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A manufacturing company is thinking of launching a new product. The company expects to sell $950,000 of the new product in the first year and $1,500,000 each year thereafter. Direct costs including labor and materials will be 45% of sales. Indirect incr

1. Why is the monthly reconciliation of bank accounts by an independent person an important internal control over cash balances? Which individuals will generally not be considered independent for this responsibility? Name some compensating controls if segregation of duties around bank reconciliations is not possible. 2. Which analytical procedures are most important in verifying notes payable? Which types of misstatements can the auditor uncover by the use of these tests? At what type of client would notes payable be a risky balance? 3. Here is a review question that covers the entire course. We’ve talked about it, but sometimes I like to pause and think about what these terms actually mean in the proper context. What is meant by the term level of assurance? How does the level of assurance differ for an audit of historical financial statements, a review, and a compilation? Describe how you measure how much assurance is needed for each of these. 4. During the audit of the Merrill Manufacturing Company, Ralph Pyson, CPA, has become aware of four lawsuits against the client through discussions with the client, reading corporate minutes, and reviewing correspondence files. How should Pyson determine the materiality of the lawsuits and the proper disclosure in the financial statements? Does this create any further audit tests? 5. Bank recs are so important to every organization. This is why segregation of duties is critical. For this reason, many organizations have opted to use third parties to perform this function. If affordable, this is a great option as it serves as a control and alleviates the need for segregation of duties. Many companies prefer to keep this function in house, but this is one area that can be easily outsourced. Any experience with outsourcing this function? Do you agree this is a good control? 6. I have been involved in a few public bond and private bond placement issues when I worked for a private college. We had pretty favorable covenants on both. In both cases we were adding dorm space and for each the building was put up as collateral and a pledge on dorm revenues specific to those buildings was required. In addition, we had to keep a debt coverage ratio of 1.1 for each. This means they have to take in 1.1x more in dorm revenue than they were paying out on the loan. This isn’t too hard to do when you increase dorm charges each year. In terms of auditing, testing the covenants would be a big part of the audit procedures in this situation. This would be known as a compliance audit. In the event the covenants were not met, it would create a big problem with the Bank. Has anyone else been through a debt issuance? 7. If a company wanted to misstate notes payable, why would they do so? Is notes payable an item that is typically overstated or understated? In my opinion, it’s not the intentional misstatements, but rather the incidental transactions that create the need to review this item in more detail. Interest expense should be a standard entry based on an amortization table. The principal should be reduced with each interest payment made. However, in my days auditing this was not always the case. On more than one occasion I noticed that the amortization schedule was off, so interest expense and the liability were both misstated. Is this likely to be material? There are 7 questions and each need 100+ words.

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