Last updated: April 25, 2019
Topic: BusinessCompany
Sample donated:

Keystone Case Study


Question 6C-1:

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Section                                                                                       Purpose                                                                          Content


Audit approach






Significant risks






Significant accounting

& auditing matters





Planning materiality






Scheduling & staffing

The method of internal control

to be used





Risks identified about KCN and its environment





Need to review accounting methods with FASB requirements




Using operating results as basis for estimating materiality amounts for planning purposes




Tentative dates for internal audit



Control procedures’ same as last year. Plan to perform tests of controls to assess control risk at less than the maximum for financial statements.


The risks are: (1) strategy to sell to customers with high credit risks, and (2) company officers performance based bonuses on quarterly reports.


Methods to be reviewed with FASB requirements are (1) revenue recognition, and (2) capitalizing certain costs of development


Steady growth in sales and earnings in last three years. Hence, using percentages of financial statement bases’ to, compute planning materiality.


The audit schedule is:

(1)         Begin interim audit work November 10, 20X5

(2)         Complete interim audit work by November 15, 20X5

(3)         Issue management letter on interim work by November 30, 20X5

(4)         Observe physical inventory December 30, 20X5

(5)         Begin year-end audit work February 12, 20X6

(6)         Complete fieldwork by February 20, 20X6

(7)         Closing conference February 2

(8)         Issue audit report by March 5, 20X6

(9)         Issue letter required by financial agreement by March 5, 20X6

(10)       Issue updated management letter by March 19, 20X6


The staffing time requirements for the engagement are:

Total (195) with Interim (98) and Final (97)


Question 6C-2

Risk                                                                                                                                                                                                                                                                                                                                       Implications and response


(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
Increased number of higher credit losses, which may exceed the increase in sales. This risk is dealt by daily review of aging of accounts receivable by Loren Steele, controller.


These are increased expenditures, which may not produce desirable results. This risk can be checked by giving bonuses on basis of performance by officers, on quarterly intervals.
Question 6C-3


Development Software which is capitalized by this standard, must be amortized in an organized and logical method over the estimated useful life of the software. This estimated useful life for amortization has to be consistent with the one used for planning the software’s acquisition.

For every module of a software, the amortization should start as that module has been tested successfully. If the use of that module is relying on completion of some other module, the amortization of that module should commence when both that module and the other module has been successfully tested.

Any additions to the book value or changes in useful life should be treated appropriately. The change(s) have to be accounted for the period of the change and future periods. No adjustments to be done to previously done amortization. When replacing current internal use software with a new software, then the unamortized cost of the old software has to be expensed when the new software has acheived successful testing.Then the salvage value for all capitalized internal use software should be kept zero.


Question 6C-4b:

Accounts to be identified are:

1        Accounts receivable

2        Average sales per day

3        Net sales

4        Average inventory

5        Cost of goods sold

6        Gross profit

Question 6C-4c:

Days’ sales in Accounts receivables: The ratio for firm for 20X5 is 29.2, as compared to the industry average of 37.0. In previous year the ratio of the firm was 33.2. The ratio is calculated by dividing accounts receivable by average sales per day; it indicates the average length of time the firm must wait after making a sale before it receives cash. Keystone inc. this year adopted the policy of engaging with customers with high credit risks, but the trend shows that customers are paying their bills on time.

Inventory turnover and days inventory on hand: The inventory turnover ratio for the firm for year 20X5 is x9.3, while for the industry is 10.0. This ratio was x10.4 last year. The ratio is calculated by dividing sales by inventories. The days inventory on hand for the firm is 39.4 for year 20X5, while for the industry is 36.0. This ratio was 35.2 for the firm last year.  These ratios suggest that Keystone is holding too much inventory. Excess inventory is very unproductive and it is usually a resultant of an investment with a low or zero rate of return. The low inventory makes us also wonder whether the firm is actually holding obsolete goods not worth their stated value.

Gross profit ratio: This ratio for the firm for the year 20X5 is 36.2%, while for the industry it is 24.0%. The same ratio for the firm during the last year was 32.9%. The ratio is found by dividing gross profit by net sales. An increase in the ratio suggests that the cost of goods sold may have decrease, which shows that production of each unit i.e. the operations have been efficient.



Question 14A-1a:

Error or fraud controlled
1.     Computer matches information from vendors’ invoice with purchase order and receiving data


2.     The computer assigns numbers to receiving reports



3.     Checks are mailed by check signer
Late or early recording of cost of purchases – cut off problems



Duplicate recording of purchases




Inaccurate  recording of a purchase or disbursement




Question 14A-1b:

Test of controls
1.     Computer matches information from vendors’ invoice with purchase order and receiving data


2.     The computer assigns numbers to receiving reports



3.     Checks are mailed by check signer
Reconcile liabilities with creditor’s monthly statement; confirm accounts payable ; perform analytical procedures


Search for unrecorded accounts payable




Obtain trial balance of payables and reconcile with the ledgers.
Question 14A-2:

The two weaknesses identified and there implications are:

1.      Approved vendor is selected by purchasing manager who also purchases goods. This leads to doubtful valuation and accuracy of accounts payable and purchase transactions.

2.      Vendors’ statements are not reconciled to the accounting records. This leads to doubtfulness in the existence or occurrence, completeness, valuation and accuracy of the accounts payable and purchase transactions.



Question 14A-3:

The audit program for the test of controls for the acquisition cycle is:

1        Procedures for sales transactions:

1.      Observe and inquire about the segregation of duties for authorization of purchases, receiving merchandise, approving payment to vendors, and signing checks.

2.      Inspect documentation of the Great Plains ACCPAC software package.

a.   Computer assigns numbers to purchase orders, receiving reports and checks

b.   Computer matches information from vendors’ invoices with purchase orders, and receiving data

c.   Computer tests numerical accuracy of vendors’ invoices

3.      Review the approval of vendors’ invoices prior to payment

4.      Observe as checks are mailed by the check signer

5.      Inquire about the monthly reconciliation procedure of the bank accounts by an employee who is independent of invoice processing, cash disbursements, cash receipts, petty cash, and general ledger functions.

6.      Inquire and review the comparison of actual disbursements to budgeted amounts and investigation of variances.






B. Sawyer Lawrence (1981) The Practice of Modern Internal Auditing: Appraising Operations for Management: Institute of Internal Auditors