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:
Correct Answer:
H&L should adopt a risk-based audit approach for RRI, focusing on areas with the highest risk of material misstatement due to weak internal controls and reliance on manual processes. Specifically, H&L should emphasize substantive procedures over control testing, given the lack of formalized internal controls and segregation of duties.
Explanation:
Based on the information gathered from the meeting with Sam Real, H&L should use a risk-based audit approach tailored to RRI’s specific operations and control environment. The company operates with limited staff, with Sam handling project execution and Lucky managing administrative tasks, including bookkeeping. Although Lucky demonstrates diligence and performs reconciliations, her limited technical knowledge in financial reporting, combined with Sam’s disregard for documentation, significantly increases the risk of errors or misstatements.
RRI’s reliance on manual processes—such as using Excel spreadsheets to track costs and billings—presents additional risks, including data input errors, lack of version control, and absence of audit trails. The audit should prioritize substantive testing, especially of project cost allocations, contractor reimbursements, and credit card expenditures. Since there is limited segregation of duties and informal oversight of receipts, the audit must include detailed vouching of expenses, review of supporting documentation, and bank and credit card reconciliations to verify completeness and accuracy.
Particular attention should be given to reimbursements to contractors, especially those lacking receipts or based on estimates, as these are highly susceptible to fraud or misstatement. H&L should also assess whether estimated reimbursements are material and how consistently they are applied.
Due to the small size of the business and the reliance on personal judgment, the auditor should maintain professional skepticism, particularly regarding transactions initiated by Sam or involving estimates. An emphasis on analytical procedures, including comparisons across projects and time periods, will help detect anomalies.
Finally, as RRI is a small business with evolving processes, H&L should communicate control weaknesses to management and provide recommendations for improved documentation, receipt tracking, and segregation of duties.
