Designed to be used in an undergraduate or Master's auditing course, this Case asks students to evaluate work performed on the financial statement audit of a private wholesale merchandiser. Through this evaluation, students can uncover issues relating to gaining knowledge of a client and its environment, risk assessment, materiality, audit strategy, and specific audit procedures for the revenue/receivables/receipts accounting cycle. The Teaching Notes provide support both for instructors who ask students to prepare the Case in advance of class and for instructors who instead assign the Case for analysis in real-time during class, whereby the Case is read aloud paragraph-by-paragraph and issues are discussed as they are detected.
Ramm Wholesale, Inc., incorporated six years ago, is a distributor of kitchen appliances, cookware products, and consumer electronics. The president, Mary Maxall, has been working in retail sales for more than 20 years. Ramm is a private corporation that has recently enjoyed significant sales growth as a result of embarking on an extensive advertising campaign and implementing a new Internet sales system.
To support the expanded sales, working capital needs increased significantly. Ramm financed much of the additional working capital with an increase in its revolving line of credit at National Bank. Ramm must abide by a bank covenant that limits the maximum amount borrowed under the line of credit to no more than 75 percent of receivables plus 50 percent of inventory, using the balances reported in Ramm's audited year-end financial statements. Violation of this covenant results in significantly higher interest rates and gives the bank the right to demand immediate repayment of the line-of-credit balance.
Tick & Bop LLP (T&B) has been Ramm's auditor since its appointment for the December 2009 year-end. T&B has always considered Ramm to be one of the firm's “good” clients. Although the audit team leaders acknowledge that there were some challenges during the first audit year, they are quick to point out that Ramm was able to work around them. For example, when Ramm's internal controls were examined in 2011, T&B quickly determined that a lack of segregation of duties existed in many areas of the company. Based on this observation, T&B assessed most control risks at the maximum and proceeded with substantive audit procedures. When updating T&B's understanding of the client for fiscal 2012, the audit team noted that Mary had responded to the segregation-of-duties problem in the first quarter of 2012. At that time, Mary reassigned work responsibilities as part of introducing Ramm's new Internet sales system and made other changes in its computer system. Mary believes these changes have improved the control effectiveness at Ramm.
It is now March 2013. You have just been assigned responsibility for reviewing the 2012 Ramm audit file. You are taking over from the T&B senior initially assigned to the Ramm audit, who left T&B on January 10 to join a competing accounting firm. The partner in charge of the audit, Grace Goldham, has asked you to prepare a memo that describes any significant engagement issues. You have reviewed the fieldwork documentation, which led to the observations summarized in Exhibit 1. You also have reviewed the draft balance sheet and income statement in Exhibit 2, and are ready to prepare the memo.
Observations Arising from Review of Fieldwork Documentation for the Audit of Ramm's 2012 Financial Statements
1. The T&B senior documented that he had heard Mary describe several system changes when he was wrapping the 2011 audit; but he did not document those changes in detail when planning the 2012 audit, and instead concluded that a combined audit approach would be inefficient in 2012. Consequently, he planned to rely completely on substantive procedures for the 2012 audit. Fieldwork was substantially completed on February 25, 2013.
2. In 2011, T&B had set materiality at $126,000. As a result of recent sales growth, 2012 materiality was set at a higher level: $239,000.
3. T&B reviewed the adequacy of the allowance for doubtful accounts and inquired about selected balances that were over 90 days old. T&B sent out positive confirmations on 55–60 percent of the accounts receivable balances in 2012, consistent with the work done in 2011, as shown below:
When requested confirmations were not received, T&B applied alternative procedures consisting of examining cash receipts subsequent to year-end and vouching to related shipping documents.
4. Following the approach used in the 2011 audit, T&B performed tests of 2012 sales transactions to document the audit team's understanding of the flow of sales through the accounting system to the general ledger. The sales transactions tested are summarized below:
5. In the tests of sales transactions in 2012, several unusually large sales were made near year-end, including six invoices to Southwestern, Inc., totaling $370,490—all of which were dated December 30, 2012. An invoice for $644,685 to Balco on December 28, 2012, also was chosen for testing. The T&B assistant who was responsible for performing the sales transaction tests noted that the recorded sales were vouched to invoices to verify the existence of the sales.
6. The receivables section of the audit file noted that Southwestern was sent a positive accounts receivable confirmation at year-end. Ramm's records reflected a total receivable of $418,323, which included the six invoices dated December 30, 2012. Southwestern confirmed a balance of $47,833 and included a detailed listing of the open invoices that made up this balance. The audit file indicated that a second confirmation request was sent, but did not include any indication that the second confirmation was received. T&B auditors performed alternative procedures on the balance that was not covered in the confirmation from Southwestern, reporting that:
The unconfirmed invoices were sales recorded in late December and not received by the customer as of year-end and therefore were not recorded in the customer's accounts payable. T&B reviewed supporting documentation for these amounts as part of sales testing. Pass—No Further Work.
7. T&B sent a positive confirmation to Balco, and Balco confirmed the balance in a letter to T&B. The confirmation letter was scanned and included in the audit file. T&B's audit file included the following comment, which was inserted in the scanned letter:
The inventory included in this sale was purchased from a Balco subsidiary in October 2012, and was sold to Balco at year-end at a small profit and with payment terms of 90 to 120 days. T&B discussed this transaction with Mary Maxall, who stated that Balco was a good customer, which justified extending these favorable payment terms. T&B noted that Balco has a reliable past payment history on similar transactions, as corroborated by T&B's sales cutoff work in 2011. Pass—No Further Work.
8. Based on the review of 90-day-old accounts receivable, T&B auditors concluded that the allowance for doubtful accounts was understated by $115,401. The audit file stated that this amount was less than planning materiality, so T&B passed on proposing an adjustment.
CASE LEARNING OBJECTIVES AND IMPLEMENTATION GUIDANCE
This Case is designed to develop the students' skills in evaluating the sufficiency and appropriateness of audit evidence and to link audit procedures to risk assertions. More specifically, the Case aims to fulfill four learning objectives:
Encourage students to consider how recent changes in a client's business affect the audit plan for the current year;
Develop students' skills in evaluating the appropriateness and sufficiency of audit evidence;
Develop students' skills in identifying high risk assertions and related audit tests; and
Encourage students to identify deficiencies in existing audit work and propose ways to remedy those deficiencies.
The Case is best suited for undergraduate and Master's courses in auditing and assurance.
Assigning the Case
The Case context places students in an evaluation of audit evidence collected by an audit team. Given this context, we believe that this Case is best used later in a course, after students are familiar with audit planning, risk analysis (including the assessment of fraud risk and assertions pertaining to account balances in the revenue/receivables/receipts cycle), audit approaches, and audit procedures.
In summer 2012, the Case was used in a Master's-level auditing course taught by one of the authors of the Case. In fall 2012, the Case was used in an undergraduate auditing course taught by a colleague who was not involved in authoring the Case. The summer 2012 use involved a “real-time analysis” format wherein the Case was not distributed prior to class but instead was distributed, read, and discussed paragraph-by-paragraph during class. The fall 2012 use involved an “advanced preparation” format, wherein the Case was assigned for student reading in advance of class, with students' responses to assigned Case questions discussed during class. In the instructors' experiences, both the real-time and advanced preparation formats were successful. As reported later, students similarly perceived the Case to be effective when used in these formats.
The Case is effective when analyzed in real time because each paragraph contains rich information for discussion and can enable students to share initial insights at the moment they arise. This format creates a lively learning environment, and is beneficial in helping students understand the Case facts and rationale that lead to the discovery of issues. When using this real-time method of Case discussion, the instructor should focus initially on eliciting key observations from the students, guided by the paragraph-by-paragraph points provided in the Teaching Notes. Later, the instructor can assist students in summarizing the class's observations in a coherent structure, such as the categories of a typical audit planning and summary review memo, including business risks, audit risks, and account/assertion-level accounting/audit issues (for further discussion of these categories, see Earley and Phillips ).
If, instead, the Case is assigned for pre-class reading and preparation, the instructor could provide varying amounts of direction, depending on the experience, maturity, and skill of the students. When the Case was used in the undergraduate auditing course, students were given a set of seven guiding questions that directed their preparations. These questions are presented in the Teaching Notes. We also have used an earlier draft of the Case in an advanced preparation format with a Master's class, for which we required only that students “prepare the memo.” Instructors can choose the level of guidance that best fits their students' profiles by assigning the task of preparing a memo, preparing responses to all seven questions, or preparing responses to a subset of the seven questions.
In summer 2012, one of the authors used the Case in a real-time analysis with 83 Master of Accounting students. After completing the Case discussion, the students completed a questionnaire to rate the extent to which they perceived the Case had assisted them in achieving the learning objectives of the Case. To encourage candid responses, students were asked not to indicate their names on the survey questionnaire. Seventy-nine out of 83 students (95 percent) completed the questionnaire. Using a ten-point scale anchored with endpoints of 1 (“little”) and 10 (“a great deal”), students indicated the extent to which they believed the Case helped them to understand each of the four specified learning objectives. Means and standard deviations for each of these ratings are presented in the first data column in Table 1.
In Fall 2012, an instructor who is not an author of the Case used the Case with 53 undergraduate students enrolled in an introduction to auditing and assurance course. He assigned the Case reading and the seven discussion questions presented in Part III of the Teaching Notes during the last week of the semester. He then discussed the Case in class and, at the conclusion of class, administered the same questionnaire that we had administered in summer 2012. All 53 students in attendance completed the questionnaire. Means and standard deviations for each of the learning objective ratings are presented in the second data column in Table 1.
As Table 1 indicates, students in both the Master's and undergraduate courses perceived the Case beneficial in learning: (a) how recent changes in the organization affect the audit plan, (b) how to evaluate the appropriateness and sufficiency of audit evidence, (c) how to identify high risk assertions and the resulting necessary direction of audit tests, and (d) how to identify deficiencies in existing audit work and propose ways to remedy those deficiencies. All average ratings exceeded 7.5, which appears to be a typical rating given by undergraduate students for other auditing cases published in this journal (e.g., Jones 2012; Schmidt and Phillips 2012). These data suggest the Case was perceived effective when used by either an author in a real-time format or a non-author in an advanced preparation format.
We also asked both groups of students to indicate the extent to which they were interested in the Case, using a ten-point scale anchored with endpoints of 1 (“boring”) and 10 (“interesting”). The ratings given by the Master's students (mean = 8.1, standard deviation = 1.3) and the undergraduate students (mean = 7.6, standard deviation = 1.6) suggest that the Case engaged both audiences. The final data we collected were open-ended qualitative comments about students' experiences with the Case. Specifically, we asked students whether anything in the Case was unclear or unrealistic, whether they would have wanted additional information to aid in understanding the Case, whether they recommended the Case for use at other universities, and whether they had other comments about the Case. We used the few comments about unclear aspects of the Case to refine and clarify it, yielding the version presented in these materials. Only one undergraduate student recommended that the Case not be used at other universities (but that student did not provide a reason). The vast majority of student comments expressed positive reactions to the Case; a representative sample of responses is listed below (with labels to distinguish Master's and Undergraduate students):
M1: Really made me think about users, materiality, and assertions that were high risk, and procedures necessary to mitigate.
M2: It highlighted why you shouldn't just copy the prior year's audit file, which is a common problem in practice.
M3: I thought this Case was great for learning how to tie assertions into audit procedures and for evaluating an audit plan and procedures.
M4: Illustrates how procedures need to be modified based on change in client business.
M5: It helped to highlight important assertions and deficient work in an interesting and informative way.
U1: I liked how it got you thinking a lot about assertions and what you actually need to obtain appropriate audit evidence.
U2: It covers a broad spectrum of audit issues. It ties together a lot of topics.
U3: Questions guide you through what you should look for.
U4: Interesting yet efficient.
U5: It was easy to read, easy to understand, interesting, and tied into all that we have learned throughout this audit class.
The undergraduate course instructor indicated that the Case and Teaching Notes were easy to use and had elicited great classroom discussion. He advised that we place the guiding discussion questions in the Teaching Notes rather than the implementation guidance because some of the questions were leading and, if accessed by students, would interfere with the Case being used in a real-time format.
The Teaching Notes present, in Part I, a paragraph-by-paragraph discussion of the Case materials. Part II of the Teaching Notes presents a summary of key points, organized by typical sections of an audit planning and summary review memo. Part III of the Teaching Notes presents guiding discussion questions and responses for each of the discussion questions.
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The authors thank Regan Schmidt and two anonymous reviewers for comments on a prior version of the Case.