Task #4 As part of the audit planning, you recently met with Sam Real and learned the following pertinent information: RRI tends to work on one large renovation project at a time. Sam Real acts as the foreman and employs independent contractors as needed to execute the projects. He employs his wife, Lucky, as his office administrator. Lucky has a diploma in bookkeeping. While she works hard to manage the day-to-day administrative responsibilities for RRI on her own, she does not have knowledge about the more technical aspects of financial reporting. Sam is known as a creative thinker, and he prides himself on being able to “focus on the big picture of a project without getting lost in all of the mundane and annoying details and paperwork.” This obliviousness to details is a source of frustration for Lucky, who must constantly remind him to keep track of his receipts and submit the working hours for his contractors on a timely basis. Sam uses Microsoft Excel to track costs and billings for each project. Lucky insists that he submit his Excel file to her each Friday, along with any supporting documentation. Lucky uses the Excel file to make entries in the accounting software used by RRI. She also reconciles the bank and company credit card on a weekly basis, which helps her identify whether Sam has failed to submit receipts to her. Sam and Lucky are the only individuals who have access to a corporate credit card for RRI. If an independent contractor makes a purchase related to an RRI job, they submit the receipt to Lucky for reimbursement. Lucky ensures that all receipts are allocated to the appropriate job. The challenges with this process are (1) there is sometimes a prolonged delay before contractors submit their receipts and (2) sometimes the contractors lose the receipts and Lucky reimburses them an estimated amount. Discuss the audit approach that H&L should employ for this audit.
The correct answer and explanation is:
Audit Approach for RRI
H&L should adopt a risk-based audit approach to assess the financial reporting and internal controls of RRI. Given the nature of RRI’s operations and its reliance on a small team, the audit should focus on areas with a higher risk of misstatement or fraud. The following steps should be included in the audit approach:
1. Understanding Internal Controls & Assessing Risk
- Evaluate the segregation of duties within RRI. Since Lucky handles most of the financial administration alone, there is a risk of errors or misstatements going undetected.
- Identify the key risks associated with using Excel for tracking project costs and billings, as manual data entry increases the likelihood of errors.
- Assess the adequacy of Lucky’s reconciliations and determine if they sufficiently mitigate risks associated with missing receipts or incorrect expense allocation.
2. Substantive Procedures
- Review of Supporting Documentation: Given Sam’s lack of attention to details and the potential for lost receipts, auditors should obtain and review available receipts and compare them with recorded expenses.
- Contractor Payment Verification: Cross-check contractor payments with their submitted hours and receipts. Where estimated reimbursements were made due to lost receipts, evaluate if these estimates are reasonable and consistent with past transactions.
- Bank Reconciliation Review: Verify the weekly reconciliations conducted by Lucky, ensuring that all transactions are properly recorded and classified.
3. Analytical Procedures
- Compare project expenses across different periods to identify anomalies.
- Analyze trends in contractor payments and project billings to detect inconsistencies.
4. Fraud and Error Assessment
- Given the lack of oversight on Sam’s expenditures, auditors should assess the risk of unauthorized transactions.
- Evaluate whether expenses are appropriately allocated to each project and if personal expenditures are charged to RRI.
By focusing on these key areas, H&L can ensure a thorough audit of RRI’s financial records.