Apollo Shoes, Inc. Consideration of Fraud Memo December 31, 2020 We identified the following key risk factors: 1) Significant competition in industry. 2) Control environment dominated by one individual. 3) Trending a significant increase in net income despite stagnant sales. 4) Emphasis on meeting profitability targets. 5) Concerns over product quality based upon sales returns and product litigation. 6) Concerns over inability to speak with predecessor auditor over their withdrawal after last year's engagement. In response to these key risk factors, the professional literature requires that as an audit team we: Place an increased emphasis on professional skepticism. Putting aside any prior beliefs as to management's honesty, the audit team must exchange ideas or brainstorm how frauds could occur. These discussions are intended to identify fraud risks and should be conducted while keeping in mind the characteristics that are present when frauds occur: incentives, opportunities, and ability to rationalize. Throughout the audit, our engagement team should think about and explore the question, "If someone wanted to perpetrate a fraud, how would it be done?" From these discussions, our engagement team should be in a better position to design audit tests responsive to the risks of fraud. Have discussions with management. Our engagement team is expected to inquire of management and others in the organization as to the risk of fraud and whether they are aware of any frauds. We should make a point of talking to employees in and outside management. Giving employees and others the opportunity to "blow the whistle" may encourage someone to step forward. It might also help deter others from committing fraud if they are concerned that a co-worker will turn them in. Perform unpredictable audit tests. During the audit, we must test areas, locations and accounts that otherwise might not be tested. The team should design tests that would be unpredictable and unexpected by the client. Respond to management override of controls. Because management is often in a position to override controls in order to commit financial-statement fraud, the standard includes procedures to test for management override of controls on every audit. ACCOUNTING AND CONTROL PROCEDURE MANUAL Sales and Accounts Receivable Daily sales invoices shall be analyzed by sales totals in the athletic shoes product lines. Sales credits are coded to three product line sales revenue accounts. Charges to customer accounts should be dated the date of shipment. When sales invoices are computer generated, the numerical sequence shall be checked by an accounts receivable clerk monthly, and missing invoices must be explained and voided. The items shipped (as noted on the pick slip) shall be compared to the items billed for proper quantity, price, and other sales order terms. The general ledger supervisor shall compare the daily sales totals with the individual accounts posting total sent from the accounts receivable department. Discrepancies shall be investigated to help assure that the customer subsidiary accounts are posted for the same total amount posted to the control account. At the end of each month, the total of the trial balance of customer account balances (prepared by the accounts receivable department) shall be reconciled to the general ledger control account by the general ledger supervisor. Sales invoices shall be dated with the date of shipment, and totals (including product line sales for athletic shoes) are automatically accumulated and recorded in the accounts receivable control and sales revenue accounts. The general ledger supervisor shall approve all monthly summary returns entries before they are posted to the general ledger. The treasurer shall approve all cash refunds and allowance credit memos for sales returns, after initiation by customer relations personnel. The marketing vice president shall periodically analyze sales activity by product lines in comparison to budgets and forecasts and prior years' activity. Cash Management The monthly bank statements shall be accessed online and maintained by the cash management department in the treasurer's office. Personnel use the duplicate deposit slips retained when bank deposits were made, the cash receipts journal listing, and the cash disbursements listing to reconcile the general bank accounts. The payroll bank account is also reconciled, utilizing the payroll register retained by the treasurer's office. Cash management personnel shall compare cash receipts journal daily deposit records with the bank deposits and duplicate deposit slips when the general bank account reconciliation is performed. At the discretion of the director of internal audit, internal auditors will occasionally make unannounced reviews of the bank account reconciliations. They may also prepare reconciliations without prior notice given to cash management personnel. Cash Receipts and Accounts Receivable Processing All cash receipts from customers related to sales shall be credited to accounts receivable individual and control accounts. The accounts receivable department shall post credits to individual customer accounts, dating the entries with the date of the remittance list. Statements of accounts receivable balances shall be mailed or emailed to customers each month by the accounts receivable accounting department. Customers' reports of disputes or differences shall be handled by customer relations personnel in the marketing department. Apollo Accounting and Control Systems: Revenue and Collection Cycle As evident in the company organization chart (A-3), Apollo has several departments and offices concerned with management, accounting, and control. The company also has an abbreviated accounting and control manual (C-2), although the manual has not been kept up to date. Officers and employees have described accounting and control procedures informally under the heading of several transaction cycles. Descriptions of the company's current revenue cycle activities appear below. Credit Approval and Sales Processing Customer orders are received primarily via the company website, but also accepted in the mail, over the telephone, and over the counter by salesclerks in the marketing department. Online orders are assigned an order number (RC #1) when completed by the customer or sales associate. The sales order documents used in the office are not prenumbered but are assigned an electronic number as soon as they are entered into the system. The clerks prepare online sales orders for telephone and counter customers, printing and then signing each one and asking the counter customers to sign in person. All sales orders contain the customer name, a customer number (usually the phone number/assigned immediately for new customers), customer address, identification of products, and the quantity ordered (RC#2). Hard copies of sales order forms with signatures are kept in the salesclerks' working area through which many people pass during the day. All sales orders are entered into the computer system daily by the salesclerks (RC #3). The salesclerks prepare an estimate of the dollar amount of the order and write it on the form. For online orders this is done automatically. The sales orders are then sent to the credit manager, who is also in the marketing department. The credit manager manually checks new customers' credit file information using a computer-based inquiry system. If credit is approved, the credit manager approves the sales order. Online orders for established customers are automatically checked based on thresholds set and managed by the credit manager (RC #4). If credit is not approved, the customer is asked to pay in advance, and the sales order is held until notification of payment is received from the cashier (RC#5). The sales order is stamped or marked "paid" and sent to the billing department (RC #6). Likewise, when customers pay cash over the counter, the money is taken by the cashier, and the sales order is marked "paid" within the sales order system and sent to the billing department. For bookkeeping convenience, these "cash" sales are treated the same as credit sales, with the invoice amount being charged to an account receivable set up for the customer, and the customer's payment being applied immediately to the same account. After credit has been approved, or a payment received, the sales orders are sent to the billing department in the controller's office. The billing clerks produce a sales invoice assigned an invoice number by the system. They double check the customer and product information from the customer order, the date, and the product unit prices from an approved price list (RC #7). Sales taxes, delivery charges, and the invoice total are computed and put on the invoice. The salesclerks prepare an estimate of the dollar amount of the order and write it on the form. For online orders this is done automatically. The sales orders are then sent to the credit manager, who is also in the marketing department. The credit manager manually checks new customers' credit file information using a computer-based inquiry system. If credit is approved, the credit manager approves the sales order. Online orders for established customers are automatically checked based on thresholds set and managed by the credit manager (RC #4). If credit is not approved, the customer is asked to pay in advance, and the sales order is held until notification of payment is received from the cashier (RC #5). The sales order is stamped or marked "paid" and sent to the billing department (RC #6). Likewise, when customers pay cash over the counter, the money is taken by the cashier, and the sales order is marked "paid" within the sales order system and sent to the billing department. For bookkeeping convenience, these "cash" sales are treated the same as credit sales, with the invoice amount being charged to an account receivable set up for the customer, and the customer's payment being applied immediately to the same account. After credit has been approved, or a payment received, the sales orders are sent to the billing department in the controller's office. The billing clerks produce a sales invoice assigned an invoice number by the system. They double check the customer and product information from the customer order, the date, and the product unit prices from an approved price list (RC #7). Sales taxes, delivery charges, and the invoice total are computed and put on the invoice. The sales invoice, the customer order, and the sales order are sent to the accounts receivable accounting department, which is also in the controller's office. These e-documents are held in invoice numerical order in a "pending shipment" file, awaiting matching with the shipping forms (RC #8). Shipment and Delivery Upon receipt of a sales order which serves as the authorization to move goods to the shipping area (RC #9), the inventory storekeeper supervises removal of shoe products from shelves and bins. Warehouse employees utilize tablets and cloud based inventory tracking software to fulfill orders. The tablet displays sales order, and product location (RFID scanning technology) for all customer orders. As products are picked they are scanned and entered into software which flows through to the shipping receipt which flows to the sales invoice, adjusts inventory levels, and produces shipping information (weights, destination etc.). Before the package is shipped all documentation is reviewed by an inventory manager (RC #10). If partial orders are shipped due to lack of in stock inventory the sales order with the remaining items is placed in an electronic que (master pending file) to fulfill the order when inventory becomes available. Shipping information, once complete is sent to the billing and accounts receivable department. Auditor Note: Per auditor review we have concluded that RC#4 is a significant control because it relates directly to accounts receivable and the precision of the estimates made to the allowance for doubtful accounts. Per auditor review we have also concluded that RC#8 is a significant control because it relates direction to revenue recognition, if sales are recorded when goods have not been shipped that could be a material misstatement. rage Apollo Shoes, Inc. Consideration of Fraud Memo December 31, 2020 We identified the following key risk factors: 1) Significant competition in industry. 2) Control environment dominated by one individual. 3) Trending a significant increase in net income despite stagnant sales. 4) Emphasis on meeting profitability targets. 5) Concerns over product quality based upon sales returns and product litigation. 6) Concerns over inability to speak with predecessor auditor over their withdrawal after last year's engagement. In response to these key risk factors, the professional literature requires that as an audit team we: Place an increased emphasis on professional skepticism. Putting aside any prior beliefs as to management's honesty, the audit team must exchange ideas or brainstorm how frauds could occur. These discussions are intended to identify fraud risks and should be conducted while keeping in mind the characteristics that are present when frauds occur: incentives, opportunities, and ability to rationalize. Throughout the audit, our engagement team should think about and explore the question, "If someone wanted to perpetrate a fraud, how would it be done?" From these discussions, our engagement team should be in a better position to design audit tests responsive to the risks of fraud. Have discussions with management. Our engagement team is expected to inquire of management and others in the organization as to the risk of fraud and whether they are aware of any frauds. We should make a point of talking to employees in and outside management. Giving employees and others the opportunity to "blow the whistle" may encourage someone to step forward. It might also help deter others from committing fraud if they are concerned that a co-worker will turn them in. Perform unpredictable audit tests. During the audit, we must test areas, locations and accounts that otherwise might not be tested. The team should design tests that would be unpredictable and unexpected by the client. Respond to management override of controls. Because management is often in a position to override controls in order to commit financial-statement fraud, the standard includes procedures to test for management override of controls on every audit. ACCOUNTING AND CONTROL PROCEDURE MANUAL Sales and Accounts Receivable Daily sales invoices shall be analyzed by sales totals in the athletic shoes product lines. Sales credits are coded to three product line sales revenue accounts. Charges to customer accounts should be dated the date of shipment. When sales invoices are computer generated, the numerical sequence shall be checked by an accounts receivable clerk monthly, and missing invoices must be explained and voided. The items shipped (as noted on the pick slip) shall be compared to the items billed for proper quantity, price, and other sales order terms. The general ledger supervisor shall compare the daily sales totals with the individual accounts posting total sent from the accounts receivable department. Discrepancies shall be investigated to help assure that the customer subsidiary accounts are posted for the same total amount posted to the control account. At the end of each month, the total of the trial balance of customer account balances (prepared by the accounts receivable department) shall be reconciled to the general ledger control account by the general ledger supervisor. Sales invoices shall be dated with the date of shipment, and totals (including product line sales for athletic shoes) are automatically accumulated and recorded in the accounts receivable control and sales revenue accounts. The general ledger supervisor shall approve all monthly summary returns entries before they are posted to the general ledger. The treasurer shall approve all cash refunds and allowance credit memos for sales returns, after initiation by customer relations personnel. The marketing vice president shall periodically analyze sales activity by product lines in comparison to budgets and forecasts and prior years' activity. Cash Management The monthly bank statements shall be accessed online and maintained by the cash management department in the treasurer's office. Personnel use the duplicate deposit slips retained when bank deposits were made, the cash receipts journal listing, and the cash disbursements listing to reconcile the general bank accounts. The payroll bank account is also reconciled, utilizing the payroll register retained by the treasurer's office. Cash management personnel shall compare cash receipts journal daily deposit records with the bank deposits and duplicate deposit slips when the general bank account reconciliation is performed. At the discretion of the director of internal audit, internal auditors will occasionally make unannounced reviews of the bank account reconciliations. They may also prepare reconciliations without prior notice given to cash management personnel. Cash Receipts and Accounts Receivable Processing All cash receipts from customers related to sales shall be credited to accounts receivable individual and control accounts. The accounts receivable department shall post credits to individual customer accounts, dating the entries with the date of the remittance list. Statements of accounts receivable balances shall be mailed or emailed to customers each month by the accounts receivable accounting department. Customers' reports of disputes or differences shall be handled by customer relations personnel in the marketing department. Apollo Accounting and Control Systems: Revenue and Collection Cycle As evident in the company organization chart (A-3), Apollo has several departments and offices concerned with management, accounting, and control. The company also has an abbreviated accounting and control manual (C-2), although the manual has not been kept up to date. Officers and employees have described accounting and control procedures informally under the heading of several transaction cycles. Descriptions of the company's current revenue cycle activities appear below. Credit Approval and Sales Processing Customer orders are received primarily via the company website, but also accepted in the mail, over the telephone, and over the counter by salesclerks in the marketing department. Online orders are assigned an order number (RC #1) when completed by the customer or sales associate. The sales order documents used in the office are not prenumbered but are assigned an electronic number as soon as they are entered into the system. The clerks prepare online sales orders for telephone and counter customers, printing and then signing each one and asking the counter customers to sign in person. All sales orders contain the customer name, a customer number (usually the phone number/assigned immediately for new customers), customer address, identification of products, and the quantity ordered (RC#2). Hard copies of sales order forms with signatures are kept in the salesclerks' working area through which many people pass during the day. All sales orders are entered into the computer system daily by the salesclerks (RC #3). The salesclerks prepare an estimate of the dollar amount of the order and write it on the form. For online orders this is done automatically. The sales orders are then sent to the credit manager, who is also in the marketing department. The credit manager manually checks new customers' credit file information using a computer-based inquiry system. If credit is approved, the credit manager approves the sales order. Online orders for established customers are automatically checked based on thresholds set and managed by the credit manager (RC #4). If credit is not approved, the customer is asked to pay in advance, and the sales order is held until notification of payment is received from the cashier (RC#5). The sales order is stamped or marked "paid" and sent to the billing department (RC #6). Likewise, when customers pay cash over the counter, the money is taken by the cashier, and the sales order is marked "paid" within the sales order system and sent to the billing department. For bookkeeping convenience, these "cash" sales are treated the same as credit sales, with the invoice amount being charged to an account receivable set up for the customer, and the customer's payment being applied immediately to the same account. After credit has been approved, or a payment received, the sales orders are sent to the billing department in the controller's office. The billing clerks produce a sales invoice assigned an invoice number by the system. They double check the customer and product information from the customer order, the date, and the product unit prices from an approved price list (RC #7). Sales taxes, delivery charges, and the invoice total are computed and put on the invoice. The salesclerks prepare an estimate of the dollar amount of the order and write it on the form. For online orders this is done automatically. The sales orders are then sent to the credit manager, who is also in the marketing department. The credit manager manually checks new customers' credit file information using a computer-based inquiry system. If credit is approved, the credit manager approves the sales order. Online orders for established customers are automatically checked based on thresholds set and managed by the credit manager (RC #4). If credit is not approved, the customer is asked to pay in advance, and the sales order is held until notification of payment is received from the cashier (RC #5). The sales order is stamped or marked "paid" and sent to the billing department (RC #6). Likewise, when customers pay cash over the counter, the money is taken by the cashier, and the sales order is marked "paid" within the sales order system and sent to the billing department. For bookkeeping convenience, these "cash" sales are treated the same as credit sales, with the invoice amount being charged to an account receivable set up for the customer, and the customer's payment being applied immediately to the same account. After credit has been approved, or a payment received, the sales orders are sent to the billing department in the controller's office. The billing clerks produce a sales invoice assigned an invoice number by the system. They double check the customer and product information from the customer order, the date, and the product unit prices from an approved price list (RC #7). Sales taxes, delivery charges, and the invoice total are computed and put on the invoice. The sales invoice, the customer order, and the sales order are sent to the accounts receivable accounting department, which is also in the controller's office. These e-documents are held in invoice numerical order in a "pending shipment" file, awaiting matching with the shipping forms (RC #8). Shipment and Delivery Upon receipt of a sales order which serves as the authorization to move goods to the shipping area (RC #9), the inventory storekeeper supervises removal of shoe products from shelves and bins. Warehouse employees utilize tablets and cloud based inventory tracking software to fulfill orders. The tablet displays sales order, and product location (RFID scanning technology) for all customer orders. As products are picked they are scanned and entered into software which flows through to the shipping receipt which flows to the sales invoice, adjusts inventory levels, and produces shipping information (weights, destination etc.). Before the package is shipped all documentation is reviewed by an inventory manager (RC #10). If partial orders are shipped due to lack of in stock inventory the sales order with the remaining items is placed in an electronic que (master pending file) to fulfill the order when inventory becomes available. Shipping information, once complete is sent to the billing and accounts receivable department. Auditor Note: Per auditor review we have concluded that RC#4 is a significant control because it relates directly to accounts receivable and the precision of the estimates made to the allowance for doubtful accounts. Per auditor review we have also concluded that RC#8 is a significant control because it relates direction to revenue recognition, if sales are recorded when goods have not been shipped that could be a material misstatement. rage