You are the manager in the audit of Vernal Manufacturing Company and are turning your

attention to the income statement accounts. The in-charge auditor assessed control risk
for all cycles as low, supported by tests of controls. There are no major inherent risks
affecting income and expense accounts. Accordingly, you decide that the major emphasis
in auditing the income statement accounts will be to use analytical procedures. The client
prepared a schedule of the key income statement accounts that compares the prior-year
totals with the current year totals. The in-charge auditor completed the last column of the
audit schedule, which includes explanations of variances obtained from discussions with
client personnel.

Required
a. Examine the schedule prepared by the client and your staff and write a memorandum to
the in-charge that includes criticisms and concerns about the audit procedures performed
and questions for the in-charge auditor to resolve.
b. Evaluate the explanations for variances provided by client personnel. List any
alternative explanation to those given.
c. Indicate which variances are of special significance to the audit and how you believe
they should be responded to in terms of additional audit procedures.

SOLUTION

a.

To: In-Charge Auditor

From: Audit Manager

Subject: Concerns about the schedule prepared by the client and the staff
assistant in the audit of Vernal Manufacturing Company

The analytical procedures schedule for the audit of Vernal Manufacturing

Company is completely inadequate and needs to be redone. There are several
deficiencies:

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 1. The headings, references, and indexing on the audit schedule are incomplete. It
appears that the schedule was prepared by the client, but it is not possible to
determine from the schedule.

2. A classified income statement would provide more useful information than the
single-step statement provided.

3. The schedule should include the additional columns showing the percent of net
sales for 12-31-10 and 12-31-11. This information would permit us to more
effectively evaluate the relative change in each account.

4. There is no indication that the general ledger totals were compared to general
ledger balances or that calculations were tested.

5. There is no identification of accounts that we are concerned may be materially

misstated. For example, the $1,381 change in insurance expense appears
immaterial but the 427% change in other expense may be significant.

6. There is no indication of specific accounts that require additional investigation

and the nature of such investigation.

7. There is no indication that the client's explanations have been evaluated and
supported by evidence. Management inquiry is a weak form of evidence and
unsatisfactory by itself.

b. For every explanation provided by the client, an alternative possibility is a

misstatement in the financial statements. The auditor must be satisfied that
significant differences are not material misstatements.
The following are a few examples:

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 c. To perform a meaningful determination of the most important variances, an
alternative design of the audit schedule follows. It is much easier to determine
relevant variances with an adequate analytical procedures schedule.

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 The following are variances of special significance to the audit that have been determined
from the revised analytical procedures worksheet. Before doing additional work, there
should be further discussion with knowledgeable management about the variances
identified. After investigating management's explanations, the following additional audit
procedures may be appropriate:

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