• • • • • • • • • • • • • • • • Tie the inventory warehouse report to Apollo’s inventory status report (see pg. 91) Judgmentally sample a number of unit costs from recent invoices and tie them to the inventory status report (see pg. 91) Audit Prepaids (see pg. 115) I-1 (Complete the investments and other assets section) (see pg. 115) Audit PP&E (see pg. 121) ICP-1 (Memo discussing responsibilities for auditing the controls…) (see pg. 131) L-4 (Substantive payroll procedures) (see pg. 131) R-1 (look at revenues) (see pg. 139) X-1 (look at expenses) (see pg. 139) Use analytic procedures for those that should be comparable to those in the previous year (see pg. 139) Double-check the board of directors’ minutes for explanations of fluctuations (see pg. 139) Prepare a memo (to be placed in the A series with the financial statements) on these subsequent events and how you believe we should address them (see pg. 143) You need to draft a proposed management representation letter(see pg. 146) You need to also draft the management certification statement required by Sarbanes-Oxley. (see pg. 146) Propose the adjustments to the financial statements you believe necessary for Arnold to give the standard unmodified report on the Apollo Shoes financial statements (see pg. 147) Prepare a “scoresheet” working paper for the proposed adjusting journal entries. (see pg. 147) Major Project (Group) Audit Team Mission: Planning the Engagement to Drafting the Final Report for the Audit of APOLLO SHOES, INC. _________________________________ APOLLO SHOES, INC. An Audit Case to Accompany AUDITING AND ASSURANCE SERVICES Prepared by Timothy J. Louwers M. Loretta Manktelow Copyright 2015 © McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Page 1 James Madison University J. Kenneth Reynolds Indiana University Copyright 2015 © McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Page 2 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. Your Audit Team has been asked to assume the role of veterans of two-to-three “busy” seasons, “in-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 interns. While the interns can do “grunt work,” such as vouching and gathering information for you, they appear 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/louwers6e/) 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 and 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 an usuaual 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 Harrisonburg, VA Loretta Manktelow Harrisonburg, VA J. Kenneth Reynolds Bloomington, IN Copyright 2015 © McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Page 3 Table of Contents Introduction ................................................................................................................................................ 3 Table of Contents ....................................................................................................................................... 4 Planning ..................................................................................................................................................... 5 Internal Control Evaluation ..................................................................................................................... 51 Substantive Testing: Cash ........................................................................................................................ 64 Substantive Testing: Accounts Receivable .............................................................................................. 74 Substantive Testing: Inventory ............................................................................................................... 85 Substantive Testing: Prepaids and Other Assets .................................................................................... 109 Substantive Testing: Fixed Assets ......................................................................................................... 115 Substantive Testing: Liabilities .............................................................................................................. 119 Substantive Testing: Payroll .................................................................................................................. 125 Audit Wrap-up ....................................................................................................................................... 133 Copyright 2015 © McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Page 4 Copyright 2015 © McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Page 5 Date: 21 OCT 2014 00:42:35 +0000 From: "Darlene Wardlaw" Subject: Upcoming Apollo Shoes Engagement Attachment: 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 “Uncle 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 to familiarize yourself with Apollo Shoes and help me out by doing the following: 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 (2013) 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 (onepage) audit staffing memo (GA-2) telling me what expertise (e.g., tax specialist, IT specialist, etc.) 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. 1. 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 Copyright 2015 © McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Page 6 Minutes of the Audit Committee, Apollo Shoes October 17, 2014 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. 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 of 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. Meeting ended 5:30 P.M. /s/ Jeff Chesnut, Secretary Copyright 2015 © McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Page 7 Copyright 2015 © McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Page 8 Date: 22 OCT 2014 4:43:17 +0000 From: "Larry Lancaster" Subject: Attached 10-K Filing Attachments: , , 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. Copyright 2015 © McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Page 9 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-ofthe-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. Copyright 2015 © McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Page 10 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 Copyright 2015 © McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Page 11 -------------------------------SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 -----------------------FORM 10-K ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 2013 COMMISSION FILE NUMBER 1-9Z40 APOLLO SHOES INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) MAINE (STATE OR OTHER JURISDICTION OF INCORPORATION OR ORGANIZATION) X8-061325 (IRS EMPLOYER IDENTIFICATION NO.) SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: TITLE OF EACH CLASS ------------------- NAME OF EACH EXCHANGE ON WHICH REGISTERED ----------------------------------------- COMMON STOCK, PAR VALUE, $1.00 PER SHARE STUDS SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: NONE Indicate 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 filing requirements 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 contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] As of March 7, 2014, the aggregate market value of the registrant's voting stock held by non-affiliates of the registrant was approximately $24,315,000. As of March 7, 2014, 8,105,000 shares of the registrant's Common Stock were issued and outstanding. DOCUMENTS INCORPORATED BY REFERENCE Definitive Proxy Statement dated December 12, 2013 for the Annual Meeting of Shareholders to be held on Tuesday, February 4, 2014 at the End of the Universe Restaurant in downtown Shoetown. Copyright 2015 © McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Page 12 APOLLO SHOES INC. ANNUAL REPORT ON FORM 10-K TABLE OF CONTENTS Item 1. Business ............................................................................................................... i Item 2. Properties ............................................................................................................ ii Item 3. Legal Proceedings.............................................................................................. iii Item 4. Submission of Matters to a Vote of Security Holders. ..................................... iii Item 5. Market for Registrant's Common Equity and Related Stockholder Matters. ... iii Item 6. Selected Financial Data .................................................................................... iv Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations ..................................................................v Item 8. Financial Statements and Supplementary Data ................................................ vi Item 9. Changes in and Disagreements with Accountants ......................................... xix Item 10. Directors and Executive Officers of the Registrant ........................................ xix Item 11. Executive Compensation ................................................................................ xix Item 12. Security Ownership of Certain Beneficial Owners and Management. xix Item 13. Certain Relationships and Related Transactions. xix Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K................xx Copyright 2015 © McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Page 13 This Annual Report on Form 10-K contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, including statements with regard to the Company'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 or achievements, and may contain the words "believe," "anticipate," "expect," "estimate," "intend," "plan," "project," "will be," "will continue," "will result," "could," "may," "might," or any variations of such words or other words with similar meanings. Any such statements are subject to risks and uncertainties that could cause the Company's actual results to differ materially from those discussed in such forward-looking statements. Prospective information is based on management's then current expectations or forecasts. Such information is subject to the risk that such expectations or forecasts, or the assumptions underlying such expectations or forecasts, become inaccurate. ITEM 1. BUSINESS. Apollo Shoes, Inc. (the “Company”) is a planetary distributor specializing in technologically superior athletic podiatric products. The Company’s brands-- SIREN, SPOTLIGHT, and SPEAKERSHOE-- are used extensively in many athletic competitions, such as the Switzerland Watersports Games in Zurich. The Company is excited about this annual event that exhibits to the entire world the skills and spirit of outstanding Swiss aquatic athletes. The Company’s products are shipped to large and small retail outlets in a six-state area. The Company 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, Maine area. Apollo Shoes, incorporated in the state of Delaware, is a public corporation. Its stock is traded in the over-the-counter market. No one presently owns more than 4 percent of the outstanding common stock. The company is subject to the reporting requirements of the Securities and Exchange Act of 1934. Organization and Personnel Apollo Shoes is a medium-sized corporation. It has over 100 employees organized in five departments headed by vice presidents. Marketing The marketing department handles advertising and direct contact with customers. The marketing department vice president supervises the sales staff, the advertising staff, and the customer relations staff. i Copyright 2015 © McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Page 14 Finance The finance department has two subordinate offices—the treasurer and the controller. The treasurer supervises the cashiers and the cash management professionals. The controller’s office has the following departments and personnel: billing department, accounts receivable/cash receipts department, accounts payable/cash disbursements department, inventory records department, payroll department, general ledger department, and financial statement department. Information Systems An information systems department was created this past year. At present, the staff consists of a Director of IS (information systems), a systems development project manager and two programmer/analysts, an operations manager (who also serves as the librarian and control clerk), and two machine operators. When the information systems department became active, the director was promoted to vice president. Apollo obtained a wireless local area network (LAN) multiserver soon after and began testing the hardware and software. Since the new computer system was designed and customized to Apollo’s needs, every effort was made to keep as many as possible of the procedures and business documents used in the manual system. This made the transition to the computer system easy on the employees, thus reducing training and employee objections to the computer. Operations The operations department contains production planning specialists and some production control professionals, who assist the marketing department in technical matters and assist customers with product specifications. Operations supervisors supervise hourly workers who move products from receiving, inventory, and shipping to serve customer demand. The department also supervises the timekeepers, who maintain the workers’ time clocks and collect payroll time cards. The operations department contains the critical functions of purchasing, receiving, and shipping. Inventory storekeeping responsibility is also in this department, with some inventory managers. For reasons lost to history, the department also has the mailroom and the personnel department. ITEM 2. PROPERTIES. Until February of 2013, the Company leased most of the properties that were used in its business. Its corporate headquarters relocated at that time to office facilities in Shoetown, Maine. At its corporate headquarters, the Company occupies approximately 10,000 square feet of space. A lease on an operations facility expires on June 30, 2014. This warehouse and distribution center is located approximately one mile from the Company headquarters and contains approximately 450,000 total square feet of usable space. ii Copyright 2015 © McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Page 15 ITEM 3. LEGAL PROCEEDINGS. On September 12, 2013, the Company agreed to settlement of a suit brought against the Company by a competitor for patent infringement for the Company's use of the Siren. While the Company denies any wrongdoing, the Company felt that the settlement would be preferable to a long litigation process. The final settlement totaled $11,695,000 ($19,172,000, net of a tax benefit of $7,477,000). ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. No matter was submitted during 2013 to a vote of security holders, through the solicitation of proxies or otherwise. ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS. The Company's common stock is quoted on the Security Traders, Underwriters, and Dealers System (STUDS) under the symbol APLS. The following table, derived from data supplied by STUDS, sets forth the quarterly high and low sale prices during 2013 and 2012. 2013 First Second Third Fourth High 14 5/8 11 8 1/4 5 5/8 2012 Low 3 3/8 2 5/8 3 1/4 3 1/8 High 4 4 5/8 8 1/8 11 1/2 Low 3 1/2 4 1/4 4 5 The stock price at closing on December 31, 2013, was $3 1/4 per share. As of December 31, 2013, there were approximately 15,342 holders of record of the Company's Common Stock including those shares held in "street name." The Company believes that it has in excess of 16,000 shareholders. The Company has never paid cash dividends on its Common Stock and the Board of Directors intends to retain all of its earnings to finance the development and expansion of its business. However, there can be no assurance that the Company can successfully expand its operations, or that such expansion will prove profitable. Future dividend policy will depend upon the Company's earnings, capital requirements, financial condition, and other factors considered relevant by the Company's Board of Directors. iii Copyright 2015 © McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Page 16 ITEM 6. SELECTED FINANCIAL DATA. APOLLO SHOES, INC. in thousands (except per share data) Income Statement Data Year Ended December 31 2013 Net Sales 2012 2011 2010 $240,575 $236,299 $182,209 $138,920 Income Before Taxes $26,337 $54,680 $2,226 $1,757 Income Taxes $10,271 $21,634 $636 $502 $4,371 $1,745 $1,590 $1,255 $0.54 $0.22 $0.55 $0.44 Net Income Earnings Per Share Balance Sheet Data As of December 31, 2013 2012 2011 2010 Working Capital $20,482 $16,866 ($1,951) ($2,356) Total Assets $36,794 $21,304 $6,754 $6,062 $0 $0 $0 $0 $22,119 $17,748 $5,470 $3,880 Long-Term Debt Shareholders' Equity iv Copyright 2015 © McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Page 17 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 2013 Financial Results Net sales for the year ended December 31, 2013 increased 2% to $240,575,000, when compared to the same period in 2012. The sales growth was primarily due to new products introduced during the 2013 fiscal year. The average selling price per product in the year ended December 31, 2013 increased approximately 2% from the year ended December 31, 2012. Gross profit for the year ended December 31, 2013 was 41% of sales compared with 49% for the year ended December 31, 2012. The decrease was primarily due to higher prices charged by our suppliers for raw materials. Selling, general and administrative expense for the year ended December 31, 2013 was 30% of net sales as compared to 26% for the year ended December 31, 2012. The increase of 16% to $71,998,000 was primarily the result of increases in staffing and increased professional expenses. The increased professional fees were primarily related to the settlement of litigation brought against us by a competitor. Rather than face a costly, lengthy litigation process, the Company decided to settle out of court. The Company vehemently denies any wrongdoing in the matter. Liquidity and Capital Resources The Company's principal source of operating funds has been from proceeds from short-term borrowing against a $50 million line of credit. While the credit facility must be renewed each year, the Company foresees no problems with renewal for the foreseeable future. The Company intends to use its capital resources to expand its operations facilities and to increase research and development in order to maintain its competitive advantage in podiatric technology. There are no other significant capital requirements identified at this time. Management believes that the effect of inflation on the business of the Company for the past three years has been minimal. The Company believes that its current working capital of $20,482 million and anticipated working capital to be generated by future operations will be sufficient to support the Company's working capital requirements for the foreseeable future. v Copyright 2015 © McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Page 18 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA CONSOLIDATED STATEMENTS OF INCOME APOLLO SHOES, INC. in thousands (except per share data) For the year ended, December 31, 2013 2012 Net Sales (Note 2) Cost of Sales Gross Profit Selling, General and Administrative Expenses Interest Expense (Note 7) Other Expense (Income) Earnings from Continuing Operations Before Taxes Income Tax Expense (Note 9) Earnings from Continuing Operations Discontinued Operations, Net of tax benefit Extraordinary Item, Net of tax benefit (Note 10) Net Income Earnings Per Common Share From Continuing Operations Other Net Income Weighted shares of common stock outstanding $240,575 $141,569 $99,006 $236,299 $120,880 $115,419 $71,998 $875 ($204) $61,949 0 ($1,210) $26,337 $10,271 $16,066 $54,680 $21,634 $33,046 ($31,301) ($11,695) $4,371 $1,745 $1.98 ($1.44) $0.54 $4.08 ($3.86) $0.22 8,105 8,105 The accompanying notes are an integral part of the consolidated financial statements. vi Copyright 2015 © McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Page 19 CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION APOLLO SHOES, INC. in thousands As of December 31 2013 2012 Assets Cash $3,245 $3,509 Accounts Receivable (Net of Allowances of $1,263 and 210, respectively) (Note 3) 15,148 2,738 Inventory (Note 4) 15,813 13,823 951 352 Current Assets $35,157 $20,422 Property, Plant, and Equipment (Note 5) 1,174 300 Less Accumulated Depreciation (164) (31) $1,010 $269 Investments (Note 6) 573 613 Other Assets (Note 6) 54 0 $36,794 $21,304 Accounts Payable and Accrued Expenses $4,675 $3,556 Short-Term Liabilities (Note 7) 10,000 0 $14,675 3,556 0 0 $14,675 3,556 Common Stock 8,105 8,105 Additional Paid-in Capital 7,423 7,423 Retained Earnings 6,591 2,220 $22,119 $17,748 $36,794 $21,304 Prepaid Expenses Total Assets Liabilities and Shareholders’ Equity Current Liabilities Long-Term Debt (Note 7) Total Liabilities Total Shareholders' Equity Total Liabilities and Shareholders' Equity The accompanying notes are an integral part of the consolidated financial statements. vii Copyright 2015 © McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Page 20 CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY APOLLO SHOES, INC. in thousands Balance, December 31, 2011 Shares Par Value ($1 per share) Additional Paidin Capital Retained Earnings Other Total 2,873 $2,873 $2,122 $475 $0 $5,470 Net Income Exercise of Stock Options $1,745 $1,745 232 $232 $301 $533 Other 5,000 $5,000 $5,000 $10,000 Balance, December 31, 2012 8,105 $8,105 $7,423 Net Income Exercise of Stock Options $2,220 $0 $4,371 0 $4,371 $0 $0 Other Balance, December 31, 2013 $17,748 $0 8,105 $8,105 $7,423 $6,591 $0 $22,119 The accompanying notes are an integral part of the consolidated financial statements. viii Copyright 2015 © McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Page 21 CONSOLIDATED STATEMENTS OF CASH FLOWS APOLLO SHOES, INC. in thousands For the year ended December 31, 2013 2012 Cash Flows from Operating Activities Net Income $4,371 $1,745 $133 $26 ($12,410) ($2,073) ($1,990) ($11,861) ($599) ($123) $1,119 $5,504 ($13,747) ($8,527) ($9,376) ($6,782) ($834) ($255) Adjustments to Reconcile Net Income to Net Cash Provided Depreciation and Amortization Changes in Operating Assets and Liabilities Decrease (Increase) in Current Assets Accounts Receivable Inventory Prepaid Expenses Increase (Decrease) in Current Liabilities Accounts Payable and Accrued Expenses Total Adjustments Net Cash (used in) Operating Activities Cash Flows from Investing Activities Capital Expenditures Purchase of Other Assets ($54) Net Cash (used for) Investing Activities ($888) ($255) Cash Flows from Financing Activities Proceeds from the Issuance of Debt $10,000 Proceeds from the Issuance of Common Stock Net Cash Provided by Financing Activities $10,533 $10,000 $10,533 Net Increase (Decrease) in Cash ($264) $3,496 Cash at Beginning of Year $3,509 $13 Cash at End of Year $3,245 $3,509 The accompanying notes are an integral part of the consolidated financial statements. ix Copyright 2015 © McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Page 22 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS APOLLO SHOES, INC. 1. Summary of Significant Accounting Policies Business activity The Company develops and markets technologically superior podiatric athletic products under various trademarks, including SIREN, SPOTLIGHT, and SPEAKERSHOE. Marketable Securities Investments are valued using the market value method for investments of less than 20%, and by the equity method for investments greater than 20% but less than 50%. Cash equivalents Cash equivalents are defined as highly liquid investments with original maturities of three months or less at date of purchase. Inventory valuation Inventories are stated at the lower of First-in, First-out (FIFO) or market. Property and equipment and depreciation Property and equipment are stated at cost. The Company uses the straight-line method of depreciation for all additions to property, plant and equipment. Intangibles Intangibles are amortized on the straight-line method over periods benefited. Net Sales Sales for 2013 and 2012 are presented net of sales returns and allowances of $4.5 million, and $0.9 million, respectively, and net of warranty expenses of $1.1 million, and $0.9 million, respectively. Income taxes Deferred income taxes are provided for the tax effects of timing differences in reporting the results of operations for financial statements and income tax purposes, and relate principally to valuation reserves for accounts receivable and inventory, accelerated depreciation and unearned compensation. Net income per common share Net income per common share is computed based on the weighted average number of common and common equivalent shares outstanding for the period. Reclassification Certain prior year amounts have been reclassified to conform to the 2013 presentation. 2. Significant Customers Approximately 15%, and 11% of sales are to one customer for years ended December 31, 2013 and 2012, respectively. x Copyright 2015 © McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Page 23 3. Accounts Receivable Accounts Receivable consists of the following at December 31: in thousands 2013 Trade Receivables Employee and Officer Receivables $16,411 0 16,411 (1,263) Less Allowance for Doubtful Accounts Net Accounts Receivable $ 15,148 Amount charged to bad debt expense for the year ended December 31, 2013 was $1,622,000. Writeoffs for the year were approximately the same. 4. Inventories Inventories consist of the following at December 31: in thousands 2013 Siren Speaker Spotlight $3,098 9,571 6,156 18,825 (3,012) Less Reserve for Inventory Obsolescence Ending Inventory $15,813 5. Property and equipment Property is stated at cost net of accumulated depreciation. Property and Equipment at December 31 was as follows: in thousands 2013 Land Buildings and Land Improvements Machinery, Equipment and Office Furniture $117 624 433 Total Land, plant and equipment Less Accumulated depreciation 1,174 (164) Net Land, Plant and Equipment $1,010 xi Copyright 2015 © McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Page 24 6. Investments and Other Assets In order to receive a higher rate of return on its excess liquid assets, the Company invested approximately $0.6 million in stock for a 35% share in the SHOCK-PROOF SOCKS Company in 2012. This investment is valued in the financial statements using the Equity method. SHOCK-PROOF SOCKS did not recognize any income and did not pay any dividends in 2012 and 2013. In addition, on December 31, 2013, the Company incurred approximately $54,000 in legal fees to register the patent for the PHONESHOE. 7. Debt At December 31, 2013, the Company had $10,000,000 outstanding in short-term borrowings under a $50 million secured revolving credit line with a local financial institution. The line of credit is secured by the Company’s inventory. The interest rate charged on this agreement is the Prime Rate plus 3%. This credit line is evaluated annually on June 30 by the lending institution. Annual maturities of debt obligations are as follows: 2014 2015 Total Debt $10,000,000 0 $10,000,000 8. Commitments Annual obligations under non-cancelable operating leases are as follows: 2014 Thereafter $1,200,000 0 Rent expense charged to operations for the years ended December 31, 2013 and 2012 was $2.6 million and $3.7 million, respectively. xii Copyright 2015 © McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Page 25 9. Income taxes The provision (benefit) for income taxes consists of the following for the years ended December 31: Current: Federal State Deferred: Federal State 2013 2012 $ 2,025 365 $ 2,390 $ 873 154 $ 1,027 $ 340 64 $ 404 $ (42) (7) $ (49) $ 2,794 $ 978 Deferred income taxes are provided for the tax effects of timing differences in reporting the results of operations for financial statements and income tax purposes, and relate principally to valuation reserves for accounts receivable and inventory, accelerated depreciation and unearned compensation. A reconciliation of the statutory federal income tax provision to the actual provision follows for the years ended December 31: Federal Statutory Rate State taxes, less federal benefit Research and experimentation credit Other Effective Tax Rate 2013 2012 34.0% 6.0% (2.0%) 1.0% 39.0% 34.0% 6.0% (1.4%) 1.0% 39.6% 10. Litigation On September 12, 2013, the Company agreed to settlement of a suit brought against the Company by a competitor for patent infringement for the Company's use of the Siren. While the Company denies any wrongdoing, the Company felt that the settlement would be preferable to a long litigation process. The final settlement totaled $11,695,000 ($19,172,000, net of a tax benefit of $7,477,000). 11. Related-party transactions On February 1, 2013, the Company purchased its operating facility and equipment from a company controlled by two previous directors and shareholders of the Company for $623,905.92. Currently, the Company leases a second facility and equipment from the same company for approximately $200,000 per month. The Company’s lease ends in June 2014 at which time all operations will be moved to the central headquarters building. xiii Copyright 2015 © McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Page 26 12. Employee benefit plans The Company sponsors a defined-contribution retirement plan covering substantially all of its earth employees. Contributions are determined at the discretion of the Board of Directors. Aggregate contributions made by the Company to the plans and charged to operations in 2013, 2012 and 2011 were $3 million, $3 million and $3 million, respectively. 13. Concentrations of credit risk Financial instruments which potentially subject the Company to credit risk consist principally of trade receivables and interest-bearing investments. The Company sells a significant amount of its product to one retail distributor with sales operations located throughout North America, Europe and Asia Pacific. The Company is currently negotiating to increase its sales to that company, as well as enter into long-term relationships with two other large retail distributors. The Company performs on-going credit evaluations of all of its customers and generally does not require collateral. The Company maintains adequate reserves for potential losses and such losses, which have been minimal, have been included in management's estimates. The Company places substantially all its interest-bearing investments with several major financial institutions. Corporate policy limits the amount of credit exposure to any one financial institution. xiv Copyright 2015 © McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Page 27 CERTIFICATIONS We, Larry Lancaster and Joe Bootwell, certify that: 1. We have reviewed this annual report on Form 10-K of Apollo Shoes, Inc.; 2. Based on our knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on our knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. We are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and 5. We have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent functions): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting. Date: February 1, 2014 Larry Lancaster Joe Bootwell Larry Lancaster Chairman of the Board of Directors, President and CEO Joe Bootwell Executive Senior Vice-President and CFO xv Copyright 2015 © McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Page 28 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Shareholders of APOLLO SHOES, INC. We have audited the accompanying consolidated statements of financial condition of APOLLO SHOES, INC. as of December 31, 2013 and 2012 and the related consolidated statements of income, shareholders’ equity, and cash flows for each of the two years in the period ended December 31, 2013. We have also audited management’s assessment, included in the accompanying Management’s Report on Internal Control Over Financial Reporting, that APOLLO SHOES, INC. maintained effective internal control over financial reporting as of December 31, 2013, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO criteria). APOLLO SHOES’ management is responsible for these financial statements, for maintaining effective internal control over financial reporting, and for its assessment of internal control over financial reporting. Our responsibility is to express an opinion on these financial statements, an opinion on management’s assessment, and an opinion on the effectiveness of the company’s internal control over financial reporting based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audit of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions. A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of APOLLO SHOES, INC. as of December 31, 2013 and 2012 and the results of its operations and cash flows for each of the two years in the period ended December 31, 2013 in conformity with U.S. generally accepted accounting principles. Also in our opinion, APOLLO SHOES, INC. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2013, based on the COSO criteria. Copyright 2015 © McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Page 29 Smith & Smith, CPA's Shoetown, Maine January 24, 2014 xvi Copyright 2015 © McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Page 30 CORPORATE INFORMATION Auditors Smith & Smith, CPA's 31st Financial Avenue Shoetown, ME 00002 Transfer Agent and Registrar The Twenty-First National Bank of Maine is the Transfer Agent and Registrar for the Company's common stock and maintains shareholder accounting records. The Transfer Agent should be contacted on questions of changes in address, name or ownership; lost certificates and consolidation of accounts. The Twenty-First National Bank of Maine Shareholder Correspondence Post Office Box 1 Shoetown, ME 00002 Form 10-K For a copy of the Form 10-K Annual Report, filed with the Securities and Exchange Commission write to: Office of Investor Relations Apollo Shoes Inc. 100 Shoe Plaza Shoetown, ME 00001 Annual Meeting The Annual Meeting of Shareholders was held at 10:00 a.m., local time, on Tuesday, February 19, 2013 at the End of the Universe Restaurant in downtown Shoetown. Shareholders of record on February 5, 2013 were entitled to vote at the meeting. The PHONESHOE, SIREN, SPEAKERSHOE, and the SPOTLIGHT Designs are registered trademarks of Apollo Shoes, Inc. xvii Copyright 2015 © McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Page 31 BOARD OF DIRECTORS Larry Lancaster Chairman, President and CEO APOLLO SHOES, INC. Eric. P. Unum Vice-President - Finance *Fritz Brenner President The Widget Corporation *Ivan Gorr President Far More Drugs, Inc. *Harry Baker Executive Vice President and Treasurer Iguana Growers of America Inc. *Theodore Horstmann Minister of Commerce Anglonesia *Josephine Mandeville, PH.D., CPA Professor of Accountancy and Typing Graduate School of Business and Clerical Skills CORPORATE OFFICERS Larry Lancaster Chairman, President and CEO Joe Bootwell Executive Senior Vice President and CFO Fred Durkin Vice-President - Marketing Daisy Gardner Vice-President - Operations Eric. P. Unum Vice-President - Finance Sue D. Fultz Vice-President - Legal Affairs Mary Costain Treasurer Jeff Chesnut Secretary * External Directors xviii Copyright 2015 © McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Page 32 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS Smith and Smith, CPAs, withdrew as the Company’s auditors after completing the 2013 audit. The auditors expressed concerns about “mutually incongruent goals.” The Company is considering legal action against the firm. ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The president, Larry Lancaster, is both chairman of the board of directors and President and chief executive officer (CEO). Eric Unum (Vice-President – Finance) is also a member of the board, along with five outside (independent) directors who never worked for the Apollo organization. Three outside board members constitute the audit committee of the board. ITEM 11. EXECUTIVE COMPENSATION (Approximate amounts expressed in thousands) Larry Lancaster, Chairman, President and CEO Sue D. Fultz, Vice-President - Legal Affairs Joe Bootwell, Executive Senior Vice President and CFO Fred Durkin, Vice-President – Marketing Eric. P. Unum, Vice-President – Finance Daisy Gardner, Vice-President – Operations $2,500 1,500 1,200 1,000 590 410 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. Currently, no management personnel hold stock ownership in the Company ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. On February 1, 2013, the Company purchased its operating facility and equipment from a company controlled by two previous directors and shareholders of the Company for $623,905.92. Currently, the Company leases a second facility and equipment from the same company for approximately $200,000 per month. The Company’s lease ends in June 2014 at which time all operations will be moved to the central headquarters building. The two previous directors are no longer associated with Apollo Shoes. xix Copyright 2015 © McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Page 33 ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K QUARTERLY RESULTS OF OPERATIONS (Unaudited) 2013 March 31 June 30 September 30 December 31 Total Net Sales $58,236 $59,759 $60,239 $62,341 $240,575 Gross Profit $24,372 $24,996 $24,356 $25,282 $99,006 S,G, & A Expenses $16,478 $17,695 $17,347 $20,478 $71,998 $4,815 $4,454 ($7,785) $2,887 $4,371 $0.59 $0.55 ($0.96) $0.36 $0.54 Net Income Earnings Per Share The Company filed one 8-K dealing with the withdrawal of its auditor on January 30, 2014. It is incorporated in this document by reference. xx Copyright 2015 © McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Page 34 Apollo Shoes Inc. Organizational Chart As of 9/30/2014 Audit Committee Board of Directors Larry Lancaster Chairman, President, & CEO Internal Audit Karina Ramirez Joe Bootwell Executive Sr. VP & CFO Sue Fultz Legal Affairs Daisy Gardner VP- Operations Eric Unum VP- Finance Mary Costain Treasurer Ernst Hathaway VP – Info Systems Samuel Carboy Controller Fred Durkin VPMarketing Credit Manager Copyright 2015 © McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Page 35 Date: 24 OCT 2014 07:14:35 +0000 From: "Karina Ramirez" Subject: Upcoming Apollo Shoes Engagement Attachment: Per your request, I have attached a copy of our accounting and procedures manual. We look forward to your upcoming fieldwork. Please let us know if there is anything else we can provide you to make your job easier. Karina Karina Ramirez Director, Internal Audit Apollo Shoes, Inc. 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. Copyright 2015 © McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Page 36 Apollo Shoes Accounting and Control Procedure Manual Sales and Accounts Receivable Daily batches of sales invoices shall be analyzed by sales totals in the athletic shoes product lines. Sales credits are coded to three product line sales revenue accounts. Charges to customer accounts should be dated the date of shipment. When sales invoices are recorded, the numerical sequence shall be checked by an accounts receivable clerk, and missing invoices must be located and explained. The items shipped shall be compared to the items billed for proper quantity, price, and other sales order terms. The general ledger supervisor shall compare the copy 2 daily batch total with the copy 4 individual accounts posting total sent from the accounts receivable department. Discrepancies shall be investigated to help assure that the customer subsidiary accounts are posted for the same total amount posted to the control account. At the end of each month, the total of the trial balance of customer account balances (prepared by the accounts receivable department) shall be reconciled to the general ledger control account by the general ledger supervisor. Sales invoice batches shall be dated with the date of shipment, and totals of batches (including product line sales for athletic shoes) shall be accumulated each month and recorded in the accounts receivable control and sales revenue accounts. The general ledger supervisor shall approve all monthly summary entries before they are posted to the general ledger. The treasurer shall approve all cash refunds and allowance credit memos for sales returns, after initiation by customer relations personnel. The marketing vice president shall periodically analyze sales activity by product lines in comparison to budgets and forecasts and prior years’ activity. Cash Management The monthly bank statements shall be mailed to the cash management department in the treasurer’s office. Personnel use the duplicate deposit slips retained when bank deposits were made, the cash receipts journal listing, and the cash disbursements listing to reconcile the general bank accounts. The payroll bank account is also reconciled, utilizing the payroll register retained by the treasurer’s office. Cash management personnel shall compare cash receipts journal daily deposit records with the bank deposits and duplicate deposit slips when the general bank account reconciliation is performed. At the discretion of the director of internal audit, internal auditors will occasionally make unannounced reviews of the bank account reconciliations. They may also prepare reconciliations without prior notice given to cash management personnel. Cash Receipts and Accounts Receivable Processing All cash receipts from customers related to sales shall be credited to accounts receivable individual and control accounts. The accounts receivable department shall post credits to individual customer accounts, dating the entries with the date of the remittance list. Copyright 2015 © McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Page 37 Statements of accounts receivable balances shall be mailed to customers each month by the accounts receivable accounting department. Customers’ reports of disputes or differences shall be handled by customer relations personnel in the marketing department. Cash Disbursements All disbursements shall be made by check, signed by the treasurer, including reimbursements of the petty cash funds. Checks shall be made payable to a named payee and not to “cash.” Blank check stock shall be kept under lock and key in the accounts payable accounting department. Under no circumstances may blank checks be signed by the treasurer. Voided and spoiled checks shall be transmitted to the treasurer for inspection and later filed in numerical order with paid checks. Cash disbursement journal entries shall be dated with the date of the check. The related monthly general ledger summary entries shall carry the date of the month summarized. Inventory Perpetual Records Inventory additions shall be dated with the date of the receiving report. Inventory issues shall be dated with the date of shipment. Fixed Asset Records and Transactions When acquisition costs exceed the capital budget authorization by 10 percent or more, the additional expenditure shall be approved by the treasurer and board of directors, in advance if possible. Zero salvage values shall be used in all depreciation calculations. Useful life and depreciation method assignments for financial statement calculations shall follow these general guidelines: Buildings Equipment Declining Balance Declining Balance 15 years 3-6 years All repair, maintenance, and capital additions less than $5,000 shall be expensed. Amounts over $5,000 should always be capitalized unless unusual conditions point to proper expensing. Copyright 2015 © McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Page 38 Copyright 2015 © McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Page 39 Date: 24 OCT 2014 06:42:35 +0000 From: "Darlene Wardlaw" Subject: Upcoming Apollo Shoes Engagement Apollo denied our request to speak with the predecessor auditors because of “litigation concerns.” I’ve looked at the 8-K filed by Apollo and the auditors referenced in the 10-K. I didn’t attach a copy because it didn’t say much, just something about “incongruent goals,” blah, blah, blah. Against my advice, Arnold decided to accept the engagement anyway. Keep your eyes open! The good news is that the predecessor auditors, Smith and Smith, CPAs, have a good reputation, so you can use last year’s audited numbers from the 10-K. The bad news is that we don’t have access to prior year working papers. You’ll need to come up with programs for the substantive audit procedures for each of the functional balance sheet areas (indicated with an asterisk (*) below). You can perhaps get them from an old auditing textbook. My preference is to place the audit programs at the beginning of each section. Label the sections as follows: GA series (GA-1, GA-2, etc.) ICC series ICD series ICP series A series B series* C series* D series* E series* F series* I series* L series* N series* Q series* R series* X series* General and Administrative (Planning) Revenue/Collection Cycle Internal Control Evaluation Purchasing/Disbursements Internal Control Evaluation Payroll Internal Control Evaluation Trial Balance/Financial Statements/Adjustments/Footnotes Cash Substantive Workpapers Accounts Receivable Substantive Workpapers Inventory Substantive Workpapers Prepaids Substantive Workpapers Property, Plant and Equipment Substantive Workpapers Other Assets Substantive Workpapers Current Liabilities Substantive Workpapers Notes Payable Substantive Workpapers Stockholders’ Equity Substantive Workpapers Revenue Substantive Workpapers Expenses Substantive Workpapers Because we are so understaffed during busy season, you are going to have to perform the bulk of the audit yourself. I was only able to get you a spring intern (Bradley Crumpler) from Caledonia State University (heck, I didn’t even know they had an accounting program!). He is the only unassigned person in the office right now. Because I am unsure of his training, I suggest that you only use him for “grunt work.” Also, I checked into the background and experience of Karina Ramirez, Apollo’s Internal Auditor. Apparently, she was an auditor with a Big 4 firm for 8 years before coming to Apollo and has served on the state CPA society’s ethics committee. I also went through her workpapers; they appear to be top-notch. Lastly, she reports directly to the Audit Committee, so we can rely on her to be objective. I think we can rely on her work during our engagement. DW P.S. Thanks for drafting the engagement letter. I only had to make a couple of changes before Arnold signed it. Copyright 2015 © McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Page 40 Date: 13 JAN 2015 12:45:39 +0000 From: "Darlene Wardlaw" Subject: Apollo Shoes minutes Attachments: >>> Hope the inventory observation went well. I saw Bradley in the office working on some inventory stuff. He said that he would e-mail it to you when it was completed. Sorry I haven’t made it out to Apollo yet. I did meet with Jeff Chestnut (Apollo’s corporate secretary) who allowed me to copy the minutes of the Board of Directors. The board of directors met twice during the period under audit, January 1 through December 31, and once more last week. I have attached copies. Study these minutes – they provide a history of every important event and transaction that Apollo has undergone during the past year. Make notes in the form below for the audit working papers of matters relevant for the audit of the 2014 financial statements. Prepare a working paper (GA-3) for my review with proper headings and these two columns: Information Relevant to 2014 Audit Audit Action Recommended You may want to stick a copy of the minutes in the workpapers (GA-3-1, GA-3-2, etc.) behind your memo when you are done with them. DW Copyright 2015 © McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Page 41 MEETING HELD JANUARY 6, 2014 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** Ivan Gorr* Harry Baker* Fritz Brenner** Theodore Horstmann** Eric Unum * Outside director ** Outside director and member of the audit committee. The minutes of the December 16, 2013 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, effective as of February 2, 2014, and rolled into a $12 million note payable with the Twenty-First National Bank of Maine, due January 1, 2015. 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 2014 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 Exec Sr. VP and CFO, Joe Bootwell VP Marketing, Fred Durkin VP Finance, Eric Unum VP Legal Affairs, Sue Fultz $2,750,000 1,320,000 1,100,000 649,000 1,650,000 VP Operations, Daisy Gardner Internal Audit Director, Karina Ramirez 451,000 235,000 Treasurer, Mary Costain Controller, Samuel Carboy 222,000 214,000 Mr. Lancaster encouraged everyone to watch the 2014 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 Copyright 2015 © McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Page 42 MEETING HELD JUNE 30, 2014 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** Ivan Gorr* Harry Baker* Fritz Brenner** Theodore Horstmann** 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 2015 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 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 to Mr. Lancaster’s personal 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, 2051. 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. This proposal was unanimously approved. Copyright 2015 © McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Page 43 Meeting ended 7:30 P.M. /s/ Jeff Chesnut, Secretary AudComMins—06.doc MEETING HELD JANUARY 6, 2015 Larry Lancaster, chairman of the board, presided over the regular meeting, beginning at 2 P.M. All members were present: Larry Lancaster Josephine Mandeville** Ivan Gorr* Harry Baker* Fritz Brenner** Theodore Horstmann** 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 2014 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, 2015 (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 2014. Lancaster replied that the machinery would be set up “soon.” Mr. 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 VP Marketing, Fred Durkin $200,000 50,000 VP Finance, Eric Unum VP Information Systems, Ernst Hathaway 50,000 50,000 VP Legal Affairs, Sue Fultz VP Operations, Daisy Gardner 50,000 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 2014, up 10% over the past several years to appease growing employee dissatisfaction. 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 Copyright 2015 © McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Page 44 AudComMins—01.doc Copyright 2015 © McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Page 45 Date: 14 JAN 2015 08:49:35 +0000 From: "Darlene Wardlaw" Subject: Apollo Shoes Trial Balances Attachments: , I got a copy of Apollo’s 2014 year-end trial balance (attached) from Sam Carboy, Apollo’s Controller. I also got a copy of last year’s 2013 audited trial balance from Karina. I’ve attached copies of both to this e-mail and also posted them to the AOW intranet where you can also download them. I received it a week after he promised it to me, so apparently it wasn’t as clean a year-end close as he expected. I want you to put the numbers into three spreadsheets (one for the comparative (i.e., two-year) balance sheet (A-1), one for the comparative income statement (A-2), and one for the comparative statement of cash flows (A-3)). I know that everyone has a particular style of workpaper formatting, but my preference is for the following columns for the income statement and balance sheet: Acct # Acct Title W/P Ref Last year’s (Audited) Current Year (unaudited) Adjustments Dr. Cr. Current Year (Audited) DW Copyright 2015 © McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Page 46 Apollo Shoes, Inc Preclosing Trial Balance (Audited) 31-Dec-13 Account ID 10100 10200 10300 10400 11000 11500 12000 12300 14100 14200 14300 14400 14700 15000 15100 15200 17000 19000 19900 20000 23100 23200 23300 23350 23400 23500 23600 23700 23800 23900 24100 24200 24700 27000 39003 39004 39005 40000 41000 42000 45000 46000 50010 57500 60000 61000 62000 64000 64500 65000 66000 67000 68000 70000 70100 70110 70120 71000 72000 73000 74000 77500 78000 78500 78510 80000 Account Description Cash on Hand Regular Checking Account Payroll Checking Account Savings Account Accounts Receivable Allowance for Doubtful Accounts Inventory - Spotlight Reserve for Inventory Obsolescence Prepaid Insurance Prepaid Rent Office Supplies Notes Receivable-Current Other Current Assets Land Buildings and Land Improvements Machinery, Equipment, Office Furniture Accum. Depreciation Investments Other Noncurrent Assets Accounts Payable Sales Tax Payable Wages Payable FICA Employee Withholding Medicare Withholding Federal Payroll Taxes Payable FUTA Tax Payable State Payroll Taxes Payable SUTA Tax Payable FICA Employer Withholding Medicare Employer Withholding Line of Credit Current Portion Long-Term Debt Other Current Liabilities Notes Payable-Noncurrent Common Stock Paid-in Capital Retained Earnings Sales Sales Returns Warranty Expense Income from Investments Interest Income Cost of Goods Sold Freight Advertising Expense Auto Expenses Research and Development Depreciation Expense Warehouse Salaries Property Tax Expense Legal and Professional Expense Bad Debt Expense Insurance Expense Maintenance Expense Utilities Phone Postal Miscellaneous Office Expense Payroll Tax Exp Pension/Profit-Sharing Plan Ex Rent or Lease Expense Administrative Wages Expense Interest Expense Income Tax Expense - Federal Income Tax Expense - State Loss on Legal Settlement Debit $1,987.28 $198,116.52 $0.00 $3,044,958.13 $16,410,902.71 Credit $1,262,819.88 $18,825,205.24 $3,012,000.00 $743,314.38 $200,000.00 $7,406.82 $117,000.00 $623,905.92 $433,217.10 $164,000.00 $572,691.08 $53,840.59 $4,633,118.09 $0.00 $29,470.32 $1,318.69 $583.99 $6,033.01 $2,815.47 $1,318.69 $583.99 $10,000,000.00 $8,105,000.00 $7,423,000.00 $2,219,120.65 $246,172,918.44 $4,497,583.20 $1,100,281.48 $0.00 $204,302.81 $141,569,221.61 $4,302,951.46 $897,140.01 $208,974.39 $31,212,334.17 $133,000.00 $4,633,383.82 $80,495.32 $3,605,133.96 $1,622,425.99 $853,942.65 $61,136.04 $135,642.99 $76,373.78 $128,033.21 $17,023.27 $1,550,989.06 $3,000,000.00 $2,603,485.87 $16,875,305.98 $875,000.00 $2,365,000.00 $429,000.00 $19,172,000.00 $283,238,404.03 $283,238,404.03 Copyright 2015 © McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Page 47 Preclosing Trial Balance December 31, 2014 Account ID 10100 10200 10300 10400 11000 11400 11500 12000 12300 14100 14200 14300 14400 14700 15000 15100 15200 17000 19000 19900 20000 23100 23200 23300 23350 23400 23500 23600 23700 23800 23900 24100 24200 24700 27000 39003 39004 39005 40000 41000 42000 45000 46000 47000 50010 57500 60000 61000 62000 64000 64500 65000 66000 67000 68000 70000 70100 70110 70120 71000 72000 73000 74000 77500 78000 78500 78510 Account Description Cash on Hand Regular Checking Account Payroll Checking Account Savings Account Accounts Receivable Other Receivables Allowance for Doubtful Accounts Inventory Reserve for Inventory Obsolescence Prepaid Insurance Prepaid Rent Office Supplies Notes Receivable-Current Other Current Assets Land Buildings and Land Improvements Machinery, Equipment, Office Furniture Accum. Depreciation Investments Other Noncurrent Assets Accounts Payable Sales Tax Payable Wages Payable FICA Employee Withholding Medicare Withholding Federal Payroll Taxes Payable FUTA Tax Payable State Payroll Taxes Payable SUTA Tax Payable FICA Employer Withholding Medicare Employer Withholding Line of Credit Current Portion Long-Term Debt Other Current Liabilities Notes Payable-Noncurrent Common Stock Paid-in Capital Retained Earnings Sales – Spotlight Sales Returns Warranty Expense Income from Investments Interest Income Miscellaneous Income Cost of Goods Sold Freight Advertising Expense Auto Expenses Research and Development Depreciation Expense Warehouse Salaries Property Tax Expense Legal and Professional Expense Bad Debt Expense Insurance Expense Maintenance Expense Utilities Phone Postal Miscellaneous Office Expense Payroll Tax Exp Pension/Profit-Sharing Plan Ex Rent or Lease Expense Administrative Wages Expense Interest Expense Income Tax Expense - Federal Income Tax Expense - State Debit Amt $2,275.23 $557,125.92 Credit Amt $3,645,599.15 $51,515,259.98 $1,250,000.00 $1,239,009.75 $67,724,527.50 $846,000.00 $3,424,213.78 $8,540.00 $117,000.00 $674,313.92 $2,929,097.13 $610,000.00 $1,998,780.39 $53,840.59 $1,922,095.91 $8,439.65 $11,414.99 $118,086.12 $55,106.86 $8,439.65 $11,414.99 $44,403,000.00 $12,000,000.00 $8,105,000.00 $7,423,000.00 $6,590,483.64 $242,713,452.88 $11,100,220.89 $1,158,128.47 $1,426,089.31 $131,881.46 $2,166,000.00 $130,196,645.26 $4,240,263.09 $1,036,854.01 $210,502.80 $528,870.44 $446,000.00 $4,720,715.56 $99,332.45 $4,913,224.45 $36,106.92 $35,502.87 $137,332.18 $52,599.02 $77,803.61 $24,891.82 $1,577,811.85 $3,300,000.00 $1,206,574.00 $16,197,225.43 $2,591,736.50 $8,900,000.00 $3,100,000.00 $329,788,915.21 $329,788,915.21 Copyright 2015 © McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Page 48 Date: 6 JAN 2015 10:44:22 +0000 From: "Darlene Wardlaw" Subject: Analytic Procedures 1. I need you to perform preliminary analytical procedures on the financial statements. a. Calculate common-size financial statements and dollar amount and percent changes. I suggest you simply make a copy of your spreadsheet from your pro-forma financial statements that I asked you to prepare yesterday and remove the adjustment columns. Have there been any significant changes that we need to examine closer? b. Calculate financial ratios. Assume the market value of the common stock is $24 million in both the current and prior years. Does anything jump out at you? c. If you have time, compare Apollo’s numbers with those of its closest competitors, Nike and Reebok. You can get those companies’ numbers from EDGAR (www.sec.gov). I am not sure if industry averages are available, but that too would be helpful. 2. Write a brief memo (GA-4) highlighting what you believe are potential problem areas. Include printouts of your calculations as support (GA-4-1, GA-4-2, etc.) DW Copyright 2015 © McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Page 49 Date: 15 JAN 2015 12:15:49 +0000 From: "Darlene Wardlaw" Subject: Materiality for Apollo Shoes Engagement You need to prepare a memo (GA-5) addressing materiality for Apollo Shoes. Remember that the workpapers document that we are following Generally Accepted Auditing Standards. In the memo, 1. Briefly describe independent auditors’ concept of materiality. 2. Describe some common relationships and other considerations used by auditors when assessing the dollar amount considered material. In other words, what are some common measures of materiality with respect to income, sales, and total assets? 3. Based upon your professional judgment and your discussion of items 1 and 2 above, determine an amount you consider to be a minimum material misstatement for Apollo Shoes and justify your recommendation in your memo. DW Copyright 2015 © McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Page 50 Date: 16 JAN 2015 1:15:49 +0000 From: "Darlene Wardlaw" Subject: Memo on Consideration of Potential Fraud We need a memo (GA-6) addressing the potential for fraud for Apollo Shoes. This workpaper is necessary to document that we are following the professional literature concerning fraud consideration. Some things you might want to include in your memo: • • • • Have you noticed any “red flags” in either the minutes or your analytic procedures so far? Address fraud risk in general terms: types of risk (Remember that improper revenue recognition is always a “red flag.”), significance of risk, likelihood of risk (what is the probability of fraud?), pervasiveness of risk (is fraud risk centralized to one function or individual or is it throughout the organization?) How might a fraud be perpetrated and concealed in the entity Suggest ways that we might alter our audit approach to address the potential for fraud, such as assignment of personnel, predictability of auditing procedures, and examination of journal entries and other adjustments We will need to get together with the entire audit team (you, me, and Bradley) for a “brainstorming” session next week. DW Copyright 2015 © McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Page 51 Date: 16 JAN 2015 07:42:35 +0000 From: "Arnold Anderson" Subject: Apollo Shoes and Computers Darlene mentioned your inquiry earlier this week, and yes, Anderson, Olds, and Watershed (AOW) was aware of Apollo’s mid-year computer installation. In fact, the planned conversion was discussed and AOW was advised of the conversion process by the director of internal audit. I haven’t thought about it much, so I appreciate you bringing it to my attention. The more I think about it, the more I am concerned about how the computer processing of the last two quarters’ transactions will affect our audit this year. Also, our firm has recently obtained several laptop computers but we have not used them on any audit to date. To be honest, I am not too comfortable with computers but I am interested in how they can increase our firm’s profitability. Any suggestions as to how computers might be used on the Apollo Shoes engagement? For example, can correspondence, memos, and auditing working papers be prepared and maintained on the computer? Could they save audit time as well as make the audit easier for me to supervise and review? Prepare a memo in the General and Administrative section of the current year workpapers (GA series) to document how planning might be affected by the computer processing of accounting transactions. I suggest you consider such things as the extent of computer usage, complexity of computer operations, organization structure of computer activities, availability of data, computer-assisted audit techniques, and need for specialized skills. “Uncle” Arnie Copyright 2015 © McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Page 52 Date: 16 JAN 2015 10:07:15 +0000 From: "Karina Ramirez" Subject: Upcoming Apollo Shoes Engagement Attachment: I’m sorry I missed you when you stopped by earlier today. Per your request, I have tried to summarize the new information processing system: The computer accounting system is a combination of a simple batch computer system and an advanced computer system. Accounting clerks directly enter accounting transactions from their terminals located in the various accounting departments; thus, entry is online. However, the transactions are not validated at entry to check for input errors. To prevent errors from entering the financial records, the transactions are not immediately posted to the various subsidiary ledgers maintained in the database. Validation occurs after the transactions are balanced by batch. The transactions are then posted to the ledgers by batches every night; therefore, the various databases, such as inventory, are only up-todate as of the prior working day’s transactions. (I insisted that Apollo start the accounting processing in this mode to establish control. As employees become more familiar with the terminal entry and control over transaction entry proves adequate, I will consider moving to online data entry and online input validation.) In addition, Apollo Shoes is using a wireless local area network multiserver with a small information systems staff. This small staff cannot support all of the ideal division of duties that would provide the proper separation auditors desire among computer personnel. I’ve attached an excerpt from our workpapers that describes the system in more detail. I hope this summary satisfies your needs. Please let us know if there is any additional information that you require. Karina Karina Ramirez Director, Internal Audit Apollo Shoes, Inc. 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. Copyright 2015 © McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Page 53 The information systems department became active in June. At that time the director, Ernst Hathaway, was promoted to vice president. Apollo obtained a wireless local area network (LAN) multiserver soon after and began testing the hardware and software. The testing of the new computer system progressed throughout the early fall with the accounting processing run on both the old manual system and the new computer system for the month of September. On October 1, Apollo converted to the wireless multiserver system. As the new computer system was designed and customized to Apollo’s needs, every effort was made to keep as many as possible of the procedures and business documents used in the manual system. This made the transition to the computer system easy on the employees, thus reducing training and employee objections to the computer. Further, most of the controls and separation of duties previously described were retained. Hardware Description Apollo installed a wireless Local Area Network (LAN), featuring 10 TB (terabyes, or 10 trillion bytes) of storage capacity. This system can support 400 client machines, but Apollo currently uses about 20. This system utilizes a Storage Area Network (SAN) for database storage, file management system and redundancy. Network printers are located in each department. Accounting Software The financial accounting software is an integrated application combining a comprehensive set of general ledger, accounts receivable, and accounts payable functions. The financial accounting system allows online entry with online data validation and online posting. However, to provide better control, Apollo has elected to utilize batch entry, deferred validation, and deferred posting. In this mode, the data are not validated at the time of entry. A special input validation routine, which reports all validation errors, is employed after the batches are balanced. The erroneous entries can be corrected through maintenance functions. The transfers of transactions from the Accounts Receivable and Accounts Payable modules to the General Ledger module also are done in batch mode. Batches are validated and posted every night; thus, the detailed accounting records are never more than one day from being accurate. Two levels of security are provided in the system. The terminals require a special password. Access to any function (data entry, data review, review invocation) for each unique set of transactions is controlled by another set of passwords. Thus, allowed operations are isolated to the department that must enter and use the data. For example, the order entry accounting clerks cannot access the cash disbursement records or enter cash disbursement transactions without knowledge of the appropriate passwords. Organization and Duties of Information Systems Personnel The information systems department consists of Ernst Hathaway—the Vice President of Information Systems, a systems development project manager and two programmer/analysts, an operations manager (who also serves as the librarian and control clerk), and two machine operators. Following is a brief summary of the responsibilities and duties of each. Vice President of Information Systems (VP-IS). The VP-IS is responsible for computer processing operations. Included responsibilities include long-range planning, setting policy and procedures for information systems (IS) employees, approving all equipment purchases, and preparing the department budget. The VP-IS also provides the primary contact with other department vice presidents and has overall responsibility for training other department personnel in the use of the new system. The VP-IS works with the systems development manager and the various users to set priorities for the...