SAMPLE SCHNEIDER WRITING – Pony

Written under a time constraint based on ROP.

ROP – stands for READ, OUTLINE AND PLAN – an important skill when preparing a case
simulation

From: CPA
To: Partner
Re: Pony Audit

General/overview

We noted certain factors that indicate that fraudulent activity has occurred at the client. Factors are:
• Pony has one computer but it suppliers indicate they sold/delivered two;
• Customers have indicated that they pay $40 per hour when the charge should be $30;
• Horses appear to be ridden more than what is recorded in records
If there is a fraud it may be limited to employee (Devanney). If client/shareholders (lack integrity)
are involved in fraud we should consider resigning from audit

Planning memo

Risk
OFSL risk – We have identified:
• Possible fraud (above) increases risk of misstatement;
• Control environment is weak – owners play minimal role in oversight
Conclude: OFSL risk is high
RMM Other
• 1st time audit – lack of experience with client; have to deal with opening balances;
• repeat losses – increases risk of going concern issue
• internal controls are weak (see IC memo for details) – control risk is high
• a number of accounting issues – indicates lack of client knowledge in accounting and
increases risk of material misstatement
Conclude: RMM is high. Overall this is a high risk audit.

Approach
• Given that RMM is high; internal controls are weak (CR high) – our approach will be substantive
• We will have to do audit work on opening balances [CAS 510] – in particular inventory. We
may be able to “rollback” amounts, but unlikely given consists of food & supplies. If we are
unable to – have a scope issue and may have to qualify audit report (except for) relating to
opening balances
• Per CAS 240 – as we have identified factors that indicate increased risk of fraud, we will have
to increase our testing in those significant areas/accounts

Materiality per CAS 320

Primary users → Bank – Pony has significant debt – bank interested in assets/ earnings
Shareholders → f/s – not involved in management – use f/s to assess earnings; stewardship

Given users are sensitive to information and possibility of fraud – materiality should be set at a low
amount. Given that Pony has losses materiality should be set using a benchmark – 1/2% of assets
or 1/2% of revenues

Performance materiality – given the high risk and possible fraud we would set performance
materiality low at 60% of materiality

Procedures – see accounting discussion

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Address Accounting Issues and audit procedures for significant areas

Issue: Treatment of horses – inventory or PPE

Analysis: Pony shows $273K of horses as inventory (current assets). s. 3031 defines inventories
as goods held for sale in ordinary course of business (or a part of production process). s. 3061
defines PP&E as tangible assets held for use in the production/supply of services. Pony primary
business is providing horses for riding. Although like any capital asset a horse may be sold, the
horses it had are used by riders who pay a fee. The horses are not just bred and held for sale.
Recommend/conclude: Current client treatment is in error/wrong. Given that the horses are for
riding rental they should be classified as PPE. Given that they have a finite life – the cost of the
horses should be amortized over their beneficial life. They should also be tested for impairment
and written down if their carrying value is not recoverable (3063)

Procedure
Risk/assertion – Horses may be incorrectly classified as inventory. Presentation/classification –
Enquire of management the primary use of the horses (riding or for sale); review number of horses
sold in period;
Risk/assertion – Horses may not exist. Existence → we should inspect/ physically examine that the
horses recorded at y/e exist;
Risk/assertion – Horses values may be overstated. Valuation → we need to examine supporting
documentation as to cost. We will need to assess the reasonableness of any accounting estimate
used for depreciation. We may be required to use an expert (e.g. vet) to assist in determining useful
life and if any impairment.

Issue: Revenue recognition – initial $1000 fee

Analysis: Pony currently records the full $1000 for the two year boarding contract when received.
s. 3400 requires service revenue to be recorded when collectible, measurable and performance
has occurred. The primary issue here is performance as the amount is already collected. HBK
3400.07 – performance when service is rendered. Pony needs to provide food and care for 2 years
– and so this amount is earned over time. Further supported by the fact that the monthly fee goes
up from $350 to $400 after the 2 years.
Recommend/conclude: Current treatment by client is an error. Revenue needs to be recognized
over two years. Unearned revenue needs to be set up as a liability.

Procedure
Risk/assertion – Revenue is recorded in wrong period. Validity/Occurrence/accuracy → Obtain and
review customer contracts. Test (recalculate) amount deferred ($1000/24 months x remainder);
→ use analysis

Procedure for revenue (generally)

Risk/asserton – In light of fraud, revenue may not be correctly recorded. Completeness/accuracy

→ select sample of rides from calendar and trace to GL and bank deposit
Use analysis (ART) - #of horses x #of day rental x amount – and compare to recorded

Issue: Revenue – gross or net (presentation)

Analysis: Pony matches the boarded horses with possible riders for which they receive $75.
Currently they record the $1230 as revenue and the $1155 as an expense. s. 3400.23 requires an
entity to show as revenue that amount that relates to their services. As Pony essentially acts as
an agent and does not have responsibility for the order or does not take on the credit risk (.24) – it
really only has revenue of $75.

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Recommend/conclude: Current client treatment is in error/wrong. Should only present the $75

Procedure

Risk/assertion – Pony may be incorrectly showing excess revenue. Presentation.

- Review contracts to determine fee amount of $75

Issue: Non-monetary transaction – Shoe horses for boarding

Analysis: s. 3831 requires NMT to be recorded and measured at FV of asset given up or received
– whatever is more determinable. The exceptions set out in that section do not apply (e.g.
transaction has commercial substance; dissimilar exchange). In this case the $400 per month
amount is readily determinable.
Recommend/conclude: Record 12 x 400 = $4800 as revenue and expense.

Procedure
Confirm agreement with the local groomer; confirm $400 per month amount.

Issue: Treatment of related party transaction

Analysis: Sarah, Megan and husband/brother control both Animal Galaxy and Pony and therefore
are related parties (s.3840). Sale of riding gear is a RPT and is not a financial instrument.
Applying s. 3840 → the transaction is not in normal course of business as they do not normally sell
riding gear; the change of ownership was substantive as ownership changed; the amount of the
exchange does not appear to be supported by independent evidence and so the transaction should
be recorded at the carrying amount ($14000).
Recommend/conclude: See above. (if $11K is verifiable as value – use exchange amount)

Procedure
Vouch receipt of $11,000 and original cost amount of $14,000

Issue: $10K – to Saddle Stables – loan or investment

Analysis/Recommendation: In substance, the $10,000 is a loan as the amount must be repaid.
Conversion is a contingent type of event. The loan is a financial instrument and s. 3856 requires it
be recorded at fair value. As it is over 5 years and does not bear interest, it would need to be
discounted to determine fair value.

Procedure
Existence → confirm loan with SStables;
Valuation → determine that payment has been made and amount collectible or write down

Improvements Internal Control

W – Lack of segregation of duties as Mrs. Devanney does record keeping and custody of the assets
(e.g. cash)
W – Pony encourages cash payments
I – Mrs. Devanney can steal cash and fail to record it (so not found/fraud)
R – Someone other (independent) than Mrs. Devanney should have custody of the funds (e.g. the
receptionist or Megan ) and deposit at bank. Should encourage customers to only pay by cheque
or credit card, as cash is easily misappropriated.

W – Lack of expense approval and too many cheque signers

I – Currently no advance approval of expenditures (e.g. computer) and cheques are signed without
adequate back up and by any of the shareholders. Implication is that there can be duplicate
payments or payments for items not ordered/required. Also as all three shareholders can sign can
lead to confusion or misappropriation by a shareholder

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R – All expenses should be approved in advance. Cheques should only be signed if supported by
original invoice and purchase order. Same two shareholders should be required to sign all
cheques.

W – Bank recs are not reviewed approved

I – Lack of monitoring (IC). Bank rec can identify fraud/error and should be reviewed by
irregularities.
R – Shareholder (same one) should review and approve each monthly bank reconciliation.

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