This is letter is to inform you of the plans for the beginning of the audit process that we plan to take to complete the audit of Apollo Shoes. There are many parts to the process and we will discuss each within this letter. The beginning of the audit process is to describe the objectives of the audit, and the responsibilities and strategies to complete the audit.
The primary objective of the audit is to issue an opinion on the financial statements of the company. With this opinion, the users of the financial statements are able to know that the financial statements are presented fairly and in accordance with the Generally Accepted Accounting Principles. “An auditor’s opinion enhances the degree of confidence that intended users can place in the financial statements” (Arens, Elder, & Beasley, 2014). If the statements are not fairly stated, then we will notify all users with the report.
Next are the responsibilities of the management and the auditors. Management is responsible for many things from ensuring that internal controls are in place, fraud risks are identified, and effective governance is established (University of Nebraska-Lincoln, 2015). With these responsibilities accomplished, the users have assurance that the financial information is reliable. The auditor’s main responsibility is to detect any material misstatements that may have been found within the financial statements. The auditor will use the Generally Accepted Auditing Standards as a framework for the audit.
Some strategies for completing the audit are first to obtain sufficient evidence to support all of the information given and the assertions of management about the financial statements. Also before the audit is even completed, “the auditor must have a thorough understanding of the client’s business and related environment, including knowledge of strategies and processes” (Arens, et al., 2014).
Analytical procedures are used during an audit to gain some knowledge of Apollo’s business and its risks. “Business risks are the factors that could prevent or hinder the achievement of organizational goals and objectives” (Accounting Simplified, 2013). The procedures that are done can be as simple as comparing the financial ratios of Apollo with prior years or even the average of the other companies in the same industry. If the ratios are different by a large amount, then the auditor can look into the parts of the ratios and may find a misstatement.
The analytical procedures are performed during the planning, testing and completion phases. In the planning part of the audit, the procedures help identify significant matters requiring special consideration later in the audit (Arens, et al., 2014). During the testing or conducting part of the audit, the procedures support the data from the account balances. The auditor computes the ratios and compares them with the expected ratios. The auditor must include all documentation of these test ratios. Finally, the tests are done to take a last look for any misstatements that may have been missed. This final look is usually done by the more experienced partner of the audit firm.
When designing the audit, we will be also discussing the consideration of materiality and risk. Materiality is the measure of the estimated effect that the presence or absence of an item of information may have on the accuracy or validity of a financial statement. When a material misstatement is found, the auditor will have to convey it to the company. The application of materiality is done in a couple of steps. The auditor will determine the performance materiality as well as the materiality of the statements as a whole first. Then the auditor will estimate the each part of the financial statements and combine them to get one misstatement. The last step is to compare them with the preliminary judgment to see if the financial statements are acceptable.
Audit risk is the risk that the auditor will not find any material misstatement during the audit. There are many risks associated with the audit. Planned detection risk is when the evidence collected for the audit will fail to detect misstatements. This risk helps the auditor determine how much evidence is needed to make sure that no material misstatement exists. Another type of risk is inherent risk. This is measures how susceptible a management assertion is to a material misstatement. Next is control risk. Control risk is when an auditor thinks that a misstatement could happen but it would not be found or stopped by the internal controls implemented by management. Lastly, there is acceptable audit risk. “AAR is a measure of how willing the auditor is to accept that the financial statements may be materially misstated after the audit is completed and an unqualified opinion has been issued” (Arens, et al., 2014).
Information Technology will be implemented into the audit. The computers help go from manual controls to automated controls so the risk of human error is reduced and the information available via the computer is readily available. The auditing done with IT is done two different ways, auditing around the computer or through the computer. Auditing around the computer is when the auditor will complete the audit of the internal controls the same way they would do it with a manual accounting system. Auditing through the computer means that the documents needed to complete the audit are only available electronically. The auditor will complete different test because of this. The auditor will use one of three approaches. The first is the test data approach. This means that auditor will use the company’s system and program to run data and the system should either accept or reject the data. The next approach is parallel simulation. This is when the auditor
runs the same data as the company simultaneously using generalized audit software (GAS). The last approach is the embedded audit module approach. Using this approach, the auditor has the ability use actual transaction done by the company to compare with what output is generated by the company and the module.
The planning of the audit will be done with all of these aspects incorporated.
Accounting Simplified. (2013). Audit Riskes & Business Risks. Retrieved from http://accounting-simplified.com/audit/risk-assessment/audit-risk-business-risk.html Arens, A. A., Elder, R. J., & Beasley, M. (2014). Auditing and Assurance Services (15th ed.). Upper Saddle River, NJ: Pearson. University of Nebraska-Lincoln. (2015, Winter). Management’s Responsibilities. Retrieved from http://audit.unl.edu/managements-responsibilities
Engagement Checklist, Timeframes and Milestones
1) Plan and design the audit
a) Decide to accept client or not
b) Conduct research about the client’s industry and business
c) Examine business risk and perform analytical procedures d) Set materiality
e) Asses control risk
f) Compute fraud risks
g) Develop strategy and audit program (milestone #1)
The first part should be completed before financial statements are issued. Due 9-30-07
2) Perform test of controls and transactions
a) Examine the level of control risk, Can it be reduced?
b) If yes, perform tests of internal controls over financial reporting c) If no, perform substantive tests of the transactions
d) Asses likelihood of misstatements (milestone #2)
This testing will be completed throughout the year but must be done by 10-31-07
3) Analytical Procedures and Tests of balances are completed now (milestone #3)
a) Perform substantive analytical tests to assess reasonableness of balances and transactions b) Test of details of balances
This will be completed by 12-31-07 and then there will also be more analytical procedures done after books are closed. Books planned to be closed by 1-8-2008.
4) Finish Audit and issue report
a) Test presentation and disclosure
b) Evaluate results of audit
c) Issue Report (milestone #4)
d) Discuss with audit committee and management the audit report
Apollo Shoes Inc.
100 Shoe Plaza
Shoetown, ME 00001
Dear Management of Apollo,
The request to audit the financial statements of Apollo Shoes, Inc. from the year ending December 31, 2007, which include the balance sheet, income statement, statement of cash flow and the statement of stockholders equity, has been accepted by our audit firm. We will conduct the audit with the objective of expressing our opinion on the financial statements.
The audit will be conducted in accordance with GAAS, the standards of auditing in the United States. According to those standards, we must perform the audit to obtain reasonable assurance that the financial statements are free from what we deem as a material misstatement. We will also evaluate the estimates made by management, the usefulness of accounting policies and the presentation of the statements, which includes all notes and disclosures.
In completing the audit, there is a risk involved in which a material misstatement may not be found. This can happen even if the audit is properly planned and executed correctly. Also, internal control will not be tested but we would communicate with you if we found a deficiency in internal control in writing.
The audit will need the help of management. Management must allow my team to have access to all information that was needed to prepare the statements. They must also give us access to anyone that may have any of the audit evidence that we will need to prepare our report.
The fees associated with the audit will be billed as days are completed. The hours worked will be used as the main factor. Any other expenses incurred will also be billed. We estimate total fees to be about $150,000.00. You will be notified if we think that we will go over that estimate.
At the end of the audit, we will issue a report. The report will go to management and the board of directors.
Please sign and return this letter to indicate you acknowledgement of, and agreement with, the arrangement of the audit of the financial statements.