Illustrative Audit Case: Keystone Computers & Networks, Inc. Part I: Audit Planning The Keystone Computers & Networks, Inc. (KCN), case is used throughout the text to illustrate audit procedures and methodology. KCN is a company that sells and installs computer workstations and networking software to business customers. The CPA firm of Adams, Barnes & Co. has audited the financial statements of KCN for the past three years. This part of the case illustrates selective audit planning working papers prepared by the staff of Adams, Barnes & Co. for this year's audit. You should read through the information to obtain an understanding of the nature of the information that is important to planning an audit engagement. The working papers include The balance sheet and income statement for the company for the prior year, 20X4. A trial balance for 12/31/X5, with comparative amounts for 12/31/X4. The analytical ratios working paper, partially completed. The overall audit strategy for the audit of the financial statements for the year ended 12/31/X5. A fraud risk assessment. The engagement letter for the audit, presented in Figure 6.2 of this chapter. KEYSTONE COMPUTERS & NETWORKS, INC. Balance Sheet December 31, 20X4 Assets Current Assets Cash Trade receivables, less allowance for doubtful accounts of $96,000 Accounts receivableofficers Inventory Prepaid expenses Total current assets Equipment and leasehold improvements, at cost Equipment and furniture Leasehold improvements $ 53,964 8,438,524 57,643 1,234,589 156.900 $ 9,941,620 Less accumulated depreciation $ 1,090,634 98.900 S 1,189.534 _(250.987) $ 938,547 $ 1.000.000 $11.880.167 Intangible assets net of amortization Liabilities and Stockholders' Equity Current Liabilities Line of credit Accounts payable S 6,612,550 1.349.839 Current Liabilities Line of credit Accounts payable Current maturities of capital lease obligations Accrued expenses Total current liabilities Capital lease obligations, less current maturities Total liabilities Stockholders' equity Common stock, $1 par value; 1,000,000 shares authorized: 200,000 shares issued and outstanding Additional paid-in capital Retained earnings $ 6,612,550 1,349,839 43,200 178.900 $ 8,184,489 $ 456.700 S 8,641,189 $ 200,000 423,500 2.615.478 $11.880.167 KEYSTONE COMPUTERS & NETWORKS, INC. Statements of Income and Retained Earnings Year Ended December 31, 20X4 Net sales Cost of goods sold Gross profit Selling expenses: Salaries $ 3.167.889 Payroll benefits and taxes 913,456 Advertising and promotion 1.200,786 Travel and entertainment 609.788 $96,459,566 74.122.435 $22.337.131 Selling expenses: Salaries Payroll benefits and taxes Advertising and promotion Travel and entertainment Miscellaneous $ 3,167,889 913,456 1,200.786 609.788 334.890 $6,226,809 Operating and administration expenses: Operating salaries Administrative salaries Payroll benefits and taxes Rent Utilities Insurance Legal and accounting Bad debt Supplies Depreciation and amortization Software development Miscellaneous $ 4.878.900 4,234,234 1.812.344 797,800 210.495 356,890 457.577 234,500 556,345 334,565 289.100 234.556 $14.397.306 Total selling, operating, and administrative expenses Operating income Interest expense Income before income taxes $20.624.115 $ 1.713,016 421.344 $ 1.291.672 $ 1,291.672 Income before income taxes Income taxes: Current Deferred $ 256,765 45.632 Net income Retained earnings, January 1. 20X4 Retained earnings, December 31, 20X4 302.397 $ 989,275 $ 1.626,203 $ 2.615.478 WL Prepared by Reviewed by Page 1 Adjustments Dr (Cr) Adjusted Balance Dr (Cr) KEYSTONE COMPUTERS & NETWORKS, INC. Working Trial Balance For the Period Ended December 31, 20X5 Prior Period Unadjusted Account Name Balance 12/31/X4 Trial Balance Dr (Cr) Ref # Cash General Account 42.754 66,034 Cash-Special Account 9.960 10,150 Cash in Register 1.200 1.200 Petty Cash 50 Accounts receivable-trade 8.534.524 10.235.457 Accounts receivable officers 57.643 84,670 Allowance for bad debts (96.000) (104.000) Inventories 1.234.589 1.375.835 Prepaid expenses 156.900 176,456 Furniture & fixtures 300,980 344.900 Office equipment 789,654 974.676 50 98.900 (2,50,987) Leasehold improvements Accumulated depreciation Software development cost Intangible assets Accounts payable--trade Capital lease obligations-current Accrued liabilities Unearned service revenue Line of credit Capital lease obligations noncurrent Capital stock Paid-in capital Retained earnings Dividends 1,000,000 (1.349,839) (43,200) (178,900) (6.612.550 (456,700) (200,000) (423,500) (1.626,203) 91.230 (404,560) 178,000 800,000 (1.429,033) (45,675) (203.450) (42.300) (8.632,105) (423,680) (200,000) (423,500) (2.615,478) 415.000 229.877 (229.827) 989,275 12.89.275) a A 6 WL Prepared by Reviewed by Page 2 Account Name Adjustments Dr (Cr) Adjusted Balance Dr (Cr) Account # 6000.10 6010.10 6020.10 6030.10 702010 7070.10 7070.50 7075.10 7080.10 700 30 7090.10 7090.30 7090.50 7100.10 7140.10 7200.10 KEYSTONE COMPUTERS & NETWORKS, INC. Working Trial Balance For the Period Ended December 31, 20X5 Prior Period Unadjusted Balance Trial Balance 12/31/X4 D r (Cr) Ref# Sales of computers (44.890.788) (42,345,675) Software licenses (248.900) (236,700) Service revenue (4.567.888) (4.325.777) Consulting revenue 46,751,990) (45.677.899) Cost of sales 74.122,435 72,134 566 Salaries sales 3.167.889 2.765,677 Payroll benefits-sales 857,368 Advertising & promotion 1,567.889 Travel & entertainment 445.000 Miscellaneous exp-sales 334,890 278.656 Salaries operations 4,878,900 4,544,860 Salarisadministrative 4234234 3,945,670 Payroll benefits-admin 1.734,565 Rent 797,800 721,345 Utilities 210.195 234.839 Insurance 913,456 1.200,786 609,788 210.495 356,890 7140.10 7200.10 7260.30 7320.10 7410.10 7600.10 7650.10 7700.10 7800.10 7900.10 7900.70 9000.00 Utilities Insurance Legal & accounting Bad debt expense Supplies Depreciation and amort. Software development Miscellaneous exp-administrative Interest expense Current income taxes Deferred income taxes P&L Summary 457,577 234,500 356,345 334,565 289.100 234,556 421,344 256.765 45.632 989.275 234,839 378,677 485,767 256,678 478,900 367.867 345.645 245,456 476,899 80.100 9.150 (229.877) 229.877