APOLLO SHOES, INC.

An Audit Case to Accompany

AUDITING AND ASSURANCE SERVICES

SUGGESTED SOLUTIONS

Prepared by

Timothy J. Louwers
Brad Roof
James Madison University

2017 Edition
 Introduction

We designed the Apollo Shoes audit case to introduce students to the entire audit process, from
planning the engagement to drafting the final report. Students are asked to assume the role of a
veteran of two-to-three “busy” seasons, “in-charging” for the first time. Communication between the
students and client personnel and other firm members takes the form of e-mail messages from the
engagement partner (Arnold Anderson), the engagement manager (Darlene Wardlaw), an intern
(Timothy Crumpler) assigned to do the “grunt work”, and the director of Apollo’s internal audit
department (Karina Ramirez). Required assignments and memos are in bold print. The solution
manual highlights the assignments at the beginning of each section and provides highlights and
teaching tips for each section.

The Anderson, Olds, and Watershed intranet site (found at the textbook website:
www.mhhe.com/louwers7e/) has many useful resources for the students, such as a repository of
electronic documents (so that they won’t need to input data or retype documents), an archive of e-
mail messages and their attachments, and a bulletin board of frequently asked questions (FAQ) so that
they may find assistance from other members of the firm (um, actually, that would be us!).

The information is sequential in nature. In other words, the students must pay close attention to
information disclosed early in the audit (for example, in the Board of Director’s minutes) as the
information 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.

Yes, the title says “Suggested Solutions.” Depending upon a number of different factors, students
may come up with many different answers. We have listed all the intentional mistakes in the
following documents, but as the standard audit report states, many of the proposed adjustments
depend upon student’s “assessment of the accounting principles used and significant estimates made by
management, as well as their evaluation of Apollo’s overall financial statement presentation.” We have
provided a value for each estimate in order to prepare the year end audited financial statements,
however, as the instructor you have the advantage of changing various estimate parameters, in case
the solutions “get out” from one semester to another. Thus, if the solution does get out, students must
still justify their estimates of the allowance for doubtful accounts, estimates of the reserve for
inventory obsolescence, etc. Additionally, we have left in some troubling accounting issues (i.e.,
when is an intangible asset impaired?) that may cause differences in the numbers students report.
Finally, students may be able to justify a number of different reports other than the one we suggest
(qualified opinion for a GAAP departure with a going concern disclosure, an emphasis of a matter,
and a reference to other auditors). We believe these issues are one of the strength of the case, even
though it may cause us as instructors to be cautious in our grading.

While we designed the case to be completed by students individually, we recommend the case be
given to groups of two or three. We have found that stronger students are able to help weaker
students in a group-learning environment, leading to a better educational experience for all group
members. We also require students to turn in evaluations of the other group members to inhibit “free
rider” behavior. Based upon our students’ estimates, the case can be completed in approximately 80-
120 hours.
 Teaching Notes

The planning portion of the audit incorporates many areas in the evaluation of current or
potential clients. Most of the steps required in the planning phase of the engagement are the
same for new or existing clients. Apollo is a “new” client, thus there are no prior year
workpapers to use. As a teaching tool, this benefits the students as they must begin from
scratch. While there are many audit procedures associated with the planning of an audit, the
Apollo case focuses on the following tasks (the referenced page number indicates where the
task is mentioned in the casebook):

An audit plan for these steps is also included in order to show the students what other
procedures may be required.

General Procedures:
Task: Apollo Page
 Review Audit Committee meeting on October 17, 2017 and 6
draft an appropriate engagement letter.
 Write a Brief Audit Staffing Memo. 6
 Develop audit plans for the substantive audit procedures for 37
the balance sheet and income statement areas listed.
 Review the Minutes of the Board of Directors Meetings and 38
prepare a working paper of the matters relevant to the 2017
Audit.
 Create an Income Statement and Balance Sheet from the Trial 42
Balance.
 Perform Preliminary Analytical Procedures on the 2017 45
Unaudited Financial Statements.
 Prepare a Memo explaining your findings from the analytical 45
procedure review.
 Prepare a Memo addressing Materiality for Apollo Shoes. 46
 Prepare a Memo discussing the potential for fraud at Apollo 47
(SAS 99).
 Prepare a Memo evaluating the Apollo computer system and 48
how planning may be affected by the computer processing of
accounting transactions.
Note: Students should use the following calendar when performing audit
procedures that require knowing when during the week the fiscal year ends.
Calendar
December 2017 January 2018
Sun Mon Tues Weds Thu Fri Sat Sun Mon Tues Weds Thu Fri Sat

1 2 3 4 5 6 1 2 3
7 8 9 10 11 12 13 4 5 6 7 8 9 10
14 15 16 17 18 19 20 11 12 13 14 15 16 17
21 22 23 24 25 26 27 18 19 20 21 22 23 24
28 29 30 31 25 26 27 28 29 30 31
Points to Remember:
 Engagement Letter
o The engagement letter from the textbook should be modified to include only the
additional work to performed on this audit (the Federal Tax and State Franchise Tax
return)
o The completion date of the audit.
 o The audit fee (students will need this again when examining accounts payable).
o The standards are those of the Public Company Accounting Oversight Board
 Review of the Minutes
o This review will vary among students. The main point is to insure that the student
understands the significance of this review in the planning stages.
o You want the student to present their findings in such as a way, so that they can easily
refer back to their recommended audit action.
o This review provides an excellent opportunity to emphasize the importance of audit
documentation and to explain how their supervisor will review their work. Many
students will not think about including copies of the minutes with the review memo.
 Materiality
o Due to the limitations of a case, developing materiality limits is not feasible. Thus, the
student is asked to provide their understanding of materiality and what the
considerations of determining materiality are.
 Staffing Memo
o Some student’s may also prepare a listing of the staff assigned to the audit.
 Fraud Memo
o All that is really asked for here is that the student prepare a brief memo capturing the
essence of the professional requirements concerning consideration of potential fraud.
 Computer System Evaluation
o This area also just asks the student to develop a memo explaining their understanding
of how the computer system is treated in planning the audit.
 Working Trial Balance
o The working trial balance has been formatted in the Income Statement and Balance
Sheet as Darlene requested. A cash flow statement is not required yet! This is a good
time to point out to students what adjusting journal entries are. When students are
first introduced to adjusting journal entries, they are thinking about accruals at the end
of the period (i.e. depreciation, wages payable, interest expense, etc.). The idea that
these adjustments are corrections that the auditor needs to make in order to have the
financials in conformity with GAAP may not be clear to the student at first.
 Analytical Procedures
o This is one of the most valuable tools that a student can master. This understanding
of the relationship among accounts is a valuable tool that will help separate your
students from others as they begin work! Thus, you should have many different
responses as some students don’t understand how in depth this analysis should be.
These explanations and ratio analysis are just the beginning of what some students
may supply.
 Audit plan – General (GA)
General Planning Procedures

Audit Procedures Audit W/P Initials Comments

Objective Ref.
s
General Planning

1. If this is a new client, complete and review

the “Engagement Acceptance Form.”

2. If this is a continuing client:

a. Reevaluate whether to continue auditing the
client’s financial statements
b. Determine whether there is any change in
independence.
c. Review the matters in the “Engagement
Acceptance Form” focusing on any changes
in circumstances that could affect the
engagement’s continuance.

3. Review correspondence files, prior year audit

workpapers, permanent files, financial
statements and auditor’s reports. Also, read
any current year interim financial statements.

4. Determine the extent of involvement, if any,

of other audit firms, consultants, specialists,
or internal auditors.

a. If our firm is the principal auditor and

another audit firm is involved as the
other auditor, inquire about its
independence and professional
reputation.
b. If our firm is the other auditor,
consider inquiring of the principal
auditor about matters that may be
significant to our audit.
c. If the work of internal auditors will be
used in the engagement, determine
that it is used in accordance with
professional standards.
Audit Procedures Audit W/P Initials Comments
Objective Ref.
s

5. Obtain an understanding of the company, its

internal control, and its audit risk factors
(including the risk of material misstatements
due to fraud).
a. Hold a discussion among engagement
team members about the risks of
material misstatements due to fraud.
Document the discussion.
b. Complete the “Audit Planning Form.”
c. Make inquiries of management and
other employees about the risks of
fraud. Document the inquiry
procedures.
d. Consider the existence of fraud risks
factors.
e. Identify and assess risks of material
misstatements due to fraud and
develop your responses.
f. Complete the revenue internal control
questionnaire and document
understanding of the revenue and
collection cycle.
g. Complete a test of controls for the
Revenue Cycle

6. Apply preliminary analytical procedures by

(a) comparing account balances for the
current period to similar amounts in the prior
period annual financial statements and (b)
performing analytical procedures to identify
unusual or unexpected relationships that may
indicate fraudulent financial reporting.
a. Identify unusual or unexpected
balances or relationships.
b. Consider whether matters identified
have other financial statement and
audit planning implications, such as
whether they indicate a higher risk of
material misstatement due to error.
c. Consider specific risks identified in
preparing specific audit plans.
Audit Procedures Audit W/P Initials Comments
Objective Ref.
s
7. Discuss the type, scope, and timing of the
audit with the owner/manager, board of
directors or, if applicable, the audit
committee. Also, discuss adequacy of
working space for the audit team, access to
client records, and assistance, if any, to be
furnished by the client.

8. Obtain an engagement letter from the client.

9. Complete the materiality worksheet for

planning purposes.

10. Prepare audit plans for each significant area

covered by the audit.

11. Complete a time budget by audit area.

12. Determine staffing assignments based on

consideration of audit risks, and discuss the
preliminary audit plan and key dates, i.e.
inventory observation, mailing of
confirmations, etc. with the audit staff.

13. Obtain partner approval of audit work

programs, staff assignments, and if
applicable, time budgets.

Trial Balance, Minutes, Agreements, and Journal

Entries

1. For trial balances and other schedules and

analyses prepared by client personnel,
perform the following:
a. Trace amounts to the general ledger.
b. Foot and crossfoot totals.
c. Trace prior period balances to the
closing balances in the prior period’s
audit workpapers.
Audit Procedures Audit W/P Initials Comments
Objective Ref.
s
2. Review the minutes of the board of directors
and committee meetings for the year and any
new agreements, leases, contracts, or other
important documents. Obtain copies of the
minutes or agreements for the current or
permanent workpaper files. Highlight
matters relevant to the related audit area or
for which disclosure will be required in the
financial statement or notes

3. Examine journal entries recorded in the

general ledger and other adjustments made in
preparing the financial statements.
a. Scan the general ledger and select
specific journal entries for testing.
Document the items selected.
b. Examine the related accounting
records and supporting documents or
ensure that selected items have been
examined as part of testing performed
in individual audit plans.
c. Identify and consider appropriateness
to general ledger balances made in
preparation of the financial
statements. Examine supporting
documentation or agree amounts to
audit workpapers where tested.
d. Make inquiries of employees involved
in the financial reporting process
about the possibility of unusual or
improper journal entries.
 GA-1
Apollo Shoes, Inc.
Draft of Engagement Letter

Anderson, Olds, Watershed

October 26, 2017

Mr. Larry Lancaster, Chairman

Apollo Shoes, Inc.
Shoetown, ME

Dear Mr. Lancaster:

This will confirm our understanding of the arrangements for auditing Apollo Shoes,
Inc. financial statements for 2017.
We will audit the balance sheet at December 31, 2017, and the related statements of
income, retained earnings, and cash flows for the year ending that date. Our audit will be
made in accordance with the Standards of the Public Company Accounting Oversight Board
and will include such tests of the accounting records and such other auditing procedures as
we consider necessary.
Our audit will be based on samples of recorded transactions. We will plan the audit to
detect material errors and frauds that may affect your financial statements. Our work,
however, is subject to the unavoidable risk that errors, frauds, and illegal acts, will not be
detected. We expect to obtain reasonable, but not absolute, assurance that major
misstatements do not exist in the financial statements. Our findings regarding your system of
internal control, including information about significant deficiencies and material
weaknesses, will be reported to the audit committee of your board of directors in a separate
letter at the close of the audit.
At your request, but pending approval by your Board of Directors, we will prepare all
required federal tax returns and the state franchise tax returns.
We will provide your staff with a list of schedules needed by our staff during the
audit. The delivery dates have been discussed and mutually agreed upon. We understand
that your staff will prepare all the schedules in the package, all the financial statements and
notes thereto, and the Form 10-K for our review. The scope of our services does not include
preparation of any of these financial statements.
Ms. Darlene Wardlaw will be the manager in charge of all work performed for you.
She will inform you immediately if we encounter any circumstances that could significantly
affect our fee estimate of $750,000 discussed with you on October 17, 2017. She is aware of
the due date for the audit report, March 15, 2018. You should feel free to call on her at any
time.
If the specifications above are in accordance with your understand of the terms of our
engagement, kindly sign below and return the duplicate copy to us. We look forward to
serving you as independent public accountants.

Accepted by______________________________________ Date ________________

 GA-2
Minutes of the Audit Committee, Apollo Shoes
October 17, 2017

Present at Meeting: Arnold Anderson, CPA (partner in charge of the audit); Darlene
Wardlaw, CPA (engagement manager); Eric Unum (Apollo’s vice president of finance);
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 finance): Well, I want to welcome the auditing firm of Anderson, Olds, and
Watershed, CPAs to what we call the “Apollo 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 finance): 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 staff,
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 finance): 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 perform an attestation engagement on the effectiveness of Apollo’s internal
controls, as well as provide you the usual separate management letter on our internal control
evaluation and other related findings.
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 staff
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 staffperson 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 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 schedules and analyses that our previous auditors needed.
Ms. 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 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 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 finance): Thank you. This has been a productive meeting of the minds. We look
forward to your getting started next month.

Meeting ended 5:30 P.M. /s/ Jeff Chesnut, Secretary

 GA-3
Prepared by:
Reviewed by:
Apollo Shoes, Inc.
RELEVANT MATTERS FROM MINUTES
12/31/17
Information Relevant to 2017 Audit Audit Action Recommended

January 06, 2017

Larry Lancaster, Chairman, President, and CEO is a new Investigate Larry’s background?
hire.
Sales expected to increase 10% Note for analytic review of expenses
COGS and exp. to remain constant Note for analytic review of expenses
Authorized purchase of $1.3 million in equipment. Vouch to supporting documentation, trace to PP&E
workpapers
ST credit refinanced, rolled into LT N/P Note for liabilities work; ensure proper accounting
and disclosure.
Officers’ salary increase 10% Note for payroll analytic procedures
Cost of Superbowl ad rose 10% ($1 million). Note for review of expenses

June 30, 2017

Damages from “Nor’easter” cost $50,000. Should be treated as repair, rather than capital
addition
Company raised prices 10% to meet expectations Examine reasons for not meeting goals
Stopped R&D on Phoneshoe. Implications for intangible assets.
Postage and telephone expense saved through e-mails Note for analytic procedures involving expenses.
Write-off A/R for $23,810.13. Only write-off?
Advanced $1.25 million to Larry Lancaster’s secretary Related party transaction should be disclosed in
(personal) footnotes. 1% interest
Authorized $1 million for purchase of computer systems. Verify purchase.
Authorized $44,403,000 draw on LOC. Verify the accounting for the liability.

January 6, 2018

Anderson, Olds, and Watershed hired (fee $750,000)X-1 Fee should be included in Professional Expenses
Approved cash dividend ($860,000) (disbursed 03/01/18 Dividend should be accrued.
for SH of record 12/31/17)
Reported a $12 million negligence suit Contact client attorneys, possible contingent
liability.
Machinery purchased in early 2014 not operational Check on status.
Approved bonuses for 12/31/17 $450,000 bonuses should be accrued at 12/31/17
Company approved $3,300,000 contribution to EBP Note for footnotes.
No Superbowl ad this year Note for analytic procedures
 GA-3-1
MEETING HELD JANUARY 6, 2017

Larry Lancaster, chairman of the board, presided over the first meeting of the year,
beginning at 3 P.M. The meeting was conducted in the boardroom of Apollo’s new
global headquarters. All members were present:

Larry Lancaster
Josephine Mandeville** Fritz Brenner**
Ivan Gorr* Theodore Horstmann**
Harry Baker* Eric Unum

* Outside director ** Outside director and member of the audit committee.

The minutes of the December 16, 2016 meeting were reviewed and approved.
Reporting on the annual meeting of shareholders, Mr. Lancaster welcomed the new
or reelected board members: Josephine C. Mandeville, Professor of Accountancy
and Typing at the Graduate School of Business and Clerical Skills; Ivan W. Gorr,
President and CEO of Far More Drugs; Harry R. Baker, Executive Vice President and
Treasurer of the Iguana Growers of America Inc., Theodore Horstmann, Minister of
Commerce of Anglonesia; and Fritz Brenner, President of The Widget Corporation

Mr. Unum presented the forecast for the year, attached. Sales are expected to
increase 10 percent, with costs of goods sold and general expenses bearing about
the same relationships as experienced last year. Mr. Lancaster stated, “Well, they
better increase by that much, or heads will roll!” Mr. Lancaster’s plan to move
production to within the company was discussed. Over Mr. Horstmann’s vehement
disagreement, the board authorized purchase of equipment totaling $1.3 million to
facilitate internal production of Apollo products by a vote of 6-1.

Mr. Unum reported that the Company’s short-term line of credit was refinanced as
of February 2, 2017 and rolled into a $12 million note payable with the Twenty-First
National Bank of Maine, due January 1, 2018 (N-1.1).

Mr. Brenner moved a declaration of dividends for the year ended the previous
December 31. The motion died for lack of a second.

Mr. Unum moved, and Mr. Lancaster seconded, officers’ salary increases of 10
percent for 2017 as well as stipends for outside Board Members of $90,000 each.
The board approved these salaries and stipends by a 6-1 vote:

President and CEO, Larry Lancaster $2,750,000 L-4

Exec Sr. VP and CFO, Joe Bootwell 1,320,000 L-4
VP Marketing, Fred Durkin 1,100,000 L-4
VP Finance, Eric Unum 649,000 L-4
VP Legal Affairs, Sue Fultz 1,650,000 L-4
VP Operations, Daisy Gardner 451,000 L-4
Internal Audit Director, Karina Ramirez 235,000 L-4
Treasurer, Mary Costain 222,000 L-4
Controller, Samuel Carboy 214,000 L-4

Mr. Lancaster encouraged everyone to watch the 2017 Superbowl to watch for
Apollo’s 15- second commercial. He noted that the cost of the commercial time
rose approximately 10% from last year. The cost of production and airing the ad is
now approaching $1,000,000.

Meeting ended 5:30 P.M. /s/ Jeff Chesnut, Secretary

AudComMins—01.doc
 GA-3-2

MEETING HELD JUNE 30, 2017

Larry Lancaster, chairman of the board, presided over the second meeting of the
year, beginning at 3 P.M. All members were present:
Larry Lancaster
Josephine Mandeville** Fritz Brenner**
Ivan Gorr* Theodore Horstmann**
Harry Baker* Eric Unum

* Outside director ** Outside director and member of the audit committee.

The minutes of the January 6 meeting were reviewed and approved.

Mr. Lancaster reported on damage caused by a “Nor’easter” storm that hit Shoetown
in April. Damages amounted to approximately $50,000, just under the insurance
deductible.

Mr. Unum reported that sales revenues are not meeting expectations, primarily
because of parents’ growing disenchantment with spoiling their children; parents
were no longer willing to buy $300 premium shoes for their kids as they did in
previous years. Mr. Gorr concurred and mentioned something about “not sparing
the rod.” In order to compensate for decreased sales, the Company has raised prices
by about 10% with respect to product costs.

Mr. Lancaster lamented that the quality of Apollo products was too high—the shoes
were just not wearing out fast enough. Mr. Lancaster also stated that because of the
strength of current product lines and as a cost-cutting measure, he decided to stop
research and development efforts on the Phoneshoe, thereby eliminating Research
and Development expense for the current year. The development lab will be
modified in 2018 to house a personal gym for corporate executives. Scientists
working in the lab have been reassigned to maintenance duties elsewhere in the
company. The Company has also saved postage and telephone expense through
increased use of e-mail.

In other business, the board authorized the write-off of one account receivable for
$23,810.13 (C-1) for an account that had been outstanding for over a year. Mr.
Lancaster noted that he did not anticipate any other write-offs during the year, or
that “heads would roll!”

Mr. Unum moved that Apollo advance $1,250,000 (C-1) to Mr. Lancaster’s secretary
as a personal loan to cover personal legal expenses related to her previous
employer. Mr. Unum further suggested that the promissory note plus accrued
interest of 1% per year be due on June 30, 2054. Mr. Lancaster suggested that it be
recorded in “other receivables,” rather than “employee advances” so as to not
trouble shareholders with needless details. After general agreement among the
board that similar options be made available to other board members in the future
on an as needed basis, the advance was approved unanimously. Mr. Lancaster asked
Mr. Unum to have the check drawn to him immediately at the conclusion of the board
meeting; he would cash it and give it to his secretary.
 The board unanimously supported Ernst Hathaway’s promotion from Director of MIS
to VP-Information Systems. He reported on the plans for the purchase and
installation of a new information system. The board authorized up to $1.2 million for
the purchase of the new computer system. Ms. Mandeville offered to consult on the
purchase and installation. To fund the purchase and pay other expenses, Mr. Unum
requested that the board authorize a draw of $44,403,000 on the Company’s line of
credit on July 1 (N-1.1). This proposal was unanimously approved.

Meeting ended 7:30 P.M. /s/ Jeff Chesnut, Secretary

AudComMins—06.doc
 GA-3-3

MEETING HELD JANUARY 6, 2018

Larry Lancaster, chairman of the board, presided over the regular meeting,
beginning at 2 P.M. All members were present:
Larry Lancaster
Josephine Mandeville** Fritz Brenner**
Ivan Gorr* Theodore Horstmann**
Harry Baker* EricUnum

* Outside director ** Outside director and member of the audit

committee.

The minutes of the June 30 meeting were reviewed and approved.

The selection by the audit committee of Anderson, Olds & Watershed as
auditors was ratified. The $750,000 fee was approved for the 2017 audit.

Ms. Mandeville moved, and Mr. Gorr seconded, a proposal to declare

retroactively a cash dividend of $860,000 payable March 1 to stockholders of
record on December 31. Approved by a vote of 5–2.

Ms. Fultz, VP-Legal affairs, stated that on January 5, 2018 (yesterday), a class
action suit alleging gross negligence and violation of warranty of
merchantability was brought against Apollo for $12,000,000. The action stems
from the use of one of the Company's products in an aquatic environment,
which may have caused severe electrical shock to the wearer(s). She is
working closely with Apollo’s legal counsel, Perley Stebbins, to vigorously
defend Apollo’s good name. Ms.Fultz stated that the company’s current
insurance does not cover these types of actions.

Mr. Baker inquired as to the status of the machinery purchased in early 2018.
Mr. Lancaster replied that the machinery would be set up “soon.”

Mr. Lancaster moved and Mr. Unum seconded the approval of officers’ bonuses
for the year just ended December 31. Approved by a 4–3 vote.

President, Larry Lancaster $200,000

VP Marketing, Fred Durkin 50,000
VP Finance, Eric Unum 50,000
VP Information Systems, Ernst Hathaway 50,000
VP Legal Affairs, Sue Fultz 50,000
VP Operations, Daisy Gardner 50,000

The Board approved the Company’s contribution to the Employee Benefits

program. Mr. Unum stated that the contribution was increased by $300,000 for
2017, up 10% over the past several years to appease growing employee
dissatisfaction (X-2). Given the company’s plans to automate the distribution
process, Mr. Unum stated that employee benefits will decrease significantly in
future years.

Mr. Unum noted also that the company decided not to air a Superbowl ad this
year.
 Meeting ended 8:30 P.M. /s/ Jeff Chesnut, Secretary

AudComMins—01.doc
GA-4
APOLLO SHOES, INC.
Materiality
December 31, 2017

Materiality defined
The element of materiality implies importance--relative or absolute--and the materiality
of an item may be dependent upon its nature or its size, or both. Materiality is not a
universally quantifiable concept; it must be determined in light of professional judgment
on a case-by-case basis. There is some general agreement, however, that materiality
should be based on amounts that would influence decisions of readers of the financial
statements. Materiality may depend on either quantitative or qualitative characteristics,
often on a combination of both. In assessing a matter's importance, auditors consider its
nature as well as its relative magnitude and relative financial effect both singly or
cumulatively in light of the surrounding circumstances.
(AICPA adapted)

Some common relationships and other considerations used by auditors in judging

materiality are these:

1. net income 7. nature of items or an item

2. gross margin 8. potential litigation
3. sales 9. future impact on financial statements
4. total assets 10. change in net income
5. total current assets 11. trends of net income
6. total current liabilities

Based upon the above discussion, students may choose varying levels of materiality for the
Apollo engagement based upon their own individual professional judgments. This determination
is one that we typically discuss in class, pointing out which student (or “firm”) will have the
higher audit risk, which firm will perform the higher quality audit, which firm will need to
perform more audit work, etc.
 GA-5
Apollo Shoes, Inc.
Audit Staffing Memo
December 31, 2017

Based on the information reviewed in the Apollo Shoes 10-K, minutes of the board of
directors, and other documents, I believe that the audit team will require the following
specialized expertise:

a. Special expertise in Apollo's business and products is probably not necessary. The
products are ordinary shoes. The company gave no indication of dealing in complicated
transactions such as rubber futures hedging. Auditors with general retail and wholesale
experience ought to be able to cope with the expertise demands.

b. The audit team will need some special expertise in several areas: (1) the tax personnel
probably know how to prepare the state franchise tax return, and that expertise might not
be very special, (2) auditors with SEC knowledge and experience will need to
participate, and (3) the team will need people with computer expertise on the
engagement.
GA-6
 Apollo Shoes, Inc.
Potential Problem Areas
December 31, 2017

The following refers to the Comparative Trial Balances, GA-7.1 through GA-7.5:

 Accounts Receivable, Other Receivables, Allowance for Doubtful Accounts, Bad Debt
Expense
Apollo had a decrease in Net Sales, but the AR increased very significantly. The
“Other Receivable” is a loan to Mr. Lancaster’s secretary (see minutes from
6/30/17). The Allowance account did not increase in relation to the huge increase
in AR. There is no bad debt expense.
 Inventories and Reserve for Inventory Obsolescence
Inventories increased significantly; however sales did not. There is a potential
over-valuation of inventory, and/or the company is engaging in inventory
stockpiling. Also, the Reserve account did not increase in relation to the huge
increase in inventory - it actually decreased by 71%.
 Prepaid Insurance and Insurance Expense
Prepaid Insurance increased by 360%. Insurance Expense decreased by 96%.
 Machinery, Equipment, and Office Furniture
This account increased significantly because of 2 large purchases.
 Accounts Payable
This account decreased by 59%. Why? Also, inventories increased significantly,
but AP decreased.
 Taxes Payable
All of the taxes payable accounts have zero balances.
 Line of Credit
What is the purpose of a line of credit of this size? What “other expenses” were
the company’s officers referring to when deciding to draw this amount (see
minutes from 6/30/17)?
 Sales, Sales Returns, Net Sales – Relationship to Inventory
Net Sales decreased by $10 million, mostly because of sales returns. Sales
Returns increased significantly. Why is the inventory so high when sales actually
decreased?
 Research & Development
This department was dissolved (see minutes from 6/30/17). The dissolution of
this department is largely the reason for the significant increase in Apollo’s Net
Income for 2017.
 Administrative Wage Expense
This account decreased despite the fact that the salaried officers received raises
(see minutes from 1/6/17).
 Miscellaneous Income
Where did this revenue come from?

The following refers to GA-7.5 – Selected Ratio Comparison:

  Days Sales in Inventory – This ratio increased from 49 days to 190 days. The inventory
is not moving, yet the inventories increased significantly from last year.

 Days Sales in Accounts Receivable – This ratio increased from 25 days to 82 days. The
accounts are not being collected, yet the Allowance decreases, and Bad Debt expense is
non-existent. Refer to the minutes from 6/30/17, Lancaster authorizes the write-off of
one (immaterial) receivable, and basically says that he refuses to approve any more write-
off’s for the year.

Other points of interest:

Apollo’s stock price hasn’t increased in recent years. This is a sign that the company is not
growing, when the financial statements reflect the exact opposite. The company could be trying
to make their financial situation seem better than it really is because of the stagnant stock price.
Alternatively, the market may be “seeing through” Apollo’s numbers.
 7GA-7.1
Apollo Shoes, Inc.
Analytic Procedures
December 31, 2017
Audited Unaudited Change
12/31/16 12/31/17
Acct. Account W/P Common Common
# Title Ref. Balance Size Balance Size Amount Percentage
ASSETS
10100 Cash on Hand 1,987.28 0.01% 2,275.23 0.00% 287.95 14.49%
10200 Regular Checking Acct. 198,116.52 0.54% 567,125.92 0.42% 369,009.40 181.21%
10300 Payroll Checking Acct. 0 0.00% 0 0.00% 0 na
10400 Savings Account 3,044,958.13 8.28% 3,645,599.15 2.78% 600,641.02 19.73%
11000 Accounts Receivable 16,410,902.71 44.60% 51,515,259.98 39.26% 35,104,357.27 213.91%
11400 Other Receivables - 0.00% 1,250,000.00 0.95% 1,250,000.00 nm
11500 Allow. For Doubtful (1,262,819.88) -3.43% (1,239,009.75) -0.94% 23,810.13 -0.70%
12000 Inventory 18,825,205.24 51.16% 67,424,527.50 51.62% 48,899,322.26 259.75%
12300 Res. For Inv. Obsoles. (3,012,000.00) -8.19% (867,000.00) -0.64% 2,166,000.00 -71.91%
14100 Prepaid Insurance 743,314.38 2.02% 3,424,213.78 2.61% 2,680,899.40 360.67%
14200 Prepaid Rent 200,000.00 0.54% 0 0.00% (200,000.00) -100.00%
14300 Office Supplies 7,406.82 0.02% 8,540.00 0.01% 1,133.18 15.30%
14400 Notes Receivable - Curr 0 0.00% 0 0.00% 0 na
14700 Other Current Assets 0 0.00% 0 0.00% 0 na
15000 Land 117,000.00 0.32% 117,000.00 0.09% 0 0.00%
15100 Buildings & Land Improv. 623,905.92 1.70% 674,313.92 0.51% 50,408.00 8.08%
15200 Mach, Equip, O Furniture 433,217.10 1.18% 2,929,097.13 2.23% 2,495,880.03 576.13%
17000 Accum. Depreciation (164,000.00) -0.45% (610,000.00) -0.46% (446,000.00) 271.95%
19000 Investments 572,691.08 1.56% 1,998,780.39 1.52% 1,426,089.31 249.02%
19900 Other Noncurrent Assets 53,840.59 0.15% 53,840.59 0.04% 0 0.00%
Total Assets 36,793,725.89 100.00% 131,205,563.84 100.00% 94,411,837.95 256.60%

na – not applicable (0 divided by 0)

nm – not meaningful (current amount divided by 0)
GA-7.2
LIABILITIES
20000 Accounts Payable 4,633,118.09 12.59% 1,922,095.91 1.46% -2,711,022.18 -58.51%
23100 Sales Tax Payable - 0.00% - 0.00% - -
23200 Wages Payable 29,470.32 0.08% - -29,470.32 -100.00%
23300 FICA Employee Withhold 1,318.69 0.00% 8,439.65 0.01% 7,120.96 540.00%
23350 Medicare Withholding 583.99 0.00% 11,414.99 0.01% 10,831.00 1854.66
23400 Fed. Payroll Taxes Payab 6,033.01 0.02% 118,086.12 0.09% 112,053.11 1857.33
23500 FUTA Tax Payable - 0.00% - -
23600 State Payroll Taxes Payab 2,815.47 0.01% 55,106.86 0.04% 52,291.39 1857.29
23700 SUTA Tax Payable - 0.00% - -
23800 FICA Employer Withhold 1,318.69 0.00% 8,439.65 0.01% 7,120.96 540.00
23900 Medicare Employer With 583.99 0.00% 11,414.99 0.01% 10,831.00 1854.66
24100 Line Of Credit 10,000,000.00 27.18% 44,403,000.00 33.84% 34,403,000.00 344.03
24200 Current Portion LT Debt - 0.00% -
24700 Other Current Liabilities - 0.00% -
27000 Notes Payable – Noncurrent - 0.00% 12,000,000.00 9.15% 12,000,000.00 NM-
Total Liabilities 14,675,242.25 39.89% 58,537,998.17 44.62% 43,862,755.92 298.89

OWNER'S
EQUITY
39003 Common Stock 8,105,000.00 22.03% 8,105,000.00 6.18% 0 0
39004 Paid-In Capital 7,423,000.00 20.17% 7,423,000.00 5.66% 0 0
39005 Retained Earnings 2,219,120.65 6.03% 6,590,483.64 5.02% 4,371,362.99 196.99
Current Net Income 4,371,362.99 11.88% $50,549,082.03 38.53% 46,177,719.04 1056.37
Total Owner's Equity 22,118,483.64 60.11% 72,646,565.67 55.38% 50,549,082.03 228.54

Total Liabilities & Equity 36,793,725.89 100.00% 131,205,563.84 100.00% 94,411,837.95 256.60
 GA-7.3
Audited Unaudited Change
12/31/16 12/31/17
Acct. Account W/P Common Common
# Title Ref. Balance Size Balance Size Amount Percentage
REVENUE
40000 Sales 246,172,918.44 102.33% 242,713,452.88 105.32% -3,459,465.56 -1.41%
41000 Sales Returns 4,497,583.20 1.87% 11,100,220.89 4.82% 6,602,637.69 146.80%
42000 Warranty Exp 1,100,281.48 0.46% 1,158,128.47 0.50% 57,846.99 5.26%
Net Sales 240,575,053.76 100.00% 230,455,103.52 100.00% (10,119,950.24) -4.21%

EXPENSES
50000 COGS 141,569,221.61 58.85% 130,196,645.26 56.50% (11,372,576.35) -8.03%

Gross Margin 99,005,832.15 41.15% 100,258,458.26 43.50% 1,252,626.11 1.27

%
GA-7.4
OPERATING EXPENSES
57500 Freight 4,302,951.46 1.79% 4,240,263.09 1.84% (62,688.37) -1.46%
60000 Advertising Expense 897,140.01 0.37% 1,036,854.01 0.45% 139,714.00 15.57%
61000 Auto Expenses 208,974.39 0.09% 210,502.80 0.09% 1,528.41 0.73%
62000 Research & Development 31,212,334.17 12.97% 528,870.44 0.23% (30,683,463.73) -98.31%
64000 Depreciation Expense 133,000.00 0.06% 446,000.00 0.19% 313,000.00 235.34%
64500 Warehouse Salaries 4,633,383.82 1.93% 4,720,715.56 2.05% 87,331.74 1.88%
65000 Property Tax Expense 80,495.32 0.03% 99,332.45 0.04% 18,837.13 23.40%
66000 Legal & Professional Exp 3,605,133.96 1.50% 4,913,224.45 2.13% 1,308,090.49) 36.28%
67000 Bad Debt Expense 1,622,425.99 0.67% - 0.00% (1,622,425.99) -100.00%
68000 Insurance Expense 853,942.65 0.35% 36,106.92 0.02% (817,835.73) -95.77%
70000 Maintenance Expense 61,136.04 0.03% 35,502.87 0.02% (25,633.17) -41.93%
70100 Utilities 135,642.99 0.06% 137,332.18 0.06% 1,689.19 1.25%
70110 Phone 76,373.78 0.03% 52,599.02 0.02% (23,774.76) -31.13%
70120 Postal 128,033.21 0.05% 77,803.61 0.03% (50,229.60) -39.23%
71000 Misc. Office Expense 17,023.27 0.01% 24,891.82 0.01% 7,868.55 46.22%
72000 Payroll Tax Expense 1,550,989.06 0.64% 1,577,811.85 0.68% 26,822.79 1.73%
73000 Pension/PS Plan Expense 3,000,000.00 1.25% 3,300,000.00 1.43% 300,000.00 10.00%
74000 Rent or Lease Expense 2,603,485.87 1.08% 1,206,574.00 0.52% (1,396,911.87) -53.66%
77500 Administrative Wage Exp 16,875,305.98 7.01% 16,197,225.43 7.03% (678,080.55) -4.02%
Total Operating Expenses 71,997,771.97 29.93% $38,841,610.50 16.85% (33,156,161.47) -46.05%

Net Income from 27,008,060.18 11.23% $61,416,847.76 26.65% 34,408,787.58 127.40%

Operations

OTHER INCOME (EXPENSE)

45000 Income from Investments - 0.00% 1,426,089.31 0.62% 1,426,089.31 nm
46000 Interest Income 204,302.81 0.08% 131,881.46 0.06% (72,421.35) -35.45%
47000 Misc. Income - 0.00% 2,166,000.00 0.94% 2,166,000.00 nm
78000 Interest Expense (875,000.00) -0.36% (2,591,736.50) -1.12% 1,716,736.50 196.20%
80000 Loss on Legal Settlement (19,172,000.00) -7.97% - 0.00% (19,172,000.00) 100.00%

Net Income before Tax 7,165,362.99 2.98% $62,549,082.03 27.14% 55,383,719.04 772.94%

78500 Income Tax Exp - Federal (2,390,000.00) -0.99% -8,900,000.00 -3.86% -6,510,000.00 272.38%
78510 Income Tax Exp - State (404,000.00) -0.17% -3,100,000.00 -1.35% -2,696,000.00 667.33%
0.00%
Net Income 4,371,362.99 1.82% $50,549,082.03 21.93% 46,177,719.04 1056.37%
 GA-7.5

Apollo Shoes, Inc.

Selected Ratios
12/31/17
Audited Unaudited Percentage
Ratios 12/31/16 12/31/17 Change

Current Ratio 2.40 2.71 13.05%

Debt Ratio 0.40 0.45 11.86%

Debt-Equity Ratio 0.66 0.81 21.41%

Asset Turnover 6.54 1.76 -73.14%

Liability Turnover 16.39 3.94 -75.98%

Days Sales in Inventory 48.54 189.86 291.14%

Days Sales in AR 24.90 81.59 227.69%

Net Working Capital 20,481,828.95 79,504,533.64 288.17%

GA-8
 Apollo Shoes, Inc.
Computer processing of Transactions
December 31, 2017

Having reviewed the documentation provided by Karina Ramirez related to the computer
processing of accounting transactions of Apollo, I have noted the following:

Mid-Year Conversion to Computer System

For an auditor to rely on the information provided by a computer system that was installed mid-
year, it is necessary to determine whether the conversion between the manual and automated
systems has been completed with due professional care.

Use of the PC as an Audit Tool

Our firm can use software several ways, even though we do not have any firm-prepared
specialized programs.

Word Processing
Our audit plan, audit memos, and audit report can be written on word processing. We can
even get final products prepared very nicely for final products and delivery to Apollo.

Electronic Spreadsheets
We can calculate common-size, comparative financial data and compute ratios for
analytical review. A large variety of ordinary working papers can be produced with the
typing and math functions. The working trial balance can be put on a spreadsheet, and we
will have an easier time putting in adjusting journal entries and save time adding it all up.
At least, we can substitute the electronic spreadsheet for paper and pencil.

For our administrative management purposes, we can put our time budget and actual time
on a spreadsheet for progress and billing analysis.

Statistical Software
We ought to buy some statistical package to generate random numbers and make
audit-relevant statistical calculations. Some packages can perform regressions as well as
calculate variances and standard deviations.

Computer Auditing
Our computer audit specialist can use a PC as a terminal to perform data base inquiries
and enter test data. We will need to coordinate such applications with Apollo personnel,
because we will be entering their system through communications software.
 GA-9
Apollo Shoes, Inc.
Consideration of Fraud Memo
December 31, 2017

We identified the following key risk factors:

 Significant competition in industry.

 Control environment dominated by one individual.
 Significant increase in net income despite stagnant sales.
 Emphasis on meeting profitability targets.
 Concerns over product quality based upon sales returns and product litigation.
 Concerns over inability to speak with predecessor auditor over their withdrawal after last year’s
engagement.

In response to these key risk factors, the professional literature requires that as an audit team we:

 Place an increased emphasis on professional skepticism.

Putting aside any prior beliefs as to management's honesty, the audit team must
exchange ideas or brainstorm how frauds could occur. These discussions are intended
to identify fraud risks and should be conducted while keeping in mind the
characteristics that are present when frauds occur: incentives, opportunities, and
ability to rationalize. Throughout the audit, our engagement team should think about
and explore the question, "If someone wanted to perpetrate a fraud, how would it be
done?" From these discussions, our engagement team should be in a better position to
design audit tests responsive to the risks of fraud.

 Have discussions with management.

Our engagement team is expected to inquire of management and others in the

organization as to the risk of fraud and whether they are aware of any frauds. We
should make a point of talking to employees in and outside management. Giving
employees and others the opportunity to "blow the whistle" may encourage someone
to step forward. It might also help deter others from committing fraud if they are
concerned that a co-worker will turn them in.

 Perform unpredictable audit tests.

During the audit, we must test areas, locations and accounts that otherwise might not
be tested. The team should design tests that would be unpredictable and unexpected
by the client.

 Respond to management override of controls.

Because management is often in a position to override controls in order to commit

financial-statement fraud, the standard includes procedures to test for management
override of controls on every audit.