Solutions Guide: Please reword the answers to essay type parts so as to guarantee that your

answer is an original. Do not submit as your own.

Smackey Dog Foods, Inc - Scenario Summary
Smackey is privately held.
Smackey Dog Foods, Inc. started in the kitchen of Sarah, Kim, and Jillians family home in the
suburbs of Chicago. The three sisters initially bought the ingredients for their natural dog food
recipes from the local grocery store. They used their dogs and the neighborhood dogs as their taste
testers. Their dog food products were so good, the local kennels and veterinary offices were glad
to distribute the sisters' products to their customers.
Local demand increased significantly. Local pet stores and small grocery stores discovered the
products and became distributors. The sisters moved the expanding business into a larger facility
and hired a few more workers. While their competitors sales were flat or declining, Smackey Dog
Food, Inc.s sales were on a vertical climb!
Sales were so good last year, that the sisters opened a boutique division named Best Boy Gourmet,
specializing in freshly manufactured, one-serving packages meant for consumption no later than 3
days after production. They sell this product at 3 times the cost of their other products and by
special order only through their new website. Demand is high, but waste has been an issue.
Sarah is the president and general manager of the operation. Sarah has been very proactive in
growing the business. She has met with her banker to discuss expanding the facilities and
equipment with another $150,000 loan. Their first loan for $150,000 was secured by the industrial
size, food production equipment purchased with the loan. The banker now demands an audit of the
corporate financial statements before releasing another loan to the company. Sarah has offered to
place the corporate account receivables up as collateral to secure the second loan. Based on
revenue projections by her sister Jillians sales team, Sarah believes that the company will not have
trouble paying down the loan in a short period of time.
Kim manages the production operations. She oversees the inventory, production, and shipment of
dog food products. The Best Boy Gourmet line has taken almost all of her attention lately. The
winter holidays are approaching and sales demand based on forecasts from the sales force are
higher than ever. Attaining fresh, raw ingredients is more difficult in the winter months. If any of
the fresh ingredients are delayed, production comes to a standstill. There has been significant
inventory waste as a result.
Kims assistant, Henry, monitors the production and shipment of Smackey Dog Foods regular line
of product. Henry takes pride in his work and is involved in every facet of the operation. With
only one other warehouse employee to help, Henry personally is involved in preparing and
approving all inventory records. Henry ensures that very little finished inventory sits in the
warehouse. However, the shipping dock always seems to be full of returned dog food that should
be restocked. When Kim asks him about it, Henry laughs and tells her that "first in first out"
applies to dog food returns as well. Kim smiles and just accepts that answer.

Jillian is not very good at understanding accounting. The sisters placed Jillian in charge of
sales. She manages a sales team of 12 salesmen in Illinois, Indiana, and Wisconsin. Her fear of
flying and poor driving skills limit her ability to get around to the areas outside of Chicago. As a
result, she has placed a lot of faith in her sales team. The sales team complained last year that they
did not like waiting for their commissions until after bookkeeping calculated the actual
revenues. In order to keep their spirits fired up, Jillian has her sales people project what their sales
will be in the upcoming quarter and she pays commissions in advance on those projections. The
sales team loves her and Jillian loves their approval. Jillian has noticed that the projections
typically are off by 11% on average.
The employees of Smackey Dog Food, Inc. all own dogs. It was a hiring requirement on the job
application. One employee was fired when it was discovered she never owned a dog when she was
hired. A lawsuit is pending by the fired employee.
At this time, the receivables represent 29% of the corporate assets. The Chicago retail chain Pup
Stores, Co. is Smackey Dog Foods largest buyer. They alone represent 31% of overall sales and
usually pay within 30 days. However, Pup Stores is facing a major lawsuit from an animal rights
group. The legal fees are eating into their cash reserves and they are facing some store closures.
The accounts receivable aging indicates that 38% of the receivables are 30 days or less. Twentytwo percent are 31-60 days. Twenty-one percent of the receivables are 61-90 days old. Ten percent
are 90-120 days. The remaining receivables are older than 120 days. Sarah has not written off any
of the receivables, nor will she.
Sales are projected to steadily grow at 16% next year if the company does not expand its facilities.
With the expansion, sales are projected, rising 26%, with the most significant jump in the last
quarter after expansion is completed and holiday sales pick up.

Your Role
You and your firm, Keller CPAs, have never audited a dog food manufacturer. Although it is late
in the year to be accepting a new calendar year-end audit, you need the work and have the time to
devote to the audit before your 2-week ski vacation in February.
You begin the audit process just prior to year-end by sending your audit manager, Pete, and two
audit staffers, Ben and Maureen, out to the client. They spend time assessing the client and
planning the audit.
During the first month of field work after year end, Ben and Maureen note that the dog food bags
piled high on the docks are marked Returned. One employee is seen throwing bags of the
premium Best Boy Gourmet dog food into the dumpster in the morning and pulling it out and
throwing it into Henrys car during the employee lunch hour.
Petes new best friend, Alan, was married to Smackey Dog Food, Inc.s owner, Kim, 4 years ago.
Alan is also good friends with the banker from whom Sarah is seeking the loan. Pete is unaware of
the relationship. Pete has talked about some of the details of the audit to Alan over a few beers.

Questions:
Q1:

Discuss how the SEC has influence (if any) over the audit of Smackey Dog Foods, Inc.

Solution:
The Securities and Exchange Commission has a significant influence on the audit of Smackey Dog
Foods, Inc. by Keller CPAs. This influence can be observed in the audit standards that have to be
followed in establishing the independence of auditors involved in the audit of Smakey.
In the audit of publicly listed companies including Smackey, auditors need to observe principles.
Independence is one of the six ethical principles of the American Institute of Certified Public
Accountants (AICPA) Code of Professional Conduct. The other principles are responsibilities, the
public interest, integrity, objectivity and independence, due care, and scope and nature of services.
More specifically, audit team members are required to be objective and independent with regard to
the audit by maintaining objectivity and being free of conflicts of interest in discharging
professional responsibilities and by being independent in fact and appearance when providing
auditing and other attestation services (p. 82). In here the influence of the SEC is very obvious.
Under the SOX, auditors have to be objective and independent otherwise legal sanctions can be
incurred.
Although the above standards are enforceable for the audit of public companies, it can also be
applied to the audit of non public companies like Smackey Dog Foods, Inc.
Q2: Discuss the essential activities involved in the initial planning of an audit. How do these all
specifically to the Smackey Dog Food client?
Solution:
The following are several of the essential activities involved in the initial planning of an audit and
as they relate to Smackey Dog Food, Inc.
1. Understand the clients business and industry. The audit firm can capitalize on its experience in
auditing other food manufacturer in planning and doing the audit for Smackey. So far,
members of the Audit team, the audit manager Pete and two audit staffers Ben and Maureen,
have to understand the clients business and industry.
2. Assess client business risk. Business risk is the risk that Smackey will fail to achieve its
objectives. In this activity, the audit team assesses the risk of material misstatements arising
from Smackeys business risk. For example, the high wastage in Smackeys Best Dog division
presents a lot of business risk, and therefore material misstatement risk.
3. Perform preliminary analytical procedures. Keller CPAs needs to compare the performance of
Smackeys with the industry to further support its initial assessment of business risk. These
analytical procedures help the audit team indentify areas where the risks of misstatement are
very high.
4. Set materiality and assess acceptable audit risk and inherent risk. The Smackey audit team now
has to set the acceptable level of materiality. The circumstances of Smackey have to be taken
into account in setting materiality level as this level is purely a relative and subject to auditors
judgment.

5. Develop overall audit plan and audit program. The audit plan and program aims to achieve the
audit risk objectives of the audit team and to provide reasonable assurance and basis for the
audit report and opinion.
Q3: Discuss the 4 stages of the audit and the major activities performed by the auditor in each
phase. Give an example of how each of these specifically applies to the Smackey Dog Food, Inc
audit. For instance, examine the apparent internal control weaknesses and possible negative
outcome of each.
Solution:
The four stages of audit and how each of the major activities specifically applies to the audit of
Smackey Dog Food, Inc. are:
1. Planning and risk assessment. For Smackey, the risks can initially be assessed by obtaining
understanding of Smackeys business and its industry. More specifically, the design and
implementation of the clients internal control procedures, processes and systems are studied
and analyzed for the audit team to be able to assess the control risk for each of the transactionrelated audit objective occurrence, completeness, accuracy, classification, timing and posting
and summarization.
2. Test of internal controls. The audit team can perform tests of controls by making inquiries of
appropriate client personnel, examining documents, records, and reports maintained by
Smackey, observing control-related activities such as the one done for the inventory procedures
for returned Best Boy Gourmet dog food, and reperforming client procedures.
3. Substantive tests. The Smackey audit team needs to perform substantive tests on the balances
of the accounts receivables and inventory accounts. Moreover, substantive tests can be done
through performing substantive tests of transactions, analytical procedures and test of details of
balances.
4. Audit finalization. At this stage, the audit team compiles a report to Smackeys management as
regards matters that came to the teams attention during the audit, evaluates and reviews the
audit evidence obtained in the audit, and considers the audit opinion to be issued based on the
evidence obtained.
Q4: Describe Keller CPAs responsibilities related to communications regarding internal control
matters. What internal controls issues do you identify?
Solution:
Generally accepted auditing standards and professional conduct requires that the auditor
communicate, in writing, to management and those charged with governance, significant
deficiencies and material weaknesses identified in an audit.
The following internal control issues were identified as regards the audit for Smackey Dog Food,
Inc. and thus have to be communicated to appropriate people within Smackey:
1. Granting of commissions to sales people based on estimated sales. This internal control issue
presents risks as regards the companys financial resources as sales people might be paid for
sales not made, and there is no refund process for commissions paid for this type of sale.
2. Segregation of duties as regards the handling of inventory. With a single person assigned with
the preparation and approving all inventory records, the changes of material misstatements are
high.

3. Lack of control procedures and guidelines in handling returned dog foods which presented
opportunities wherein employees take home returned items.
4. Lack of control procedures and guidelines in handling and recording accounts receivable. This
is much more important now since a major client which represents 31 per cent of total sales is
experience financial difficulty. Moreover, the urgency of these procedures and guidelines is in
light of the magnitude of receivables (29 per cent of total assets).
Q5: You decide that you will address Smackey Dog Food, Inc.s accounts receivables through
confirmations. Discuss the various types of confirmations and what forms you will implement and
why.
Solution:
There are two general classifications of accounts receivable confirmation: 1) positive and 2)
negative confirmations.
Positive confirmations are confirmations that asked debtors to confirm directly to the auditors
whether the balance of the accounts receivable from the debtors is correct or not. Examples of
positive confirmations are blank and invoice confirmation forms.
A negative confirmation requests debtors to respond only when they disagree with the stated
amount in the confirmation form.
As to the audit of Smackey Dog Food, Inc.s accounts receivables, I will implement an invoice
confirmation form under the positive confirmation approach.
Q6:

What are the major factors affecting sample size for confirming accounts receivable?

Solution:
The following are factors affect the sample size for confirming accounts receivable:
1. Tolerable accounts receivable and financial statement misstatement.
2. Inherent risk which is dependent on the size of total accounts receivable, the number of
accounts, prior-year results, and expected misstatements.
3. Control risk.
4. Achieved detection risk based on other substantive tests, and
5. Type of confirmation. Generally a positive confirmation requires a smaller number of sample
size.
Q7: A major issue in verifying the ending balance in property, plant and equipment is the
possibility of legal encumbrances. Discuss what specific concerns you have. Describe the
procedures your firm will perform to obtain evidence about existing legal encumbrances.
Solution:
Keller CPAs will need to perform the following to obtain evidence about existing legal
encumbrances include:
1. Inquiry with property, plant and equipment custodians
2. Review of minutes of meetings
3. Review of items noted during property, plant and equipment inventory observations
4. Confirmation of the clients liabilities

5. Reading and reviewing lease agreements

6. Reading and reviewing property, plant and equipment purchase contracts and agreements
The above procedures aim to assess whether encumbrances and liens to the property, plant and
equipment have been identified and whether property currently pledged as collateral on a loan has
not been sold or damaged.
Q8: The client wants to know if you will be present at the year-end inventory. What is your
decision and why? What role or actions will you take at the inventory if you decide to attend the
inventory? Why?
Solution:
The presence of the audit team during the year-end inventory taking is necessary. The
representation of the audit team provides assurance that the physical count was carried out
carefully and systematically by persons fully informed of the duties involved.
Thus, the auditors responsibility is to ascertain whether the client's employees are carrying out
their instructions properly during the count. During the count, the auditor needs to test the
efficiency of the counting by arranging for a count or a recount of selected items in the audit
teams presence.
Moreover, the auditor will be taking notes considered necessary to be followed up. These can
include details of items of inventory selected so that the particulars may be checked to the final
count sheets; lists of items actually counted in the auditor's presence; details of any inventory noted
by the auditor as being obviously defective, damaged or slow-moving; and details of instances
where the client's physical count procedures were not carried out.
Q9: Considering the general six functions that make up the inventory and warehousing cycle for
Smackey Dog Foods, Inc., identify the related documents and/or records that would be used. From
your analysis of the internal controls related to the inventory and warehousing cycle of Smackey
Dog Foods, Inc., what internal control weaknesses exist?
Solution:
The six general functions that make up the clients inventory and warehousing cycle are:
1. Processing of purchase orders - purchase requisitions, quotations from suppliers, and purchase
orders
2. Receipt of purchased materials - receiving report
3. Storage of materials or inventory - materials requisition form
4. Processing raw materials - job cost sheet, process cost sheets
5. Storage of finished goods - sales invoice, sales order form.
6. Shipping finished goods - shipping form and invoices.
Internal control weaknesses observed as regards Smackeys inventory and warehousing cycles are:
1. No procedures for the receipt, storage and disposal of returned dog foods.
2. Processing purchase orders, receipt of purchased materials, storage of raw materials and
finished goods, particularly the documents supporting these functions, are handled by a single
person. Breaches in internal control in this case are very high.

Q10: Discuss if Keller CPAs or its auditors are breaching any Professional Rules of Conduct and
why or why not?
Solution:
Yes, unfortunately the members of the audit team assigned to Smackeys are breaching any
Professional Rules of Conduct. One violation is under confidentiality. In the case, Pete, a member
of the audit team, has been discussing details of the audit to Alan over few beers. Ethical conduct
and principles require that auditors maintain integrity in performing all responsibilities as regards
the audit with the highest sense of integrity. Not disclosing and discussing details of the audit with
people not members of the audit team is part of this responsibility.
Q11: Discuss the CPA firms legal liability concerns for this audit if they make a material
unintentional or intentional mistake. Include any other legal liability concerns regarding
possible Professional Rule violations.
Solution:
The audit profession agrees that the failure of an audit to uncover material misstatements which
then resulted to the issuance of an incorrect audit opinion makes the auditors discharge of his
audit responsibility and services questionable, particularly on whether such were exercised with
due care. However, how the auditor performed his responsibility as regards the audit and the extent
of the damage incurred by third parties relying on the financial statements will determine his legal
liability.