Audit Planning for Apple: Ratios, Risk, and Financial Review

Introduction and Scope of the Audit Program

The firm selected for this hypothetical audit scenario is Apple Corporation, a major publicly traded company. This report outlines and identifies the critical steps necessary for an audit program associated with a review of Apple's financials. At least two performance ratios will be analyzed, and the tests used to calculate and evaluate those ratios will be described. In total, at least three analytical procedures will be applied across those ratios. The report also reviews Apple's balance sheet and income statement, along with the evidence-collection procedures that would go into verifying the authenticity and accuracy of that information. The report concludes with a discussion of the audit risk model and the primary responsibilities of an audit firm when the final report is an unqualified audit report. While Apple Corporation has been something of a juggernaut in recent years, there are some signs of potential issues in its financials worth examining.

Performance Ratio Analysis: Return on Equity

The critical steps necessary for this audit are fairly basic in nature, but attention to detail is paramount. First, data collection must be complete, drawn from reputable sources, and carefully scrutinized for anything that is missing, suspect, or otherwise improper. Doing this correctly — even in the era of GAAP and IFRS as currently constructed — can be difficult, because companies wield and use accounting standards differently depending on the situation, what is occurring operationally, and the financial picture they wish to project. This is not to say that public companies are always acting improperly when they use standards to their advantage. Rather, they sometimes present information positively when additional detail needs to be disclosed in order to remain ethical toward investors and analysts (Yahoo Finance, 2016).

The two ratios analyzed here are return on equity (RoE) and net profit margin. Return on equity is the amount of net income returned as a percentage of shareholders' equity. It is a strong metric and estimate of a corporation's profitability, as it reveals how much profit a company generates with the money entrusted to it by shareholders. The ratio is expressed as a percentage and is calculated simply as net income divided by shareholders' equity. This metric is also commonly referred to as return on net worth (RNOW) (Ready Ratios, 2013).

In terms of Apple's return on equity, the company is performing quite well, with a current RoE slightly above forty percent. Over the previous five years, the ratio fluctuated considerably — peaking at nearly fifty percent in early 2012, declining to approximately twenty-eight percent in early 2014, and then recovering to a more recent peak of about forty-three percent. The current value therefore represents a recent high, matching levels last seen in late 2012. One effective way to analyze this metric is to compare it against the broader market — specifically, the S&P 500. In that context, Apple is performing extremely well, given that the average return on equity for S&P 500 companies is approximately 11.86%. Apple's RoE is therefore well over three times the S&P 500 average (Yahoo Finance, 2016).

Performance Ratio Analysis: Net Profit Margin and Competitor Benchmarking

Apple's net profit margin is also strong. For the fiscal year ending September 26, 2015 — the most recently completed year at the time of this analysis — Apple reported total revenue of $233.72 billion and net income of $53.39 billion, reflecting a net profit margin of nearly twenty-three percent. Compared to the S&P 500, this is exceptionally strong, as the average net profit margin for S&P 500 companies is approximately seven percent (Yahoo Finance, 2016).

The same benchmarking method has been applied to both metrics thus far. A third analytical procedure involves comparing Apple to its direct competitors, such as Microsoft and Samsung. This comparison is complicated by the fact that Apple competes in multiple product categories, making a true apples-to-apples comparison difficult to construct. For example, Apple has virtually no direct competition in the MP3 player market. In smartphones, however, Apple and Samsung compete very closely, alongside other manufacturers such as LG and HTC. In the personal computer and tablet space, Microsoft (with its Surface line), Hewlett Packard, and Dell are relevant comparators. Despite this complexity, drilling down beyond the S&P 500 average is important, because profit margins can vary significantly from sector to sector (Yahoo Finance, 2016).

With that context in mind, Microsoft's return on equity stands at a mere 12.71%, well below Apple's figure. For net profit margin, Microsoft reports 12.06% — barely above the S&P 500 average, while Apple remains substantially higher. Samsung, Apple's most formidable smartphone competitor, reports a profit margin of approximately 9.50% and an RoE of 11.38%. In short, Samsung and Microsoft are clustered closely together on both selected metrics, while Apple's figures are markedly superior (Yahoo Finance, 2016).

The third and final analytical procedure involves drilling down into the underlying components that feed the revenue, net income, and other figures. For return on equity specifically, the auditor would examine both the amount being invested (shareholders' equity) and net income for accuracy, since both inputs drive the ratio (Yahoo Finance, 2016).

Conclusion: Qualified vs. Unqualified Audit Report

Based on the definitions of qualified and unqualified audit reports, Apple falls into the latter category rather than the former. A qualified report is issued when something obvious and apparent is found to be amiss with the publicly presented data. Since no such issue was uncovered in the course of this review, a qualified report is not warranted here. Nonetheless, there are surely other companies in the broader market that bend and shape the intentions of GAAP beyond what is ethically appropriate, and auditors must remain vigilant in those cases.

References

Accounting Simplified. (2016). Audit risk model — inherent risk, control risk & detection risk. Accounting-Simplified.com. Retrieved 30 May 2016, from http://accounting-simplified.com/audit/risk-assessment/audit-risk.html

Ready Ratios. (2013). Most important financial ratios. Readyratios.com. Retrieved 30 May 2016, from http://www.readyratios.com/reference/analysis/most_important_financial_ratios.html

Yahoo Finance. (2016). Yahoo Finance — business finance, stock market, quotes, news. Yahoo Finance. Retrieved 30 May 2016, from http://finance.yahoo.com