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Audit Program Design for Apollo Shoes

Essay by   •  July 14, 2012  •  Case Study  •  2,502 Words (11 Pages)  •  3,182 Views

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Audit Program Design for Apollo Shoes, Inc.

This document describes the audit program designed by Anderson, Olds, and Watershed, LLP (AOW), in respect of inventory and warehousing, and cash cycles, for audit of Apollo Shoes, Inc., a publicly traded company, in compliance with the regulations and guidelines provided by the U.S. Public Company Accounting Oversight Board (PCAOB), and the U.S. Securities and Exchange Commission (SEC). The audit program covers tests of controls, substantive tests of transactions, and analytical procedures, for the inventory and warehousing, and cash cycles, in accordance with the generally accepted auditing standards (GAAS).

Inventory and warehousing cycle

Audit related to the inventory and warehousing cycle tests financial information relating to the inventory counts, sales, value of inventory, cost of goods sold, sales returns and allowances, and estimates of allowance for slow moving inventory. "The objective of auditing the inventory and warehousing cycle is to determine that raw materials, work-in-progress, finished goods inventory, and cost of goods sold are stated fairly in accordance with generally accepted accounting principles" (Arens, Elder, & Beasley, 2006). The procedures, for audit of inventory and warehousing cycle, for Apollo Shoes, Inc., are divided into five parts, as follows:

1. Acquiring and recording raw materials, labor and overhead: As Apollo Shoes, Inc. has not manufactured shoes yet, there are no true raw materials. However, as Apollo purchases shoes from its principal suppliers, the activities related to acquiring and recording raw materials involve recording of purchase transactions, receiving of purchased goods, storing of the inventory, and releasing of the inventory for sales activities etc. As the tests on purchase orders have already been completed through the acquisition and payment cycle, there will be no need to re-test the purchasing activity again under the inventory and warehousing cycle. However, as Apollo incurs labor and overhead costs, audit will cover cost accounting controls involving physical control over inventory movement, and controls over related costs.

2. Transferring assets and costs: AOW will review Apollo's processes in respect of internal transfers, specifically related to testing of the cost accounting records.

3. Shipping goods and recording revenue and costs: As recording of shipments and the related revenues, have been included in the sales and collection cycle, the audit for the inventory and warehousing cycle will review the cost control aspects of the cost of goods sold.

4. Physically observe inventory: As review of inventory is essential for the audit of inventory and warehousing cycle, AOW will observe the counting of inventory and will also test the actual inventory to verify that there are no material misstatements in counting and recording of the inventory quantities and costs.

5. Price and compile inventory: AOW will conduct price tests to determine whether Apollo has followed an appropriate inventory method in accordance with generally accepted accounting principles (GAAP) and whether the method has been consistent with the method used in the previous years. In addition, AOW will conduct compilation tests to verify if the physical counts have been summarized correctly, and the prices and quantities of inventory have correctly been accounted for.

The methodology, for designing tests of controls, includes setting materiality and assessing audit risk, inherent risk for the inventory and warehousing cycle. Further, AOW will assess the control risk for inventory and warehousing cycle. Accordingly, AOW will design and conduct tests of controls, substantive tests of transactions, and analytical procedures, in respect of the inventory and warehousing cycle, for Apollo Shoes, Inc., as detailed here-under:

Test of controls

Audit procedures will include tests of controls to verify whether the inventories are physically controlled and that they are safe from theft or misuse. The audit test of controls will include examining inventory storage area to verify whether the inventory is stored under lock and key, and whether the inventory control process is followed by the storekeeper, as a competent custodian, protecting the inventory from theft and misuse.

In respect of verification of the existence and validity objectives, the tests of controls will include accounting for sequence of purchase or sale requisitions, examining the requisitions are properly approved, comparing the quantity, description and date with the information in the inventory master file, and comparing the purchases and sales records to verify whether the inventories are physically delivered to the storeroom and released from the storeroom, respectively. To verify the timeliness, the tests of controls will examine whether the inventories are processed daily and are included in the receiving reports, and whether the shipping documents are processed daily to record the shipment of goods to the customers.

Further, to verify authorization, tests of controls will examine whether there are any unauthorized purchases leading to excessive inventory levels, obsolescence of inventory, and understating or overstating of any category of inventory. To verify valuation, the tests of controls will include comparing inventory on hand with amounts shown in the perpetual inventory records and reviewing standard costs to verify whether the inventory and cost of goods sold are properly accounted.

In respect of verification of posting and summarization, tests of controls will review reconciliation of perpetual inventory to general ledger account to ensure that the amount and value of perpetual inventory agrees with the inventory account in general ledger.

Substantive tests of transactions

Substantive tests of transactions are designed to tests of details of inventory to satisfy balance-related audit objectives. As the inventory management process interacts with the revenue, purchasing, and payroll processes, the control procedures over the receipt of raw materials, shipment of goods, and assignment of labor costs are normally tested as part of those processes. However, as the audit of inventory and warehousing cycle needs to obtain substantive evidence on the perpetual inventory records, the tests of receipt and shipment of goods will be extended by tracing the transactions into the perpetual inventory records.

To verify existence and accuracy objectives, audit tests will verify random sample of shoe boxes stacked in pallets and examine whether they contain shoes as have been marked on the boxes and pallets. The substantive tests

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