AC410 Auditing Unit 7Assignment 1: Material Items in Liabilities and Equity

Chapter 14

14-37 Document Review Simulation

This simulation, available online, presents an audit request list document for materials requested of management that has been prepared by an audit team staff member for the Keystone audit. Because this simulation addresses material presented in Chapters 10-13 (plus other general knowledge concerning auditing), we include it here. Note, however, that the information obtained through such an audit request list would be obtained very early in the audit. The CPA firm Adams, Barnes & Co. is preparing for the year 20X5 audit of Keystone Computers & Networks Inc. (KCN), a calendar year-end nonissuer. An audit staff member started with the 20X4 year audit request list for KCN and updated it as he thought appropriate. As the audit senior for this engagement, it is your responsibility to review and revise the year 20X5 request list for KCN as needed. Use the additional client information in the exhibits to consider the draft request list, correcting any errors and removing any inappropriate or unnecessary items, given the overall context and purpose of the list. Ensure that the 20X5 list is appropriate given the information provided. The materiality for the year 20X5 audit has been set at $300,000.

CALLOUT LIST #1

Accounts receivable summarized by date of most recent purchase. (Callout #1)

Choose an option below:

a. [Original text] Accounts receivable summarized by date of most recent purchase.

b. [Delete text]

c. Accounts receivable aged by date due.

d. Accounts receivable summarized by length of business relationship with KCN.

e. Accounts receivable matched with sales items.

CALLOUT LIST #2

Invoices supporting depreciation expense for the year.(Callout #2)

Choose an option below:

a. [Original text] Invoices supporting depreciation expense for the year.

b. [Delete text]

c. Lawyer's letter response on expected life of fixed assets.

d. Cash deposit slip for increase in cash for 20X5.

e. Schedule of details of depreciation expense calculation for 20X5.

CALLOUT LIST#3

Software development cost invoices and other support. (Callout #3)

Choose an option below:

a. [Original text] Software development cost invoices and other support.

b. [Delete text]

c. Confirmation requests to developers involved with software development costs.

d. Details of amortization of software development cost.

e. Physical examples of the software developed.

CALLOUT LIST#4

Vouchers supporting increase in leasehold improvements. (Callout #4)

Choose an option below:

a. [Original text] Vouchers supporting increase in leasehold improvements.

b. [Delete text]

c. Schedule of additions and retirements to leasehold improvements.

d. Schedule of descriptions of estimated lives of this year's new additions.

e. Schedule of tax depreciation for this year's new additions.

CALLOUT LIST #5

Detailed analysis and reconciliation of each unpaid account payable at year-end. (Callout #5)

Choose an option below:

a. [Original text] Detailed analysis and reconciliation of each unpaid account payable at the balance sheet date.

b. [Delete text]

c. Trial balance of accounts payable at the balance sheet date.

d. List of amortization of accounts payable at the balance sheet date.

e. Current and past credit ratings of each supplier.

CALLOUT LIST#6

Documentation supporting change in capital stock outstanding. (Callout #6)

Choose an option below:

a. [Original text] Documentation supporting change in capital stock outstanding.

b. [Delete text]

c. Documentation of cash receipts related to new stock issuance.

d. Addresses of new shareholders.

e. Schedule supporting retained earnings effect relating to current stock.

CALLOUT LIST #7

Management's review of receivables from officers. (Callout #7)

Choose an option below:

a. [Original text] Management's review of receivables from officers.

b. [Delete text]

c. Cash of deposit receipt related to new receivables from officers.

d. Copy of Board of Director approval of new loans from officers.

e. Copy of loan agreement with Mr. Best.

CALLOUT LIST#8

Account 7140.10 expense analysis. (Callout #8)

Choose an option below:

a. [Original text] Account 7140.10 expense analysis.

b. Account 1000.30 detailed analysis.

c. Account 5100.10 detailed analysis.

d. Account 7100.10 expense analysis.

e. Account 7200.10 expense analysis.

EXHIBITS:

1.Excel Spreadsheet?KCN Working Trial Balance

2.Memo to Files

3.Forwarded E-mail from Controller to Partner

4.E-mail from Audit Manager to Audit Partner

EXHIBIT 4 E-mail from Audit Manager to Audit Partner TO: Charles Adams, KCN, Partner FROM: Karen West, Manager SUBJECT: KCN Allowance for Doubtful Accounts DATE: December 29, 20X5EXHIBIT 3 Forwarded E-mail from Controller to Partner TO: Sam Best. Partner FROM: Loren Steele, Controller, KCN SUBJECT: RE: Software Development DATE: November 5. 20x5 TO: Loren Steele. Controller FROM: Sam Best, President SUBJECT: Software Development DATE: August 12, 20X5 As you know, we have spent signicant amounts on software development. Although we are at an early stage here, let's make sure that we capitalize these costs ($178,000) because, ultimately, we may be able to develop software that not only do we use, but so do our customers. These expenditures could lead to greatly enhanced sales after a year or two. Sam PS: Did I tell you that, even though the rent on our building is going up, the new lease doesn't require a payment for the rst three months? At least that's good. EXHIBIT I ON Working Inal Balance 12/31/X4 12/31/X5 (unaud.) Debit Credit Debit Credit 1000.10 Cash-General account 42.754 66,034 1000.20 Cash-Special account 9.960 10,150 1000.30 Cash in register 1,200 1,200 1000.40 Petty cash 50 50 1050.10 Accounts receivable-trade 8,534.524 10,235,457 1050,40 Accounts receivable-officers 57,643 84.670 1040.90 Allowance for bad debts 96,000 104,000 1100.10 Inventories 1,234,589 1,375,835 1300.10 Prepaid expenses 156,900 176,456 2050.10 Furniture & fixtures 300.980 344,900 2050.30 Office equipment 789.654 974,676 2050.80 Leasehold improvements 98,900 98,900 2050.85 Amortization of leasehold 7.670 improvements 2050.90 Accumulated depreciation 250,987 404,560 2100.00 Software development cost 178,000 2200.00 Intangible assets 1,000,000 800,000 3050.10 Accounts payable-trade 1.349.839 1.429.033 3100.00 Capital lease 43,200 45.675 obligations-current 3210.10 Accrued liabilities 178,900 203,450 3300.30 Unearned service revenue 42.300 3400.50 Line of credit 6,612,550 8,632.105 4400.10 Capital lease 456,700 423,680 obligations-noncurrent 5050.10 Capital stock 200,000 200,000 5100.10 Paid-in capital 423.500 423,500 5700.10 Retained earnings 1,626,203 2.615.478 5900.00 Dividends 415,000 6000.10 Sales of computers 44.890,788 42,345,675 6010.10 Software licenses 248,900 236,700 6020.10 Service revenue 4,567,888 4,325.777 6030.10 Consulting revenue 46,751,990 45,677,899 7020.10 Cost of sales 74,122.435 72,134,568 7070.10 Salaries-sales 3,167,889 2,765,677 7070.50 Payroll benefits-sales 913.456 857,368 7075.10 Advertising & promotion 1,200.786 1,567,889 7080.10 Travel & entertainment 609,788 445,600 7080.30 Miscellaneous expense-sales 334,890 278.656 7090.10 Salaries-operations 4.878.900 4,544,860 7090 30 Salaries-administrative 4,234,234 3,945,670 7090.50 Payroll benefits-admin. 1.812.344 1,734.565 7100.10 Rent 797,800 721,345 7140.10 Utilities 210.495 234,839 7200.10 Insurance 356,890 378.677 7260.30 Legal & accounting 457.577 485,767 7320.10 Bad debt expense 234 500 256,678 7410.10 Supplies 556,345 478.900 7600.10 Depreciation and amort. 334.565 367.867 7650.10 Software development cost 289,100 345,645 7700.10 Miscellaneous 234.556 245,456 exp.-administrative 7800.10 Interest expense 421,344 476,899 7900.10 Current income taxes 256.765 80,100 7900.70 Deferred income taxes 45.632 9,150 107,697,445 107,697,445 107,117,502 107,117.502EXHIBIT 2 Memo to Files: Upcoming Keystone Computers & Networks Inc. (KCN) Audit Charles Adams, Partner November 5, 20x5 Mr. Loren Steele, controller of Keystone computers, joined me for lunch today. While this was an informal get together, we did speak some about the coming audit. He suggested that he would appreciate it if we could get together our audit request list of the various documents and other materials that we would like them to prepare for the audit as soon as possible. Keystone has hired a number of outstanding young employees with particularly strong IT skills. The yearend 20x3 purchase of Plumbtree Systems, a small business accounting system, is not working out as well as they had hoped as sales are slow. Recently the software was rated poorly by a trade association journal and it has been suggested that it is somewhat dated. Mr. Steele indicated that while the intangible asset account related to it was amortized $200,000 in 20X4 (based on a six-year amortization period), the firm would have to \"come to grips\" with whether to write off more than $200,000 this year. His thought was that it might well be necessary to write off half or more of the remaining $1,000,000 this year. He stated that on top of that, KCN total earnings so far this year were down about 40 percent as compared to the end of the third quarter last year. He indicated to me that he would forward details related to the software development costs the company started capitalizing this year. After lunch he forwarded an email from Mr. Sam Best, President. to him on this. See Exhibit 3. There will be an increase in the accounts receivable from officers as President Best asked for and obtained a loan from the companyithis is a loan agreement Mr. Steele signed with the company, not a simple receivable. Because its amount was slightly below the amount necessary for Board of Directors approval, the matter was not addressed by the Board. Finally. on a more personal level, he told me that his wife had recently inherited a large sum of cash and they were in the enviable position of investing it. They recently bought a large, distinguished, old house in Jerome, AZ, that they will use as a \"vacation\" home. He invited my wife and me to come visit them some weekend