I need help with the audit case below. Please see attachment

Allowance for Sampling Risk” schedule by ranking the projected misstate- ments as appropriate. (Hint: If you forgot how to do this, refer to Chapter 8.)

6. Print the document. 7. Explain the meaning of the following amounts:

a. Basic precision; b. Incremental allowance for sampling error; c. Allowance for sampling risk; and d. Upper misstatement limit.

8. Evaluate the sampling results. Do they support Derick’s concerns regarding possible material misstatement? Note the audit adjustment based on mis- statements discovered while examining the sample. Is this adjustment ade- quate to bring the population into acceptable bounds? If not, what alternate actions might you choose to pursue, based on the sampling results?

Module XII: Estimated Liability for Product Warranty All Biltrite products are sold under a one-year warranty covering all parts and labor. Repairs are performed locally, either by the dealer who sold the bicycle or by local entities licensed as official Biltrite bicycle repair shops. Biltrite reim- burses the dealers and shops for labor and parts. Reimbursement is based on work orders submitted by the repairing agency. The customer signs the work orders, and the serial number of the product repaired also appears on each work order. Defective parts or products replaced must be returned with the accompanying work order. The parts and products are received and logged in on color-coded receiving reports designed for returns.

At the end of each month, the following standard journal entry is posted as an adjustment to estimated product warranty.

8330 Product Warranty Expense 2070 Estimated Product Warranty Liability For 2009, the company applied 0.5% to cost of goods sold in determining the

amount of the monthly adjustment. Debits to account 2070 are for reimburse- ments and for product and parts replacements. Defective parts and products are “zero valued” and placed in the rework department. Derick has asked you to analyze product warranty and determine the appropriate balance in the liability account. He has already provided you with a partially completed document and a client-prepared analysis of returns over the past four years. You have completed the document and are now ready to evaluate the adequacy of the balance.

Requirements 1. Using the spreadsheet program and downloaded data, retrieve the file labeled

“Warranty.” Examine the document carefully and comment on its adequacy and completeness. (Note that the 12/31/08 audited balances appear to be unreasonable because you have not yet selected an appropriate provision per- centage based on the “data from client-prepared analysis of warranty claims.”)

2. Scroll to the bottom of WP 20 and enter audit adjustments already made in previous modules that affect cost of goods sold for 2009. You should iden- tify the following adjustments. (If you weren’t assigned the respective mod- ules, ask your instructor for details regarding amounts and accounts.)

• AJE No. 1 (Module IV correction of repairs expense capitalized as factory equipment); and

• AJE No. 3 (2009 purchase recorded in 2010, detected in completing Module VI).

802 Chapter 14 Audit of Longer-Term Liabilities, Equity, Acquisitions

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3. What comprises the documentation examined by the auditor (audit legend E) supporting the debits to account 2070?

4. How would you audit the client-prepared analysis of warranty claims? (See “Year of Claim/Year of Sale” analysis in the middle of WP 20.)

5. Enter equations in cells C44, D44, and E44 that will calculate the percentage of warranty claims to cost of goods sold for each of the three years 2004–2006.

6. Note the percentage that now appears in cell B46 and the resulting adjust- ment to product warranty expense.

7. Draft AJE No. 12 on the document. 8. Print the document. 9. Shelly Ross, the other assistant auditor on the engagement, asks why you

didn’t adjust the prior years under provision through beginning retained earnings. What is your response?

Module XIII: Mortgage Note Payable and Note Payable to Bank Two In addition to a deferred tax liability relating to temporary book and tax depre- ciation differences, Biltrite’s long-term liabilities consist of the following: 10% mortgage note payable to Dallas Dollar Bank—$60 million; and 12% note payable to Bank Two—$45 million.

In 2004, Biltrite upgraded its manufacturing facilities at a cost of $150 mil- lion. The project was financed by issuing 2 million shares of common stock at $25 per share, and by issuing a $100 million 10% mortgage note payable to Dallas Dollar Bank. The mortgage agreement requires repayment in ten annual installments of $10 million each. Interest on the unpaid principal is payable on the first day of each month. The principal installments are due on January 1. The next payment is due on 1/1/10.

The 12% note payable to Bank Two was issued to alleviate the effects of the liquidity problems encountered in 2009. This note is unsecured and requires repayment in ten equal annual installments. Unlike the Dollar Bank mortgage loan, interest on the Bank Two loan is payable annually. The first principal install- ment, together with interest, is due on 3/1/10. This note contains restrictive covenants, as described earlier, relating to a $10 million compensating balance requirement and restrictions regarding further borrowing and dividend payments.

Derick has asked that you analyze the long-term notes payable, being partic- ularly alert to any violations of the restrictive covenants contained in the Bank Two loan agreement.

Requirements 1. Using the spreadsheet program and downloaded data, retrieve the file

labeled “Notes.” Locate the following documentation in this file:

• WP 14—Notes payable and accrued interest—lead schedule; and • WP 14.3—Notes payable—long-term.

Scroll to WP 14.3, “Notes Payable—Long-Term.” What are the audit objec- tives in the examination of long-term notes payable? What would the auditor consider to be the most relevant assertions? Has the evidence provided in the document addressed the audit objectives and the most relevant assertions?

2. Record Reclassification Journal Entry C for the current portion of both notes as of 12/31/07, and enter the amounts in WP 14.3. Now scroll up to WP 14, the lead schedule for notes payable and interest. Post your reclassifications to the lead schedule.

3. Print documentation 14 and 14.3. 4. What is the probable nature of the adjustment to “notes payable—trade” and to

“interest payable” appearing in the adjustments column of the lead schedule?

Module XIII: Mortgage Note Payable and Note Payable to Bank Two 803

Copyright 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s).

Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.