1. Propose the adjustments to the financial statements you believe necessary for Arnold to give the standard unqualified report on the Apollo Shoes financial statements.
a. Review the Apollo cash audit for possible adjustments.
b. Review the search for unrecorded liabilities audit work for possible adjustments. (Be careful to determine the proper accounts for adjustment when inventory is included or excluded from the physical count and compilation. “Included” means that the inventory cost is already in the general ledger balance shown in the trial balance. When the previous recorded inventory was adjusted to match the physical count, the adjustment was to cost of goods sold.)
c. Review the property, plant, and equipment and prepaids audit work for possible adjustments.
d. Review the liabilities audit work for possible adjustments.
e. Review the findings about subsequent events and propose adjusting journal entries if any.
f. Review the findings from the various expense analyses and your proposed adjusting journal entries, if any.
g. Adjust the income tax expense to reflect an income tax rate of 40 percent for all income (and set up a corresponding income tax payable or receivable). The tax return and financial statement income are identical, so there are no deferred or prepaid income taxes resulting from timing differences. The tax department “codeheads” will take a closer look when they prepare the corporate returns.
2. Prepare a “scoresheet” working paper for the proposed adjusting journal entries.
3. While we will tell them of everything that we have found, it will be their responsibility to make or not make the entries. Remember to keep materiality in mind. Arnold will fight hardest for the adjustments that will materially affect the financial statements.
Write a brief one-page memo analyzing management’s estimates described above to put in the A-series workpapers. For each one, determine (calculate) the auditor’s “range of reasonableness estimate.” Do the company’s estimates produce a bias toward overstatement or understatement of income (before income taxes and after income taxes)? Explain the relative size of the bias amounts in comparison to (1)income in the unaudited financial statements, and (2)income in the adjusted financial statements, taking the proposed adjustments into account.
1. Prepare the balance sheet as of December 31, 2011, and the income statement for the year ended December 31, 2011 assuming Apollo doesn’t adjust sales and accounts receivable for the questionable December sale. (Remember that even though we are drafting the statements; Apollo’s management is responsible for them.)
2. Prepare a cash flow statement for the year ended December 31, 2011.
3. Identify information you believe should be included in notes to the financial statements. Draft the notes. You can use last year’s as a guide.
4. Also, you may want to draft any management letter comments on anything you believe Apollo Shoes can do better from an operational economy and/or efficiency perspective, or methods of strengthening their internal controls. Even though we do not intend to be Apollo’s auditor next year, we want to maintain our professionalism.
One last thing to do and then we can wash our hands of the whole thing. You need to draft an audit report to go with the financial statements you drafted (put it in the A-series workpapers).
1. You should date the report as of the end of fieldwork next week (March 7, 2012).
2. Remember that we didn’t audit Apollo last year, so we will probably need to refer to the “other auditors” who audited the previous year’s financial statements.
3. Adjust the report to reflect the fact that Apollo didn’t adjust its accounts receivable/allowance/sales for the Mall-Warts problems.
4. What do you think about a going-concern disclosure? We will probably need a memo in the workpapers (A-series) addressing this issue and discussing the reasons why we should or shouldn’t give them a going concern paragraph.
5. Any subsequent events that need disclosure?