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Audit Design Program Part II

Team B

ACC/546

March 12, 2012

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Apollo Shoes, Inc. – Test of Controls, Substantive Test and Analytical Procedures

During the audit plan, there are three important cycles that will be of focus for our team,

they are Sales and Collection Cycle, Payroll and Personnel Cycle, and Acquisition and Payment

Cycle. There are five classes of transactions in the sales and collection cycle; sales cash receipts,

sales return and allowances, charge-off uncollectible accounts, and estimate of bad debt expense.

Under the sales class are four business functions and the under the other classes are one each.

Business functions in the sale class cover, processing customer orders, granting credit, shipping

goods, and billing customers and recording sales (Arens, Elder, & Peasley, 2006). We want to

mention that payroll cycle has one class of transaction, but has four business functions; personnel

and employment, timekeeping, and payroll processing, payment of payroll, and preparation of

payroll tax returns and payments of taxes (Arens, Elder, & Peasley, 2006). Acquisition and

payment cycle has three classes of transactions; acquisition of goods and services, cash

disbursement and purchase returns and allowances and purchase discount. The first cycle has

three business functions; processing purchase orders, receiving goods and services, and

recognizing the liability (Arens, Elder, & Peasley, 2006). Finally, in order to conduct a fair and

unbiased audit, our team have formulated and designed the test of controls, substantive test of

transactions and analytical procedures for the sales and collection cycle, payroll and personnel

cycle and lastly the acquisition and payment cycle. We feel these tools will be conducive in

allowing us to give your organization a complete, accurate and reasonable opinion, while

remaining in compliance with the guidelines set and generally accepted during this audit process.

Test of Controls

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Test ControlsSales and Collection Cycle

Test of Control Recorded sales are for shipments made to customers.(Existence, Completeness)

Examine sales invoices and compare bill of lading with customers order form also check for appropriate authorizing signatures.

Confirm corresponding shipping/delivery documents exists for invoices.

Test of Control Sales of goods shipped/delivered are correctly billed and recorded.(Accuracy)

Review sales invoices for order quantities and check that they match with the shipping/delivery documents.

Observe whether monthly statements are sent to customers.

Test of Control Determine if all transactions are properly classified. (Classification)

Examine documents to ensure signatures are present from verification.

Review sales invoices for billing classification.

Match classification to customer agreements.

Test of Control Sales are recorded timely. (Cutoff)Sales and invoices match the sales journal totals for the day.

Test the controls to confirm that sales are recorded on the day of the transactions.

Check customer order forms by number sequence on shipping documents.

Check that order form match with corresponding

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sales invoices. Check sales invoices against the sales journal to

confirm they have been recorded on the same date.

Review and total all sales invoices and compare them to the sales journal. Verify that the totals match minus any returns.

Review the sales journals and calculate the average sales per day, week, and month.

Test of Control Sales transactions are properly recorded in accounts receivable. (Valuation and Allocation)

Test the test controls to determine if the accounts receivable master file matched the sales journal.

Examine accounts receivable reconciliation.

Observe whether customer statements are sent out monthly, verify the customers owing balance on the AR journal and the total sales for the year matches company records.

Test of Control

Cash receipts are received. (Existence and Completeness)Cash receipts are posted to customer accounts.(Accuracy and Classification)

Observe whether proper signatures are present.

Observe whether monthly statements are sent.

Observe whether the bank statement is reconciled.

Test of Control Determine if returned sales have been deduct and returned to inventory. (Accuracy, Existence, Completeness)

Review all returned merchandise invoices against the sales journal.

Review monthly billing statements against the return invoices to verify customers have received credit for the return.

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Review return invoice totals against the sales journal totals and calculate the percentage of returns against total sales.

Test of Control Determine the amount of debt, determine is charge-off are handle properly and properly recorded, determine the extent of the bad debt, determine if the accounts with past due balances and prior credit approval.(Existence, Accuracy, Completeness, Valuation)

Review the age trail balance and investigate accounts with a balance over 90 days.

Determine which accounts have been sent to collection and which accounts have filed bankruptcy.

Determine which accounts have made alternate payment arrangements and which are not likely to pay.

Check with the credit department and determine if any of the accounts with a past due amount greater than 90 days had prior credit approval.

Test of Controls Payroll and Personnel Cycle

Test of Control Recorded employee’s payroll payments. (EO)Time cards are properly approved by supervisors.Examine time clocks for proper functioning.Examine employee’s files for employment authorization.

Test of Control Existing payroll transactions are recorded. (CP)Account for a sequence of payroll checks.Discuss with employees and observe reconciliation. Review bank reconciliation and verify it is reviewed and approved by manager.

Test of Control Payments are for work actually performed by existing employees and are proper pay rates; withholdings are properly calculated. (EO, CP, A)Review a selection of timecards to ensure;

Time clock is used to record time

Time cards are properly approved by supervisors

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Trace hours to payroll register

Review the payroll journal, general ledger, and earning records for large or unusual items. Examine authorizations in personnel file.

Test of Control Separation of duties (EO)Ensure there is a separation of duties among personnel, timekeeping, and payroll disbursements.

Review organization chart

Discuss with employees

Observe performance of duties.

Observe access to payroll master file and other payroll records is restricted to authorized employees.Observe access to personnel files and other HR records is restricted to authorized employees.

Test of Control Payroll transactions are properly classified (CL)Review chart of accounts.Examine indication of internal verification.Compare classification with chart of accounts or procedures manual.

Test of Control Payroll transactions are recorded on the correct dates. (T)Review when payroll transactions are recorded.Compare date of check in payroll journal to date on cancelled check and timecard.Compare date on check with date cleared the bank statement.

Test of Control Payroll transactions are properly included in the payroll master file and properly summarized. (P, A)Foot payroll journal to confirm accuracy.Payroll master file totals are compared with general ledger totals.

Test of Controls Acquisition and Payment Cycle

Test of Control Verify documents from requisitions are prepared and transmitted in duplicates to the correct departments. (CP)Check to see proper invoices, reports, and relating documentation is current.

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Test of Control Acquisitions are in connection with items ordered. ( Existence)Accounts for sequences of receiving reports, vouchers, and purchase orders (Arens, Elder, & Beasley, 2006).

Test of Control Acquisitions are accurate. (Accuracy)Examine internal acceptance.Examine batch totals for authoritative signatures.Compare to computer summary.Examine permitted approval of purchases and payments.

Test of Control Acquisitions are classified correctly. (CL)Review the acquisitions journal entries.

Determine if the entries reflect the appropriate classification.

Determine if the classification matches the appropriate department and use.

Test of Control Acquisitions are dated correctly. (Timing)Determine if there is evidence that there is follow up to ensure transactions are being recorded on the appropriate date. Examine to see if invoices of vendors are missing.

Test of Control Determine if the disbursements have been completed accurately. (A)Review vendor invoices/billing statements, receiving reports and the acquisition journals. Review subsequent payments to determine if prior period expenses were properly accrued. Review the cancelled checks and determine if dates listed on the checks match the dates listed on the cash disbursement journal.Review bank statements for company accounts and reconcile the totals with system account balances.

Test of Control Acquisition are included in accounts payable and referenced in master files of inventory and accounts payable (Posting and summarization)Examine verification party signatures.Examine initials on general ledger accounts.Examine accounts payables comparing this to the purchase order and receiving reports.

Substantive Tests of Transactions

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Substantive tests of transactions have similarities and differences in the sales and

collection cycle, payroll and personnel cycle and acquisition and payment cycle. In each cycle,

transaction-related audit objectives should be identified and substantive tests should be designed

to determine if the objective is met. Tests completed before the balance sheet date must follow

the procedures set forth by the Public Company Accounting Oversight Board in AU Section 313.

Below is a listing of the substantive tests for each cycle.

Sales and Collection Cycle

Under the sales and collection cycle, sales and cash receipts or collections are distinctive

pieces requiring separate tests. The first key audit objective under sales is to determine whether

or not recorded sales are related to shipments that were actually made to customers. As noted in

the initial testing, there are areas of concern surrounding invoices that should be explored further

(Louwers & Reynolds, 2006). In order to test this, the auditor should perform a test to account

for a sequence of invoices. The next test to confirm recorded sales is a review of the journals for

unusual transactions. Finally, the auditor should confirm existence of appropriate sales

documentation such as sales orders, bills of lading and other documentation (Arens, Elder &

Beasley, 2006).

The next objective that should be confirmed is completeness meaning that existing sales

transactions are recorded. To confirm this, the auditor should select shipping documents and

confirm that the appropriate corresponding amounts are recorded in the journals (Arens et. al.,

2006).

The third audit objective that should be explored for sales is to determine if the sales

that are recorded are for the correct amounts. In order to confirm this, the auditor should confirm

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that there are corresponding sales invoices for entries in the sales journal. Next, the auditor

should recalculate the amounts on the invoices to confirm they were arithmetically correct. The

auditor(s) should also confirm the details of the sales invoices (Arens et. al., 2006).

Other audit objectives that should be confirmed for sales are that the sales are properly

classified recorded on the correct dates and are accurately reflected in the accounts receivable

master file. In order to confirm the sales are properly classified, the sales invoices should be

examined to confirm the classification. The sales journals should be examined and compared to

the invoices to confirm the timing (Arens et. al., 2006).

For cash receipts, the first objective is to confirm that the cash receipts recorded were

actually received. The cash journals should be reviewed for unusual amounts. A proof of cash

receipts should be created. The cash entries should be reconciled to the bank statements (Arens

et. al., 2006).

The next objective is to confirm completeness meaning to determine if the cash received

was recorded in the cash journal. The first step to confirm completeness is the auditor should

compare a cash prelisting with the journal confirming details such as names, amounts and dates.

The next step is confirming the amounts on the prelisting tie to deposit slips (Arens et. al., 2006).

The remaining objectives for cash are confirming that the amounts are recorded

accurately, the receipts are classified properly, recorded on the correct dates and are properly

recorded in the accounts receivable mater files. In order to complete these steps, the same basic

substantive tests should be performed as in the sales portion of the cycle (Arens et. al., 2006).

Payroll and Personnel Cycle

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The first objective in the payroll and personnel cycle is to confirm existence meaning

that it should be confirmed that the payments were made to actual employees. In order to

accomplish this, a review of any unusual amounts in the payroll journal and earnings records

should be completed. Details of cancelled checks should be confirmed to match the payroll

journals. Additionally cancelled checks should be reviewed to determine if they have proper

endorsements and are consistent with personnel records (Arens et. al., 2006).

The next objective that should be tested is completeness. The first test that should

be completed is that payroll disbursements in the journal should equal those on the payroll bank

statements. Finally, a reconciliation of bank statements should be completed (Arens et. al.,

2006).

The next objective that should be tested is accuracy. The first step is that hours, gross

pay and net pay should be recomputed using the time cards to ensure the correct amounts were

paid. Pay records should be compared to any union contracts or other contracts. Next pay

withholdings should be confirmed to make sure they adhere to the tables (Arens et. al., 2006).

The remaining objectives to be tested are confirming that transactions are properly

classified, that the correct timing is reflected and that payroll transactions are properly reflected

in the payroll master files. To confirm classification, the auditor should review transactions to

ensure they are consistently reflected to the appropriate accounts in the chart of accounts.

Transactions should be reviewed to determine if the expenses are reflected in the appropriate

periods by comparing the dates recorded on the checks with the payroll journal (Arens et. al.,

2006).

Acquisition and Payment Cycle

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The first objective that needs to confirm in acquisition and payments is existence. Tests

that should be performed to confirm this objective are that the journal should be reviewing for

unusual amounts, underlying documents should be reviewed for reasonableness and authenticity,

the vendor master file should be reviewed for unusual vendors and the fixed assets that were

acquired should be examined (Arens et. al., 2006).

The next objective that should be confirmed is completeness. To confirm this, a file of

receiving reports and file of vendors’ invoices should be compared to the acquisitions journal

(Arens et. al., 2006).

The third objective that should be examined is accuracy. A test that should be

performed for this objective is a comparison of the recorded transactions with supporting

documentation such as vendors’ invoices. Another test is that clerical accuracy of the vendor’s

invoices should be recalculated (Arens et. al., 2006).

Other objectives that should be tested are confirming classification, timing and the

existence of these transactions in the accounts payable and inventory master files. To confirm

classification, the auditor should review transactions to ensure they are consistently reflected to

the appropriate accounts in the chart of accounts. Transactions should be reviewed to determine

if the expenses are reflected in the appropriate periods by comparing the dates recorded on

documentation with the acquisition journal (Arens et. al., 2006).

Analytical Procedures

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Our team of auditors’ designed analytical procedures to evaluate financial information

and its relationship in comparison to previous year financial data. In following the guidelines of

Statement of Auditing Standards no. 56, the analytical procedures for the cash and collections

cycle, payroll and personnel cycle and the acquisition and payments cycle are found the

following tables:

Design of Analytical Procedures for Cash and Collection Cycle

Analytical Procedures Possible MisstatementsCompare gross margin percentage with previous years

Overstatement or understatement of sales and accounts receivable

Compare sales returns and allowances as a percentage of gross sales with previous years

Overstatement or understatement of sales returns and allowances and accounts receivable.

Compare bad debt expense as a percentage of gross sales with previous years.

Uncollectible accounts receivable that have not been provided for.

Compare days that accounts receivable are outstanding with previous years

Uncollectible accounts receivable to assess the reasonableness of the allowance for uncollectible accounts.

Compare allowance for uncollectible accounts as a percentage of accounts receivable with previous years

Overstatement or understatement of allowance for uncollectible accounts and bad debt expense.

Compare charge-off of uncollectible accounts as a percentage of total accounts receivable with previous years

Overstatement or understatement of allowance for uncollectible accounts and bad debt expense.

Design of Analytical Procedures for Payroll and Personnel Cycle

Analytical Procedures Possible MisstatementsCompare payroll expense account balance with previous years.

Misstatement of payroll expense accounts.

Compare direct labor as a percentage of sales with previous years.

Misstatement of direct labor and inventory.

Compare commission expense as a percentage Misstatement of commission expense and

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of sales with previous years. commission liability.Compare payroll tax expense as a percentage of salaries and wages with previous years.

Misstatement of payroll tax expense and payroll tax liability.

Compare accrued payroll tax accounts with previous years.

Misstatement of accrued payroll taxes and expense.

Compare payroll benefits expense as a percentage of salaries and wages with previous years.

Misstatement of payroll benefits expense and payroll benefits liability.

Compare accrued payroll benefits accounts with previous years.

Misstatement of accrued payroll benefits and payroll benefits expense.

Design of Analytical Procedures for Acquisition and Payment Cycle

Analytical Procedures Possible MisstatementsCompare depreciation expense divided by gross equipment cost with previous years.

Misstatement in depreciation expenses and accumulated depreciation.

Compare accumulated depreciation divided by gross equipment cost with previous years.

Misstatement in accumulated depreciation.

Compare monthly or annual repairs and maintenance, supplies expense and other similar accounts with previous year.

Expensing accounts that should be capitalized.

Compare individual expenses with previous years.

Overstatement or understatement of a balance in an expense account.

Compare individual asset and liability balances with previous years.

Overstatement or understatement of a balance sheet account that will also affect an income statement account.

Compare individual expenses with budgets Misstatement of expenses and related balance sheet accounts.

Compare gross margin percentage with previous years.

Misstatement of cost of goods sold and inventory.

Compare inventory turnover ratio with previous years.

Misstatement of cost of goods sold and inventory.

Compare prepaid expenses with previous years.

Misstatement of expense and prepaid accounts.

Compare commission expenses divided by sales with previous years.

Misstatement of commission expense and accrued commissions.

Compare individual manufacturing expenses divided by total manufacturing expenses with previous years.

Misstatement of individual manufacturing expenses and related balance sheet accounts.

Conclusion

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As a final point, our team designed the test of controls, substantive test of transactions

and analytical procedures necessary to perform an audit on the Sales and Collection Cycle,

Payroll and Personnel Cycle and Acquisition and Payment Cycle. The test we designed will

focus on determining whether or not recorded sales are related to shipments in the sales and

collection cycle. In addition, designs were put in place to confirm payments made to actual

employees in the payroll and personnel cycle. Furthermore, we designed test to confirm

classification, timing and existence of transactions in the acquisition and payment cycle. And

lastly, we feel the designs we are utilizing during our audit process will confirm the importance

of conducting such testing and procedures to reasonably ensure the proper controls are in place

and detect any misstatements in the financial statements due to errors or fraudulent activities.

References

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Arens, A. A., Elder, R. J., & Beasley, M. S. (2006). Auditing and assurance services: an

integrated approach (11th ed.). New York, NY: Pearson.

Public Company Accounting Oversight Board. (2012). AU Section 313: Substantive tests prior

to the balance sheet date. Retrieved from: http://pcaobus.org/Standards/Auditing/

Pages/AU313.aspx.

Louwers, T. J., & Reynolds, J. K. (2002). Apollo Shoes casebook. New York, NY: McGraw-

Hill.

Content60 Percent

Points Available

7.0

Points EarnedX/7.0

Additional Comments:

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Design and fully describe each of the designed tests

Show concrete connections between analytical procedures and the tests selected for each cycle

Demonstrate an understanding of current industry practices, including non-statistical procedures and integration of information technology into the auditing process.

7.0

Excellent work. Each area outlined well and the testing matrices were very well organized.

Sales and payroll cycle well researched and described.

Payable section contained great description of controls. Payroll section described well with good details.

Organization / Development20 Percent

Points Available

2.5

Points EarnedX/2.5

Additional Comments:

Paper is appropriate length Paper provides sufficient background on the topic and

previews major points

Paper is logical, flows, and reviews the major points2.5

Paper length appropriate.

Major points discussed effectively.

Paper is logical and flows smoothly

Mechanics 20 Percent

Points Available

2.5

Points EarnedX/2.5

Additional Comments:

Formatting or layout and graphics pleasing to the eye (font, colors, spacing)

Rules of grammar, usage, and punctuation are followed, and spelling is correct

APA

2.5

Format and layout appropriate.

Grammar appropriate.

APA followed.

Total Available

Total Earned

  12 12 Overall, a comprehensive job.