The final paper will be based on Appendix 6C Illustrative Audit Case: Keystone Computers at pages 233-240 in your text. Write, in outline format but in complete sentences, a 6 to 10 page audit plan. It is recommended that you look at Figure 18.8 on page 703, which shows the control objectives related to accounts receivable.

Also reflect back over your entire accounting program and think about how the accounts are interrelated. For example, when allowance for doubtful accounts is credited the offset is to bad debt expense. Therefore one of the steps should be to trace the debit side of the entry to the balance for bad debt expense.

Make you comments as specific as possible. Rather than say look for unusual entries, say look for entries from unusual sources and rounded amounts with focus on those near an accounting cut off. Use precise language. Rather than saying you ?vouched accounts payable,? say that you looked at the item to determine that it was a bona fide business expense. Remember to focus on the key audit objectives and support needed after applying the audit risk model.

Remember, the purpose of the Final Paper is for you to culminate the learning achieved in the course by describing your understanding and application of knowledge in the field of accounting.

The Final Paper should focus on real life, real time application of topics covered in this course; the uses you have seen and the uses you can envision. The paper must be submitted to your instructor no later than the last day of class. Earlier submittal is appreciated?

ANswer:

Section

Purpose

Content

OBJECTIVES OF THE ENGAGEMENT

To describe the services to be delivered to the client.

The objectives are (1) audit of KCN's financial statements for the year ended 12/31/X5, and (2) issuance of a letter on compliance with covenants of the client's letter of credit agreement.

BUSINESS AND INDUSTRY CONDITIONS

To describe the nature of KCN's business and industry.

KCN sells and services micro-computers, networking hardware and software to business customers. The industry is sensitive to economic conditions and very competitive, with KCN competing with companies much larger than itself. KCN?s long-term success depends on its ability to attract and retain qualified information technology personnel. The annual growth in spending for information technology products and services is expected to be 6% per year for the next three years.

PLANNING MEETINGS

To indicate meetings held with client and with CPA engagement team.

At this point, one meeting has been held with client personnel and one with the engagement team.

OWNERSHIP AND MANAGEMENT To describe the owners and management of the company. KCN is privately owned by Terry Keystone, Mark Keystone, John Keystone, Keith Young, and Rita Young.

Terry and Mark Keystone participate in management.

OBJECTIVES, STRATEGIES AND BUSINESS RISKS To describe KCN?s business objectives, major strategies and the risks related to achieving its objectives. The major objective of KNC is to increase revenues by 10% and increase net income by 12% for each of the next 3 years. Major strategies include: (1) aggressive advertising, (2) sales to customers with higher risk profiles, and (3) new software development. The primary risks include (1) advertising may not create the desired results, (2) credit losses may exceed benefits of increased sales, and software development activities may not produce products.

MEASUREMENT AND REVIEW OF FINANCIAL PERFORMANCE Describes the methods used by management to monitor performance. Measures used to monitor performance include: (1) inventory and receivables turnover, (2) aging of accounts receivable, (3) sales and gross margins by type of revenue, (4) net income, and the total inventory balance.

PROCEDURES TO OBTAIN AN UNDERSTANDING OF THE CLIENT AND ITS ENVIRONMENT Describes the procedures used by the auditors to obtain an understanding of the client and its environment. The procedures used include (1) review of information from the prior-year?s audit, (2) Inquiries of management, (3) reading board minutes, (4) review of monthly performance reports, (5) review of industry reports, review of the company?s website, and (6) review of articles in the Wall Street Journal.

AUDIT APPROACH

To describe the overall approach to be taken on the audit.

Consistent with the previous year's audit, the CPAs will plan to perform tests of controls to assess control risk at less than the maximum for most assertions.

SIGNIFICANT RISKS

To describe the significant risks identified by the auditors. Two significant risks were identified: (1) KCN has engaged in a strategy to sell to customers with higher credit risk, and (2) the officers of the company receive significant bonuses based on quarterly results.

SIGNIFICANT ACCOUNTING AND AUDITING MATTERS

To describe particular accounting and auditing matters of concern.

Two particular concerns exist: (1) proper accounting for extended warranties and (2) capitalization of software costs.

PLANNING MATERIALITY

To identify an amount to be used as a measure for planning materiality.

Based on an analysis of sales, total assets, and pretax net income, an amount of $70,000 will be used as a measure of planning materiality.

SCHEDULING AND STAFFING PLAN

To provide the schedule for major portions of the audit, and the staffing requirements for the engagement.

The section includes major dates beginning with interim audit work through the issuance of an updated management letter. A total of 118 hours are budgeted for the audit.

6C-2 KCN Risks

Risks Implications and Response

1. KNC has engaged in a strategy to sell to customers with higher credit risk. The implication of this factor is there may be an increased risk of misstatement of bad debt expense and the allowance for bad debts. The auditors may decide to assign a more experienced auditor to this audit area. In addition, the auditors will decide to increase the evidence related to the adequacy of the allowance by perhaps examining the credit worthiness of more of the accounts. In addition, the auditors should not rely on tests of related controls that were performed in prior periods.

2. The officers of the company receive significant bonuses based on quarterly results. The implication of this factor is an increased risk that management may misstate quarterly results to maximize bonuses. The auditors may respond by adjusting the staffing of the engagement, increasing the level of skepticism, adding more unpredictability to the audit procedures, or increasing the evidence collected. The auditors may also increase the extent of the procedures directed at quarterly results.

6C-3 KCN Capitalization of Software Development Costs

(a)

KEYSTONE COMPUTERS & NETWORKS, INC.

December 31, 20X5

Memorandum on Accounting Issues?Accounting for Extended Warranties

In 20X4 KCN initiated to expand networking software product for sale. This year the company has started capitalizing certain costs of development. FASB Statements (FAS) Nos. 2 and 86, and to a lesser extent, FASB Interpretation No. 6 (FIN 6) provide guidance in this area. FAS 2 makes clear that the nature of the activity for which the software is being developed should be considered in determining whether software costs should be included or excluded in research and development (para. 31). FIN 6 indicates that to the extent that the acquisition, development, or improvement of a process by an enterprise for use in its selling or administrative activities includes costs for computer software, those costs are not research and development costs. Examples of such costs include development of a general management information system and the computerized reservation system of an airline. This does not appear to be the type of costs involved in this situation.

FAS 86 further clarifies the issue by stating that all costs incurred to establish the technological feasibility of a computer software product to be sold, leased or otherwise marketed are research and development costs (para. 3). The technological feasibility of a product is established when the enterprise has completed all planning, designing, coding, and testing activities that are necessary to establish that the product can be produced to meet its design specifications including functions, features, and technological performance requirements. Paragraph 4 of FAS 86 provides a summary of tests to indicate whether technological feasibility has been established.

Costs incurred subsequent to establishing technological feasibility are to be capitalized. The capitalization of computer software costs ceases when the product is available for general release to customers. Costs of maintenance and customer support should be charged to expense when related revenue is recognized or when the costs are incurred, whichever occurs first.

Warren Love

December 22, 2005.

(b)

The major audit issue involved will be determining that the client has properly categorized costs between research and development (those costs involved in establishing technological feasibility) and those costs that should be capitalized. The auditors will have to determine at what point the software product reached the point of technological feasibility.

6C-4 KCN Ratio Analysis

Keystone Computers & Networks, Inc.

Analytical Review Ratios

For the Period Ended December 31, 20X5

12/31/X5 12/31/X4 Industry

Current Ratio 1.858 1.752 1.300

Days' Sales in Accounts Receivable, Computed with Average Accounts Receivable

29.524

33.224

37.000

Allowance for Doubtful Accounts / Accounts Receivable .010 .011 ------

Bad Debt Expense / Net Sales .005 .003 ------

Inventory Turnover Computed with Average Inventory 9.255 10.397 10.000

Days? Inventory on Hand, Computed with Average Inventory

39.436

35.222

36.000

Total Liabilities to Net Worth 1.107 1.444 2.900

Return on Total Assets .194 .180 .090

Return on Net Worth .409 .441 .290

Return on Net Sales .040 .032 .023

Gross Profit / Net Sales .362 .329 .240

Selling, Operating and Administrative Expense .305 .282 .239

Times Interest Earned 8.541 6.902 5.500

Details of Computations of 20X5 ratios

Current Ratio

Current Assets / Current Liabilities

$2,091,489 / $1,125,756 = 1.858

Days Sales in A/R Computed

with Average A/R

Sales per day = Sales / 365

= $11,602,506 / 365 = 31,788

Average A/R = (Beg. A/R + End A/R) / 2

= ($853,452 + $1,023,545))/2 =$938,499

Days sales = Average A/R / Sales per day

= $938,499 / $31,788 = 29.524

Allowance for Bad Debts / A/R

$10,400 / $1,023,545 = .010

Bad Debts Expense / Net Sales

56,477 / $11,602,506 = .005

Inventory Turnover Computed with Average Inventory

Average Inv. = (Beg. Inv. + End Inv) / 2

= ($694,744 + $903,766) / 2 = $799,255

Inv. Turnover = Cost of Goods Sold / Average Inv.

= $7,397,368 / $799,255 = 9.255

Days Inventory Computed with

Average Inventory

CGS per day = Cost of Goods Sold / 365

= $7,397,368 / 365 = $20,267

Days Inv. = Average Inv. / CGS per day

= $799,255 / $20,267 = 39.436

Total Liabilities to Net Worth

Total Liabilities / Stockholders' Equity

$1,240,171 / $1,119,988 = 1.107

Return on Total Assets

Net Income / Total Assets

$458,437 / $2,360,159 = .194

Return on Net Worth

Net Income / Stockholders' Equity

$458,437 / 1,119,988 = .409

Return on Net Sales

Net Income / Net Sales

$458,437 / $11,602,506 = .040

Gross Profit / Net Sales

Gross Profit / Net Sales

$4,205,138 / $11,602,506 = .362

Selling, Operating and Admin. Expense / Net Sales

Selling, Operating and Admin. Exp. / Net Sales

$3,543,798 / $11,602,506 = .305

Times Interest Earned

Operating Income / Interest Expense

$661,340 / $77,434 = 8.541

(b) & (c) After completing the part a, the book requests us to review the ratios and identify the financial accounts that needed to be investigated, because the ratios were not comparable to prior-year ratios and industry averages. This section it is complicated to disclose because there are no major changes in ratios. Some aspects must be measured:

Days Sales in Accounts Receivable

? Changes in credit policy

? Better economic conditions

? Change in customer mix

? Overstatement of sales

? Understatement of receivables

Inventory Turnover

? Change in inventory policy

? Inventory obsolescence

? Overstatement of inventory

? Understatement of purchases

Days Inventory on Hand

? Change in inventory policy

? Inventory obsolescence

? Overstatement of inventory

? Understatement of purchases

Gross Profit / Net Sales

? Change in sales mix

? Increase in sales pricing

? Reduction of costs

? Understatement of cost of goods sold and related overstatement of inventory

The audit plan for the audit of Keystone Computers & Networks, Inc., appears on pages 237-244. Review each major section of the audit plan and briefly describe the purpose and content of the section. Organize your solution in the following manner: Dear Sirs, I need help to complete or finalize my final paper in auditing. I have I say 90% done with all calculations and requirements. However, I need an expert that can review the below information asked from my college, to see what else I suppose to do here. I am not sure what is my next step. Please analylize it and provide me with a cost. This is urgent and I seriously need help. Below is what I am requested and also what I have completed.In the attachment is a pdf. file of the exercise from the book. Requested: The final paper will be based on Appendix 6C Illustrative Audit Case: Keystone Computers at pages 233240 in your text. Write, in outline format but in complete sentences, a 6 to 10 page audit plan. It is recommended that you look at Figure 18.8 on page 703, which shows the control objectives related to accounts receivable. Also reflect back over your entire accounting program and think about how the accounts are interrelated. For example, when allowance for doubtful accounts is credited the offset is to bad debt expense. Therefore one of the steps should be to trace the debit side of the entry to the balance for bad debt expense. Make you comments as specific as possible. Rather than say look for unusual entries, say look for entries from unusual sources and rounded amounts with focus on those near an accounting cut off. Use precise language. Rather than saying you \"vouched accounts payable,\" say that you looked at the item to determine that it was a bona fide business expense. Remember to focus on the key audit objectives and support needed after applying the audit risk model. Remember, the purpose of the Final Paper is for you to culminate the learning achieved in the course by describing your understanding and application of knowledge in the field of accounting. The Final Paper should focus on real life, real time application of topics covered in this course; the uses you have seen and the uses you can envision. The paper must be submitted to your instructor no later than the last day of class. Earlier submittal is appreciated... ANswer: Section Purpose Content OBJECTIVES OF THE ENGAGEMENT To describe the services to be delivered to the client. The objectives are (1) audit of KCN's financial statements for the year ended 12/31/X5, and (2) issuance of a letter on compliance with covenants of the client's letter of credit agreement. BUSINESS AND INDUSTRY CONDITIONS To describe the nature of KCN's business and industry. KCN sells and services micro-computers, networking hardware and software to business customers. The industry is sensitive to economic conditions and very competitive, with KCN competing with companies much larger than itself. KCN's long-term success depends on its ability to attract and retain qualified information technology personnel. The annual growth in spending for information technology products and services is expected to be 6% per year for the next three years. PLANNING MEETINGS To indicate meetings held with client and with CPA engagement team. At this point, one meeting has been held with client personnel and one with the engagement team. OWNERSHIP AND MANAGEMENT To describe the owners and management of the company. KCN is privately owned by Terry Keystone, Mark Keystone, John Keystone, Keith Young, and Rita Young. Terry and Mark Keystone participate in management. OBJECTIVES, STRATEGIES AND BUSINESS RISKS To describe KCN's business objectives, major strategies and the risks related to achieving its objectives. The major objective of KNC is to increase revenues by 10% and increase net income by 12% for each of the next 3 years. Major strategies include: (1) aggressive advertising, (2) sales to customers with higher risk profiles, and (3) new software development. The primary risks include (1) advertising may not create the desired results, (2) credit losses may exceed benefits of increased sales, and software development activities may not produce products. MEASUREMENT AND REVIEW OF FINANCIAL PERFORMANCE Describes the methods used by management to monitor performance. Measures used to monitor performance include: (1) inventory and receivables turnover, (2) aging of accounts receivable, (3) sales and gross margins by type of revenue, (4) net income, and the total inventory balance. PROCEDURES TO OBTAIN AN UNDERSTANDING OF THE CLIENT AND ITS ENVIRONMENT Describes the procedures used by the auditors to obtain an understanding of the client and its environment. The procedures used include (1) review of information from the prior-year's audit, (2) Inquiries of management, (3) reading board minutes, (4) review of monthly performance reports, (5) review of industry reports, review of the company's website, and (6) review of articles in the Wall Street Journal. AUDIT APPROACH To describe the overall approach to be taken on the audit. Consistent with the previous year's audit, the CPAs will plan to perform tests of controls to assess control risk at less than the maximum for most assertions. SIGNIFICANT RISKS To describe the significant risks identified by the auditors. Two significant risks were identified: (1) KCN has engaged in a strategy to sell to customers with higher credit risk, and (2) the officers of the company receive significant bonuses based on quarterly results. SIGNIFICANT ACCOUNTING AND AUDITING MATTERS To describe particular accounting and auditing matters of concern. Two particular concerns exist: (1) proper accounting for extended warranties and (2) capitalization of software costs. PLANNING MATERIALITY To identify an amount to be used as a measure for planning materiality. Based on an analysis of sales, total assets, and pretax net income, an amount of $70,000 will be used as a measure of planning materiality. SCHEDULING AND STAFFING PLAN To provide the schedule for major portions of the audit, and the staffing requirements for the engagement. The section includes major dates beginning with interim audit work through the issuance of an updated management letter. A total of 118 hours are budgeted for the audit. 6C-2 KCN Risks Risks Implications and Response 1. KNC has engaged in a strategy to sell to customers with higher credit risk. The implication of this factor is there may be an increased risk of misstatement of bad debt expense and the allowance for bad debts. The auditors may decide to assign a more experienced auditor to this audit area. In addition, the auditors will decide to increase the evidence related to the adequacy of the allowance by perhaps examining the credit worthiness of more of the accounts. In addition, the auditors should not rely on tests of related controls that were performed in prior periods. 2. The officers of the company receive significant bonuses based on quarterly results. The implication of this factor is an increased risk that management may misstate quarterly results to maximize bonuses. The auditors may respond by adjusting the staffing of the engagement, increasing the level of skepticism, adding more unpredictability to the audit procedures, or increasing the evidence collected. The auditors may also increase the extent of the procedures directed at quarterly results. 6C-3 KCN Capitalization of Software Development Costs (a) KEYSTONE COMPUTERS & NETWORKS, INC. December 31, 20X5 Memorandum on Accounting IssuesAccounting for Extended Warranties In 20X4 KCN initiated to expand networking software product for sale. This year the company has started capitalizing certain costs of development. FASB Statements (FAS) Nos. 2 and 86, and to a lesser extent, FASB Interpretation No. 6 (FIN 6) provide guidance in this area. FAS 2 makes clear that the nature of the activity for which the software is being developed should be considered in determining whether software costs should be included or excluded in research and development (para. 31). FIN 6 indicates that to the extent that the acquisition, development, or improvement of a process by an enterprise for use in its selling or administrative activities includes costs for computer software, those costs are not research and development costs. Examples of such costs include development of a general management information system and the computerized reservation system of an airline. This does not appear to be the type of costs involved in this situation. FAS 86 further clarifies the issue by stating that all costs incurred to establish the technological feasibility of a computer software product to be sold, leased or otherwise marketed are research and development costs (para. 3). The technological feasibility of a product is established when the enterprise has completed all planning, designing, coding, and testing activities that are necessary to establish that the product can be produced to meet its design specifications including functions, features, and technological performance requirements. Paragraph 4 of FAS 86 provides a summary of tests to indicate whether technological feasibility has been established. Costs incurred subsequent to establishing technological feasibility are to be capitalized. The capitalization of computer software costs ceases when the product is available for general release to customers. Costs of maintenance and customer support should be charged to expense when related revenue is recognized or when the costs are incurred, whichever occurs first. Warren Love December 22, 2005. (b) The major audit issue involved will be determining that the client has properly categorized costs between research and development (those costs involved in establishing technological feasibility) and those costs that should be capitalized. The auditors will have to determine at what point the software product reached the point of technological feasibility. 6C-4 KCN Ratio Analysis Keystone Computers & Networks, Inc. Analytical Review Ratios For the Period Ended December 31, 20X5 12/31/X5 12/31/X4 Industry Current Ratio 1.858 1.752 1.300 Days' Sales in Accounts Receivable, Computed with Average Accounts Receivable 29.524 33.224 37.000 Allowance for Doubtful Accounts / Accounts Receivable .010 .011 -----Bad Debt Expense / Net Sales .005 .003 -----Inventory Turnover Computed with Average Inventory 9.255 10.397 10.000 Days' Inventory on Hand, Computed with Average Inventory 39.436 35.222 36.000 Total Liabilities to Net Worth 1.107 1.444 2.900 Return on Total Assets .194 .180 .090 Return on Net Worth .409 .441 .290 Return on Net Sales .040 .032 .023 Gross Profit / Net Sales .362 .329 .240 Selling, Operating and Administrative Expense .305 .282 .239 Times Interest Earned 8.541 6.902 5.500 Details of Computations of 20X5 ratios Current Ratio Current Assets / Current Liabilities $2,091,489 / $1,125,756 = 1.858 Days Sales in A/R Computed with Average A/R Sales per day = Sales / 365 = $11,602,506 / 365 = 31,788 Average A/R = (Beg. A/R + End A/R) / 2 = ($853,452 + $1,023,545))/2 =$938,499 Days sales = Average A/R / Sales per day = $938,499 / $31,788 = 29.524 Allowance for Bad Debts / A/R $10,400 / $1,023,545 = .010 Bad Debts Expense / Net Sales 56,477 / $11,602,506 = .005 Inventory Turnover Computed with Average Inventory Average Inv. = (Beg. Inv. + End Inv) / 2 = ($694,744 + $903,766) / 2 = $799,255 Inv. Turnover = Cost of Goods Sold / Average Inv. = $7,397,368 / $799,255 = 9.255 Days Inventory Computed with Average Inventory CGS per day = Cost of Goods Sold / 365 = $7,397,368 / 365 = $20,267 Days Inv. = Average Inv. / CGS per day = $799,255 / $20,267 = 39.436 Total Liabilities to Net Worth Total Liabilities / Stockholders' Equity $1,240,171 / $1,119,988 = 1.107 Return on Total Assets Net Income / Total Assets $458,437 / $2,360,159 = .194 Return on Net Worth Net Income / Stockholders' Equity $458,437 / 1,119,988 = .409 Return on Net Sales Net Income / Net Sales $458,437 / $11,602,506 = .040 Gross Profit / Net Sales Gross Profit / Net Sales $4,205,138 / $11,602,506 = .362 Selling, Operating and Admin. Expense / Net Sales Selling, Operating and Admin. Exp. / Net Sales $3,543,798 / $11,602,506 = .305 Times Interest Earned Operating Income / Interest Expense $661,340 / $77,434 = 8.541 (b) & (c) After completing the part a, the book requests us to review the ratios and identify the financial accounts that needed to be investigated, because the ratios were not comparable to prior-year ratios and industry averages. This section it is complicated to disclose because there are no major changes in ratios. Some aspects must be measured: Days Sales in Accounts Receivable Changes in credit policy Better economic conditions Change in customer mix Overstatement of sales Understatement of receivables Inventory Turnover Change in inventory policy Inventory obsolescence Overstatement of inventory Understatement of purchases Days Inventory on Hand Change in inventory policy Inventory obsolescence Overstatement of inventory Understatement of purchases Gross Profit / Net Sales Change in sales mix Increase in sales pricing Reduction of costs Understatement of cost of goods sold and related overstatement of inventory The increased level of profitability could be a reason why some of the ratios show considerable changes