1.

Nancy Howe, your staff assistant on the April 30, 20X2, audit of Wilcox Company,
was transferred to another audit engagement before she could complete the audit of
unrecorded accounts payable. Her working paper, which you have reviewed and are
satisfied is complete, appears below.

Wilcox Company
Unrecorded Accounts Payable M-1-1
April 30, 20X2
Invoice
Date Vendor and Description Amount
Hill & Harper—unpaid legal fees at Apr. 30, X2 (see
lawyer’s letter at M-4) $ 1,650y

Apr.1,X2 Drew Insurance Agency—unpaid premium at year-end on

fire insurance for period Apr. 1, X2- Mar. 31, X3

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(see insurance broker letter at J-1-1). Payment made

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on May 7, 20X2. 4,140y

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Apr.30,X2 Mays and Sage, Stockbrokers—advice for 100 shares of

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Madison Ltd. common stock (settlement date May 7,
X2) rs e 2,450y
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Lane Company—shipment received Apr. 30, X2 per
receiver no. 3361 and included in Apr. 30, X2,
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physical inventory; invoice not yet received (amount

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is per purchase order) 6,188y

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$ 14,428
y-Examined document described.

In my opinion, the $14,428 adjustment includes

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all material unrecorded accounts payable.

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N.A.H.
May 29,
X2
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Prepare a proposed adjusting journal entry for the unrecorded accounts payable of
Wilcox Company at April 30, 20X2. The amounts are material. (Do not deal with income
taxes.) (If no entry is required for a transaction/event, select "No journal entry
required" in the first account field. Do not round intermediate computations.)

No Date General Journal Debit

1 April 30, 20X2 Marketable securities 2,450
Unexpired insurance (4,140 x 11/12) 3,795
Insurance expense 345

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 Professional fees expense 1,650
Cost of goods sold 6,188
Accounts payable

Explanation
Unexpired insurance (11/12 × $4,140) = $3,795
To record liability for following unpaid invoices:

Hill & Harper $ 1,650

Drew Insurance Agency 4,140
Mays and Sage 2,450
Lane Company 6,188

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Total $14,428

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2. Listed below are types of errors and fraud that might occur in financial statements and audit

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procedures. Match the error or fraud with the audit procedure that is most likely to detect the
error or fraud. Replies may be used more than once.
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Error or Fraud
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1. The existence of an unrecorded accrued payable not due for payment for several months. Reviewing union co

2. The existence of unrecorded accounts payable. Vouching cash disb

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3. The existence of related party payables. Reviewing unusual

The existence of a fictitious account payable in an audit in which accounts payable are not Vouching selected
4.
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confirmed. accounts payable.

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A purchase was recorded before year-end which should have been recorded after year-end and Reviewing receivin
5.
payment of it has not yet occurred. year-end.

3.

Testing Subsequent Disbursements

Read the overview below and complete the activities that follow.

A common step in the testing for accounts payable is to test subsequent disbursements
for improper/proper inclusion/exclusion in year-end accounts payable.

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 CONCEPT REVIEW:
A common way to test accounts payable is to examine the check register after period
end and make selections for testing. Items are selected and then examined for detail. A
determination is then made to conclude whether the amount should have been a
liability as of year-end and, if so, if it was recorded as such.

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4.

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Testing Subsequent Disbursements
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Read the overview below and complete the activities that follow.
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A common step in the testing for accounts payable is to test subsequent disbursements
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for improper/proper inclusion/exclusion in year-end accounts payable.

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CONCEPT REVIEW:
A common way to test accounts payable is to examine the check register after period
end and make selections for testing. Items are selected and then examined for detail. A
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determination is then made to conclude whether the amount should have been a
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liability as of year-end and, if so, if it was recorded as such.

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1. When searching for unrecorded liabilities, the auditors consider transactions recorded _____ year-end. after
2. Accounts payable _______ can be mailed to vendors from whom substantial purchases have been made. confirm
3. To gain overall assurance as to the reasonableness of accounts payable, the auditor may consider ________. ratios
4. When auditors find unrecorded liabilities, before adjusting they must consider_______. materi
5. Auditors need to consider _____terms for determining ownership and whether a liability should be recorded. shippi

Explanation
1. Auditors look at subsequent payments to search for unrecorded liabilities.

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 2. Auditors may send confirmations to major vendors.
3. Ratios help auditors test for reasonableness.
4. While auditors may find a misstatement, they must consider materiality before recording.
5. Shipping terms are an important factor in deciding ownership.

5.

Other Current Liabilities

Read the overview below and complete the activities that follow.

In addition to trade accounts payable, many companies have other types of current
liabilities. These include amounts withheld from employees' pay, sales and other taxes
payable, deposits, and other accrued liabilities.

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CONCEPT REVIEW:

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Companies have many different types of current liabilities. These can include various

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taxes payable (income tax, sales tax, payroll tax), accrued amounts for salary, vacation

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or other benefits, and estimates such as accrued utilities and warranty. To adhere to the
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concept of the matching principle, companies must estimate the amount of their other
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liabilities.
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6.

Other Current Liabilities

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Read the overview below and complete the activities that follow.
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In addition to trade accounts payable, many companies have other types of current
liabilities. These include amounts withheld from employees' pay, sales and other taxes
payable, deposits, and other accrued liabilities.

CONCEPT REVIEW:
Companies have many different types of current liabilities. These can include various
taxes payable (income tax, sales tax, payroll tax), accrued amounts for salary, vacation
or other benefits, and estimates such as accrued utilities and warranty. To adhere to the
concept of the matching principle, companies must estimate the amount of their other
liabilities.

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 Federal and state governments do not specify the exact _____to be maintained, but do specify the amounts to
1. reco
be withheld.
Income taxes withheld from employees but not yet submitted to the government are considered to be a(n)
2. liabil
_______.
3. When testing customer deposits, auditors typically review a(n) ______of the individual deposits. list
When testing other accrued liabilities, auditors may independently calculate the amount and ______ it to
4. com
management's estimate.
5. Property tax payments are typically ______in number. few

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Explanation

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Federal/state governments do not require certain records but do require that the records be

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accurate.
2. If the company has withheld taxes but not yet remitted them, it is considered a liability.

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3. To test the liability for customer deposits, auditors typically review the detailed list.
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Auditors may compare their estimate to that of management in auditing liabilities.
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5. Property tax payments are typically few in number--with just a few payments per year
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Testing Product Warranty Liabilities

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The product warranty liability is often a difficult accrual to audit. Clients need to make
their best estimate of an amount to be incurred for warranty related to current sales.
They estimate this number based on historical trends, sales data, and other factors.
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Because it is impossible to create an actual amount, judgment comes into play.

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CONCEPT REVIEW:
The audit of product warranty accruals is often performed by an experienced auditor
based on the scrutiny and estimates involved. Expenses for warranty need to be
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recognized when the product is sold, not when the claim is exercised, which makes it
difficult to estimate--especially with long-term warranties. Auditors must apply judgment,
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industry knowledge, and expertise when auditing this sensitive area.

BACKGROUND:
Products in a manufacturing environment are often sold with a warranty--a promise to
repair or replace a product that malfunctions during a designated period. In recent
years, based on a competitive economy, many companies are extending this warranty
for longer periods. GAAP requires that the expense for these warranties be recorded to
match with the product sale. Therefore, a product sold in 20XX with a 5-year warranty
needs to have an estimate of its future warranty claims expensed in 20XX, although
many of those claims may not result for five years. This is an area of great scrutiny and
judgment for both auditors and clients alike.

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 Tanner CPA is conducting a second-year audit on its client, Lucas Manufacturing, Inc.
Lucas Manufacturing offers a standard 5-year warranty on all products sold. The client
calculates its accrued product warranty based on historical trends in warranty claims
and claims incurred to-date. Traditionally, its estimates have proven reliable. Tanner
CPA is ready to audit the accrued product warranty for the period 20XX.

a. How should Tanner CPA approach the audit of Lucas Manufacturing's accrued warranty if the
products sold are consistent with prior years?
b. Would Tanner's audit approach be different if a brand-new product was sold in the current
year (20XX)?
c. What else (in addition to sales and claims history and product mix) should Tanner consider?

Explanation

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1.

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Tanner CPA should consider the percentage of claims relative to current year sales as well as the

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historical data of warranty claims.
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2.
Yes, a new product typically has a greater number of claims as the bugs have not been worked out.
Typically clients accrue more for new products.
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3.
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It is important for Tanner to consider whether or not Lucas' warranty terms remain the same.
Oftentimes clients may modify their terms to remain competitive and auditors may not be aware. An
important first step for Tanner CPA is to read the actual warranties and discuss them with the
company's personnel who are involved in sales and manufacturing, in addition to discussing it with
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the accounting personnel.

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8.
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Testing Product Warranty Liabilities

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The product warranty liability is often a difficult accrual to audit. Clients need to make their best estima
amount to be incurred for warranty related to current sales. They estimate this number based on histor
trends, sales data, and other factors. Because it is impossible to create an actual amount, judgment co
play.

CONCEPT REVIEW:
The audit of product warranty accruals is often performed by an experienced auditor based on the scru
estimates involved. Expenses for warranty need to be recognized when the product is sold, not when t
is exercised, which makes it difficult to estimate--especially with long-term warranties. Auditors must ap
judgment, industry knowledge, and expertise when auditing this sensitive area.

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 1. As repairs on warranty items take place, the accrual account is ________. debited
2. Auditors need to compare the percentage of claims accrued to current year ______. sales
With respect to auditing product warranty accruals, auditors should be alerted to changes in the
3. products
client's _______ sold.
When all of a company's products are sold with warranties, the balance in the accrual account should directly
4.
move ____ the balance in sales. with
5. Tax guidelines do not allow the ______ of the accrual for warranty claims. deduction

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Explanation

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Companies increase the accrual for potential claims and decrease, or debit, the accrual for actual

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claims.
Auditors should compare the amount of claims to sales to gain comfort with this percentage as

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2.
compared to historical data.
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As specific products sold change, warranty expense also may change, so auditors need to be
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3.
alerted.
A change in sales volume should lead to a direct change in warranty expense and in the accrual
4.
account.
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5. Warranty expenses can only be deducted when they are incurred.

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