Audit Planning and Controls for a Large Retail Company

Audit Planning and Preliminary Engagement

The American Institute of CPAs (AICPA) has published guidelines for preparing an audit plan. The first step is the preliminary engagement activities, which focus on establishing an understanding of the terms of engagement for the audit. The steps in the planning process are to identify the scope of the audit, to determine the reporting objectives, to consider the results of the preliminary engagement, and to determine the resources that will be required to conduct the audit — including the timing of when those resources will be needed (AICPA, 2015).

To audit Home Depot, it is important first to determine what the scope will be, as this will help to define resource requirements. A preliminary meeting with the company will help to establish this — for example, is it necessary to visit stores? Conduct inventory? Speak with Canadian headquarters? Or is a visit to the main corporate headquarters sufficient? Obtaining the contact information of key personnel within the company is essential to this part of the process. Once the scope is determined, the audit team can begin thinking about the internal resources needed — how many people, how much time, and how much money. The person leading the audit must make determinations about these factors in order to plan effectively.

A company like Home Depot operates a fairly straightforward retail business, but it is also an extremely large organization, and those characteristics must be taken into account when determining an appropriate audit scope. It is important that this part of the process includes a proper identification of risk factors, because those will partly determine the scope and the resources required (Knechel & Willekens, 2004).

Key Performance Ratios in Retail Auditing

There are several important performance ratios in a retail business. Determining which ones should be the focus of an audit requires careful consideration of where risk lies. Inventory is one such area, particularly at a company with operations across the country like Home Depot. The company carries an enormous amount of inventory on its books, and the state of inventory levels is material to the company's financial health. A company like Home Depot will utilize automated inventory systems; some industry leaders have even introduced robotics in their warehouses, so the accuracy of inventory tracking systems is critically important. There are several ways to establish that accuracy, such as running system tests. One key ratio is inventory turnover — ensuring this figure is accurate matters because if inventory is turning over too slowly, some items may need to be written down, or the figure may simply be recorded improperly if the numbers are off. Examining the various factors that could influence the inventory turnover ratio is therefore essential (Kang & Gershwin, 2004).

Another ratio worth investigating is the quick ratio. This is material because it directly reflects the solvency of the business and, importantly, excludes inventories. The quick ratio should be tested by ensuring that accounts receivable are accurate, that cash is recorded properly — that items classified as cash equivalents genuinely qualify as such, for example. By understanding the quick ratio, the audit will be better positioned to establish the solvency of the company.

At this stage, the audit is examining accounts receivable, cash, and inventories. As noted, there are several ways to audit inventories. A full physical count is not always feasible — though it can be conducted for smaller companies or when a specific location is identified as having irregular numbers. Testing the software that manages inventory is therefore the most important method: if the software is functioning correctly, inventory counts should be reasonably accurate. This can be combined with spot physical testing to verify that the software test did not yield a false negative.

Cash is more straightforward, because the company will have financial statements outlining the value of its various accounts. It will hold some physical cash on hand — in its tills, for instance — and a physical spot count may be conducted, but most of the company's cash assets will be held in financial accounts. These should be verified to ensure that cash holdings are what the statements indicate.

Testing accounts receivable is a different matter. This is revenue earned but not yet collected — typically from credit card companies. It can therefore be audited from both ends. Accounts receivable must be reconciled between revenue and amounts that have been paid; electronic records should be available for all of this data (Accounting Tools, 2016). Accounts receivable can also be tested by confirming that the credit card companies agree with Home Depot on the amounts owed. If that agreement exists, the figure is likely accurate. Any tests conducted on the veracity of revenue figures will also contribute to a proper and adequate examination of accounts receivable.