Scenario for Week 1 The audit plan (all assignments) will be based on the following scenario. You are a senior auditor assigned to the team performing an audit for Restorative Pharmaceutical Corporation (RPC), a 10-year-old publicly held corporation listed on the New York Stock Exchange (NYSE), which specializes in anti-aging products such as vitamins, protein-infused beverages, and dietary supplements. RPC’s corporate office is located in San Diego, CA. Its annual sales are approximately $100 million. Restorative’s products have been endorsed by noted doctors and talk show hosts on daytime network television. Restorative also develops and markets products through television commercials, drawing clients to their Web site to accomplish direct sales as well as via major drugstore chains. None of Restorative’s products are FDA-approved, as these are part of a class of products which do not require approval to be marketed in the United States. However, the products are subject to scrutiny when claims regarding various outcomes are assured for clients; general product safety is critical. Products are manufactured primarily in Tijuana, Mexico and are imported for distribution from the main warehouse in National City, CA which is between the corporate office and the manufacturing plant. Your team lead and senior audit manager and firm partner, Scott Payne, CPA, has recruited you to write the engagement letter for the year-end audit of Restorative Pharmaceutical. In addition, he believes it is time for you to begin writing an audit plan under his supervision. Week 1 Deliverable The engagement letter is one of the first official deliverables in the audit-planning process. It clarifies the responsibilities and expectations of each party (i.e., the client and the CPA firm) and this is an important element of managing engagement risk, especially the risk related to litigation. The engagement letter includes the acknowledgment of expectations for both the client and the CPA firm conducting the engagement. Restorative Pharmaceutical Corporation (RPC), a 10-year-old publicly held corporation listed on the NYSE which specializes in anti-aging products such as vitamins, protein infused beverages, and dietary supplements. RPC’s corporate office is located in San Diego, CA. Develop an engagement letter on behalf of the audit partner, Scott Payne, CPA, for the annual year-end audit of RPC. Assume that the project fee for the audit will be $50,000. Be sure to mention any relevant regulation requirements in your letter, and address the letter to appropriate RPC personnel. ANSWER: Scott Payne, CPA Certified Public Accountants September 8, 2016 Restorative Pharmaceutical Corporation San Diego, CA Dear Sirs, AUDIT ENGAGEMENT LETTER We are pleased to approve our understanding of the services we are to provide for Restorative Pharmaceutical Corporation “RPC” “The Company” for the year ended December 31, 2015 with regards to annual financial reporting requirements in conformity with generally accepted auditing standards. We will audit the Company's balance sheet as of 2015, and the related statements of income, and the cash flow statement for the year then ended 2015, with the aim of expressing an opinion on them. The financial statements are the sole responsibility of the Company’s management and our responsibility is to express an opinion on the financial statements based on our audit. The purpose of this letter is to establish the basis on which we are to act as auditors of RPC and the corresponding areas of responsibility of the company and of ourselves. Responsibilities of Management of The Company The management of RPC has the responsibility with regards to: a) Preparation and reasonable presentation of the financial statements in conformity with accounting principles generally accepted in the United States of America and these statements should be free of material misstatements whether due to error or fraud. b) The strategy, implementation, and maintenance of internal control relevant to the preparation and reasonable presentation of the financial statements. c) Ensuring that all transactions relating the year of audit have been duly documented in the books of accounts. d) The company has the responsibility to provide to us the necessary information with regards to provision of financial statements and books of accounts to enable us to carry out analysis of accounts. e) Offer to us unlimited accesses to employees of the company whom we determine are necessary to provide us with audit evidence. f) Providing us with written representations required to be obtained under professional standards and written representations that we deem fit for the audit. An audit does not relieve the management or those charged with administration of these responsibilities. Auditor’s responsibility with regards to the audit We have the statutory authority to report as to whether your financial statement reflects a true and fair view of the company’s affair. In order to arrive at our opinion, we will seek to determine whether: a) The company has maintained accurate accounting records and they are in agreement with the books of accounts. b) Whether we have obtained all the information, disclosures and explanations, which we deem necessary for the purpose of our audit. c) All transactions have been duly recorded in the books of accounts. d) It’s our responsibility to arrange and conduct the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether caused by error or fraud. e) We have a certified duty to report if the accounts do not conform in any material respect with appropriate accounting standards, unless in our opinion the noncompliance is supportable in the circumstances. Scope of the audit a) Our audit will be conducted in agreement with the generally accepted auditing standards (GAAS) and we will seek an understanding of the accounting systems and internal control systems in order to weigh their adequacy as a basis for the preparation of the accounts and to establish whether proper books of accounts have been maintained by the Company and we expect to obtain such complimentary evidence so that we can be able to draw reasonable conclusion from them. b) Due to the large number of transactions of your company, the audit will include inspecting, on a test basis, proof supporting the amounts and disclosures in the financial statements. c) Our measures will include tests of documented evidence collaborating the transactions recorded in the accounts. At the conclusion of our audit, we will request certain written statements and disclosures from you about the financial statements and matters related thereto. d) While the audit is considered to provide reasonable guarantee by detecting errors and material misstatements result from from the financial statements, it cannot be relied upon to disclose all material errors and fraud. Nevertheless, we will disclose to you of any material errors or fraud that come to our attention. e) Due to the test nature of the audit and other essential restrictions connected with an audit together with inherent restrictions of internal control system, there is an inherent risk that some material misstatements may remain undetected. Therefore we will only provide a reasonable assurance level as opposed to an absolute assurance level. FEES Our fees are computed on the basis of the time devoted to the audit of your company by our staff and also based on the levels of skill and accountability involved. For the purposes of this audit, the audit fee will be a fixed fee of $50,000. AGREEMENT OF TERMS Once you have agreed, to the terms and conditions of this letter, it will be implied that from one audit meeting to another, until it is replaced arising from material changes in audit scope or other circumstances, the letter will remain binding. We shall be pleased if you could confirm in affirmative by writing to us that you agreement to these terms by signing and returning the acknowledgement copy of this letter, or otherwise, let us know if they are not in agreement with your understanding of our terms of engagement. We appreciate the opportunity to serve you. Yours truly, Scott Payne, CPA We agree to all the terms of this letter. Signed.................................................................. Date.............. For and on behalf of Restorative Pharmaceutical Corporation REFERENCES Hayes, R., Wallage, P., & Gortemaker, H. (2014). Principles of auditing: an introduction to international standards on auditing. Pearson Higher Ed. Messier Jr, W. (2016). Auditing & assurance services: A systematic approach. McGraw-Hill Higher Education. Millichamp, A. H. (2002). Auditing. Cengage Learning EMEA. Whittington, R., & Pany, K. (2001). Principles of auditing and other assurance services. Irwin/McGraw-Hill. Week 2 Scenario: You are the senior auditor assigned to the team performing an audit for Restorative Pharmaceutical Corporation (RPC), a 10-year-old publicly held corporation listed on the New York Stock Exchange (NYSE) which specializes in anti-aging products such as vitamins protein infused beverages and dietary supplements. RPC’s corporate office is located in San Diego, CA. The audit firm’s lead and senior audit manager and firm partner, Scott Payne, CPA, has requested that you develop two audit/internal control procedures which address the following issues which emerged during the past three reviews of RPC: 1. 2. The company’s newest product, an acai and mango blend smoothie, is under scrutiny by the FDA because claims have been initiated by consumers indicating that the product does not “improve memory by 50% and lower cholesterol count by 50% in those over 50” as RPC’s advertisements had claimed. A class action lawsuit is pending for $2 million. RPC’s attorneys indicate that there may be some merit to the claims, although the product is generally safe. No entry or disclosure was provided in the year-end financial statements. The company’s supply chain is subject to some risk due to the Mexican infrastructure. Also, certain inventory shipments did not arrive in a timely manner over the border, and this resulted in lost sales of approximately $5 million over the course of a year Answer: RPC has a pending claim, which is a lawsuit worth a contingency of $2 million. The audit matter in question here is auditing contingencies i.e. legal suit and claims. Since in this case the actual or potential litigation, claims, and assessments have been identified during the audit, although the management of RPC has not disclosed the matter, the auditor should work to obtain the audit evidence pertinent to the following: a) The period in which the underlying causes for legal action occurred. b) The likelihood or probability of an unfavorable outcome as such outcome will have material consequences to the financial reports. c) The amount or range of any potential loss which in this case have been determined at $2 million Since no disclosure has been made as of that date from the management a description and evaluation of the lawsuit by FDA which is in existence as of the date of the financial statements, the auditor need to seek written representations from the management and the legal counsel. Since the audit procedures did earlier have explicitly indicated that there is an actual claim causing a risk of material misstatement to exist, the auditor should from now seek direct contact with RPC’s external legal counsel. The auditor should do so through a letter of inquiry prepared by management and sent by the auditor requesting the RPC’s external legal counsel to communicate directly with the auditor. In addition to the direct communications with the RPC's external legal counsel, the auditor should also seek direct communication with the RPC’s in-house legal counsel if they exist. However, audit evidence obtained from in-house legal counsel should not in any way substitute that obtained from the external counsel. In case of management refusal to permit the auditors to have direct communication with the legal counsel, this will give rise to limitation of scope to the auditor and in this case the auditor may issue a qualified opinion or a disclaimer of opinion. The auditor should then request the RPC’s legal counsel to inform the auditor in writing of the pending lawsuit and an assessment of the outcome of the lawsuit as well as an estimate of the contingency value or costs involved should the lawsuit have an unfavorable outcome. Where RPC may have changed its legal counsel or in the event that the legal counsel has resigned, the auditor need to inquire from the management about the reasons for any changes in legal counsel and such should constitute management representation. In this case, the auditor needs to confirm with certainty about the following to mitigate against the risk of frauds and misreporting: a) All recorded transactions have occurred. b) All of the transactions relating to that period are recorded. c) The transactions have been recorded accurately. d) The transactions have been recorded in the correct accounting period. e) The transactions have been recorded in the proper accounts. On confirming that all these are in order with regards to the sales, the auditor need to perform substantive and analytical procedures to confirm the sales figures as well as stock control procedures of RPC to ascertain that the goods were actually ordered by doing tests of control over the merchandise order system while ensuring proper segregation of duties. The auditor needs to confirm the purchasing documents including the invoices, order documents, shipping documents etc. Where the goods have been subsequently received, the auditor should ascertain the physical inventory, which should be reported in the closing balances. In the case where the inventory was received after the reporting period, the auditor should perform audit procedures for subsequent events and ensure that the loss in sales can be accounted for through the inventory in stock. The auditor needs to perform a supply chain audit to assess the supply chain organization, processes, and systems and ensure that they are not prone to control risk by the personnel in charge. If the auditor is able to associate the loss in sales with the delays in the supply chain and audit evidence supports the assertions of the management, then the auditor would be in a position to make an unqualified opinion on the audit report as well as point on the weak links in the supply chain so that the management can work on them in the next period. REFERENCES Arens, A. A., Elder, R. J., & Beasley, M. S. (2007). Auditing and assurance services: An integrated approach. Prentice Hall. Louwers, T. J., Ramsay, R. J., Sinason, D. H., Strawser, J. R., & Thibodeau, J. C. (2013). Auditing and assurance services. New York, NY: McGraw-Hill/Irwin. Whittington, R., & Pany, K. (2001). Principles of auditing and other assurance services. Irwin/McGraw-Hill. Week 3 Scenario: You are the senior auditor assigned to the team performing an audit for Restorative Pharmaceutical Corporation (RPC), a 10-year-old publicly held corporation listed on the New York Stock Exchange which specializes in anti-aging products such as vitamins protein infused beverages, and dietary supplements. RPC’s corporate office is located in San Diego, CA. The audit firm’s lead and senior audit manager and firm partner, Scott Payne, CPA, has requested that you develop two audit/internal control procedures which address the following issues which emerged during the past three reviews of RPC: 1. 2. The company has an equal balance of equity and debt which compose its capital structure. It is subject to a number of debt covenants, including its current ratio, which should be maintained above 1.5 per the debt covenant. The year-end current ratio attained is 1.45. There is no opportunity to refinance short term debt and reclassify liabilities to ameliorate the ratio. A number of sample products are provided to fitness centers, health fairs, marathons, and charitable walking events. A significant stock sample pull amounting to $200,000 for the New York marathon was not recorded as an inventory reduction for this promotional event, and was discovered during the physical inventory at year end. Answer Week 3: Internal Control Procedure Restorative Pharmaceutical Corporation Policies and procedures that are put in place to see to it that the Company runs in an efficient and effective manner are referred to as internal controls. The following is a report that details the internal control procedures that are aimed at addressing the issues that emerged at the Restorative Pharmaceutical Corporative Company during the audit that was conducted. The Restorative Pharmaceutical Corporative Company has an equal balance of equity and debt, which make up its capital structure. Restorative Pharmaceutical Corporative Company subject to some debt covenants, including the ratio that the company holds, which should be upheld above 1.5 per the debt agreement. The current year-end ratio attained by the Restorative Pharmaceutical Corporative Company 1.45. There is no opportunity to refinance short-term debt and reclassify liabilities to ameliorate the ratio for the Restorative Pharmaceutical Corporative Company. The Restorative Pharmaceutical Corporative Company provides some sample products to fitness centers, health fairs, marathons, and charitable walking events. A significant stock sample pulls adding up to the Restorative Pharmaceutical Corporative Company did not document $200,000 for the New York marathon as an inventory discount for this advertising event. The Restorative Pharmaceutical Corporative Company discovered the amount during the physical inventory at year-end. Due to the above findings, the senior auditor found it fit to propose the following two audit procedures that would go a long way in addressing the issues that emerged due to the auditing that was carried out at the Company: Physical Audits and Approval authority (Sathe, Bhalkar, Bhadre, & Mosamkar, 2015). According to the report, The Restorative Pharmaceutical Corporative Company has an equal balance of equity and debt, which make up its capital structure (Mussoi Ribeiro, Silva do Carmo, Lopes Fàvero, & Nelson Carvalho, 2016). The report goes on to show that Restorative Pharmaceutical Corporative Company subject to some debt covenants, including the ratio that it holds now, which should be kept above 1.5 per the debt covenant (Mussoi Ribeiro, Silva do Carmo, Lopes Fàvero, & Nelson Carvalho, 2016). Since the current year-end ratio attained by the Restorative Pharmaceutical Corporative Company 1.45 there is a need to step up the approval authority to safeguard the power of confidentiality within the operations of the Corporation (Sathe, Bhalkar, Bhadre, & Mosamkar, 2015). Since there is no opportunity to refinance shortterm debt and reclassify liabilities to ameliorate the ratio for the Restorative Pharmaceutical Corporative Company, it will do the Corporation some good if it will safeguard the assets that it has against the liabilities that it has (Sathe, Bhalkar, Bhadre, & Mosamkar, 2015). The Corporation should then wait for the opportune time for it to regain its wealth and bargaining power. Since some sample products are provided to fitness centers, health fairs, marathons, and charitable walking events by the Restorative Pharmaceutical Corporative Company and were not accounted for it is important that physical audits are conducted to track down the last units of expenditure that are expended by the Corporation (Mussoi Ribeiro, Silva do Carmo, Lopes Fàvero, & Nelson Carvalho, 2016). There are numerous computer errors that can escape the human agent and hence the use of the physical auditing will go a long way in tracking down the expense (Sathe, Bhalkar, Bhadre, & Mosamkar, 2015). Since s significant stock sample pull adding up to $200,000 for the New York marathon was not recorded for this promotional event by the Restorative Pharmaceutical Corporative Company there lays some form of discrepancy in the Corporation’s system of accounting that ought to be fixed to avert any future failing (Mussoi Ribeiro, Silva do Carmo, Lopes Fàvero, & Nelson Carvalho, 2016). The Restorative Pharmaceutical Corporative Company discovered the amount during the physical inventory at year-end, and this means that there could be some human agent that is responsible for the leakage and the dishonesty (Sathe, Bhalkar, Bhadre, & Mosamkar, 2015). One way of seeing to it that the corporation does not lose any funds is by conducting physical audits. REFERENCES Mussoi Ribeiro, A., Silva do Carmo, C. H., Lopes Fàvero, L. P., & Nelson Carvalho, L. (2016). Manager's Discretionary Power and Comparability of Financial Reports: An Analysis of the Regulatory Transition Process in Brazilian Accounting. Revista Contabilidade & Finanças USP. , 27 (70), 12-28. Sathe, A. B., Bhalkar, M. S., Bhadre, R. B., & Mosamkar, S. P. (2015). Management of Internal Quality Control (IQC) data in a clinical biochemistry laboratory using spreadsheet software. Somaiya Medical Journal , 2 (1), 31-39.
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