Apply audit risk and materiality concepts to address the following circumstances regarding Able
& Baker LLP’s audits of the financial statements of Foster Engineering, Inc.
1. Able & Baker LLP auditors are beginning their audit of Foster’s 2017 financial statements.
Because of changes in the market and increased competition, Foster changed the terms of its
sales at the beginning of 2017. Previously, Foster’s customers had to pay for maintenance of the
Foster products at the time such maintenance was performed. Beginning in 2017, Foster included
3 years of maintenance as a part of the sales price. This requires Foster to defer a portion of
revenue from sales of the product and recognize it in future periods. Accordingly, Foster’s
accounting staff must estimate the amount to defer based on Foster’s future involvement with the
products sold. This change resulted in Foster showing the following unaudited results: a lower
gross profit margin, but significantly increased sales, which increased Foster’s overall net profit
as compared to 2016.
Questions: How do each of the changes described above affect the amount of audit evidence the
Able & Baker LLP auditors will need to obtain about the occurrence and accuracy of the
recorded revenue, as compared to the previous year, and why?
2. Because of its overall good results in 2017, Foster has become recognized as one of the
leading private companies in its industry. Because of this and other factors, Foster’s shareholders
and board of directors voted in 2018 to have an initial public offering of its common stock and to
become a publicly traded company by the middle of 2019.
Questions: Does the plan to become a pubic company affect the overall amount of audit evidence
the Able & Baker LLP auditors will obtain in its audit of Foster’s 2018 financial statements, as
compared to 2017? Why or why not?
3. In past audits, the Able & Baker LLP auditors found few, if any, errors in its substantive audit
procedures for the existence of Foster’s accounts receivable. During the 2017 audit, Able &
Baker LLP decided to change its audit strategy for the existence of accounts receivable by
reducing assessed control risk. In the past, Able & Baker LLP assumed control risk was high.
After performing the necessary tests, the auditors concluded that the controls were designed and
operated effectively. Additionally, the auditors did not discover any errors in connection with
their substantive tests of details of balances.
Questions: a. What effects did the change in strategy have on the planned nature and extent of
auditing procedures performed regarding the existence of Foster’s accounts receivable as
compared to the 2016 audit and why? b. What do the results of the substantive tests of details of
balances indicate, how should the auditors respond, and why?