This assignment is expected to take you the following time: Internet research ? 3 hours Industry analysis ? 2 hours Completing the checklist ? 1hour Preliminary analysis ? 2 hours You are being asked to complete part of the checklist for the knowledge of a client?s business, as you would do for any new client of your audit firm. It is expected that you will study at least two competitors for the fictional company described below. The case is as follows. Java Stop Limited (JSL) is a private company with corporate offices at 10 Bay Street, Suite 409 in Toronto. It was founded July 2, 2002 by Michael Beber. Mr. Beber was working as a banker at the time. While visiting a client in the import business, his client pointed to the coffee Mr. Beber had bought at the corner coffee shop for $1.75 and told him that the beans to make one cup cost about 20 cents. Knowing that the other main ingredient was water, which was almost costless, Mr. Beber did the math on the other fixed and variable costs, looked at the competition and the market and decided there was room for one more coffee chain. The first store, run by his now ex-wife Lori, opened October 1, 2002. Java Stop distinguished itself from its competitors in three areas. First, they use distilled water instead of tap water. Technically speaking, anything added to tap water is mostly boiled away during the brewing process. Displaying the water jugs to the customers reinforces the image of purity. Surveys have shown this to be a positive feature of their locations. The second advantage was that right from the beginning, free internet was made available to customers. While this is common in the competitors today, it was not as common in 2002. Lastly, Jave Stop prices its products at 90% of the price at the leading chain. When incorporated, 1,000,000 shares were issued. He owned 75% and his wife owned 25%. Mr. Beber and his wife were divorced in 2006, at which time there were 7 locations in Toronto, and one in Kingston. After their divorce settlement, Lori owned 200,000 shares, Mr. Beber 400,000 and a family trust had 400,000. The family trust was set up to benefit the couple?s two children. Mr. Beber quit the bank in 2006 to run the company full time and it now has 23 locations. Lori ceased to be involved in operating the company in 2005. The current management team is composed of Kathy Kus, CFO, Hy Haberman, V.P. Operations and Michael Beber, CEO. All three sit on the Board of Directors along with four others who are mostly friends of Mr. Beber. There are several challenges faced by the company. The first is that within the next five years, it is planned to change their incorporation from the Ontario Corporations Act to the Federal Canada Corporations Act. While not necessary in order to expand into other provinces, it will make it easier to expand into the United States. At the same time, the company is expected to go public and use the funds to expand rapidly. It is for this reason that they have chosen to have the financial statements audited. Because of Mr. Beber?s contacts at the Bank of Nova Scotia, 100 Yonge St., 9th floor Toronto ON, M5H 1H1, operating lines of credit were secured by a general charge on assets and internally prepared financial statements were deemed to be acceptable. No review or audit has been done in the past. Ms. Kus is a CA with 20 years experience and there six employees in the accounting department, including the Accounting Manger, Joan Zhou, who recently completed her CGA. They are currently using ACCPAC v 5.4 operating on a Dell Data Server. JSL outsources its IT services to FC DataNet, Limited which is headquartered in Calgary and has offices across Canada. Ms. Kus believes this system will be scalable up to 100 locations, at which time it is likely the company will bring its systems in house and upgrade to a larger software platform such as SAP. Ms. Kus is familiar with SAP through her work as Controller for Nabisco Canada prior to joining JSL. There is only a small chance that JSL will have that many locations by the time it goes public. The last challenge to the business is what to do with its coffee import operations. JSL uses its buying power to buy beans and roast them on behalf of smaller coffee shops. This helps use up capacity at its own roasting plant but also helps strengthen its competitors and has a low gross margin of less 15% even though there is no extra operating costs.. Roughly 20% of sales come from the roasting side of the business. It also accounts for all of the accounts receivable. The year end is December 31. Required a) (10 marks) Fill out the client acceptance checklist. This will require you to do research on the coffee shop industry. You may wish to contact the library if you need help with research. Feel free to expand the Knowledge of Industry section to have enough room to give the results of your research. b) (8 marks) Perform a preliminary analysis of the financial information. c) (4 marks) Calculate materiality based on the information you?ve been given and justify your calculation. d) (8 marks) Identify four areas of inherent risk that might affect your audit planning. Would you say these are high risks or low? KNOWLEDGE OF THE CLIENT'S BUSINESS CHECKLIST This appendix provides a checklist that may help the auditor obtain and document knowledge of some of the characteristics of the client's business. This checklist is not meant to be an exhaustive list of the characteristics of the client's business that may be important for the audit. In addition, this checklist is not designed to group all of the information necessary for understanding internal control for planning purposes and assessing control risk. I. KNOWLEDGE OF THE ENTITY A. CHARACTERISTICS OF OWNERSHIP AND MANAGEMENT 1. Type of entity: 0Corporation 0 Sole proprietorship 0Private 0Public 0 Joint venture 0 Crown corporation 0 General partnership 0 Not-for-profit organization 0 Limited partnership 0 Other (describe) 2. Jurisdiction of incorporation: Statute: Date: 3. Listed on stock exchange: (name of stock exchanges, listed securities) 4. Principal owners, directors and officers: Name Title % interest I. KNOWLEDGE OF THE ENTITY B. OPERATIONS 1. Nature of activities (manufacturing, distributing, service, etc.; industrial, commercial, residential, individual, etc.): Description of products and services % of activities 2. Territory covered Location % of activities 3. Production or sales cycles 4. Patents, trademarks, rights, permits: I. KNOWLEDGE OF THE ENTITY C. FINANCIAL POSITION 2. Sources of financing: Financial institutions (name, address, bank accounts) Other sources of financing: 3. Is there a doubt as to the entity's ability to continue as a going concern? D. INFORMATION SYSTEMS 1. Accounting records and documents: Accounting cycle or subsystem System or software Frequency 2. Description of computerized system: II. KNOWLEDGE OF THE INDUSTRY 1. Economic conditions of the industry: (market conditions, decline or expansion of business, price changes, economic cycle of products, etc.): 2. Description of technological changes, internationalization of business transactions and their effects on the market: 3. Major competitors: Name Products or services offered 4. Financial statement users and reporting requirements: 5. Specific knowledge required of the audit team: Type of knowledge Description Canadian accounting standards US accounting standards Other accounting standards Specific industry guidance Materiality: Materiality should be calculated as: This amount is appropriate for the following reasons:

SCHOOL OF FINANCIAL SERVICES Term ACCOUNTING DIPLOMA Assignment COURSE NAME: Auditing I PROFESSOR: Rand Rowlands AGENDA: Term Assignment Part 1 DUE DATE: June 16, 2010 This assignment is expected to take you the following time: Internet research - 3 hours Industry analysis - 2 hours Completing the checklist - 1hour Preliminary analysis - 2 hours You are being asked to complete part of the checklist for the knowledge of a client's business, as you would do for any new client of your audit firm. It is expected that you will study at least two competitors for the fictional company described below. The case is as follows. Java Stop Limited (JSL) is a private company with corporate offices at 10 Bay Street, Suite 409 in Toronto. It was founded July 2, 2002 by Michael Beber. Mr. Beber was working as a banker at the time. While visiting a client in the import business, his client pointed to the coffee Mr. Beber had bought at the corner coffee shop for $1.75 and told him that the beans to make one cup cost about 20 cents. Knowing that the other main ingredient was water, which was almost costless, Mr. Beber did the math on the other fixed and variable costs, looked at the competition and the market and decided there was room for one more coffee chain. The first store, run by his now ex-wife Lori, opened October 1, 2002. Java Stop distinguished itself from its competitors in three areas. First, they use distilled water instead of tap water. Technically speaking, anything added to tap water is mostly boiled away during the brewing process. Displaying the water jugs to the customers reinforces the image of purity. Surveys have shown this to be a positive feature of their locations. The second advantage was that right from the beginning, free internet was made available to customers. While this is common in the competitors today, it was not as common in 2002. Lastly, Jave Stop prices its products at 90% of the price at the leading chain. When incorporated, 1,000,000 shares were issued. He owned 75% and his wife owned 25%. Mr. Beber and his wife were divorced in 2006, at which time there were 7 locations in Toronto, and one in Kingston. After their divorce settlement, Lori owned 200,000 shares, Mr. Beber 400,000 and a family trust had 400,000. The family trust was set up to benefit the couple's two children. Mr. Beber quit the bank in 2006 to run the company full time and it now has 23 locations. Lori ceased to be involved in operating the company in 2005. Page 1 of 4 SCHOOL OF FINANCIAL SERVICES Term ACCOUNTING DIPLOMA Assignment The current management team is composed of Kathy Kus, CFO, Hy Haberman, V.P. Operations and Michael Beber, CEO. All three sit on the Board of Directors along with four others who are mostly friends of Mr. Beber. There are several challenges faced by the company. The first is that within the next five years, it is planned to change their incorporation from the Ontario Corporations Act to the Federal Canada Corporations Act. While not necessary in order to expand into other provinces, it will make it easier to expand into the United States. At the same time, the company is expected to go public and use the funds to expand rapidly. It is for this reason that they have chosen to have the financial statements audited. Because of Mr. Beber's contacts at the Bank of Nova Scotia, 100 Yonge St., 9th floor Toronto ON, M5H 1H1, operating lines of credit were secured by a general charge on assets and internally prepared financial statements were deemed to be acceptable. No review or audit has been done in the past. Ms. Kus is a CA with 20 years experience and there six employees in the accounting department, including the Accounting Manger, Joan Zhou, who recently completed her CGA. They are currently using ACCPAC v 5.4 operating on a Dell Data Server. JSL outsources its IT services to FC DataNet, Limited which is headquartered in Calgary and has offices across Canada. Ms. Kus believes this system will be scalable up to 100 locations, at which time it is likely the company will bring its systems in house and upgrade to a larger software platform such as SAP. Ms. Kus is familiar with SAP through her work as Controller for Nabisco Canada prior to joining JSL. There is only a small chance that JSL will have that many locations by the time it goes public. The last challenge to the business is what to do with its coffee import operations. JSL uses its buying power to buy beans and roast them on behalf of smaller coffee shops. This helps use up capacity at its own roasting plant but also helps strengthen its competitors and has a low gross margin of less 15% even though there is no extra operating costs.. Roughly 20% of sales come from the roasting side of the business. It also accounts for all of the accounts receivable. The year end is December 31. Required (10 marks) Fill out the client acceptance checklist. This will require you to do research on the coffee shop industry. You may wish to contact the library if you need help with research. Feel free to expand the Knowledge of Industry section to have enough room to give the results of your research. b) (8 marks) Perform a preliminary analysis of the financial information. c) (4 marks) Calculate materiality based on the information you've been given and justify your calculation. d) (8 marks) Identify four areas of inherent risk that might affect your audit planning. Would you say these are high risks or low? a) Page 2 of 4 SCHOOL OF FINANCIAL SERVICES Term ACCOUNTING DIPLOMA Assignment JAVA STOP LIMITED Balan ce Sh e e t As At De ce mb e r 31 A SSETS 2009 2008 344,937 407,766 204,500 957,203 2 07,773 2 95,126 3 32,051 1 51,000 9 85,950 3 ,829,179 210,588 610,406 4 ,650,173 2 ,359,878 2 ,290,295 3 ,247,498 3 ,079,634 1 93,173 5 45,905 3 ,818,712 1 ,837,294 1 ,981,418 2 ,967,368 4 0,689 629,732 5 1,644 1 7,705 739,770 5 28,212 4 5,073 1 2,253 5 85,538 Lo ng te rm Liab ilitie s: Bank lo an du e Ap ril 1, 2013 (7.25% ) 1,000,000 1 ,000,000 To tal Liab ilitie s 1 ,739,770 1 ,585,538 Sto ckho lde rs' Equ ity: C o mmo n sto ck au thorize d 1,000,000 sh are s, i ssue d and outstandin g 1,000,000 share s Re taine d e arning s Total Stockh olde rs' Eq uity TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY 200,000 1 ,307,728 1 ,507,728 3 ,247,498 2 00,000 1 ,181,830 1 ,381,830 2 ,967,368 Cu rre nt Asse ts: Cash Accoun ts re ce ivab le le ss allowan ce fo r dou b tful acco unts In ve nto rie s P re paid e xp e nse s To tal Curre n t Asse ts P ro pe rty, plant, & e quipme n t, at cost Machin e ry and e q uipm e nt Au tomo tive e quip me n t O ffice furniture an d fixture s Le ss accumu late d de p re ciation TOTAL ASSETS LIABILITIES AND STOCKHOLDERS' EQUITY C u rre nt Liab ilitie s: Bank line of cre dit Accoun ts payab le Accrue d liab ilitie s In come taxe s payab le Total curre n t liab ilitie s Page 3 of 4 SCHOOL OF FINANCIAL SERVICES Term ACCOUNTING DIPLOMA Assignment JAVA STOP LIMITED State me n t of In come Ye ars e nde d De ce mb e r 31 2009 Sale s and othe r re ve nue s C o st of g oo ds sold Sto re o pe rating costs 2008 1 3,674,687 4,186,570 6,799,050 10,979,747 3 ,200,842 5 ,379,250 Store marg in 2,689,067 2 ,399,655 Se lling, g e n e ral, and administrative 1,897,267 1 ,717,449 O p e ratin g Income 7 91,800 682,206 Amo rtizatio n Inte re st Ne t inco me b e fore fe de ral inco me taxe s 522,584 7 2,500 1 96,716 473,561 7 2,500 136,145 7 0,818 4 9,012 1 25,898 8 7,133 P ro vision for inco me taxe s NET INCOME Page 4 of 4 CENTRE FOR FINANCIAL SERVICES EDUCATION BUSINESS AND CREATIVE ARTS Engagement Management Preliminary analytical procedures to identify areas of audit interest, pp 255 - 265 o The first step in planning an audit is to review material related to the business risks of a company. This is often done by looking at trade magazines to find out what has changed in the industry. o The next step is to meet with management to discuss how they are addressing changes in the industry and to review the minutes of meetings of the board of directors who are providing oversight on management. Some of the things in the minutes of the director's meetings will be: Authorization of officers' (senior management) salaries. Authorization of stock options and other "perk" compensation. Amount of dividends declared. Acceptance of major contracts, agreements, lawsuit settlements. Approval of major purchases of property and investments. Amount of dividends declared. Authorization of financing by stock issues, long-term debt, and leases. Approval to pledge assets as security for debts. Discussions of merger and divestiture progress. Discussion of negotiations on bank loans and payment waivers. Approval of accounting policies and accounting for estimates and unusual transactions. Authorizations of individuals to sign bank checks. o At this stage, an auditor will be able to obtain the draft financial statements and to perform preliminary analytical procedures. o The purpose of performing preliminary analytical procedures in the audit planning stage is to direct attention to potential problem areas so the audit work can be planned to reduce the risk of missing something important o There are five general types of analytical procedures Compare financial information with prior period(s) Compare financial information with budgets or forecasts Study predictable financial information patterns based on the entity's experience Compare financial information to industry statistics Study financial information relationships to nonfinancial information Engagement acceptance, pp 162 - 170 o An auditor is under no obligation to accept or retain a client and may resign at any time However, there is a \"service to the public\" concept underlying professional practice which says that the auditor is there to serve the public and should be careful to protect the public's interests before resigning from an audit. 1 A key warning sign is unpaid bills from previous audits. This may indicate poor cash management, financial hardship which increases the risk of error, or a serious dispute with the previous auditor. o Client acceptance and retention procedures should include: Evaluation of independence. Obtaining and reviewing financial information about prospective client. Communication with predecessor auditor (if there is one). Enquiry of bankers, legal counsel, other parties having inside knowledge of the potential client. Consideration of unusual risks. o An auditor is professionally obligated to communicate with predecessor auditors as a result of the courtesy rule of professional conduct However, the confidentiality rule prevents the predecessor from communicating confidential information to the successor auditor. The solution is to have the prospective client request that the predecessor release the information. If a client is unwilling to have the new auditor speak to the old auditor, the new auditor should consider whether this creates an unusual risk in going forward. If the client does not consent, communication must still take place. The successor will not be able to obtain any confidential information about the client but may learn that there are unpaid bills. o Ideally, a successor auditor will obtain permission to review the predecessor's working papers which will save significant time in identifying areas of audit interest but are no replacement for the successor's own work. o Continuing clients are often easier to plan for since there is history with the client documented in the prior year's working papers and there is less study needed to bring the audit team up to speed on the client's business. o Having determined that the client will be accepted or retained, an engagement letter is obtained which sets out the responsibilities and expectations of management and the auditor. This is now required as of August 2005 If you are performing contract work without a contract, you can always start by sending a letter outlining your expectations of what you will do and what your client will provide to help you do it. This may come in handy later if the work is expanded beyond the original agreement. Understanding of a client's business, pp 170 - 173 & 181 - 183 o One cannot properly account for the transactions of a business without first understanding the business itself. Consequently, an auditor cannot test the economic substance of a transaction or balance without first understanding the client's business. o To set the context for understanding a client, auditors must understand the economic environment of the business including factors such as: national economic condition and policies geographic location developments in national and local taxation and regulation specific industry characteristics (e.g. software lumber) o Understanding a client's business starts with a strategic analysis of the business to identify risks to the business. The analysis includes Client business objectives Key strategies employed to meet those objectives Page 2 Risks that threaten achievement of those objectives How management attempts to minimize those risks The next stage of understanding the business is a business process analysis. This is how management executes its plans including risk-minimization procedures. At the deepest level are systems notes which document the exact system of internal controls used to process transactions or protect assets. At a higher level are processes such as annual budgeting, hiring processes, training, sales policies, internal audit procedures, privacy policies, and data backup procedures. o Companies which fail as a business are more likely to result in law suits which might involve the auditor. Identifying business risk, pp 205 - 209 o See Appendix 6A and 6B o Once a risk has been identified it can be managed in one of four ways: It can be avoided by not performing activities that cause the risk It can reduced to acceptable levels through management control It can tolerated on a cost/benefit basis It can transferred to another party by contract o An auditor should seek to understand the business risks and to confirm that they are at acceptable levels. If not, contingencies may have to be recorded even if the risk has not yet materialized (e.g. shortcuts in manufacturing may require a higher warranty expense). Accounting cycles, pp 184- 187 o The results of the business processes are summarized by management in the financial statements. o Business processes are interrelated but are often split out as part of an efficient audit of financial statements. o Auditors consider four key accounting cycles which are ways of grouping some of a company's business processes. revenues and collection (sales and receivables) acquisition and expenditure (purchases and payables) production and conversion (including payroll) finance and investment (including contingency estimates) o These cycles tend to contain accounts which are highly related and can most efficiently be audited together at least for simpler or smaller clients. Audit programs and audit evidence working papers, pp 295 - 303 o Auditors document both their plan and their findings in the working papers o There are two types of working papers Planning file which documents that the audit was planned, that experts were used where their knowledge was required, and that assistants were supervised. The most important document in the planning file is the engagement letter The next most important is the planning memorandum which is an document prepared by the audit manager and reviewed by the partner and identifies the key audit risks. Included in the planning file is an identification of the audit team members and their experience levels Also included is a time budget which shows how much time is planned to be devoted to planning and supervision and how much to the actual work o Page 3 Any reliance on a client's internal auditors will be documented The timing of audit procedures will also be documented in the planning file. Audit evidence files which are broken into two files The permanent file which contains pieces of evidence such as the share register or lease agreements that continue from year to year. o This is carried forward from year to year and is kept separate from the current year working papers. Current working papers which contain the actual work for the year. Included are schedules prepared by the client, schedules prepared by the auditor, explanations of audit symbols, photocopies of bank reconciliations, invoices or other business documents, the schedule of unadjusted errors, the unadjusted trial balance, and the final, audited financial statements. o Also included are audit programs which are the step by step procedures performed by the auditors. Modifications to the standard programs are done at the planning stage. These modifications are also evidence of planning. Junior auditors should perform the steps exactly as shown. If they are unable to for some reason and a field modification is necessary, they must discuss it with their supervisor as they are unlikely to have the knowledge themselves to evaluate changes to audit risk by changing the step. Examples are at the back of chapters 11-14. All documents in the evidence files are cross-referenced so that the evidence supporting financial statement amounts can be easily located. Page 4 CENTRE FOR FINANCIAL SERVICES EDUCATION BUSINESS AND CREATIVE ARTS Engagement Management Preliminary analytical procedures to identify areas of audit interest, pp 255 - 265 o The first step in planning an audit is to review material related to the business risks of a company. This is often done by looking at trade magazines to find out what has changed in the industry. o The next step is to meet with management to discuss how they are addressing changes in the industry and to review the minutes of meetings of the board of directors who are providing oversight on management. Some of the things in the minutes of the director's meetings will be: Authorization of officers' (senior management) salaries. Authorization of stock options and other "perk" compensation. Amount of dividends declared. Acceptance of major contracts, agreements, lawsuit settlements. Approval of major purchases of property and investments. Amount of dividends declared. Authorization of financing by stock issues, long-term debt, and leases. Approval to pledge assets as security for debts. Discussions of merger and divestiture progress. Discussion of negotiations on bank loans and payment waivers. Approval of accounting policies and accounting for estimates and unusual transactions. Authorizations of individuals to sign bank checks. o At this stage, an auditor will be able to obtain the draft financial statements and to perform preliminary analytical procedures. o The purpose of performing preliminary analytical procedures in the audit planning stage is to direct attention to potential problem areas so the audit work can be planned to reduce the risk of missing something important o There are five general types of analytical procedures Compare financial information with prior period(s) Compare financial information with budgets or forecasts Study predictable financial information patterns based on the entity's experience Compare financial information to industry statistics Study financial information relationships to nonfinancial information Engagement acceptance, pp 162 - 170 o An auditor is under no obligation to accept or retain a client and may resign at any time However, there is a \"service to the public\" concept underlying professional practice which says that the auditor is there to serve the public and should be careful to protect the public's interests before resigning from an audit. 1 A key warning sign is unpaid bills from previous audits. This may indicate poor cash management, financial hardship which increases the risk of error, or a serious dispute with the previous auditor. o Client acceptance and retention procedures should include: Evaluation of independence. Obtaining and reviewing financial information about prospective client. Communication with predecessor auditor (if there is one). Enquiry of bankers, legal counsel, other parties having inside knowledge of the potential client. Consideration of unusual risks. o An auditor is professionally obligated to communicate with predecessor auditors as a result of the courtesy rule of professional conduct However, the confidentiality rule prevents the predecessor from communicating confidential information to the successor auditor. The solution is to have the prospective client request that the predecessor release the information. If a client is unwilling to have the new auditor speak to the old auditor, the new auditor should consider whether this creates an unusual risk in going forward. If the client does not consent, communication must still take place. The successor will not be able to obtain any confidential information about the client but may learn that there are unpaid bills. o Ideally, a successor auditor will obtain permission to review the predecessor's working papers which will save significant time in identifying areas of audit interest but are no replacement for the successor's own work. o Continuing clients are often easier to plan for since there is history with the client documented in the prior year's working papers and there is less study needed to bring the audit team up to speed on the client's business. o Having determined that the client will be accepted or retained, an engagement letter is obtained which sets out the responsibilities and expectations of management and the auditor. This is now required as of August 2005 If you are performing contract work without a contract, you can always start by sending a letter outlining your expectations of what you will do and what your client will provide to help you do it. This may come in handy later if the work is expanded beyond the original agreement. Understanding of a client's business, pp 170 - 173 & 181 - 183 o One cannot properly account for the transactions of a business without first understanding the business itself. Consequently, an auditor cannot test the economic substance of a transaction or balance without first understanding the client's business. o To set the context for understanding a client, auditors must understand the economic environment of the business including factors such as: national economic condition and policies geographic location developments in national and local taxation and regulation specific industry characteristics (e.g. software lumber) o Understanding a client's business starts with a strategic analysis of the business to identify risks to the business. The analysis includes Client business objectives Key strategies employed to meet those objectives Page 2 Risks that threaten achievement of those objectives How management attempts to minimize those risks The next stage of understanding the business is a business process analysis. This is how management executes its plans including risk-minimization procedures. At the deepest level are systems notes which document the exact system of internal controls used to process transactions or protect assets. At a higher level are processes such as annual budgeting, hiring processes, training, sales policies, internal audit procedures, privacy policies, and data backup procedures. o Companies which fail as a business are more likely to result in law suits which might involve the auditor. Identifying business risk, pp 205 - 209 o See Appendix 6A and 6B o Once a risk has been identified it can be managed in one of four ways: It can be avoided by not performing activities that cause the risk It can reduced to acceptable levels through management control It can tolerated on a cost/benefit basis It can transferred to another party by contract o An auditor should seek to understand the business risks and to confirm that they are at acceptable levels. If not, contingencies may have to be recorded even if the risk has not yet materialized (e.g. shortcuts in manufacturing may require a higher warranty expense). Accounting cycles, pp 184- 187 o The results of the business processes are summarized by management in the financial statements. o Business processes are interrelated but are often split out as part of an efficient audit of financial statements. o Auditors consider four key accounting cycles which are ways of grouping some of a company's business processes. revenues and collection (sales and receivables) acquisition and expenditure (purchases and payables) production and conversion (including payroll) finance and investment (including contingency estimates) o These cycles tend to contain accounts which are highly related and can most efficiently be audited together at least for simpler or smaller clients. Audit programs and audit evidence working papers, pp 295 - 303 o Auditors document both their plan and their findings in the working papers o There are two types of working papers Planning file which documents that the audit was planned, that experts were used where their knowledge was required, and that assistants were supervised. The most important document in the planning file is the engagement letter The next most important is the planning memorandum which is an document prepared by the audit manager and reviewed by the partner and identifies the key audit risks. Included in the planning file is an identification of the audit team members and their experience levels Also included is a time budget which shows how much time is planned to be devoted to planning and supervision and how much to the actual work o Page 3 Any reliance on a client's internal auditors will be documented The timing of audit procedures will also be documented in the planning file. Audit evidence files which are broken into two files The permanent file which contains pieces of evidence such as the share register or lease agreements that continue from year to year. o This is carried forward from year to year and is kept separate from the current year working papers. Current working papers which contain the actual work for the year. Included are schedules prepared by the client, schedules prepared by the auditor, explanations of audit symbols, photocopies of bank reconciliations, invoices or other business documents, the schedule of unadjusted errors, the unadjusted trial balance, and the final, audited financial statements. o Also included are audit programs which are the step by step procedures performed by the auditors. Modifications to the standard programs are done at the planning stage. These modifications are also evidence of planning. Junior auditors should perform the steps exactly as shown. If they are unable to for some reason and a field modification is necessary, they must discuss it with their supervisor as they are unlikely to have the knowledge themselves to evaluate changes to audit risk by changing the step. Examples are at the back of chapters 11-14. All documents in the evidence files are cross-referenced so that the evidence supporting financial statement amounts can be easily located. Page 4