Week 3 Scenario Assignments
Apple Inc. started out as a small idea, of Mr. Steve Jobs (which is still the long-standing CEO) and turned into a mega billion-dollar business. This global tech giant not only manufactures personal devices but they also are the leader of computer software and peripherals. Apple Inc’s brand extends way past cell phones; it runs over into major products such as iPads, iPods, Mac, AirPods, Apple TV and so much more.
Initial Risk Assessment
The auditing team that has been set in place will not only work independently but they will be professional in all matters and hold no personal stock within the company. Our team comes with years of experience, company knowledge and skepticism that will conclude with an ethical opinion about the audit. With Apple, Inc. being a private company on a global scale it may take some time to gather, review and conclude all evidence.
Some major risks we found consist of suppling of components, regional and global economic conditions, services and products, competition, staying ahead of customer demand, distributors, design and manufacturing. If the customer demand over powers Apple’s ability to keep up, then this could be a grave risk to the business. Another major issue would be the economy. If the total amount of money within the economy tanks; then that leaves consumers not able to afford new services and/or products for our client.
For the past 2 years, the total amount Apple Inc. sales have flourished. With increased sales there has, in fact, been an increase in operations. As Apple continues to upgrade their devices and add much needed favorite components and software, they will continue to have a huge demand for their products. In this strong bullish economic market people’s income level allows them to consistently have a demand for Apple products, but if the market gets any stronger this could cause a demand curve resulting in a shortage. Once that income level subsides, Apple may have too much product in supply and force prices to be lowered.
International Trade Opportunities
With Apple being based in Cupertino, California; it still employs and owns production plants internationally. This international setup allows for Apple to produces products faster at a much cheaper rate. Many United States companies prefer to send work overseas because the scale of work that needs to be done cannot be handle at the specific cost that Apple would prefer to pay versus sending it overseas where the cost of to employ their workers are much lower.
Another reason why Apply chooses to work globally is because many of their product components come from places all over the world. I have researched that approximately 25% of Apples components come from Samsung; which is based overseas in Seoul, South Korea. Being that Samsung is also a very sound company; this type of international trade agreement allows for both parties to be profitable.
Analysis of Competitors and Customers
Apple is a major competitor in this strong competitive market. There are tons of competitors in this tech driven market such as: Samsung, LG, HTC, Nokia, Motorola and many more. Everyone knows that Apple has a very competitive advantage that allows them to stand out from the rest. These advantages consist of a reliable iOS system, strong long-term stock rating, excessive amount of sales (year after year), and they are the top gifted luxury brand for consumers. The only disadvantage to all the advantages would be that Apple only has one main product that bring in the most money; being the iPhone. If at any time that the iPhone buzz gets stale or fades, then the stock would eventually take a huge hit; so, in other words Apple may need to start diversifying sooner than later.
Ethics and Legal Issues
Apple Inc. has a very lengthy code of ethics worldwide for every culture. The code of ethics not only applies to certain staff, but top management and executives as well. Apple also has several other governance policies and procedures in place to prevent violation of ethics.
Apple did see an issue with suppliers on the 2017 audit. “Included in the report were three debt-bonded labor violations, two underage labor violations and 38 violations of falsifying work hours data.” (Musil, 2018). Apple believes some of the violations are due to the new suppliers they acquired. Apple made the suppliers repay the debt of falsifying work hours, made the underage workers return to schools, and reimbursed the employees that were placement fees for the supplier paid by Apple.
There were no previous disputes with their previous auditing firm, but they did recently adopt a procedure to look at competitive bidding for auditors every five years. They started this policy in 2009 and when they switched, they saw a fall in costs of audits.
Apple has been susceptible to lawsuits and other legal proceedings. Just to name a few; a customer sued Apple because Siri did not work as well as advertised, Nokia sued Apple for failing to pay the right to use Nokia’s technology, which resulted in Apple countersuing Nokia for infringing 13 of Apple’s patents. Nokia responded by filing a complaint claiming all of Apple’s products violate Nokia patents. The Department of Justice sued Apple and several CEO’s for conspiring to raise e-book prices to fight Amazon’s discounting. Also, Kodak sued Apple for violating their digital imaging patents. The list continues and will always continue because many companies in the phone and tablet industry offer similar products and service. Customers will also continue to file lawsuits on anything if they feel they are violated and with this industry, it is hard to please everyone.
Regulatory and Compliance Concerns
Apple must comply to certain laws and regulations related to mobile communications and media devices within the U.S. and foreign countries. The company’s policy and procedures are designed to ensure all compliance and regulations are obeyed, but there is no guarantee all employees will not violate the policy and procedures. Apple is subject to a high-level of governmental regulation due to privacy laws, software licenses, consumer rights laws, labor laws, foreign policies, tax laws, GAAP, SOX, and several other government regulation laws and regulations.
Employees of Apple Inc. are not unionized. The contractors are unionized, but Apple Inc. as a company is not as of today. The employees are generally compliant with Sarbanes-Oxley (SOX) and other regulatory rules. As stated previously, Apple has several compliance and regulations employees must abide by and no complaints have been made of employees violating the SOX or regulatory rules other than their suppliers, but not Apple directly.
Analytical procedures are important because it shows the strength of the organization. Ratios help determine profitability, liquidity, ability to meet long-term obligations, and leverage. How a company balances out with the ratios determine if the company is successful. These ratios can also determine certain risks the company may need to be advised on to help boost the ratios. These procedures also help auditors determine irregularities with information so they can perform a risk assessment to determine if any other analytical procedures need to be done. The following chart shows a few ratios calculated based off the SEC filings from Apple and Motorala (United States Securities and Exchange Commission, 2018):
|Debt to Equity Ratio||2.41%||8.37%|
|Profit Margin Ratio||0.22%||0.17%|
When comparing to Motorola, Apple has a better profit margin ratio compared to Motorola. A higher profit margin ratio means the company is making a good profit. Motorola’s higher debt to equity ratio means the company does not have enough cash to pay obligations. The closer the margin is to 2% and under the better. Both companies have a good current ratio. The higher the current ratio, the more likely the company can liquify assets to pay their debts and Motorola is sufficiently more able to liquify debts to pay assets than Apple according to the ratio, but that may mean they are not using short-term liabilities like cash or financing as efficiently as they should be. Apple’s current ratio is more acceptable, and the ratio shows they are using cash and short-term financing responsibly and efficiently. Observantly, Apple is the most successful compared to Motorola. Motorola may be able to liquify their assets to pay obligations easier, but Apple is more profitable and balances out better than Motorola.
Using these ratios against the prior year ratios can help discover if the company is doing better or worse than the previous years. Looking at past ratios with the company and competitors will also help auditors understand the organization better and determine what is possibly expected. These types of analytical procedures are a map for an organization and tells the health and future of the company.
Materiality and Risk
Materiality and risk are essential in planning the audit and constructing the audit approach. Key concepts are summarized as follows:
Assessing Appropriateness of Audit Test Types
- Materiality – The extent to which an omission or misstatement of accounting information, regarding surrounding circumstances, is probable that the opinion of a user of the data could be altered or manipulated by the exclusion or misstatement. Materiality is a major consideration when choosing the audit report that should be issued. When a material misstatement is identified, the auditor must notify the client so that a correction can be made. Depending on the materiality of the misstatement, the auditor is required to issue an adverse or a qualified opinion when the client refuses to make the correction. Auditors follow five steps in determining materiality: 1) determine the preliminary judgement about materiality for the financial statements, 2) determine performance materiality, 3) estimation of misstatement amounts in each segment, 4) estimation of the misstatements combined, and 5) compare the combined misstatement amount with the preliminary or revised judgement materiality amount.
- Misstatement – A misstatement is the difference between a required disclosure, amount, presentation, or classification of a line item(s) in a financial statement and what is actually reported to obtain a fair presentation as applies to the accounting framework. Misstatements within an account are classified as either known or likely. Known misstatements occur when the auditor identifies the specific misstatements in an account balance or a series of transactions. Likely misstatements occur when differences between management’s and the auditor’s judgment regarding account balances or from the auditor’s projection of misstatements as determined by the auditor’s test of a population sample.
- Audit Risk – An audit risk is the chance that mistakes, or deception, will not be discovered by the auditor during the examination of the client’s financial statements. To help in reducing the level of audit risk, the auditor can increase the number of audit procedures used. Having a modest risk level is a crucial part of the audit function as financial statement users rely on the assurances provided by the auditor in reading the company’s financial statements. An audit risk falls into one of three categories: control risk, detection risk, and inherent risk. Control risk is the chance that potential material misstatements would not be prevented or discovered by the control system of the client. Detection risk is the chance that the audit procedures used do not have the capability of detecting material misstatements. Inherent risk is summarized below.
- Audit Risk Model – Auditors use the audit risk model to determine the possible risks through planning procedures used to obtain necessary audit evidence. Auditors use the model to help in determining the overall risks and the types and amount of evidence needs to be accumulated for each relevant audit objective. When auditors participate in an auditing engagement, they consider the inherent and control risks while acquiring knowledge about the client and its setting. Detection risk is determined after taking the inherent and control risks associated with the auditing engagement into consideration and the auditor’s willingness to accept the overall audit risk.
- Inherent Risk — Inherent Risk is the chance of there being a misstatement that is material occurring in the financials as the result of a mistake or exclusion caused by factors other than control failures. In a financial audit, this risk has a greater occurrence in situations where an elevated level of estimation or decision is required or when there are highly complex transactions within the organization. Inherent risk represents the highest risk since all the controls that are in place have failed. When an organization presents forward-looking financial statements to the public or investors, an inherent risk often exists.
- Relationship of Risk to Audit Evidence – The level of risk determines the amount of audit evidence that is needed. The higher the risk, the greater the amount of necessary and quality evidence that needs to be obtained. As the quality of the audit evidence increases, there is a decrease in the amount of needed documenting evidence. When the evidence is of poor quality, gathering the same type of audit evidence will not compensate for the lack of quality. The relevance and reliability of the evidence will assist in decreasing the risk level of the organization’s financial statements and corroborating evidence.
Selecting the best mix of the five audit tests can vary greatly from audit to audit due to the varying levels of inherent risk and internal control effectiveness that each organization presents. (Arens, Elder & Beasley, 2014) All audits require the initial test of risk assessment procedures which provide the auditor with an understanding of the business, its environment, and its level of internal control. (Arens, Elder & Beasley, 2014) This first test assists in making an assessment regarding the risk of material misstatement in Apple’s financial statements. As Apple is a very large public company, the risk assessment procedure test is likely to identify extensive internal controls and low inherent risk of material misstatement. Due to the presence of heavy internal controls, the appropriate mix of evidence will include extensive tests of controls that aim to identify the placement of the controls and their effectiveness. Additionally, extensive analytical procedures should be conducted with the objective of assessing whether indications exist that material misstatement of dollar values has occurred. Due to comprehensive internal controls, low inherent risk, and extensive analytical procedure testing, only a small number of substantive tests of transactions and detailed balances need occur, unless tests of controls reveal ineffective internal controls or analytical procedure tests indicate a likelihood of material misstatement.
Unsuitability of Certain Audit Test Types
A significant objective of the overall audit strategy is keeping costs low. Therefore, a major aim in selecting the appropriate types of tests and evidence to collect is the reduction of costlier tests wherever internal controls and low risk of misstatement allows. (Arens, Elder & Beasley, 2014) Substantive tests of transactions and detailed balances are the costliest and most time consuming of the five audit test types. When an entity exhibits strong and effective internal controls and extensive analytical procedures tests illustrate with reasonability that the risk of material misstatement is low, then these tests are not suitable to the overall audit strategy. (Arens, Elder & Beasley, 2014) Preliminary planning and assessment of Apple as an organization reflects this type of audit scenario to a considerable degree. Thus, anything more than a minor amount substantive tests of transactions and detailed balances should be considered unsuitable to the audit strategy of Apple, Inc.’s financial statements.
One form we focused on was the 10-k form. We analyzed Apple, Inc Corporations Securities and Exchange Commission report, otherwise known as the (SEC)10-k report. The 10-k form consists of such information as audited financial statements, company’s organizational structure, and equity along with other financial data. The data from this paper was also used to analyze and calculate their initial risk assessment, ethics, legal matters, compliance and audits.
Arens, A.A., Elder, R.J., & Beasley, M.S. (2014). Auditing and Assurance Services: An Integrated Approach (15th ed.). Retrieved from The University of Phoenix eBook Collection database.
Musil, S. (2018, March). Apple Sees Uptick in Supplier Labor Problems in Annual Audit. Retrieved from https://www.cnet.com/news/apple-finds-more-labor-problems-in-annual-supplier-audit/
United States Securities and Exchange Commission. (2018). Apple Inc. Form 10-K. Retrieved from https://s22.q4cdn.com/396847794/files/doc_financials/quarterly/2018/Q4/10-K-2018-(As-Filed).pdf
United States Securities and Exchange Commission. (2018). Motorola Solutions Form 10-K. Retrieved from http://www.snl.com/Cache/c396766818.html