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Auditing & Assurance Services: A Systematic Approach: Evidence and Documentation

Bentley Bros. Book Company publishes more than 250 fiction and nonfiction titles. Most of the company’s books are written by southern authors and typically focus on subjects popular in the region. The company sells most of its books to major retail stores such as Waldenbooks and B. Dalton. Your firm was just selected as the new auditors for Bentley Bros., and you have been appointed as the audit manager for the engagement based on your prior industry experience. The prior auditors were removed because the entity felt that it was not receiving adequate service. The prior auditors have indicated to you that the change in auditors did not result from any disagreements over accounting or auditing issues. Your preliminary review of the company’s financial statements indicates that the allowance for return of unsold books represents an important account (that is, high risk) because it may contain material misstatements. Consistent with industry practice, retailers are allowed to return unsold books for full credit. You know from your prior experience with other book publishers that the return rate for individual book titles can range from 30 to 50 percent. The entity develops its allowance for return of unsold books based on internally generated records; that is, it maintains detailed records of all book returns by title. Required: a. Discuss how you would assess the reliability of the entity’s records for developing the allowance for return of unsold books. b. Discuss how you would determine the return rate for relatively new titles. c. Consider whether any external evidence can be obtained that would provide additional evidence on the reasonableness of the account.