Question 1

Golden Years Inc. owns and operates retirement properties with a total of 10,000 rental
units.

Tenants pay rent monthly by giving a cheque to the property manager.

The manager deposits the cheques at the bank and sends the deposit information and
tenant listing to Golden Years’ head office, where the accounting manager enters the
information into the sales journal and general ledger.

The Accounting Manager reconciles the bank statements monthly.

You are in charge of auditing Golden Years’ revenues and receivables for its 20X3 year-end.

Golden Years’ draft financial statements report rental revenues of $102.6 million, tenant
receivables of $400,000, and net income of $5.9 million.

Required:
a) Indicate, with reasons, whether you would use a substantive or combined approach
to audit Golden Years’ revenues.

b) Develop an audit program consisting of five (5) audit procedures that would provide
sufficient and appropriate audit evidence regarding the rental revenues reported in
the company’s 20X3 financial statements are not materially misstated.

Suggested Solution:
a) It appears that there is easily obtainable substantive evidence regarding the
revenues and receivables, so a substantive audit approach could easily be
supported.

However, students might also consider a combined audit approach by identifying

specific controls to test and rely upon and targeted substantive procedures to verity
relevant ledger account balances.

b) An audit program should be developed listing audit procedures that will provide
sufficient & appropriate evidence. The procedures selected should be consistent
with the substantive audit approach selected in the case and cover all the assertions.
Relevant audit procedures:

Nature of audit procedure Timing

Enquiry regarding rental terms and Planning
conditions, property ownership,
etc.
Enquiry regarding property
ownership, etc.
Inspect properties, ownership/title y/e sample largest,
documents to establish cycle
Golden Years’ rights to rental through
Receipts smaller
Review tenant leases, terms y/e sample

Vouch revenue reports, cash y/e sample

receipts to bank records and bank
reconciliation

Cut-off tests of last rent payments y/e all

received/paid, first payments in
new year

Analytical procedures relating to y/e

#units, rent/unit, vacancy rates

Analysis of uncollectible accounts

(trends in relation to revenues,
economic conditions), inspect
records of unpaid rent, verify
provision is adequate

Assess vacancy information is y/e or interim

reliable by enquiry, inspection of
records, observation

Tenant confirmations, if level of y/e Sample

Risk of material misstatement
warrants
Question 2

For the following independent audit findings provide an adjusting entry to correct the
misstatement. Assume a December 31 year-end.

Required:
a. Accounts payable cheques for various suppliers totalling $4,000 were deliberately not
mailed out prior to fiscal year-end to avoid a bank overdraft.
b. Sales of $79,000 were recorded on goods that were shipped after year-end and included
in the year-end inventory count. The cost of these goods is $53,000.
c. A lawyer’s $8,000 invoice for services rendered in November was not paid or accrued
by fiscal year-end.
d. The allowance for bad debts has a credit balance of $25,000. The accounts receivable
balance is $150,000, and a reasonable estimate indicates that all but $10,000 will be
collected.
e. The company recognized $250,000 of revenue on a $750,000 contract for bridge repairs
to be performed early in the following fiscal year.

Suggested Solution:
a) There is $4,000 of cash still on hand so cash is understated, and these supplier invoices
have not been paid, so accounts payable is understated. There is no income effect. This
could be adjusted as follows:
Dr Cash 4,000
Cr A/P 4,000

b) The sales and related cost of sales are overstated. Income is also overstated by $26,000.
The error would be adjusted as follows:
Dr Sales 79,000
Cr A/R 79,000
Dr Inventory 53,000
Cr Cost of sales 53,000

c) Legal expenses and accrued liabilities are both understated.

The error would be adjusted as follows:
Dr Legal expenses 8,000
Cr Accrued liabilities 8,000

d)
Assessing whether the provision is excessive depends on how reliably expected bad debts
can be estimated, and other factors. If adjusted, the entry would be:
Dr Allowance for estimated bad debts 15,000
Cr Bad debt expense 15,000
e) There is no basis for recognizing a percentage of revenue at this point in the contract -
revenue is overstated by $250,000. Assuming the original revenue recognition entry was to
increase Accounts receivable and Construction revenues, the adjusting entry would be as
follows:
Dr Construction revenues 250,000
Cr Accounts receivable 250,000