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Running head: Audit Procedures

Jasmine Maid

Acc 640

Audit Procedures

Southern New Hampshire University

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Audit Procedures

Generally Accepted Accounting Principles (GAAP) are a set of commonly accepted

accounting principles, standards and procedures that public companies in the United States must

follow when compiling their financial statements. It was issued by the Financial Accounting

Standards Board (FASB) and is intended to improve consistency, clarity, and comparability of

financial information (Tuovila, 2019). In this paper, the potential risk factors and compliance

issues with GAAP for all the major business transactions conducted by Sears Holdings

Corporation are identified by analyzing the company’s income statement, balance sheet, and cash

and revenue.

A look at Sears Holding’s income statement straight away reveals some facts that may be

questionable about the company’s business. While most of the companies in the United States

have been improving in performance after the 2007-2008 global financial crisis, Sears Holding’s

income statement shows a drop to less than half of its sales/revenue in a five year trend from the

year 2014 to 2018. In 2014, the company had a sales revenue of $36,188 million. This dropped

to $25,146 million in 2016 and in the year 2018, it was at $16,702 million (Dow Jones &

Company Inc., 2019). This sharp drop in sales raises compliance concern with Generally

Accepted Accounting Principles, which requires companies to report relevant, reliable and

consistent information. This is particularly concerned with the Full Disclosure Principle, which

requires companies to disclose accurate and comprehensive aspects of their functioning in their

financial statements (Kumaran, 2015). Similar questions arise when we look at the company’s

pre-tax income and net income. The company has been making huge losses since 2014, with the

net loss in 2016 being $1,129 million and in 2017 being $2,221 million (Dow Jones & Company

Inc., 2019). This represents a 96.72% increase in net loss, raising the need to closely check

whether the company is indeed giving correct data or it is manipulating the data. The potential
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Audit Procedures

risk factors of GAAP compliance in the income statement include accurate matching of activities

to the periods they occurred. Therefore, estimates made, depreciation and how to report expected

income presents a great challenge when reporting the data.

The company’s balance sheet is consistent with its income statement in that most of its

components dropped significantly, with the drop being gradual over the years up to the year 2018

which we have data for. Both the total assets and total liabilities have been dropping consistently,

which can be explained in case the business is scaling down due to the consistent losses it has

been making over the years. This consistency between the information in the income statement

and the balance sheet however does not explain the significant drop in revenue the company

experiences. The total assets of the company dropped from $18,261,000 in 2014 to $7,262,000 in

2018, which is a drop of over a half in a span of just four years (Barchart, 2019). This is

questionable and requires a closer audit to determine if the company is complying with GAAP

standards or not. The questions raised above about possible data manipulation therefore still

stays. A closer look at the balance sheet reveals that every year, every component drops in

amount except for the Cash and Cash Equivalents, which increased in 2017 and 2018, short term

debt which increased in 2016 and 2018, and long term debt which increased in 2015 and 2017

(Barchart, 2019). This can be a clue about a well-planned data manipulation and should be

checked closely. Like in the income statement, estimates are also made in the balance sheet. It is

important to review these estimates because they are a great risk factor in GAAP compliance.

Balance sheet also include a number of other transactions such as account receivables, account

payables, and many other transactions that may be due and therefore should be all reflected in

the reported transactions to ensure that accurate figures are arrived at.
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Audit Procedures

The questions raised are therefore mainly about accuracy, sincerity, the Principle of

Prudence, the Principle of Utmost Good Faith, and if the company used the correct estimates.

Other GAAP compliance requirements such as the Principle of Consistency, the Principle of

Permanence of Method, the Principle of Non-Compensation, the Principle of Continuity and the

Principle of Periodicity are complied with (Tuovila, 2019). The main risk factor that most

companies face is about when to record expenses and incomes. Different companies use different

internal strategies, which of course can result in huge differences in the financial statements. To

comply with the Principle of Conservative Accounting, companies are advised to record

expenses immediately they occur but to only record income when the actual cash is received

(Kumaran, 2015).

The internal controls for cash and revenues that should be focused on in analyzing the

potential risk factors include: Ensuring that all the transactions of Account Receivables were

correctly reported, verifying all the Sales, and ensuring that all the Cash is recorded. While doing

this, all the risks should be documented and special attention should be given to Account

Receivables because they are the sources of business revenues and are therefore the most

targeted by deliberate manipulators or often wrongly recorded due to error of omission or

incorrect data entry. According to Hall (2019), account receivables should be checked for

existence and occurrence of revenues, accuracy, completeness, valuation and cutoff.

As stated earlier, all the aspects of the business are going down so fast. Both the assets

and the liabilities are dropping at a questionable rate and within a timespan of just four years,

from 2015 to 2018, everything has dropped to below half as evident in the balance sheet

(Barchart, 2019). The company has also been making huge losses from the year 2015 and it is

imperative to evaluate the rationale.

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Audit Procedures

The audit population refers to the identified series of financial transactions and the

actions required for review to ensure their accuracy. It is identified by knowing the accounting

areas that are normally prone to errors and the areas that the auditor has a chance to obtain

information from other sources to compare with what the company has provided. Account

receivables are for instance mostly targeted, and while reviewing it, the auditor should focus on

the total account receivables due, contact vendors to verify the balances, and ensure that the

allowances given for the doubtful accounts are accurate. It is these auditing focus areas that

determine the population.

The company’s financial reports shows consistent but all suspicious information, making

it a high risk company in terms of GAAP non-compliance. The consistent trend allows for a

program that only selects random transactions for review to be used instead of reviewing all the

information. Such small samples will reveal if there are any inconsistencies and non-compliance.

In this company, the huge losses reported raises doubts about their authenticity. The best audit

testing procedure I’d recommend therefore is observation. The auditor should take time to

witness the accounting transactions occur or the inventory dynamics to verify if they are

consistent with what is being reported.

From the analysis, it is evident that the company has reported huge losses in both its

income statement and balance sheet. The losses are however so huge and steadily increasing over

years, and this raises suspicion of a possible manipulation of accounting information. The

potential risks identified include risks of incorrectly reporting account receivable transactions,

incorrectly reporting sales and omission of some cash records. Account receivables have been

identified to be of the greatest risk of manipulation. To audit them, an auditor should check the

total account receivables due and verify balances with vendors.

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References

Barchart. (2019). Sears Hlds Corp (SHLDQ). Balance Sheet. Retrieved from

https://www.barchart.com/stocks/quotes/SHLDQ/balance-sheet/annual?reportPage=1

Dow Jones & Company Inc. (2019). Sears Holdings Corp. The Wall Street Journal. Retrieved

from https://quotes.wsj.com/SHLDQ/financials/annual/income-statement

Hall, C. (2019). Auditing Receivables and Revenues: The Why and How Guide. Retrieved from

https://cpahalltalk.com/auditing-receivables-revenues/

Kumaran, S. (2015). The Ten Generally Accepted Accounting Principles (GAAP). Retrieved

from https://www.invensis.net/blog/finance-and-accounting/ten-generally-accepted-

accounting-principles-gaap/

Tuovila, A. (2019). Generally Accepted Accounting Principles (GAAP). Retrieved from

https://www.investopedia.com/terms/g/gaap.asp