Auditing

University of Missouri – St. Louis

Department of Accounting

ACCTNG 4435 – Auditing – Summer 2021

Writing Assignment –

Risk Assessment and Management Assertions

at the Crafty Trinkets Company (“CTC”)

Extension of due date – the Writing Assignment is now

due by 1159 PM on 2 July.

Required:

Please read the following information about the Crafty Trinkets Company (“CTC” or

“the Company”), and follow the instructions at the end of the case. The requirements of

the case are focused and to-the-point.

While this case assignment is not intended to be some sort of massive research paper, it

does account for 10% of your final grade. Please spend the time and attention on this

assignment that 10% of your final grade would warrant. Take the time to present well-

thought out responses to the requirements, written in your best, polished writing style.

Please proofread your paper. If your paper appears to have been dashed off in a few

minutes, unfortunately your grade on the paper will reflect that. Do a professional job.

When reading the case, please pay careful attention to the dates. Imagine it is now 28

November 2018. It may be helpful to create a timeline of events, so you can put the

events in the proper context and chronology. (Please don’t include any chronology that

you prepare in your submission.) Please note that, given the dates cited below, none of

the events in the case are impacted by the covid pandemic.

I’m happy to answer any questions you have about the case or the requirements.

Introduction As a senior auditor in a public accounting firm, you have been assigned

to plan the audit of the financial statements of a privately-held company called the

Crafty Trinkets Company (“CTC” or “the Company”).

Company Background CTC designs, manufactures, and markets a variety of toys,

which are sold primarily to large national retailers like Target and Wal-Mart. CTC is a

small company compared to competitors like Mattel and Hasbro; nevertheless, CTC

managers believe their company’s toys are among the best in the world. Unlike the

larger toy makers, CTC has enjoyed success with a small portfolio of brands and

products, representing three categories: (1) soft toys, consisting primarily of its Snuggle

Pets stuffed animals; (2) sturdy toys, including metal-cast and plastic cast toys like

Speedster cars and Lightning action figures; and (3) digital toys, consisting of video game

software under development. Like most toy makers, 60 percent of CTC’s sales revenues

are generated in October and November, with the last two weeks of November driving

half of those sales.

Your firm, Smith and Company, LLP (“Smith” or “the Firm”), has been CTC’s public

accounting firm since 2013, providing audit and tax services to the Company. The

primary external user of CTC’s audited financial statements is its bank. Assume it is

now 28 November 2018. You have taken over audit senior responsibilities for the

Company’s 30 November 2018 year-end financial statement audit because the previous

audit senior has just unexpectedly left your Firm to accept a job in another city. (The

Company’s year-end date is 30 November.)

Please review the following excerpts from relevant documents involving the planning

and execution of the current year audit.

Excerpts from the document….

“Observations Noted in My Review of the

Previous Year (year-end 30 November 2017) Audit File”

(written by you, the new senior auditor…)

• In fiscal 2017, CTC exceeded its earning targets, reporting operating income of

$3,026,100 and net income before taxes of $2,572,800. The only large negatives

for the year 2017 were the substantial additions to allowances for receivables and

inventories, including an extra $300,000 in the allowance for doubtful accounts

related to the struggling Toy-Mart chain in the United States. The increase to the

allowance for inventory was due to possible obsolete inventory. The increase in

the Allowance for Doubtful Accounts was accomplished by a debit to Bad Debt

Expense and a credit to the Allowance.

• CTC’s management advised our Firm that retailers dramatically reduced the

quantity of toys they were willing to stock on its shelves at any one time in fiscal

2017, and were expected to continue this trend into 2018. This change did not (at

least in 2017) reduce the volume of the toys sold through retailers, but it has

intensified competition among industry competitors for retail shelf space, and

increased operating costs by increasing the frequency of shipments to stores. (In

the competitive environment in which CTC operates, shipping costs are usually

paid by the manufacturer, not the retailer.) It’s possible that the restrictions on

shelf-space could result in lower sales in future periods.

• Ever since 2014, CTC executives have shared in a bonus pool that is created

through CTC contributions of 10% of the first $750,000 of operating income, plus

20% on the next $750,000, and an additional 30% of the next $1,500,000. CTC’s

total contributions to the bonus pool are capped at a yearly maximum of

$675,000.

• CTC does not have an internal audit group. In addition, they have struggled to

implement the COSO Integrated Framework of Internal Control.

Excerpts from the document….

“Findings from Visit to Client and Interim (before year-end)

Audit Procedures Conducted in September 2018”

(written by the audit senior that you replaced)

• In January 2018, the long-time CEO and CFO of CTC retired, and replacements

were hired and began work in March 2018. One senior manager told me that the

pair are like “fire-breathing dragons,” and have indicated that their “sole

number-one focus will be increasing sales and profitability, and those who do

not contribute will be given the opportunity to continue their career elsewhere.”

• We developed an understanding of controls over purchases and payable and

found that controls in this area were not well designed and were not operating

effectively. Therefore, following what I know about audit strategy, I decided to

test the controls over purchases and payables in the interim period and assigned

it to one of the staff auditors. Although this testing has not yet been reviewed,

one item seemed unusual. It involved a payment of $30,000 to the International

Toy Manufacturer Workers Union. The payment was initiated by the CTC VP-

Operations and approved by the current CFO, and was properly classified as a

non-operating expense. According to the VP-Operations, the payment was “a

gesture of support for the toy factory workers – a gesture we believe is important

since workers believe themselves to be underpaid and are discussing the

possibility of work stoppages and strikes in the Fall of 2018. We hope this

payment will assist in making it possible for union executives to encourage their

members to resolve these issues before a work stoppage or strike.”

• In the tests of controls over revenues and receivables, one of the staff auditors

that conducted the testing noted that controls were effective. In particular the

staff member noted that one thing that was very impressive was that the CFO

was active in oversight of the area of bad debts and inventory obsolescence.

Indeed, as an example, the current CFO herself approved the reversal/recovery

of the $300,000 amount allowed for with respect to Toy-Mart, and had even

initiated and approved the journal entry for the transaction, reversing it into

income (debit Allowance for Doubtful Accounts, credit Bad Debt Expense)

without the involvement of the credit manager.

Excerpts from the document….

“Audit Partner Memo to 30 November 2018 Audit Workpaper File”

• CTC had been unable to produce enough Snuggle Pets for the December 2017

year-end holiday season, due to raw material shortages in an unstable stuffing

supplier market. The Company was able, however, to increase production in

January 2018, which allowed for increased sales for Valentine’s Day in February

2018. Soon after, at the insistence of the national retailers, all unsold Snuggle Pets

were returned to CTC for a full refund. The retailers insisted that the absence of

Snuggle Pets in stores after February 2018 would build demand for the

Fall/Winter 2018-2019, as the retailers focused on the end-of-the-year holidays

and gift-giving season.

• CTC has deferred their purchase of new, hi-tech manufacturing equipment due

to a shortage of cash and the inability to obtain favorable financing. This is the

second year in a row that CTC has deferred this investment.

• CTC executives entered into an agreement with Cartoon Studios, Inc., who had

produced their very first animated movie, called “The Bronx Zoo – Escape to

Manhattan!” for release on 30 November 2018. (The movie is billed as “Jumanji”

meets “Babe: Pig in the City”!) For $900,000, CTC had won the rights to produce a

line of soft and plastic toys based on characters from the movie. (CTC plans to

amortize this fee over 9 years.) The toys would be sold through CTC’s regular

retail customers. The toys were on schedule to be in stores on 30 November. The

agreement between the Company and Cartoon Studios indicated that Cartoon

Studios would compensate CTC for the cost of the unsold toys if sales of the toys

failed to reach $1,500,000 during the first two months after the movie’s release.

CTC plans to accrue $1,500,000 of sales revenue on 30 November relating to this

provision of the agreement.

• CTC executives have carefully reviewed the pricing and valuation of inventory

during early November 2018, and determined that the inventory valuation

reserve established in the previous year is no longer necessary; a journal entry

was made by the CFO on 15 November 2018 to reverse the valuation allowance

into operating income in a manner similar to the reversal related to the

Allowance for Doubtful Accounts described above.

• In October 2018, CTC announced that it was suspending it’s partnership with the

charitable organization “Toys for Kids,” an organization that distributes toys to

underprivileged children in less-developed countries around the world. In the

past, CTC had donated a substantial number of toys to “Toys for Kids.”

• On November 1, 2018, the Company’s Board of Directors Compensation

Committee agreed to double the Company’s contribution to the bonus pool, to

$1,350,000. This measure will be effective for the year-ending 30 November 2018.

Requirements: This case includes many risk factors that can be classified or

described as falling under the various categories included in the engagement risk

model that we studied earlier in the semester. (Remember, sometimes a particular

risk factor could be classified under more that one category of risk, depending on its

nature.) Using your textbook and material discussed and presented on the course

website as reference material (no citations are necessary), please address the

following issues:

• Identify at least one risk factor related to auditor business risk, and one related to

client business risk, and briefly explain why they could be classified as such.

• Identify at least four significant risk factors for material misstatement (in other

words, IR or CR [alone or in combination], or RMM, or REF) present at CTC.

Briefly explain why the factors you identify increase the risk of material

misstatement.

• Identify one risk factor that could be associated with each corner of the fraud risk

triangle (the three conditions necessary for fraud to take place). Briefly explain

why they are fraud risk factors.

• The senior auditor before you made a error that relates to the implementation of

audit strategy. Identify this error and briefly explain why it was an error.

• Sales revenue is always an audit area where the risk of misstatement is high.

Identify one management assertion relating to revenue that, based on the

material above, is particularly high-risk at CTC and briefly explain why..

• Accounts receivable is also usually an account where the risk of misstatement is

high. Again, based on the material above, identify one management assertion

related to accounts receivable that is particularly risky and briefly explain why.

Administration: In order to organize your paper and facilitate my review, please attend

to the following instructions regarding the format and style of your paper. Failure to

follow these instructions may result in point deductions from your grade on this

writing assignment.

• Please submit your writing assignment to me via email at kozloskit@umsl.edu ;

please submit your assignment in MS Word.

• Some of the requirements above essentially ask for a list. For instance, the

second requirement asks you to identify four risk factors. You may number the

risk factors, or use bullets. However, when describing the risk factor, do so in

complete sentences, and when describing why they are risk factors, again use

complete sentences, not incomplete sentences or phrases. Please follow this

approach throughout the case. That is, write in complete sentences, not phrases.

• Please use a single-spaced, block paragraph format (left and right justification),

with one space between paragraphs, headings, or items on your lists. Use a 12

point font and standard margins.

• Please see the “Important Information about Course Requirements” page of

the course website to view documents presenting guidance and tips for

writing assignments.

• As mentioned above, be careful that you understand the timeline of the events

in this case. Recognize that some of the information relates to the prior year

audit, and some relates to the current year audit coming up.

• Please do NOT spend significant portions of your write-up recounting the facts

of the case, or presenting a summary of the case. Assume I have read the case

information, am familiar with CTC, and most importantly, I am familiar with

auditing terminology, theory, and practice. You need NOT define auditing

terminology in your case write-up. Doing so is unnecessary, given your

audience, and will detract from the quality of your paper.

• This is an individual assignment. Although you may discuss the case you’re

your classmates, please be VERY CAREFUL to ensure that what you submit is

your work and yours alone. Please do NOT cut and paste from the internet.

Please refer to the ACCTNG 4435 course syllabus for guidance and information

about academic integrity/misconduct.

• Your paper should be well-written and professionally presented. I will evaluate

both the content and the style of the document. Content will account for

approximately 75% of the points relating to the paper, and style (grammar,

punctuation, etc.) will account for approximately 25% of the points. Pervasively

poor writing may cause you to lose all the points relating to style, so please

invest the effort required to improve your paper before submission.

PROOFREAD your paper and fix typos, misspellings, and grammar errors.

• IMPORTANT – The original due date for the paper was 29 June. I have

extended the due date to 1159 PM on 2 July, although early submissions are

appreciated.