6C1-KCN Audit Plan
Business and Industry Conditions
Keystone Computer Network (KCN) provides sales and services of microcomputers, software and hardware networking to customers. The industry in which the firm operates is considered as sensitive to the economic environment and highly competitive in nature, with competitors larger than KCN itself. The long-term strategic success of KCN is dependent on the retention and ability to attract qualified and competent information technology (IT) professionals. The annual growth for IT products in the next three years regarding expenditures is anticipated to be 6 percent.
Planning Meetings
The purpose of this section is to indicate the established meetings with clients and engagement team of CPA. In this regard, one meeting has been conducted with engagement tram and client personnel.
Ownership and Management
The section provides description of the respective owners and management of the company.
Keystone Computer Network is owned privately by Terry Keystone, John Keystone, Mark Keystone, Rita Young, and Keith Young. Mark Keystone and Terry are involved in the management activities.
Objectives, Strategies and Business Risks
Description of the business objectives, strategies and relative risks associated with objectives of the company.
The principal objective of Keystone Network Computer is 10 per cent increase in revenues, and 12 per cent increases in net income over a span of next three years. Primary strategies consist of the following:
New software development
Sales to customers consisting of higher risk profiles
Aggressive advertising
Fundamental risk in this regard consists of the following:
Desired outcomes may not be achieved by advertising
Benefits from increased sales may be lower than credit losses, and software development may not achieve breakthrough in production of new products.
Measurement and Review of Financial Performance
Description of the methods employed by management for performance evaluation. Evaluation of performance was conducted by employing the following measures:
Net income and net inventory balance
Sales and gross margins by revenue categorization
Aging of accounts receivable
Inventory and receivables turnover
Procedures for comprehension of clients and environment
Description of the procedures adopted by auditors for obtaining comprehension of clients and environment. The procedures employed in this regard included the following:
Wall Street Journal articles review
Review of company website and industry reports
Monthly performance report reviews
Management inquiries
Audit Approach
Description of the general approach regarding audit.
The CPA’s would perform tests of controls for assessment of controlling risks at less than the maximum for most assertions, and maintaining consistency with the audit for previous years. It is necessary to maintain consistency with previous audit reports to establish consistency principle of the audit. Failure to comply with this standard could result in invalidation of incumbent audit report or aspersions could be cast on the previous audit reports. Furthermore, it also needs to be noted that the accounting and reporting policies adopted in the formulation of previous audit reports must adhere for avoidance of any errors.
Significant Risks
It is the description of the significant risks as identified by auditors. In this regard, two significant risks identified are stated as follows:
Strategy adopted by KCN to sell customers bears higher credit risk.
Significant bonuses earned by the management on the basis of quarterly results.
Significant Accounting and Auditing Matters
The description of specific accounting and auditing matters of concern. In this regard, there are two particular concerns:
Capitalization of software costs
Proper accounting for extended warranties
Planning materiality
The identification of an amount to be used as a measure for materiality planning. In this regard, the amount of $70,000 will be used as a measure of materiality planning on the basis of sales analysis, net assets, and profit before tax.
Scheduling and Staffing Plan
Provision of schedule for key areas of audit and the staffing requirements for engagement. The section consists of key dates that initiate with interim audit work by issuing an updated management letter. The total hours budgeted for audit is 118 hours (Whittington, R., & Pany, 2006).
6C-2 KCN Risks
Risks Implications and Response
Keystone Network Computers has adopted the strategy to provide sales to customers at higher credit risk. The implication for this can be an increase in the risk of misstatement of bad debts and the provision for bad debts. The auditors may assign an experienced auditor to this area and increase the evidence associated with the adequacy of the allowance. It can be conducted by examining the credit worth of further accounting records. Additionally, the auditors must not continue reliance on the tests of related controls from previous periods.
The management of KCN earned significant bonuses by quarterly results. The impact of this may result in the increase in risk for misstatement of quarterly results to increase bonus amounts. The auditors may conduct adjustment of staffing engagements, increasing skepticism levels, adding ambiguity to audit procedures or increase the level of evidence collected. The auditors may also conduct increasing the extent of procedures related to quarterly results.
6C-3 KCN Capitalization of Software Development Costs
Part A
Keystone Computers & Networks Inc.
December 31, 20X5
Memorandum on Accounting Issues
In 20X4, KCN conducted initiation of expansion of networking software product for sale. In the incumbent year, the company has capitalized certain costs of development. In this area, FASB Interpretation 6 (FIN 6), FAS 2 and 86 provides vital guidance. FAS 2 states that the nature of the activity for which the software is being developed needs to be categorized whether the costs would be part of research and development or not. FIN 6 states that the development, acquisition, or improvement of the process by an organization for utilization in its selling or administrative activities includes costs for computer software that is not a part of research and development. The instances of these costs consist of development of general management information system and the computerized reservation system of an airline. It can be observed that these are not the same type of costs in this case.
FAS 86 also provides evidence on the issue by stating that all costs incurred for the establishment of technological feasibility of sale of computer software product, leased or marketed are subject to research and development costs. The technical feasibility of the product establishes when the plan, design, code, and test of the product establishes that the product can be produced to meet design specifications, technological features, and functional requirements. The fourth paragraph of FAS 86 gives a summary of tests for indication of the establishment of technical feasibility.
The costs that are incurred before establishment of technical feasibility are to be capitalized. The capitalization of computer software costs stops as the product is made available for the customers. The costs of customer support and maintenance should be charged to expense when the costs are incurred or when the associated revenue is recognized, whichever takes place first.
Part B
The primary audit issue will be the determination of whether the client has categorized costs appropriately between research and development. These include those costs that are involved in the establishment of technical feasibility that should eventually be capitalized. The point of the technical feasibility of the software product is what needs to be determined by the auditors (Thibodeau, 2005).
6C-4 KCN Ratio Analysis
Details of Computations
Days Sales in Accounts Receivable
Favorable economic situation
Changes in credit policy
Overstating of sales
Receivables understated
Change in customer mix
Days Inventory on Hand
Purchases understated
Inventory Overstated
Obsolete inventory
Changes in inventory policies
Inventory Turnover
Purchases understated
Inventory overstated
Obsolete inventory
Changes in inventory policies
Return on Sales
Relative inventory overstatement and cost of goods sold understatement
Costs reduction
Increase in sales pricing
Change in sales mix
References
Thibodeau, J. C. (2005). Auditing & assurance services. New York, NY: McGraw-Hill.
Whittington, G. (2014). Fair Value and the IASB/FASB Conceptual Framework Project: An Alternative View. In Accounting and Regulation (pp. 229-268). Springer New York.
Whittington, R., & Pany, K. (2006). Principles of auditing and other assurance services. Boston, MA: McGraw-Hill/Irwin.
