APOLLO SHOES, INC.
An Audit Case to Accompany
AUDITING AND ASSURANCE SERVICES
Prepared by
Timothy J. Louwers
James Madison University
J. Kenneth Reynolds
Louisiana State University
Acknowledgements
We would like to gratefully acknowledge the following individuals for their assistance in
preparing and completing this case. Sincere appreciation is due to Reagan McDougall, Meghan
Peters, Denise Patterson, Bob Ramsay, and several classes of Louisiana State University students.
Their suggestions greatly enhanced several portions of the case. However, we remain responsible
for all errors of commission and omission.
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ii Apollo Shoes, Inc.
Introduction
Apollo Shoes, Inc. is an audit case designed to introduce you to the entire audit process, from planning
the engagement to drafting the final report. You are asked to assume the role of a veteran of two-to-three
fibusy” seasons, fiin-charging” for the first time.
While Apollo Shoes’ growth has been phenomenal (there has been a dramatic growth in unaudited net
income over the past year), there are some concerns: the client doesn’t want your firm (Anderson, Olds,
and Watershed (AOW)) to talk with the predecessor auditor, a labor strike is looming, and one of Apollo
Shoes’ 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 do
figrunt work,” such as vouching and gathering information for you, he appears incapable of preparing
workpapers, making adjusting entries, or even getting good coffee and doughnuts. Assistance does come
in the form of an objective, competent internal audit staff. Communication between client personnel and
other 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 Apollo’s
internal 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/louwers3e /) has many useful resources such as a
repository of electronic documents (so that you won’t need to input data or retype documents) and an
archive 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 to
follow up directly with client personnel, you may need to rely on some evidence with which you may be
uncomfortable. In an actual audit, you would be able to inquire, observe, and otherwise follow-up on any
questions that you have until you feel comfortable relying on the evidence. To make sure that the case
can 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 early
in the audit (for example, in the Board of Director’s minutes) as it may play a role in subsequent audit
work. Similarly, the bank cutoff statement in the cash workpapers and invoices used for valuing
inventory may be useful later in the search for unrecorded liabilities. Similarly, the bank confirmation
contains 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 have
tried to make the case both interesting and enjoyable (in a perverse sort of way). You can think of the
project as a puzzle, in which you have to fill in all the pieces. Alternatively, you could look at the project
as a murder mystery that needs a solution. In either case, have fun!
Tim Louwers J. Kenneth Reynolds
Harrisonburg, VA Baton Rouge, LA
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Apollo Shoes, Inc. 1
Table of Contents
Introduction……………………………………………………………………………………………………………….……………1
Table of Contents……………………………………………………………………………………………………………………..2
Planning………………………………………………………………………………………………………………………………….3
Internal Control Evaluation ………………………………………………………………………………..…….…………….49
Substantive Testing: Cash………………………………………………………………………………………………….…….62
Substantive Testing: Accounts Receivable………………………………………………………………………………….72
Substantive Testing: Inventory …………………………………………………………………………..…….……………..83
Substantive Testing: Prepaids and Other Assets………………………………………………………………………...107
Substantive Testing: Fixed Assets……………………………………………………………………………………..…….113
Substantive Testing: Liabilities……………………………………………………………………………………………….117
Substantive Testing: Payroll………………………………………………………………………………….……………….123
Audit Wrap-up…………………………………………………………………………………………………………….……….130
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2 Apollo Shoes, Inc.
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Apollo Shoes, Inc. 3
Date: Thu, 25 OCT 2007 00:42:35 +0000
From: “Darlene Wardlaw” <DW@aow.cpa>
Subject: Upcoming Apollo Shoes Engagement
Attachment: <<AudComMins—101807.doc>>
Well, first let me congratulate you on your recent promotion. Although we have not worked on
an engagement together before, I have heard many good things about you. I look forward to
working with you on the new Apollo Shoes engagement.
I understand that this is your first engagement to in-charge. Arnold Anderson (aka fiUncle
Arnie”) will be the engagement partner; he is pretty sharp so you’ll have to stay on your toes. As
engagement manager, I’ll try to help out as much as I can. Understand, however, that I am
managing 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 the
following:
1. SEC Filing: I have asked Larry Lancaster, President and chairman of the Apollo Shoes
board of directors, to send you a copy of last year’s (2006) 10-K filing with the SEC.
Review the information when you receive it, as it is one of the most important sources of
information about a company.
2. Audit Committee Meeting: I have attached the minutes of an audit committee meeting
that occurred last week. Please review the minutes of the meeting and draft an
appropriate 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 might
want to check one of your old auditing textbooks for an example.) I’ll review the letter
before getting Arnold to sign it.
3. Audit Team: Based upon the information that you glean from 1 and 2 above, do you see
any need for special business knowledge in regard to the basic type of business and
products Apollo manages? Do you see any need for special audit or accounting expertise
for any of the work that we have agreed to perform? In other words, since you’ll be in the
trenches, what kind of expertise do you want on your audit team? Just write a brief audit
staffing memo (GA-2) telling me what expertise you need to complete the audit and I’ll
see 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 have
you tentatively scheduled for one week in October (next week) for bringing you up to
speed on Apollo and its industry, and five straight weeks beginning the last week in
December for engagement planning, internal control evaluation, and substantive testing.
Finally, since most of our interaction will be by e-mail, please forgive me if I give you too much
detail. Since we haven’t worked together before, I’d rather give you too much than too little
until we get used to working together.
DW
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4 Apollo Shoes, Inc.
Minutes of the Audit Committee, Apollo Shoes
October 18, 2007
Present at Meeting: Arnold Anderson, CPA (partner in charge of the audit); Darlene Wardlaw,
CPA (engagement manager); Eric Unum (Apollo ’s vice president of #nance); Mary Costain
(Apollo ’s treasurer); Samuel Carboy (Apollo ’s controller); and Karina Ramirez (Apollo ’s
director of internal audit). The three members of the audit committee of the board and the
corporate secretary also were present, but they did not enter into the conversation.
Mr. Unum (VP “nance): Well, I want to welcome the auditing #rm of Anderson, Olds, and Watershed,
CPAs to what we call the fiApollo Shoes Experience.” After our old auditors, Smith & Smith, CPAs,
unexpectedly withdrew from the engagement, we were 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 previous auditors resign?
Mr. Unum (VP “nance): I’d 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 sta7,
including a tax specialist and an information systems auditor. We need to keep up to date on your
computer systems. Back to your previous auditors, with your permission, we would like to contact
them.
Mr. Unum (VP “nance): Well, we’d rather you didn’t. There may be some litigation since they
withdrew from the engagement with 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 always want 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. We plan 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 Apollo’s internal controls, as well as provide you the usual
separate management letter on related finding.
Ms. Ramirez (internal auditor): Darlene, I agree, it’s hard to uncover clever schemes. While I am
new to Apollo, none of the projects 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 sta7 time
and need to have you prepare the state franchise tax return as well as the federal tax returns.
Ms. Wardlaw (manager on the audit): Our tax sta7person can do the state and federal returns,
and I will have them reviewed by Maria Olds, our tax partner. In order to perform the tax work,
Sarbanes-Oxley requires that we get prior approval from the audit 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 #ling material?
Mr. Unum (VP “nance): Yes. Will you need any sta7 help from us?
Ms. Ramirez (internal auditor): Last year, Apollo was able to save on audit fees when my sta7
prepared a stack of schedules and 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 appreciate your having them ready when we start #eldwork 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 “nance): How much is this going to cost us?
Mr. Anderson (partner on the audit): It is diBcult to give you a #xed fee deal, but my estimate,
considering the additional work, is $750,000. Darlene will let you know immediately if problems arise
to cause the work to be more extensive.
Mr. Unum (VP “nance): Thank you. This has been a productive meeting of the minds. We look
forward to your getting started next month.
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Apollo Shoes, Inc. 5
Meeting ended 5:30 P.M. /s/ Jeff Chesnut, Secretary
C:/AudComMins—101807.doc/
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6 Apollo Shoes, Inc.
Date: Fri, 26 OCT 2007 4:43:17 +0000
From: “Larry Lancaster” <LLancaster@ApolloShoes.com>
Subject: Attached 10-K Filing
Attachments: <<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 you
were busy with another client. She asked that I forward a copy of our 10-K directly to you. I’ve attached
one that we sent out to all shareholders with the Letter to Shareholders attached.
I’ve attached a copy of Apollo’s organizational table. Please let me know what my staff or I can do to help
the audit go smoothly for you. I will have Karina Ramirez, our Director of Internal Audit, contact you to
provide you with any other information that you need.
Larry
P.S. Do you play golf?
This Apollo message (including any attachments) contains confidential information intended for a
specific individual and purpose, and is protected by law. If you are not the intended recipient, you
should delete this message and are hereby notified that any disclosure, copying, or distribution of
this message, or the taking of any action based on it, is strictly prohibited.
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Apollo Shoes, Inc. 7
Letter to Fellow Shareholders
Dear Fellow Shareholders,
You may have noticed our competitor’s focus on earth-bound activities and athletes. Our
focus is in exactly the opposite direction. In actuality, the technological superiority of our products
is at the point where our sales are limited only by the technological inferiority of other scientific
fields (specifically, current transportation means). As space exploration continues, we intend to be
among the first to market our products in new worlds. It is there that our technological advances in
light and sound can combine with our rugged footwear to propel all galactic sports participants to
their fullest potential.
Back here on earth, the past year has been one of the most dynamic and exciting years since
I began my tenure at Apollo Shoes. From the beginning, Apollo Shoes, Inc. has adapted itself to
meet the needs of all its galactic customers and to take advantage of all opportunities supplied by
exploration of new frontiers. After a record year when most companies may have wanted to relax
and play it safe, we have decided to use this excitement to reach out further in our continuing
mission: to make a difference in this galaxy.
Our product lines, led by the flagship products SPOTLIGHT (for athletes who like to
compete at night) and SIREN (designed specifically for police officers working the graveyard shifts
in our nation’s most dangerous cities) have met widespread acceptance. We have signed with some
of this world’s premier athletes as spokespersons for our products, including a recent winner of the
grueling 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‘s
flashing lights are designed to go off after every team goal!
Our strategic management plans have allowed us to maintain a positive trend in income over
the past several years, and this was no easy task, given the state of the galactic economy. Our net
income for the year has been the best since we began operations four years ago. Next year appears
even better!
The strength of our results for the past year should not be confused with the truth of the
times. This was a uniformly difficult year for all businesses. Due to the conflicts in foreign
countries, and uncertainty with the Federal Reserve’s adjustments of interest rates, consumer
confidence has been negatively affected; therefore, fewer earth consumers are buying our state-of-
the-art athletic equipment. All of our operating divisions were severely tested. I am proud of their
responses. Although sales were not as strong as we had anticipated, our marketing plans will allow
us to bounce back next year.
With the advent of significant new breakthrough technology by Apollo Shoes, Inc.’s
research and development team, Apollo Shoes, Inc. now has the possibility to take a leadership role
in the galactic athletic footwear market. Apollo Shoes, Inc. has always been known for its leadership
position in electronic shoe technology, but we are now committed to expanding our marketing
focus. With new applied technologies, Apollo Shoes, Inc. can maintain its tradition of high tech
electronic performance and style. We continue to work on and improve the SPEAKERSHOE, an
athletic shoe with an amplified loudspeaker, originally designed for the international recording
group “Mythic Meathook.“ We are hard at work on new ideas, such as the PHONESHOE, the
sneaker with a cellular phone for those executives who like to simultaneously combine exercise
with work. We anticipate that the PHONESHOE will capture a significant piece of this quickly
expanding market.
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8 Apollo Shoes, Inc.
At Apollo Shoes, Inc., we like to briefly acknowledge achievement and then proceed to new
challenges. This year was great only because it provided us with resources to expand operations
and further technological progress. As we continue into this century of “more, faster, better,” it is
critical to continue this tradition because production, speed, and quality are critical elements for
future success. We look forward to the challenge.
Larry Lancaster
Chairman, President and CEO
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Apollo Shoes, Inc. 9
<<Shareholder Letter.Doc>>
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