Write an engagement letter of no more than 1,050 words for a Section 404 audit of Apollo Shoes. Assume that Apollo Shoes is a publicly traded company for which the SEC requires an audit of internal control and an audit over financial reporting. The team should include the following key points in the engagement letter:An explanation of the significant regulations and guidelines related to audits of internal controlA description of the internal control risks identified within Apollo ShoesA description of the relationship between internal controls and the audit processA brief synopsis of your responsibility in detecting and reporting fraudAPOLLO SHOES, INC.An Audit Case to AccompanyAUDITING AND ASSURANCE SERVICESPrepared by Timothy J. LouwersJames Madison University J. Kenneth ReynoldsLouisiana State University McGraw-Hill/Irwinii © The McGraw-Hill Companies, Inc., 2007Apollo Shoes, Inc. AcknowledgementsWe would like to gratefully acknowledge the following individuals for their assistance inpreparing and completing this case. Sincere appreciation is due to Reagan McDougall, MeghanPeters, Denise Patterson, Bob Ramsay, and several classes of Louisiana State University students.Their suggestions greatly enhanced several portions of the case. However, we remain responsiblefor all errors of commission and omission. McGraw-Hill/IrwinApollo Shoes, Inc. © The McGraw-Hill Companies, Inc., 2007iii McGraw-Hill/Irwiniv © The McGraw-Hill Companies, Inc., 2007Apollo Shoes, Inc. IntroductionApollo Shoes, Inc. is an audit case designed to introduce you to the entire audit process, from planningthe engagement to drafting the final report. You are asked to assume the role of a veteran of two-to-threeâbusyâ seasons, âin-chargingâ for the first time.While Apollo Shoesâ growth has been phenomenal (there has been a dramatic growth in unaudited netincome over the past year), there are some concerns: the client doesnât want your firm (Anderson, Olds,and Watershed (AOW)) to talk with the predecessor auditor, a labor strike is looming, and one of ApolloShoesâ largest customers is suffering some financial difficulties.Because of busy season, there is little help, other than from an untrained intern. While the intern can doâgrunt work,â such as vouching and gathering information for you, he appears incapable of preparingworkpapers, making adjusting entries, or even getting good coffee and doughnuts. Assistance does comein the form of an objective, competent internal audit staff. Communication between client personnel andother firm members takes the form of e-mail messages from the engagement partner (Arnold Anderson),the engagement manager (Darlene Wardlaw), the intern (Bradley Crumpler), and the director of Apolloâsinternal audit department (Karina Ramirez). Required assignments and memos are in bold print.Page indexing suggestions are given, but feel free to adjust page numbering as you see fit.The AOW intranet website (http://www.mhhe.com/louwers2e/) has many useful resources such as arepository of electronic documents (so that you wonât need to input data or retype documents) and anarchive of e-mail messages and their attachments, all filed by account group.While we tried to make the case as realistic as possible, limitations remain. Since you are unable tofollow up directly with client personnel, you may need to rely on some evidence with which you may beuncomfortable. In an actual audit, you would be able to inquire, observe, and otherwise follow-up on anyquestions that you have until you feel comfortable relying on the evidence. To make sure that the casecan be completed in a reasonable amount of time, we cut some corners with respect to audit sampling.Understand that audit sampling plays a large role in actual audit practice.The information is sequential in nature. In other words, pay close attention to information disclosed earlyin the audit (for example, in the Board of Directorâs minutes) as it may play a role in subsequent auditwork. Similarly, the bank cutoff statement in the cash workpapers and invoices used for valuinginventory may be useful later in the search for unrecorded liabilities. Similarly, the bank confirmationcontains information about long-term liabilities.Lastly, while it is difficult for us to believe that not everyone enjoys auditing as much as we do, we havetried to make the case both interesting and enjoyable (in a perverse sort of way). You can think of theproject as a puzzle, in which you have to fill in all the pieces. Alternatively, you could look at the projectas a murder mystery that needs a solution. In either case, have fun! Tim LouwersHarrisonburg, VAMcGraw-Hill/IrwinApollo Shoes, Inc. J. Kenneth ReynoldsBaton Rouge, LA © The McGraw-Hill Companies, Inc., 20071 Table of ContentsIntroduction………………………………………………………………………………………………………………………………1Table of Contents………………………………………………………………………………………………………………………2Planning …………………………………………………………………………………………………………………………………..3Internal Control Evaluation ………………………………………………………………………………………………………49Substantive Testing: Cash…………………………………………………………………………………………………………62Substantive Testing: Accounts Receivable ………………………………………………………………………………….72Substantive Testing: Inventory …………………………………………………………………………………………………83Substantive Testing: Prepaids and Other Assets…………………………………………………………………………107Substantive Testing: Fixed Assets ……………………………………………………………………………………………113Substantive Testing: Liabilities………………………………………………………………………………………………..117Substantive Testing: Payroll ……………………………………………………………………………………………………123Audit Wrap-up ………………………………………………………………………………………………………………………130 McGraw-Hill/Irwin2 © The McGraw-Hill Companies, Inc., 2007Apollo Shoes, Inc. McGraw-Hill/IrwinApollo Shoes, Inc. © The McGraw-Hill Companies, Inc., 20073 Date: Thu, 25 OCT 2007 00:42:35 +0000From: "Darlene Wardlaw" <DW@aow.cpa>Subject: Upcoming Apollo Shoes EngagementAttachment: <<AudComMinsâ101807.doc>> Well, first let me congratulate you on your recent promotion. Although we have not worked onan engagement together before, I have heard many good things about you. I look forward toworking with you on the new Apollo Shoes engagement.I understand that this is your first engagement to in-charge. Arnold Anderson (aka âUncleArnieâ) will be the engagement partner; he is pretty sharp so youâll have to stay on your toes. Asengagement manager, Iâll try to help out as much as I can. Understand, however, that I ammanaging four other busy season engagements, so my interaction time with you will be limited.For now, I want you familiarize yourself with Apollo Shoes and help me out by doing thefollowing:SEC Filing: I have asked Larry Lancaster, President and chairman of the Apollo Shoesboard of directors, to send you a copy of last yearâs (2006) 10-K filing with the SEC.Review the information when you receive it, as it is one of the most important sources ofinformation about a company.2. Audit Committee Meeting: I have attached the minutes of an audit committee meetingthat occurred last week. Please review the minutes of the meeting and draft anappropriate engagement letter (label it GA-1, for General and Administrative, page 1)addressed to Mr. Lancaster. (Since this is our first year on the engagement, you mightwant to check one of your old auditing textbooks for an example.) Iâll review the letterbefore getting Arnold to sign it.3. Audit Team: Based upon the information that you glean from 1 and 2 above, do you seeany need for special business knowledge in regard to the basic type of business andproducts Apollo manages? Do you see any need for special audit or accounting expertisefor any of the work that we have agreed to perform? In other words, since youâll be in thetrenches, what kind of expertise do you want on your audit team? Just write a brief auditstaffing memo (GA-2) telling me what expertise you need to complete the audit and Iâllsee if I can get them assigned to the audit team.4. Scheduling: We are going to have to work around your other engagements, but we haveyou tentatively scheduled for one week in October (next week) for bringing you up tospeed on Apollo and its industry, and five straight weeks beginning the last week inDecember for engagement planning, internal control evaluation, and substantive testing.1. Finally, since most of our interaction will be by e-mail, please forgive me if I give you too muchdetail. Since we havenât worked together before, Iâd rather give you too much than too littleuntil we get used to working together.DW McGraw-Hill/Irwin4 © The McGraw-Hill Companies, Inc., 2007Apollo Shoes, Inc. Minutes of the Audit Committee, Apollo ShoesOctober 18, 2007Present at Meeting: Arnold Anderson, CPA (partner in charge of the audit); Darlene Wardlaw, CPA (engagementmanager); Eric Unum (Apollo âs vice president of finance); Mary Costain (Apollo âs treasurer); Samuel Carboy(Apollo âs controller); and Karina Ramirez (Apollo âs director of internal audit). The three members of the auditcommittee of the board and the corporate secretary also were present, but they did not enter into the conversation.Mr. Unum (VP finance): Well, I want to welcome the auditing firm of Anderson, Olds, and Watershed, CPAs to what we callthe âApollo Shoes Experience.â After our old auditors, Smith & Smith, CPAs, unexpectedly withdrew from the engagement, wewere very happy to have a firm of your quality to come aboard.Mr. Anderson (partner on the audit): Well, we are always looking for high quality clients. By the way, why did your previousauditors resign?Mr. Unum (VP finance): Iâd rather not talk about it. Arnold, will Darlene be in charge?Mr. Anderson (partner on the audit): Yes, and she will be assisted by several of our best staff, including a tax specialist and aninformation systems auditor. We need to keep up to date on your computer systems. Back to your previous auditors, with yourpermission, we would like to contact them.Mr. Unum (VP finance): Well, weâd rather you didnât. There may be some litigation since they withdrew from the engagementwith so little notice. Is it necessary for you to speak with them to accept the engagement?Mr. Anderson (partner on the audit): No, not really, but it does raise some concerns for our firm.Ms. Costain (treasurer): In the past, we have never had any unpleasant discoveries of embezzlement or theft, but we alwayswant to be vigilant. Will you plan enough in-depth auditing to give us assurances about errors and frauds in the accounts?Ms. Wardlaw (manager on the audit): We will follow audit standards and base our audit work on samples of transactions. Weplan the work to look for major errors and frauds in the accounts, but cleverly hidden schemes might not be discovered.According to the Sarbanes-Oxley Act of 2002, we will need to test the effectiveness of Apolloâs internal controls, as well asprovide you the usual separate management letter on related findings.Ms. Ramirez (internal auditor): Darlene, I agree, itâs hard to uncover clever schemes. While I am new to Apollo, none of theprojects that I have undertaken this year shows anything amiss, other than normal human error types or mistakes.Ms. Costain (treasurer): This year, we want to add some work to the audit. I am short on staff time and need to have youprepare the state franchise tax return as well as the federal tax returns.Ms. Wardlaw (manager on the audit): Our tax staffperson can do the state and federal returns, and I will have them reviewedby Maria Olds, our tax partner. In order to perform the tax work, Sarbanes-Oxley requires that we get prior approval from theaudit committee to perform both the tax work as well as the audit.Mr. Anderson (partner on the audit): I assume you also want us to review the 10-K filing material?Mr. Unum (VP finance): Yes. Will you need any staff help from us?Ms. Ramirez (internal auditor): Last year, Apollo was able to save on audit fees when my staff prepared a stack of schedulesand analyses that our previous auditors needed.Mr. Wardlaw (manager on the audit): Yes, Karina, I will give you a list of schedules for various accounts. I will appreciateyour having them ready when we start fieldwork in mid January.Mr. Carboy (controller): Speaking of being ready, we will be able to give you a trial balance the day after December 31.Mr. Unum (VP finance): How much is this going to cost us?Mr. Anderson (partner on the audit): It is difficult to give you a fixed fee deal, but my estimate, considering the additionalwork, is $750,000. Darlene will let you know immediately if problems arise to cause the work to be more extensive.Mr. Unum (VP finance): Thank you. This has been a productive meeting of the minds. We look forward to your getting startednext month. Meeting ended 5:30 P.M. /s/ Jeff Chesnut, Secretary C:/AudComMinsâ101807.doc/McGraw-Hill/IrwinApollo Shoes, Inc. © The McGraw-Hill Companies, Inc., 20075 Date: Fri, 26 OCT 2007 4:43:17 +0000From: "Larry Lancaster" <LLancaster@ApolloShoes.com>Subject: Attached 10-K FilingAttachments: <<Shareholder Letter.doc>>, <<10K.doc>>,<<ApolloShoesOrgChart.xls>>I am sorry that you were unable to attend the audit meeting last week, but Darlene Wardlaw said that youwere busy with another client. She asked that I forward a copy of our 10-K directly to you. Iâve attachedone that we sent out to all shareholders with the Letter to Shareholders attached.Iâve attached a copy of Apolloâs organizational table. Please let me know what my staff or I can do to helpthe audit go smoothly for you. I will have Karina Ramirez, our Director of Internal Audit, contact you toprovide you with any other information that you need.LarryP.S. Do you play golf? This Apollo message (including any attachments) contains confidential information intended for aspecific individual and purpose, and is protected by law. If you are not the intended recipient, youshould delete this message and are hereby notified that any disclosure, copying, or distribution ofthis message, or the taking of any action based on it, is strictly prohibited. McGraw-Hill/Irwin6 © The McGraw-Hill Companies, Inc., 2007Apollo Shoes, Inc. Letter to Fellow ShareholdersDear Fellow Shareholders,You may have noticed our competitor’s focus on earth-bound activities and athletes. Ourfocus is in exactly the opposite direction. In actuality, the technological superiority of our productsis at the point where our sales are limited only by the technological inferiority of other scientificfields (specifically, current transportation means). As space exploration continues, we intend to beamong the first to market our products in new worlds. It is there that our technological advances inlight and sound can combine with our rugged footwear to propel all galactic sports participants totheir fullest potential.Back here on earth, the past year has been one of the most dynamic and exciting years sinceI began my tenure at Apollo Shoes. From the beginning, Apollo Shoes, Inc. has adapted itself tomeet the needs of all its galactic customers and to take advantage of all opportunities supplied byexploration of new frontiers. After a record year when most companies may have wanted to relaxand play it safe, we have decided to use this excitement to reach out further in our continuingmission: to make a difference in this galaxy.Our product lines, led by the flagship products SPOTLIGHT (for athletes who like tocompete at night) and SIREN (designed specifically for police officers working the graveyard shiftsin our nation’s most dangerous cities) have met widespread acceptance. We have signed with someof this world’s premier athletes as spokespersons for our products, including a recent winner of thegrueling Alaska Iditarod who used his SPOTLIGHTs to guide his dogs to a late night finish line.We are currently negotiating with a soccer league to exclusively use our SIRENs; the shoe’sflashing lights are designed to go off after every team goal!Our strategic management plans have allowed us to maintain a positive trend in income overthe past several years, and this was no easy task, given the state of the galactic economy. Our netincome for the year has been the best since we began operations four years ago. Next year appearseven better!The strength of our results for the past year should not be confused with the truth of thetimes. This was a uniformly difficult year for all businesses. Due to the conflicts in foreigncountries, and uncertainty with the Federal Reserve’s adjustments of interest rates, consumerconfidence has been negatively affected; therefore, fewer earth consumers are buying our state-ofthe-art athletic equipment. All of our operating divisions were severely tested. I am proud of theirresponses. Although sales were not as strong as we had anticipated, our marketing plans will allowus to bounce back next year. With the advent of significant new breakthrough technology byApollo Shoes, Inc.’s research and development team, Apollo Shoes, Inc. now has the possibility totake a leadership role in the galactic athletic footwear market. Apollo Shoes, Inc. has always beenknown for its leadership position in electronic shoe technology, but we are now committed toexpanding our marketing focus. With new applied technologies, Apollo Shoes, Inc. can maintain itstradition of high tech electronic performance and style. We continue to work on and improve theSPEAKERSHOE, an athletic shoe with an amplified loudspeaker, originally designed for theinternational recording group "Mythic Meathook." We are hard at work on new ideas, such as thePHONESHOE, the sneaker with a cellular phone for those executives who like to simultaneouslycombine exercise with work. We anticipate that the PHONESHOE will capture a significant pieceof this quickly expanding market.McGraw-Hill/IrwinApollo Shoes, Inc. © The McGraw-Hill Companies, Inc., 20077 At Apollo Shoes, Inc., we like to briefly acknowledge achievement and then proceed to newchallenges. This year was great only because it provided us with resources to expand operationsand further technological progress. As we continue into this century of "more, faster, better," it iscritical to continue this tradition because production, speed, and quality are critical elements forfuture success. We look forward to the challenge. Larry LancasterChairman, President and CEO <<Shareholder Letter.Doc>>McGraw-Hill/Irwin8 © The McGraw-Hill Companies, Inc., 2007Apollo Shoes, Inc. ——————————-SECURITIES AND EXCHANGE COMMISSIONWASHINGTON, D.C. 20549———————–FORM 10-KANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OFTHE SECURITIES EXCHANGE ACT OF 1934FOR THE FISCAL YEAR ENDED DECEMBER 31, 2006COMMISSION FILE NUMBER 1-9Z40APOLLO SHOES INC.(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) MAINE(STATE OR OTHER JURISDICTION OFINCORPORATION OR ORGANIZATION) X8-061325(IRS EMPLOYERIDENTIFICATION NO.) SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:TITLE OF EACH CLASS——————- NAME OF EACH EXCHANGEON WHICH REGISTERED—————————————– COMMON STOCK, PAR VALUE, $1.00 PER SHARE STUDS SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: NONEIndicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d)of the Securities Exchange Act of 1934 during the preceding 12 months, and (2) has been subject to such filingrequirements for the past 90 days. Yes [X] No [ ]Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not containedherein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statementsincorporated by reference in Part III of this Form 10-K or any amendment to thisForm 10-K. [X]As of March 8, 2007, the aggregate market value of the registrant’s voting stock held by non-affiliates of theregistrant was approximately $24,315,000.As of March 8, 2007, 8,105,000 shares of the registrant’s Common Stock were issued and outstanding.DOCUMENTS INCORPORATED BY REFERENCEDefinitive Proxy Statement dated December 12, 2006 for the Annual Meeting of Shareholders to be held onTuesday, February 27, 2007 at the End of the Universe Restaurant in downtown Shoetown. McGraw-Hill/IrwinApollo Shoes, Inc. © The McGraw-Hill Companies, Inc., 20079 APOLLO SHOES INC.ANNUAL REPORT ON FORM 10-KTABLE OF CONTENTSItem 1. Business …………………………………………………………………………………………………. iItem 2. Properties ………………………………………………………………………………………………. iiItem 3. Legal Proceedings………………………………………………………………………………….. iiiItem 4. Submission of Matters to a Vote of Security Holders. ……………………………….. iiiItem 5. Market for Registrant’s Common Equity and Related Stockholder Matters. …. iiiItem 6. Selected Financial Data …………………………………………………………………………. ivItem 7. Management’s Discussion and Analysis of FinancialCondition and Results of Operations …………………………………………………………….vItem 8. Financial Statements and Supplementary Data ………………………………………….. viItem 9. Changes in and Disagreements with Accountants ……………………………………. xixItem 10. Directors and Executive Officers of the Registrant…………………………………. xixItem 11. Executive Compensation …………………………………………………………………….. xixItem 12. Security Ownership of Certain Beneficial Owners and Management.xixItem 13. Certain Relationships and Related Transactions.xixItem 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K…………… xx McGraw-Hill/Irwin10 © The McGraw-Hill Companies, Inc., 2007Apollo Shoes, Inc. This Annual Report on Form 10-K contains forward-looking statements within the meaning ofthe Private Securities Litigation Reform Act of 1995, including statements with regard to theCompany’s revenues, earnings, spending, margins, cash flow, orders, inventory, products,actions, plans, strategies and objectives. Forward-looking statements include, without limitation,any statement that may predict, forecast, indicate or imply future results, performance orachievements, and may contain the words "believe," "anticipate," "expect," "estimate," "intend,""plan," "project," "will be," "will continue," "will result," "could," "may," "might," or anyvariations of such words or other words with similar meanings. Any such statements are subjectto risks and uncertainties that could cause the Company’s actual results to differ materially fromthose discussed in such forward-looking statements. Prospective information is based onmanagement’s then current expectations or forecasts. Such information is subject to the risk thatsuch expectations or forecasts, or the assumptions underlying such expectations or forecasts,become inaccurate. For a description of such risks, see the section below entitled "ISSUES ANDUNCERTAINTIES."ITEM 1. BUSINESS.Apollo Shoes, Inc. is a planetary distributor specializing in technologically superior athleticpodiatric products. The Companyâs brands– SIREN, SPOTLIGHT, and SPEAKERSHOE– areused extensively in many athletic competitions, such as the Switzerland Watersports Games inZurich. The Company is excited about this annual event that exhibits to the entire world the skillsand spirit of outstanding Swiss aquatic athletes.The Companyâs products are shipped to large and small retail outlets in a six-state area. Thecompany stocks a wide range of shoe products and has a large base of retail store customers.Apollo operates from a large office, operations, and warehouse facility in the Shoetown, Mainearea.Apollo Shoes, incorporated in the state of Delaware, is a public corporation. Its stock is traded inthe over-the-counter market. No one presently owns more than 4 percent of the outstandingcommon stock. The company is subject to the reporting requirements of the Se…
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