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Audit Design Program Part II Team B ACC/546 March 12, 2012

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

Test Controls
Test of Control

Sales and Collection Cycle

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 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. 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. 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

Test of Control

Test of Control

invoices to verify customers have received credit for the return. 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
Test of Control

Payroll and Personnel Cycle

Recorded employees payroll payments. (EO) Time cards are properly approved by supervisors. Examine time clocks for proper functioning. Examine employees files for employment authorization. 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. 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

Test of Control

Test of Control

Time cards are properly approved by supervisors Trace hours to payroll register

Test of Control

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

Test of Control

Test of Control

Test of Control

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

Acquisition and Payment Cycle

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.

Test of Control

Test of Control

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

Test of Control

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. 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. 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

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 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 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

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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 vendors 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 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

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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
Compare gross margin percentage with previous years Compare sales returns and allowances as a percentage of gross sales with previous years Compare bad debt expense as a percentage of gross sales with previous years. Compare days that accounts receivable are outstanding with previous years

Possible Misstatements
Overstatement or understatement of sales and accounts receivable Overstatement or understatement of sales returns and allowances and accounts receivable. Uncollectible accounts receivable that have not been provided for. Uncollectible accounts receivable to assess the reasonableness of the allowance for uncollectible accounts. Overstatement or understatement of allowance for uncollectible accounts and bad debt expense.

Compare allowance for uncollectible accounts as a percentage of accounts receivable with previous years Compare charge-off of uncollectible accounts as Overstatement or understatement of allowance a percentage of total accounts receivable with for uncollectible accounts and bad debt expense. previous years

Design of Analytical Procedures for Payroll and Personnel Cycle

Analytical Procedures
Compare payroll expense account balance with previous years. Compare direct labor as a percentage of sales with previous years. Compare commission expense as a percentage of sales with previous years. Compare payroll tax expense as a percentage of salaries and wages with previous years. Compare accrued payroll tax accounts with previous years.

Possible Misstatements
Misstatement of payroll expense accounts. Misstatement of direct labor and inventory. Misstatement of commission expense and commission liability. Misstatement of payroll tax expense and payroll tax liability. Misstatement of accrued payroll taxes and expense.

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

Misstatement of payroll benefits expense and payroll benefits liability. Misstatement of accrued payroll benefits and payroll benefits expense.

Design of Analytical Procedures for Acquisition and Payment Cycle

Analytical Procedures
Compare depreciation expense divided by gross equipment cost with previous years. Compare accumulated depreciation divided by gross equipment cost with previous years. Compare monthly or annual repairs and maintenance, supplies expense and other similar accounts with previous year. Compare individual expenses with previous years. Compare individual asset and liability balances with previous years.

Possible Misstatements
Misstatement in depreciation expenses and accumulated depreciation. Misstatement in accumulated depreciation. Expensing accounts that should be capitalized.

Overstatement or understatement of a balance in an expense account. 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 Misstatement of cost of goods sold and years. inventory. Compare inventory turnover ratio with previous Misstatement of cost of goods sold and years. inventory. Compare prepaid expenses with previous years. Misstatement of expense and prepaid accounts. Compare commission expenses divided by sales Misstatement of commission expense and with previous years. accrued commissions. Compare individual manufacturing expenses Misstatement of individual manufacturing divided by total manufacturing expenses with expenses and related balance sheet accounts. previous years. Conclusion 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

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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 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

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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: McGrawHill.

Content 60 Percent

Points Available 7.0

Points Additional Comments: Earned X/7.0 7.0 Excellent work. Each area outlined well and the testing matrices were very well organized.

Design and fully describe each of the designed tests Show concrete connections between analytical procedures and the tests selected for each cycle

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

Sales and payroll cycle well researched and described. Payable section contained great description of controls. Payroll section described well with good details.

Organization / Development 20 Percent

Points Available 2.5

Points Additional Comments: Earned X/2.5 Paper length appropriate. 2.5 Major points discussed effectively. Paper is logical and flows smoothly

Paper is appropriate length Paper provides sufficient background on the topic and previews major points Paper is logical, flows, and reviews the major points

Mechanics 20 Percent

Points Available 2.5

Points Additional Comments: Earned X/2.5 Format and layout appropriate. 2.5 Grammar appropriate. APA followed.

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 Total Available 12

Total Earned 12 Overall, a comprehensive job.