ACC: 410, Auditing

Sysco Case

Department of Accounting, American University of Sharjah

Prof. Ashraf Khallaf

December 2, 2022

Amina Ali Alhamdan, g00084256

Najia , g00085315

Fatma Jaber Al Ali, g00083167

PART A
Question [1]
[a] What should the auditor consider when determining whether an account should be
considered significant?
An auditor should primarily consider the impact of the qualitative and quantitative factors
affecting whether the account exceeds the planning materiality. Generally speaking, an
account is deemed to be significant in the event of it surpassing the planned materiality
level. However, in certain circumstances qualitative or quantitative factors conflict with
each other and result in the auditor’s need for professional judgment in determining the
significance of an account.
Specifically, a quantitative assessment requires identifying an adequate percentage of
planned materiality on the basis of the risk assessment procedures.
On the other hand, qualitative factors in order to determine the significance of an account
will include the following:
• Susceptibility of loss due to errors or fraud;
• Volume of activity, complexity, and homogeneity of the individual transactions
processed through the account;
• Nature of the account;
• Accounting and reporting complexities associated with the account;
• Exposures to losses represented by the account;
• Likelihood of significant contingent liabilities arising from the activities represented by
the account;
• Existence of related party transactions in the account, and
• Changes in account characteristics from the prior period.

[b] What qualitative factors might cause an account that is otherwise relatively small
quantitatively to be considered significant?

The aforementioned qualitative characteristics that are assessed to have inherent

and fraudulent risks may lead the auditor to consider the account significant. To
demonstrate, under the circumstance that these qualitative factors result in the auditor
acquiring reasonable suspicion that there might be material misstatement, that particular
account will be deemed to be significant.

[c] What qualitative factors might cause an account that is greater than materiality to be
considered not significant?
In contrast, certain qualitative factors may result in the auditor determining that
the account is insignificant despite the quantitative factors indicating otherwise. To
illustrate, if the qualitative factors are reversed and the auditor determines that the
account is not complex, there is low susceptibility to error, the account requires a low
level of activity, the auditor may not perform additional testing.
Question [2] Referring to Delmoss Watergrant's policy for identifying significant accounts
(see Appendix A) as well as Sysco's consolidated balance sheet and income statement,
answer the following questions:

[1] Determine a planning materiality threshold to use to identify significant accounts for
Sysco. Please show your work and justify judgments.

Level of Materiality Net Sales Net Income Planned Sales Planned

Income Materiality Materiality

High (5% NI, 2% S) 589,602 1,987,174 29480.1 39743.48

Moderate (4% NI, 589,602 1,987,174 23584.08 29807.61

1.5% S)

Low (3%NI, 1% S) 589,602 1,987,174 17688.06 19871.74

In this case, we will be identifying the planned materiality as 4% as a result of the

moderate assessed risk, with the benchmark of Total Income because there are no specific
indicators showing that any other benchmarks should be used. Therefore, we will
consider the planning materiality to be 23584.08.

[b] At a consolidated financial statement level, are there accounts on Sysco's financial
statements that are greater than planning materiality that should not be considered
significant? Please justify your response.

In this case, we have considered property plant and equipment to be an

insignificant account despite it being greater than the planned materiality. The tolerable
materiality of this account is calculated to be 75%*868,438 = 651,328.5 which is above
the planned materiality. But because this account faces low risk in terms of fraud and
inherent risk factors and possible misstatements, it is considered to be insignificant.
Additionally, raw materials also have a value greater than planned materiality; however,
they are considered insignificant because of the low-risk nature of the business as well as
the fact that there were no previous material misstatements mentioned in the previous
years.

[C] Identify two accounts, at the consolidated level, that are not quantitatively significant,
but that should be deemed significant due to qualitative factors. Provide the qualitative
factors you considered.
 An account that is not quantitatively significant yet requires further testing by the
auditor as a result of its qualitative significance is Accounts Receivables. This is
primarily due to the inherent business risk associated with such an industry as well as the
organization-specific risks. To illustrate, the bike-manufacturing business is quite risky
because the nature of the business leads to the relevant dependence upon credit sales
which leads to an elevated fraud and error risk. Additionally, Accounts receivables is an
account that requires a significant amount of activity, complex application of accounting
principles, as well as the usage of personal judgment in terms of determining the aged
receivables. With regards to the risks associated with Sysco, the company is seeking to
increase their market share within the industry; therefore, the managers may have an
incentive to override the accounting system and present a materially misstated accounts
receivables in order to inflate net income.
Yet another account that is below the materiality threshold but must be considered
significant due to the associated risk is goodwill. This is because there is a high
financially manipulative risk to achieve inflated assets and demonstrate the desired ratios.
This may be the result of the manufacturing industry’s need to maintain certain liability
contingencies in order to keep acquiring the same level of inventory and raw materials to
stabilize the flow of operations.

[d] Which Sysco business units (geographic locations), if any, would not be considered
quantitatively significant? Which business units (locations) have specific risks that would
render the unit significant regardless of its quantitative size?

The Sysco business units that are not considered to be quantitatively significant
are the US Northeast. This is because the net income and total assets of the US Northeast
is $11,541 and 153,994 which is the lowest when compared to other business units.

The business units which would be considered significant regardless of its

quantitative size is Mexico. This might be because of the resignation of the Mexican
Finance Direct which indicates a new director will be hired and there is a possibility of
weak internal control which makes this unit risky even though its size is small.

[e] If you had to eliminate or scope out one entire business unit (geographic location),
which unit would it be? Please justify your response and include both quantitative and
qualitative reasons for doing so.

If one business unit had to be eliminated, it would be the US Northeast unit. This
is because quantitatively, it has the lowest net income of $11,541 and total assets of
$110,663 which does not reach the minimum threshold the unit significant. From the
qualitative aspect, this unit has not mentioned financial misstatements in prior years.
 They also did not go through a change in management (like the resignation of the finance
director of Mexico), which poses lower risk of weaker internal control due to change in
management.

[3] Auditing standards require the identification and testing of entity-level controls. What
are examples of entity-level controls? What are the auditor's responsibilities with respect to
evaluating and testing a client's period-end financial reporting process?

Entity level control refers to the implementation of COSO’s framework in order

to achieve the desired level of IC effectivity. To illustrate, the entity-level controls
implemented by Sysco.Inc emphasize the importance of the areas of corporate
governance and social responsibility effectively establishing the control environment
through hiring a highly respected business leader, Sophie Morris, Chairman and Chief
Executive Officer of the Rubio Company to strengthen the Board of Directors in their
company. They also strengthened their internal audit function by hiring Jenna Jaynes,
immensely competent personnel with an impressive career history. This significantly
improves the management’s established tone at the top regarding the management’s
intolerance towards material misstatements as well as significantly increases the potential
of a competent ICFR. Furthermore, the establishment of the successful accounting system
that integrates the financial statements from the numerous business units demonstrates an
effective function of information and communication.

Furthermore, with regards to the auditor’s responsibilities, under Section 404 and
AS2201.01 an independent auditor must audit and report on the effectiveness of internal
control. The auditor is required to conduct an integrated audit of the entity’s internal
control over financial reporting and its financial statements in order to provide reasonable
assurance regarding the fair representation of the financial statement with accordance to
GAAP as well as the effectiveness of the internal control system. They should perform an
independent evaluation of the design and operating effectiveness of the controls for each
of the components of internal control that relate to relevant assertions for all significant
accounts and disclosures in the financial statements. They should also independently
identify each significant process over each major class of transactions and test controls at
enough significant locations to obtain sufficient competent evidence regarding the
effectiveness of internal controls over financial reporting.

PART B
[1] What are the definitions of a control deficiency, significant deficiency, and material
weakness as contained in AS 2201? Which, if any, of these deficiency categories must the
external auditor include in the audit report?

Control deficiency: “A control deficiency exists when the design or operation of a

control does not allow management or employees, in the normal course of performing
their assigned functions, to prevent or detect misstatements on a timely basis”. Control
deficiencies encompass all deficiencies, including significant deficiencies and material
weaknesses.

Significant deficiency: “A significant deficiency is a deficiency, or a combination

of deficiencies, in internal control over financial reporting that is less severe than a
material weakness, yet important enough to merit attention by those responsible for
oversight of the company's financial reporting.”

Material weakness: “A material weakness is a deficiency, or a combination of

deficiencies, in ICFR, such that there is a reasonable possibility that a material
misstatement of the annual or interim financial statements will not be prevented or
detected on a timely basis.” Material weaknesses should be included in the audit report
after notifying the management about it.

[2] Referring to Delmoss Watergrant's policy for evaluating control deficiencies (see
Appendix B), determine if the following three deficiencies represent a control deficiency, a
significant deficiency, or a material weakness. Please consider each case separately and
justify your answers.

Question [2]
[a] There is an operational deficiency within the revenue recognition control.
Despite the implementation of an adequate design of control in order to detect
unauthorized revenue and pricing, the management has failed to correctly operate it 4%
of the time resulting in improper pricing and discounts as well as inaccurate sales.
However, because this deficiency reflects an insignificant account holding about 10% of
total revenues, and the auditor is 95% confident that the errors do not exceed 9%, this
deficiency is not considered material or significant. This is justified by the rule mentioned
in Appendix B indicating that an exception not exceeding 10% is not to be considered a
significant deficiency.

[b] The cutoff error of 2.3 million is deemed to be below the planning materiality
of 23584.08*10%= 2358.408 in millions; therefore, this deficiency is considered to be
 significant but not material. In determining the likelihood and magnitude of the
deficiency, we have identified that the misstatement has a significant possibility of
affecting third-party’s judgment because it also has an impact on other financial
statement accounts as well the function of revenue recognition in terms of proper cutoff.
Overall, revenue must be recognized only after the order has been shipped to the
customer despite having adequate inventory to meet the orders in subsequent periods.
This further justifies the significant control deficiency.

[c] There is no deficiency in this account. Even though the auditor has determined
the possibility of a material understatement within the allowance of doubtful accounts as
a result of certain periods of rapid sales requiring management override of controls, there
are certain controls reducing the magnitude of the misstatements. To illustrate, the
management’s implementation of compensatory controls such as the reassessment of the
aging receivables and a control addressing the consumers with poor credit history, will
lead to a significant reduction of the magnitude of the operating deficiency.

[3] How might the overconfidence tendency affect management's assessment of the
likelihood and magnitude of potential misstatement from an observed control deficiency? If
the auditor believes that management's assessment is biased by overconfidence, how might
the auditor help management recalibrate their assessment?

Overconfidence is a form of bias which could impair the accuracy of the auditor's
decisions when performing an audit. Overconfidence, as a result, may alter management's
judgment of both, extent and likelihood of possible misstatements from a detected control
defect.

Due to the bias resulting from overconfidence, management sometimes loses the
awareness needed to make an appropriate evaluation. Furthermore, it is probable that the
management is composed of stubborn individuals who refuse to alter their behavioral
attitudes. The auditor may educate the management of their bias assumptions and
evaluations in order to assist them readjust their judgment. Because of this understanding,
managers can re-evaluate the possibility and extent of misstatements. Furthermore, the
auditor can inform the management of their missing skills and necessary knowledge
needed in order to conduct a proper and fair assessment.