Your firm, ACTG 307 \& Associates, is engaged to audit the financial statements of XYZ Corporation. It is a private manufacturing company that is considering going public in three to four years. Your firm has been preforming audit services to this client for the past five years. The client requires financial statements audits for monitoring purposes, but mainly to receive finance and loans from banks. The management team has high level of competence and integrity, and based on the other team's assessment of internal control, the control risk is low. Another team did most of the audit tests and completed most of the audit work papers (WP). Your team is assigned to complete the work papers and audit tests of the engagement. Specifically, your team is required to do the following: 1. Write an engagement letter, dated 11/6/2020, by completing WP 2-1. 2. Perform the preliminary analytical procedure WP 3-1 and 3-2 and comment on: a. The client liquidity, profitability and solvency. b. The client ability to continue as a going concern. 3. Assess the preliminary materiality based on the policy provided (WP 1-13), and complete WP 35, assuming moderate risk and satisfactory results of the analytical procedures (your answer should provide only one materiality measure, i.e., decide on the most appropriate base, and use the most appropriate percentage). 4. Complete the audit of the accounts receivables: a. Calculate the sample size for A/R confirmation by following steps in WP 25-2. b. Assume that you received answers for all of the confirmations and only one of them indicated that the balance is wrong. The balance recorded is $598,000, but the correct amount is $589,000. Prepare an adjusting entry on WP 255. c. Complete the A/R lead sheet WP 251, and complete the conclusions box by stating whether this account is fairly stated or not. (Ignore the allowance for doubtful accounts). 5. Complete the audit of inventory: a. Assume that all the steps of the inventory audit program were done and the misstatements were only found in the machinery account, AC\# 200-101. b. You need to complete WP 30-1, 30-5 and 30-15. 6. Assuming that all other tests came to be satisfactory, prepare an audit report, with the appropriate opinion (dated 2/21/2021). 7. Complete the project by having all of the required work papers with a cover page that has your group number and names of the group members, in one word document, and Notes: 1. Comparative income statements and balance sheets are provided. 2. Make sure to initial every document. [If you are from group \# 1, your initial will be G1]. 3. Five points will be deducted for each error or omission, including, but not limited to, missing initials, missing a date, wrong calculations, wrong conclusions, etc. 4. Submitting the wrong audit report or submitting two different audit reports will lead a loss of 20 points. 5. Watching the lecture videos for the related chapters will be very helpful. ACTG 307 \& ASSOCIATES, CPAs POLICY STATEMENT Professional judgment is to be used at all times in setting and applying materiality guidelines. As a general guideline, the following policies are to be applied: 1. The combined total of misstatements in the financial statements exceeding 10 percent is normally considered material, less than 5 percent is presumed to be immaterial in the absence of qualitative factors. Between 5 percent and 10 percent require the greatest amount of professional judgment to determine their materiality. 2. The 5 percent to 10 percent must be measured in relation to the appropriate base. Many times there is more than one base to which misstatements should be compared. The following guides are recommended in selecting the appropriate base: a. Income statement. Combined misstatements in the income statement should ordinarily be measured at 5 percent to 10 percent of operating income before taxes. A guideline of 5 percent to 10 percent may be inappropriate in a year in which income is unusually large or small. b. Balance sheet. Combined misstatements in the balance sheet should originally be evaluated for current assets, current liabilities, and total assets. For current assets and current liabilities, the guidelines should a. Income statement. Combined misstatements in the income statement should ordinarily be measured at 5 percent to 10 percent of operating income before taxes. A guideline of 5 percent to 10 percent may be inappropriate in a year in which income is unusually large or small. b. Balance sheet. Combined misstatements in the balance sheet should originally be evaluated for current assets, current liabilities, and total assets. For current assets and current liabilities, the guidelines should be between 5 percent and 10 percent. For total assets, the guidelines should be between 3 percent and 6 percent. 3. Qualitative factors should be carefully evaluated on all audits. Preliminary materiality Judgment XYZ Corporations ANNUAL INCOME STATEMENT (\$ ThOUSi EXCEPT PER SHARE) 12/31/2020 12/31/2019 12/31/2018 21/31/2017 7 Sales 8 Cost of Goods Sold \begin{tabular}{|} 152356 \\ 123800 \\ \hline 28556 \\ \hline \end{tabular} 15592913165724272 15542713090924518 152256 132229 10 Gross Profit 11 Selling, General \& 12 Administrative Expense 14 Operating Income Before Deprec. \begin{tabular}{|} 11530 \\ \hline 17026 \\ \hline 7219 \\ \hline 9807 \\ 2160 \\ 2914 \\ -2843 \\ \hline 7718 \\ -1897 \\ \hline \end{tabular} 1251611756 1260811910 643413593 15 Depreciation, Depletion \& 16 Amortization 18 Operating Profit 19 Interest Expense 20 Non-Operating Income/Expense 21 Special Items 22 Pretax Income 24 Total Income Taxes 25 Total income Taxes \begin{tabular}{r|r} \hline 3120 \\ \hline 4246 \\ \hline 228 \\ \hline \end{tabular} \begin{tabular}{r:r} 7458 \\ \hdashline 2127 \\ \hline \end{tabular} 8892958313102869534831 26 Income Before Extraordinary Items 27 and Noncontrolling Interests \begin{tabular}{r|r:r} \hline 9615 & 4018 \\ \hdashline-72 & 69 \\ \hline \end{tabular} 533115 6136 -52 28 Noncontrolling Interest - Inc Acc 29 30 Income Before Extraordinary 31 Items \& Discontinued Operations 32 Preferred Dividends \( 3 3 \longdiv { \text { Available for Common } } \) 35 Savings Due to Common 36 Stock Equivalents 37 38 Adjusted Available for Common 39 Extraordinary Items 40 Discontinued Operations 41 42 Adjusted Net Income 43 Income to Company Incl Extraordinary 44 Items \& Disc Ops 45 46 47 Earnings Per Share Basic- 48 Excluding Extra Items \& Disc Op 49 Earnings Per Share Basic - 50 Including Extra Items \& Disc Op 51 Earnings Per Share Diluted- 52 Exduding Extra Items \& Disc Op S3 Earnings Per Share Diluted. SA Including Extra Items \& Disc Op SS EPS Basic from Operations S6 EPS Diluted from OPs 57 Dividends Per Share 58 Com Shares for Basic EPS XYZ Corporation ANNUAL BALANCE SHEET (S thousands) 12/31/2020 12/31/2019 12/31/201821/31/2017 ASSETS Cash \& Equivalents Net Receivables Inventories Prepaid Expenses Other Current Assets Total Current Assets Gross Plant Property \& Equipment Accumulated Depreciation 7 Net Plant Property \& Equipment 8 Investments at Equity 9 Other Investments 0 Intangibles 1 Deferred Charges 2 Other Assets 4 TOTALASSETS \begin{tabular}{rrrr} 24991 & 29514 & 30240 & 28096 \\ 26388 & 25606 & 22813 & 14439 \\ 13764 & 13642 & 14039 & 14714 \\ 0 & 0 & 0 & 0 \\ 12864 & 14908 & 14409 & 12747 \\ \hline 78007 & 83670 & 81501 & 69996 \\ 63750 & 44078 & 36679 & 31662 \\ 12349 & 9275 & 7429 & 5817 \\ \hline 51401 & 34803 & 29250 & 0 \\ 9201 & 8350 & 8094 & 68845 \\ 18500 & 16006 & 14354 & 6883 \\ 5947 & 6410 & 7228 & 8782 \\ 0 & 0 & 0 & 056 \\ \hline 31464 & 28438 & 25917 & 149422 \\ \hline 194520 & 177677 & 166344 & \\ \hline \end{tabular} 5 LIABILITIES 6. Long Term Debt Due In One Year 7. Notes Payable 8 Accounts Payable 9 Taxes Payable - Accrued Expenses 1 Other Current Liabilities 32 Total Current Liabilities Long Term Debt Deferred Taxes Investment Tax Credit Other Liabilities 9 TOTAL LIABILITES 0 Redeemable Noncontrolling Int. 019562240620586521977714664354900391821541970 EQUITY 2 Preferred Stock-Redeemable 3 Preferred Stock - Nonredeemable 4 Total Preferred Stock 6 Common Stock 7 Capital Surplus 8 Retained Earnings 9 Less: Treasury Stock 13 Common Equity Stackholder's Equity - Parent Nonredeemable Noncontrolling Int. Stockholder's Equity - Total TOTAL LABIUTIES \& EQUITY COMMON SHARES OUTSTANDING Your firm, ACTG 307 \& Associates, is engaged to audit the financial statements of XYZ Corporation. It is a private manufacturing company that is considering going public in three to four years. Your firm has been preforming audit services to this client for the past five years. The client requires financial statements audits for monitoring purposes, but mainly to receive finance and loans from banks. The management team has high level of competence and integrity, and based on the other team's assessment of internal control, the control risk is low. Another team did most of the audit tests and completed most of the audit work papers (WP). Your team is assigned to complete the work papers and audit tests of the engagement. Specifically, your team is required to do the following: 1. Write an engagement letter, dated 11/6/2020, by completing WP 2-1. 2. Perform the preliminary analytical procedure WP 3-1 and 3-2 and comment on: a. The client liquidity, profitability and solvency. b. The client ability to continue as a going concern. 3. Assess the preliminary materiality based on the policy provided (WP 1-13), and complete WP 35, assuming moderate risk and satisfactory results of the analytical procedures (your answer should provide only one materiality measure, i.e., decide on the most appropriate base, and use the most appropriate percentage). 4. Complete the audit of the accounts receivables: a. Calculate the sample size for A/R confirmation by following steps in WP 25-2. b. Assume that you received answers for all of the confirmations and only one of them indicated that the balance is wrong. The balance recorded is $598,000, but the correct amount is $589,000. Prepare an adjusting entry on WP 255. c. Complete the A/R lead sheet WP 251, and complete the conclusions box by stating whether this account is fairly stated or not. (Ignore the allowance for doubtful accounts). 5. Complete the audit of inventory: a. Assume that all the steps of the inventory audit program were done and the misstatements were only found in the machinery account, AC\# 200-101. b. You need to complete WP 30-1, 30-5 and 30-15. 6. Assuming that all other tests came to be satisfactory, prepare an audit report, with the appropriate opinion (dated 2/21/2021). 7. Complete the project by having all of the required work papers with a cover page that has your group number and names of the group members, in one word document, and Notes: 1. Comparative income statements and balance sheets are provided. 2. Make sure to initial every document. [If you are from group \# 1, your initial will be G1]. 3. Five points will be deducted for each error or omission, including, but not limited to, missing initials, missing a date, wrong calculations, wrong conclusions, etc. 4. Submitting the wrong audit report or submitting two different audit reports will lead a loss of 20 points. 5. Watching the lecture videos for the related chapters will be very helpful. ACTG 307 \& ASSOCIATES, CPAs POLICY STATEMENT Professional judgment is to be used at all times in setting and applying materiality guidelines. As a general guideline, the following policies are to be applied: 1. The combined total of misstatements in the financial statements exceeding 10 percent is normally considered material, less than 5 percent is presumed to be immaterial in the absence of qualitative factors. Between 5 percent and 10 percent require the greatest amount of professional judgment to determine their materiality. 2. The 5 percent to 10 percent must be measured in relation to the appropriate base. Many times there is more than one base to which misstatements should be compared. The following guides are recommended in selecting the appropriate base: a. Income statement. Combined misstatements in the income statement should ordinarily be measured at 5 percent to 10 percent of operating income before taxes. A guideline of 5 percent to 10 percent may be inappropriate in a year in which income is unusually large or small. b. Balance sheet. Combined misstatements in the balance sheet should originally be evaluated for current assets, current liabilities, and total assets. For current assets and current liabilities, the guidelines should a. Income statement. Combined misstatements in the income statement should ordinarily be measured at 5 percent to 10 percent of operating income before taxes. A guideline of 5 percent to 10 percent may be inappropriate in a year in which income is unusually large or small. b. Balance sheet. Combined misstatements in the balance sheet should originally be evaluated for current assets, current liabilities, and total assets. For current assets and current liabilities, the guidelines should be between 5 percent and 10 percent. For total assets, the guidelines should be between 3 percent and 6 percent. 3. Qualitative factors should be carefully evaluated on all audits. Preliminary materiality Judgment XYZ Corporations ANNUAL INCOME STATEMENT (\$ ThOUSi EXCEPT PER SHARE) 12/31/2020 12/31/2019 12/31/2018 21/31/2017 7 Sales 8 Cost of Goods Sold \begin{tabular}{|} 152356 \\ 123800 \\ \hline 28556 \\ \hline \end{tabular} 15592913165724272 15542713090924518 152256 132229 10 Gross Profit 11 Selling, General \& 12 Administrative Expense 14 Operating Income Before Deprec. \begin{tabular}{|} 11530 \\ \hline 17026 \\ \hline 7219 \\ \hline 9807 \\ 2160 \\ 2914 \\ -2843 \\ \hline 7718 \\ -1897 \\ \hline \end{tabular} 1251611756 1260811910 643413593 15 Depreciation, Depletion \& 16 Amortization 18 Operating Profit 19 Interest Expense 20 Non-Operating Income/Expense 21 Special Items 22 Pretax Income 24 Total Income Taxes 25 Total income Taxes \begin{tabular}{r|r} \hline 3120 \\ \hline 4246 \\ \hline 228 \\ \hline \end{tabular} \begin{tabular}{r:r} 7458 \\ \hdashline 2127 \\ \hline \end{tabular} 8892958313102869534831 26 Income Before Extraordinary Items 27 and Noncontrolling Interests \begin{tabular}{r|r:r} \hline 9615 & 4018 \\ \hdashline-72 & 69 \\ \hline \end{tabular} 533115 6136 -52 28 Noncontrolling Interest - Inc Acc 29 30 Income Before Extraordinary 31 Items \& Discontinued Operations 32 Preferred Dividends \( 3 3 \longdiv { \text { Available for Common } } \) 35 Savings Due to Common 36 Stock Equivalents 37 38 Adjusted Available for Common 39 Extraordinary Items 40 Discontinued Operations 41 42 Adjusted Net Income 43 Income to Company Incl Extraordinary 44 Items \& Disc Ops 45 46 47 Earnings Per Share Basic- 48 Excluding Extra Items \& Disc Op 49 Earnings Per Share Basic - 50 Including Extra Items \& Disc Op 51 Earnings Per Share Diluted- 52 Exduding Extra Items \& Disc Op S3 Earnings Per Share Diluted. SA Including Extra Items \& Disc Op SS EPS Basic from Operations S6 EPS Diluted from OPs 57 Dividends Per Share 58 Com Shares for Basic EPS XYZ Corporation ANNUAL BALANCE SHEET (S thousands) 12/31/2020 12/31/2019 12/31/201821/31/2017 ASSETS Cash \& Equivalents Net Receivables Inventories Prepaid Expenses Other Current Assets Total Current Assets Gross Plant Property \& Equipment Accumulated Depreciation 7 Net Plant Property \& Equipment 8 Investments at Equity 9 Other Investments 0 Intangibles 1 Deferred Charges 2 Other Assets 4 TOTALASSETS \begin{tabular}{rrrr} 24991 & 29514 & 30240 & 28096 \\ 26388 & 25606 & 22813 & 14439 \\ 13764 & 13642 & 14039 & 14714 \\ 0 & 0 & 0 & 0 \\ 12864 & 14908 & 14409 & 12747 \\ \hline 78007 & 83670 & 81501 & 69996 \\ 63750 & 44078 & 36679 & 31662 \\ 12349 & 9275 & 7429 & 5817 \\ \hline 51401 & 34803 & 29250 & 0 \\ 9201 & 8350 & 8094 & 68845 \\ 18500 & 16006 & 14354 & 6883 \\ 5947 & 6410 & 7228 & 8782 \\ 0 & 0 & 0 & 056 \\ \hline 31464 & 28438 & 25917 & 149422 \\ \hline 194520 & 177677 & 166344 & \\ \hline \end{tabular} 5 LIABILITIES 6. Long Term Debt Due In One Year 7. Notes Payable 8 Accounts Payable 9 Taxes Payable - Accrued Expenses 1 Other Current Liabilities 32 Total Current Liabilities Long Term Debt Deferred Taxes Investment Tax Credit Other Liabilities 9 TOTAL LIABILITES 0 Redeemable Noncontrolling Int. 019562240620586521977714664354900391821541970 EQUITY 2 Preferred Stock-Redeemable 3 Preferred Stock - Nonredeemable 4 Total Preferred Stock 6 Common Stock 7 Capital Surplus 8 Retained Earnings 9 Less: Treasury Stock 13 Common Equity Stackholder's Equity - Parent Nonredeemable Noncontrolling Int. Stockholder's Equity - Total TOTAL LABIUTIES \& EQUITY COMMON SHARES OUTSTANDING