Keystone Case Study Question 6C-1:Section Purpose Content Audit approach Significant risks Significant accounting& auditing matters Planning materiality Scheduling & staffingplanThe method of internal controlto 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-2Risk 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 resultsIncreased 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 receivable2 Average sales per day3 Net sales4 Average inventory5 Cost of goods sold6 Gross profitQuestion 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:ControlError or fraud controlled1. 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 signerLate or early recording of cost of purchases – cut off problems;;Duplicate recording of purchases;;;Inaccurate recording of a purchase or disbursement;;;Question 14A-1b:ControlTest of controls1. 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 signerReconcile 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 checksb. Computer matches information from vendors’ invoices with purchase orders, and receiving datac. Computer tests numerical accuracy of vendors’ invoices3. Review the approval of vendors’ invoices prior to payment4. Observe as checks are mailed by the check signer5.
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.
;;;;References;B. Sawyer Lawrence (1981) The Practice of Modern Internal Auditing: Appraising Operations for Management: Institute of Internal Auditors;