time, as an example, the company may want to run parallel processing
where all functions are carried out both manually as well as through the new
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– All programs should be tested periodically to verify that no unauthorized
changes have been made by company employees or any other parties.
– The computer system should be physically protected to prevent unauthorized
– Because an online, real-time system is being designed by Klontz in Exhibit
13-1, many of the employees of Lakeside will have direct access into the
– The computer may be programmed so as to prevent access into files except
– Where possible, validity checks could be installed within the various systems
so that data must be verified independently before being processed. A
– Limit tests can be initiated so that transactions above or below specified
parameters will not be processed by the computer unless additional
– Employees entering data might be required to complete documents for
verification purposes. Obviously, a computerized system can virtually reduce
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SUGGESTED ANSWERS TO SARBANES-OXLEY QUESTION
(1) Sarbanes-Oxley established a list of proscribed services for a registered
auditing firms performing audits under the statute. The definition of these
The list of proscribed activities:
Bookkeeping and other accounting services
Financial information systems design and implementation