ACC 410 Auditing Keystone Computer’s & Networks, Inc.
Jacob Burdick January 16, 2012 In preparing for the audit all aspects of a company need to be reviewed. For the preparation of the audit several things must be considered as define in the following pages. The primary focus of the audit is to determine the economic status as well as determine the operational performance of a company. I. Analysis of Audit Strategy A.
Objectives of the Engagement 1. To describe the services that are to be rendered to the client. a. The objectives are to audit KCN’s financial statements for the year ended 12/31/x5. . Issue a letter on compliance with covenants of the client’s letter of credit agreement.
B. Business and Industry Conditions 1. To describe the nature of KCN’s business and industry. a.
KCN sells and services micro-computers, networking hardware and software to business customers. b. The industry is sensitive to economic conditions and very competitive, with KCN competing with companies much larger than itself. c. KCN’s long-term success depends on its ability to attract and retain qualified information technology personnel. d.
The annual growth in spending for information technology products and services is expected to be 6% per year for the next three years. C. Planning Meetings 1. To indicate meetings held with client and with CPA engagement team. a. At this point, one meeting has been held with client personnel and one with the engagement team.
D. Ownership And Management 1. To describe the owners and management of the company. a. KCN is privately owned by Terry Keystone, Mark Keystone, John Keystone, Keith Young, and Rita Young. b.
Terry and Mark Keystone participate in Management. E. Objectives, Strategies, and Business Risks . To describe KCN’s business objectives, major strategies and the risks related to achieving its objectives. a.
The major objective of KNC is to increase revenues by 10% and increase revenues by 12% for each of the next 3 years. Major strategies include: 1. Aggressive advertising 2. Sales to customers with higher risk profiles 3. New software development b.
The primary risks include: 1. Advertising may not create the desired results 2. Credit losses may exceed benefits of increased sales, and software development activities may not produce products.F.
Measurement and Review of Financial Performance 1. Describes the methods used by management to monitor performance. a. Measures used to monitor performance include: 1. Inventory and receivables turnover 2.
Aging of accounts receivable 3. Sales and Gross margins by type of Revenue 4. Net Income, and the total inventory balance. G. Procedures to Obtain an Understanding of the Client and its Environment. 1.
Describes the procedures used by the auditors to obtain an understanding of client and its environment. a. The procedures used include: 1. eview of information from the prior-year’s audit 2.
Inquiries of management 3. reading board minutes 4. review of monthly performance reports 5. review of industry reports, review of the company’s website 6.
review of articles in the Wall Street Journal. H. Audit Approach 1. To describe the overall approach to be taken on the audit. a. Consistent with the previous year's audit, the CPAs will plan to perform tests of controls to assess control risk at less than the maximum for most assertions.
I. Significant Risks 1. To describe the significant risks identified by the auditors. . Two significant risks were identified: 1. KCN has engaged in a strategy to sell to customers with higher credit risk 2.
The officers of the company receive significant bonuses based on quarterly results. J. Significant Accounting and Auditing Matters 1. To describe particular accounting and auditing matters of concern.
a. Two particular concerns exist: 1. proper accounting for extended warranties 2. capitalization of software costs.
K. Planning Materiality 1. To identify an amount to be used as a measure for planning materiality. . Based on an analysis of sales, total assets, and pretax net income, an amount of $70,000 will be used as a measure of planning materiality.
L. Scheduling and Staffing Plan 1. To provide the schedule for major portions of the audit, and the staffing requirements for the engagement. a.
The section includes major dates beginning with interim audit work through the issuance of an updated management letter. A total of 118 hours are budgeted for the audit. II. KCN Risk A. KNC has engaged in a strategy to sell to customers with higher credit risk. 1.
The implication of this factor is there may be an increased risk of misstatement of bad debt expense and the allowance for bad debts. The auditors may decide to assign a more experienced auditor to this audit area. In addition, the auditors will decide to increase the evidence related to the adequacy of the allowance by perhaps examining the credit worthiness of more of the accounts. In addition, the auditors should not rely on tests of related controls that were performed in prior periods.
B. The officers of the company receive significant bonuses based on quarterly results. 1.The implication of this factor is an increased risk that management may misstate quarterly results to maximize bonuses. The auditors may respond by adjusting the staffing of the engagement, increasing the level of skepticism, adding more unpredictability to the audit procedures, or increasing the evidence collected.
The auditors may also increase the extent of the procedures directed at quarterly results. III. KCN Capitalization and Software Development Cost A. In 20X4 KCN began developing networking software product for sale.
This year the company has started capitalizing certain costs of development.FASB Statements (FAS) Nos. 2 and 86, and to a lesser extent, FASB Interpretation No. 6 (FIN 6) provide guidance in this area. FAS 2 makes clear that the nature of the activity for which the software is being developed should be considered in determining whether software costs should be included or excluded in research and development (para. 31).
FIN 6 indicates that to the extent that the acquisition, development, or improvement of a process by an enterprise for use in its selling or administrative activities includes costs for computer software, those costs are not research and development costs.Examples of such costs include development of a general management information system and the computerized reservation system of an airline. This does not appear to be the type of costs involved in this situation. B. FAS 86 further clarifies the issue by stating that all costs incurred to establish the technological feasibility of a computer software product to be sold, leased or otherwise marketed are research and development costs (para.
3). The technological feasibility of a product is established when the enterprise has completed all planning, designing, coding, and testing activities that are necessary o establish that the product can be produced to meet its design specifications including functions, features, and technological performance requirements. Paragraph 4 of FAS 86 provides a summary of tests to indicate whether technological feasibility has been established. C. Costs incurred subsequent to establishing technological feasibility are to be capitalized.
The capitalization of computer software costs ceases when the product is available for general release to customers.Costs of maintenance and customer support should be charged to expense when related revenue is recognized or when the costs are incurred, whichever occurs first. D. The major audit issue involved will be determining that the client has properly categorized costs between research and development (those costs involved in establishing technological feasibility) and those costs that should be capitalized.
The auditors will have to determine at what point the software product reached the point of technological feasibility. | | | |Balance Sheet | | |December 31, | | | | | |Statement of Income and Retained Earnings | | |For the Years Ended December 31, | | | | | | | | | |Acct. No. |Account Name |Adjusted |Unadjusted |Ref # |Dr.
|Cr. |Adjusted | | |1000. 10 |Cash-First National Bank |26,489 |46,753 | | | |46,753 | | |1000. 30 |Cash in register |600 |600 | | | |600 | | |1050. 10 |Accounts receivable-trade |853,452 |1,023,545 | | | |1,023,545 | | |1050. 0 |Accounts receivable-officers |57,643 |84,670 | | | |84,670 | | |1050.
90 |Allowance for bad debts |(9,600) |(10,400) | | | |(10,400) | | |1100. 10 |Inventories |694,744 |903,766 | | | |903,766 | | |1300. 10 |Prepaid expenses |40,640 |42,555 | | | |42,555 | | |2050. 10 |Furniture & fixtures |35,432 |41,633 | | | |41,633 | | |2050.
30 |Office equipment |245,449 |305,450 | | | |305,450 | | |2050. 80 |Leasehold improvements |17,645 |17,645 | | | |17,645 | | |2050. 90 |Accumulated depreciation |(125,976) |(154,732) | | | |(154,732) | | |2100. 00 |Software development cost | |58,674 | | | |58,674 | | |3050. 0 |Accounts payable-trade |(504,641) |(586,699) | | | |(586,699) | | |3100. 00 |Capital lease oblig.
-current |(20,183) |(21,050) | | | |(21,050) | | |3200. 10 |Accrued liabilities |(115,332) |(130,040) | | | |(130,040) | | |3300. 30 |Unearned service revenue | |(22,100) | | | |(22,100) | | |3400. 50 |Line of credit |(309,346) |(365,867) | | | |(365,867) | | |4400.
10 |Capital lease oblig. -noncurr. |(135,465) |(114,415) | | | |(114,415) | | |5050. 10 |Capital stock |(20,000) |(20,000) | | | |(20,000) | | |5100. 10 |Paid-in capital |(41,647) |(41,647) | | | |(41,647) | | |5700. 10 |Retained earnings |(689,904) |(689,904) | | | |(689,904) | | |5900.
0 |Dividends | |90,000 | | | |90,000 | | | |Totals |0 |458,437 | | | |458,437 | | | | | | | | | | | | |6000. 10 |Sales of computers |(9,044,432) |(10,156,898) | | | |(10,156,898) | | |6010. 10 |Service revenue |(187,423) |(210,845) | | | |(210,845) | | |6020. 10 |Consulting revenue |(995,619) |(1,234,763) | | | |(1,234,763) | | |7020. 10 |Cost of sales |6,867,473 |7,397,368 | | | |7,397,368 | | |7070. 10 |Salaries-sales |513,040 |583,438 | | | |583,438 | | |7070.
50 |Payroll benefits-sales |97,478 |125,354 | | | |125,354 | | |7075. 10 |Advertising & promotion |81,644 |92,645 | | | |92,645 | | |7080. 10 |Travel & entertainment |37,628 |44,655 | | | |44,655 | | |7080. 30 |Miscellaneous exp.
sales |16,322 |21,455 | | | |21,455 | | |7090. 10 |Salaries-operations |802,988 |983,455 | | | |983,455 | | |7090. 30 |Salaries-administrative |437,889 |596,060 | | | |596,060 | | |7090. 50 |Payroll benefits-admin. |223,433 |319,876 | | | |319,876 | | |7100.
10 |Rent |124,344 |166,988 | | | |166,988 | | |7140. 10 |Utilities |92,455 |110,876 | | | |110,876 | | |7200. 10 |Insurance |109,723 |93,454 | | | |93,454 | | |7260. 30 |Legal and accounting |73,544 |91,787 | | | |91,787 | | |7320. 10 |Bad debt expense |34,545 |56,477 | | | |56,477 | | |7410. 10 |Supplies |93,844 |119,967 | | | |119,967 | | |7600.
0 |Depreciation |25,644 |28,756 | | | |28,756 | | |7650. 10 |Software development |83,341 |63,222 | | | |63,222 | | |7700. 10 |Miscellaneous exp. -admin. |37,644 |45,333 | | | |45,333 | | |7800. 10 |Interest expense |68,743 |77,434 | | | |77,434 | | |7900.
10 |Current income taxes |71,342 |122,467 | | | |122,467 | | |7900. 70 |Deferred income taxes |3,245 |3,002 | | | |3,002 | | |9000. 00 |P & L Summary |331,165 | | | | |0 | | | |Total Balance Sheet |0 |(458,437) | |0 |0 |(458,437) | | | |Total Income Statement |0 |458,437 | | | |458,437 | | | |Out-of-balance |0 |0 | | | |0 | | | | | | | | | | | | | | | | | | | | | |
