Purpose of Audit Plan
Keystone Computers & Networks, Inc. (KCN) is an information technology company that develops networking software products and sells them to its clients (Whittington & Pany, 2012). The company had hired an external audit firm to carry out its audit according to the US Generally Acceptable Accounting Principles (GAAP). The external auditor is required to carry out the audit of the company’s financial statements and provide its professional opinion based on the fundamental principles of independence, responsibility, integrity, and verified disclosure of business accounts and financial transactions.
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Moreover, the auditor has to perform the review of the internal controls of KCN and determine the degree of risks associated with different trades and their reporting. The current report describes the audit plan that has been proposed to investigate various accounts and transactions of the company incurred during the year ended on December 31, 20X5 (Whittington & Pany, 2012).
Audit Plan for KCN
It is reported that the last three years’ audit of KCN was performed by Adams, Barnes & Co. Therefore, the auditor has the experience and understanding of the company’s accounting system and internal controls. Moreover, it will be easier to perform the audit of 20X5 accounts and financial statements as the firm has previous years’ documentation. The objectives of the audit are (1) to identify and describe the objectives of the audit engagement and services that will be provided to the client by the audit team and (2) to define the responsibilities of the audit team members (Whittington & Pany, 2012).
The contents of the audit engagement are as follows.
- To perform an audit of the company’s financial statements, including the statement of financial position, statement of income, statement of total earnings, and statement of cash flows for the year ended on December 31, 20X5.
- To issue a letter confirming whether the covenants of the letter of credit agreement with Western Financial services are in full compliance or not.
Assessment of Internal Controls
The internal control related to the client’s CIT will be selected for evaluation. The reason is that its manager was involved in fraudulent activity, which caused a significant financial loss to the company. Moreover, internal controls over deliveries of products in and out of the client’s warehouse will be carefully evaluated. The audit will execute the following steps to assess the current status of the company’s internal controls.
- Assessment of the correctness of journal entries by using Computer Assisted Audit Techniques.
- Determination of the risk of a material misstatement by reviewing the basis for estimates used by the client.
- Identification of significant transactions and seek the management’s rationale for them.
- Evaluation of the segregation of duties related to the access to inventory, authorization of trades, record keeping, and verification (Whittington & Pany, 2012).
Measurement and Review of Financial Performance
The management of KCN uses various performance measures, including inventories and receivables turnover, aging of A/R, sales and gross margins by type of revenue, net income, and total inventory balance (Whittington & Pany, 2012).
The audit will investigate KCN’s list as follows.
- The inventory of KCN will be observed physically by performing an inventory count at its warehouse.
- A cutoff analysis will be performed by halting delivery of merchandise in and out of the company’s warehouse and then analyzing the deliveries before and after the physical count (Whittington & Pany, 2012).
- The inventory count will be reconciled with the general ledger balance and cost of goods sold.
- Review of freight costs and also determining inventory ownership and inventory in transit to compare with the physical count.
- Assessment of the basis for the change in the inventory policy and consistency of the inventory valuation method (Whittington & Pany, 2012).
The following procedures will be performed.
- Reconciliation of the accounts receivable report to the general ledger.
- Reconciliation of the allowance for doubtful accounts to the wrong debt expense account and also perform a consistent comparison with the method and amount/percentage used in the previous year (Whittington & Pany, 2012).
- Review of the accuracy of sample invoices, shipping documents, cash receipts, customer return records, credit memos.
- Reconciliation of sales ledger with the aged receivables’ listing.
- Comparison of the level of prepayments with the previous year’s data and also check the amount prepaid.
- Calculate the gross profit of each product and compare it with the company’s last year’s data and industry average (Whittington & Pany, 2012).
- A cutoff analysis similar to the inventory to investigate accounts receivable before and after the cutoff time.
The audit will investigate revenue recognition by KCN as follows.
- Obtain information and evaluating controls over the client’s revenue measurement, recognition, and reporting.
- Assessment of the compliance of revenue recognition procedures with the relevant financial accounting standard will be checked (Whittington & Pany, 2012).
- Detailed testing of revenue transactions and reconciliation to the general ledger.
- The quarterly sales data will be checked for overstatement of figures by performing a substantive testing procedure.
- Review of the management’s policy regarding the change in product pricing.
- Assessment of the percentage of planning materiality for sales and highlight significant variations, if recorded in the audit of sales and income.
The audit will involve the following substantive procedures.
- Reconciliation of the accounts payable report to the general ledger, suppliers’ accounts, and cost of goods sold.
- Verification of transactions for accuracy, completeness, and legitimacy by selecting an adequate sample of supplier transactions (Whittington & Pany, 2012).
- A cutoff analysis will be performed to check the recording of accounts payable before and after the cutoff time.
- Examination of documents for any unrecorded liabilities.
- Comparison of versions payable balances of the current year with the previous year and industry data.
The audit will perform the following tests.
- Review of the accounting of receipt and creation of intangible assets and reconcile their accounts with general ledger.
- Assessment of the carrying value of intangible assets and determining their market value or specialist valuation (Wahlen, Jones, & Pagach, 2017).
- Recalculation of the amortization amount and reconcile the accumulated amortization account with the expense account.
The following audit procedures will be performed during the engagement.
- Physically confirm the existence of non-current assets, including equipment, furniture, and leasehold improvements.
- Collection of the summary of the opening values of non-current assets, accumulated depreciation, and net book value (Whittington & Pany, 2012).
- Recalculation of the depreciation amount based on the estimated useful life and report any significant changes in the value of non-current assets.
- Reconciliation of the non-current assets schedule to the general ledger.
Line of Credit
It is one of the critical objectives of the audit plan, which will be addressed by performing the following procedures.
Examination of the covenants of the letter of credit and determine the compliance of KCN with them.
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Checking documentation and confirming the balance with Western Financial Services (Whittington & Pany, 2012).
The audit will carry out the following procedures.
- Review of individual accounts such as marketing and travel expenses included in miscellaneous and check for accuracy, completeness, and legitimacy by selecting an adequate sample of transactions.
- Reconciliation of individual accounts to the general ledger (Kumar & Sharma, 2015).
- Overstatement of marketing expenses will be checked and reconcile with the client’s correspondence, invoices, and payments to marketing agencies.
- Checking for overstatement of traveling expenses and negotiating with the general ledger.
The audit will perform the following tests.
- Review of individual accounts, e.g., electricity, telephone, and gas included in utilities and check for accuracy, completeness, and legitimacy by selecting an adequate sample of transactions.
- Reconciliation of individual accounts to the general ledger and bank account (Kumar & Sharma, 2015).
Rent, Insurance, and Legal and Accounting
The following audit procedures will be carried out for these expenses recorded in the income statement.
- Review the rental agreement and its terms and reconcile the rent account with the bank account.
- Review the insurance agreement and its terms and reconcile the insurance account with the bank account.
- Review the legal and accounting agreement and its terms and reconcile the legal and accounting account with the bank account.
The following audit procedures will be performed in light of the identified risks.
- Analysis of the information about the client’s relationships and environment to verify the information provided by the management of KCN.
- Since KCN has recently adopted the strategy of selling computers to high-credit risk-bearing customers, therefore the audit team cannot rely on the previous year’s audit and need to devise new substantive tests to collect evidence related to such accounts. For this purpose, the auditor will check stores of high-credit risk customers and determine the terms of sales and analyze any delinquency or default on payments.
- The audit team will review the policy of KCN to pay bonuses to executives on a quarterly basis and test its procedures for determining dividends paid to its executives in the last four quarters. The auditor will check the client’s sales and net income and adjustments made at the end of each quarter to predict variations. The audit will monitor performance against key financial targets.
Significant Accounting and Auditing Matters
The focus of audit procedures will be on the following issue.
A fundamental accounting issue is the capitalization of networking software products developed by KCN. It needs to be assessed under FASB ASC 985-20-25 Costs of Software to Be Sold, Leased, or Marketed, which requires determining whether the software is sold as a separate product or as a part of other products or services (Wahlen et al., 2017). The technical feasibility of the software developed by the company will be ascertained by examining the detailed program design and its working model. After this step, the cost of coding, testing, and other related activities will be determined for capitalization.
A significant audit issue involved in the determination of the software development cost is to determine whether KCN has categorized them properly as research and development is necessary for achieving technical feasibility. Therefore, the timing of these costs is also crucial.
The audit plan prescribed in this report covers different accounts, transactions, and policies of Keystone Computers & Network, Inc. The substantive procedures included in this plan are aimed at collecting sufficient evidence to present a complete audit report, which means that the financial statements of KCN meet various assertions, including appropriateness, accuracy, fairness, and completeness.
It is also indicated that multiple other procedures can be performed to enhance the quality of the audit to be completed. More importantly, the use of computer-assisted audit techniques can be used to verify various accounts cover in this plan. Furthermore, the findings of the internal audit are crucial to determine the areas of weakness and also the extent of substantive tests to be performed.
Kumar, R., & Sharma, V. (2015). Auditing: Principles and practice (3rd ed.). New Delhi, India: PHI Learning Pvt. Ltd.
Wahlen, J. M., Jones, J. P., & Pagach, D. (2017). Intermediate Accounting: Reporting and analysis (2nd ed.). Boston, MA: Cengage Learning.
Whittington, O., & Pany, K. (2012). Principles of auditing and other assurance services (18th ed.). Boston, MA: McGraw-Hill.