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Earthwear Clothiers Audit: Employee Stock Ownership

Earthwear Clothiers has a solid corporate structure, with founders Williams and Rogers still at the executive roles. The distribution structure consists of a range of customer offerings. The increase in revenue from 2014 to 2015 demonstrates the firm’s positive business control. The sales volume has undoubtedly risen due to overseas outlet shops and catalogs in the local language. According to Willis and Adams, Certified Public Accountants, [CPAs] (2017), an increase in net revenue and net income in 2015 were lower than in 2014.

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The rise in revenue is thought to have resulted from a shift in the distribution of catalogs and other mailings. Backorder fulfillment was disappointingly low at 85 percent, compared to previous years (Willis & Adams, CPAs, 2017). Earthware Clothiers could use an Employee Stock Purchase Plan (ESPP) to allow employees to buy stock in the business at a discounted price. The future cash flow must be estimated, which is a more challenging task (Bushman, 2017). The cash flow from 2014 to 2015 showed no improvement; hence, it is best to put an ESPP in place after the third successful cash flow update.

Independence

Willis and Adams, CPAs, must maintain a neutral and objective approach. Having performed previous audits since the company’s establishment in 1975, they are in an ideal position to gain awareness of the company and the sector in which it operates. Willis and Adams, CPAs, must have the required personnel to conduct the audit thoroughly and objectively to make an opinion on the financial statements’ accuracy. As a result, their independence ensures credibility of the audit report. There are no other facilities provided by Willis and Adams, CPAs, to Earthwear, and no conflict of interest.

Knowledge of Client Industry

To conduct an effective and efficient audit, you must first gain a thorough understanding of the client’s business. It enables us to not only tailor our work to each client’s unique facts and circumstances, but also to carry out that work and evaluate our findings with confidence. Our understanding of the client’s industry also aids us in developing and maintaining a positive professional relationship with them.

Staffing Capabilities

Willis & Adams has the capability of staffing more associates to the auditing firm. With the firm looking forward to hiring and retaining hard working staff members, it is essential for the Earthwear Clothier to ascertain that all the members of the board-room have the necessary competency required for an appropriate internal control during auditor’s reporting. The overall goal is, therefore, to grow and become notably recognized and well-respected in the community through the recommendations and praises from the satisfied clients.

Internal and External Factors

Willis and Adams, CPAs should proceed with the move of auditing the firm. A successor audit will need to contact the predecessor to obtain details relevant to management’s credibility or disputes about accounting policies. However, if the client refuses to allow the new future audit firm to speak with the predecessor, it’s a red flag that something is wrong, and the new audit firm will want to move on.

Planning the Audit

Audit Risk

The audit risk comprises the following factors: intrinsic risk, control risk, and identification risk. The auditor relies on management assertions and controls, but an individual must test the controls and determine the risk based on those controls. Evidently, the possibility of a material misstatement arises when management has established their model to make the accounting calculation significant in safeguarding the accounting controls and elimination of audit risks accordingly.

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Internal Controls

Internal controls can be divided into three categories. Preventative Controls are designed to reduce the likelihood of mistakes or anomalies occurring. Detective Controls are the process of detecting defects or anomalies after they’ve occurred. And there are directive controls, which are used to promote the desired outcome. Earthwear will no longer need to estimate forfeitures on the balance sheet because they will be able to account for them in case of a rise.

Audit Procedures

Valuation and Allocation are the assertions to be checked. The financial statements could be misstated if the ESPP fair value valuation is not an accurate approximation. It’s also essential to evaluate the presentation and disclosure. The auditor must present this new strategy so that potential investors aren’t put off by all of the options available to the employees. As such, audit procedures must be followed to ascertain limited drawbacks.

Materiality

Identifying and evaluating the possibility of material misstatements; comprehending the organization and its climate by locating its goals and plans to implement an ESPP. The audit will decide whether this significant alteration in leadership roles would lead to a material overdraft of the financial accounts. The auditor must collaborate with management and top stakeholders and communicate with other similar businesses to determine the plan’s materiality.

Control Environment

The corporation has conservative accounting practices and is dedicated to identifying and avoiding misstatements due to fraud or mistakes. They did not, however, schedule or prepare for leadership succession (Messier et al, 2017). For the majority of the year, the company was without a controller. However, they have a strong board and no turnover in senior executive positions. A cross-training worker for interim assignments principle was suggested as a way for Earthwear Clothiers to establish leadership succession procedures.

Risk Assessment

Control cannot be able to detect or avoid misstatements due to inherent limitations. Because of changes in circumstances, compliance with policies and procedures can deteriorate and become insufficient. In this regard, risk assessments provide valid loop holes that an auditor can use to advice Earthwear Clothiers, thereby allowing for easily and smooth transitions that do not take long to institute, as is the case of the company.

Control Activities

The general ledger and subsidiary ledges of Earthwear Clothiers were not reconciled promptly. The accounts payable ledger, in particular, was not reconciled to the general ledger in a timely or correct manner. Although a formal policy exists, there is no formal mechanism or procedure in place. As a result, the disparity necessitates a $376,000 audit modification, which is a significant deficiency. Even though it falls below the acceptable level of exaggeration (Messier et al., 2017), a material misstatement may occur if the company’s controls fail to detect or prevent it. Earthwear Clothiers should set up a system to ensure that the general ledger and subsidiary ledgers are reconciled.

Monitoring Activities

Management implements cost-effective internal audit recommendations. The board is focused on the control environment and controlling operations, meeting with internal and external auditors regularly. Defects in internal controls are addressed by an audit of all allegations (Messier et al., 2017). The controlling activities of the internal controls were found to be without flaws irrespective of the changes in the management at the executive and stakeholders positions.

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Opinion Communication

For the transfer of inventory between warehouses, EarthWear uses a variety of intercompany transactions. There are mostly content transfers, although there is a management requirement that such transactions be reconciled because there is no mechanism which ensures that the transactions are done regularly. As a result, Excess Workers’ Compensation [EWC] controls may likely fail to avoid or detect the misstatement. We recommend that EWC establish and incorporate a mechanism that includes leadership transparency for ensuring that reconciliations are completed recurrently.

References

Bushman, A. (2017). Employee stock ownership plan: Fact or perception. RSM. Web.

Messier, Jr., W.F., Glover, S.M., & Prawitt, D. F. (2016). Auditing & assurance services: A systematic approach (10th ed.). McGraw-Hill Education.

Willis & Adams, CPAs. (2017). Five-year consolidated financial summary. Web.

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