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 – Task #4
Given the nature and structure of RRI’s operations, H&L should adopt a risk-based audit approach that emphasizes substantive procedures, particularly on areas with higher inherent and control risks, such as project cost allocation, contractor payments, and revenue recognition.
Key Audit Focus Areas:
- Revenue Recognition
Given that RRI works on one major project at a time, the auditor should assess how revenues are recognized—especially if using the percentage of completion method. H&L should verify that revenue recognition is consistent and supported by appropriate documentation such as project milestones and billing schedules. - Contractor Payments & Expense Reimbursements
A significant area of risk arises from contractor reimbursements due to delayed or missing receipts and use of estimates. Substantive testing should include:- Reviewing supporting documents for a sample of contractor payments.
- Confirming a sample of contractors to verify hours worked and payments made.
- Evaluating the reasonableness and consistency of estimated reimbursements.
- Cost Tracking & Job Allocations
RRI relies on Excel spreadsheets maintained by Sam, which introduces risks of data integrity and errors. The auditor should:- Perform analytical procedures to identify unusual trends or inconsistencies.
- Reconcile Excel-based job costing records to the general ledger and supporting invoices.
- Segregation of Duties and Internal Controls
The limited number of personnel and reliance on one individual (Lucky) for multiple roles increase control risk. H&L should:- Assess whether compensating controls (e.g., weekly reconciliations) are effectively mitigating risks.
- Consider increasing the extent of substantive testing due to weak segregation of duties.
- Use of Professional Skepticism
Sam’s lack of attention to detail necessitates a cautious approach. Auditors should maintain professional skepticism and corroborate financial data with external evidence where possible.
