DEPARTMENT OF ACCOUNTANCY

UNIVERSITY OF ILLINOIS
MEMORANDUM

TO: Cynthia Turner and Other Business Associates at Turner Rugs

FROM: The Partners of Synergy Audit: Betul Acikgoz, Yi-Chun Jelena Ou , Ray Wu,
Bulent Sevik, and William Minor
DATE: April 27, 2010
SUBJECT: Outline of Synergy Audit Auditing Services

Introduction
It is our sincerest pleasure to explain how our services at Synergy Audit can help Turner Rugs
expand into a successful Champaign business. We offer many solutions to help you take
advantage of necessary resources to expand into the downtown area of Champaign. Our hard-
earned reputation as a leading and cost-effective CPA Private Practice Auditor in
Champaign/Urbana has been built by helping exciting local companies like yours consistently
meet and exceed short-term and long-term business goals through exemplary audit services.

Our memorandum will take great care to explain to you the importance and function of an audit,
the primary service we recommend to Turner Rugs. Synergy Audit values every aspect of the
audit procedure. Reflecting this esteem, we will take painstaking care to explain from top to
bottom how a tactful and professional audit is performed and the resulting product. The first
section of our memorandum will give explanation to the importance of an audit. The second and
third parts will describe the personnel involved and an explanation of the type of work they do.
Immediately following will be descriptions of audit time requirements, fee determination, and
communications expectations. Lastly, and very importantly, we will spend time describing the
final audit product. We appreciate your interest in Synergy Audit hope you find our
memorandum both informative and functional.

Section One: Description and Importance of an Audit

An audit can academically be described as “the accumulation and evaluation of evidence about
information to determine and report on the degree of correspondence between the information
and established criteria” (Elder et. Al 2009). Essentially, an audit is the gathering and evaluation
of evidence by an independent and qualified third party to determine whether the evaluated
information is stated fairly, most often for use by outside users. Audits are performed by
members of the CPA profession, reflecting the emphasis on competence of the individuals
performing the audit to ensure standards are met.

This brief definition likely has led you to many questions. Let us begin with a description of how
Auditing falls into the business community. With most businesses accurate information is
important to internal and external users. Companies and people who lend money to businesses
want to be reasonably assured the numbers they see from a business are fair representations of
the economic activity. The assurance provided by an audit causes them to buy, sell and regulate
more efficiently and confidently, helping companies like you attain valuable financing and
capital support. Essentially, outside parties require reliable information on your company’s
Synergy Audit
April 27, 2010
2

economic activity to do business with you. For example, an audit attesting to the accuracy of
your financial statements will provide a local bank like First Champaign Bank with confidence in
lending money to Turner Rugs to finance your desired purchase. Their confidence in your
numbers will be reflected by a lower interest rate on the debt and better loan terms, helping you
keep higher cash flow.

Auditing is an Attestation service provided by accounting firms and CPAs. Attestation services
are a type of assurance in which the CPA firm issues a report about the reliability of an assertion
made by another party. Synergy Audit and most other CPA firms can perform three types of
audit for you. The first type is an Operational Audit which evaluates efficiency and effectiveness
of your organization’s operating procedures and methods. Second, perform a Compliance Audit
to determine whether Turner Rugs is following specific obligations or guidelines set forth.
Lastly, and most relevant to this memo, we routinely perform Financial Statement Audit to
determine whether the financial statements are stated in accordance with specified criteria. Most
likely, your banking business partner will seek that your statements to be prepared in accordance
with the Auditing Standards Board (ASB) of the American Institute of Certified Public
Accountants.

We stringently adhere to ASB and GAAS guidelines and pride the quality of our work. Each of
the three audit types of audit listed above are important. However, as you enter into loan
agreements, a Compliance Audit may be necessary to ensure you are meeting your obligations as
a borrower. Please feel free to contact Emilio in our Compliance department at 217.344.4392
with any additional questions regarding a Compliance Audit.

We routinely audit companies for FCB and the other five main Champaign/Urbana banks and
have a strong working relationship with these companies. Many companies we audit do not
typically have their own audit functions or know how to prepare statements in accordance with
appropriate guidelines. Auditors, such as Synergy Audit, can help your business by
implementing a bookkeeping system for you to use. This service is not free but would provide
Turner Rugs with a cutting edge, versatile accounting platform to manage business.

Section Two: Personnel involved

Hierarchy of our CPA Firm

Staff Level Average Typical Responsibility
Experience
Staff Assistant 0-2 years Performs most of the detailed audit work
Senior or in-charge auditor 2-5 years Coordinates and is responsible for the audit field
work, including supervision and reviewing staff
work.
Synergy Audit
April 27, 2010
3

Manager/Senior Manager 5-10 years Helps the in-charge plan and manage the audit,
reviews the in-charge’s work, manages relations
with the client, designs the auditing plan. A
manager may be responsible for more than one
engagement at the same time.
Partner/Director 10+years Reviews the overall audit work and is involved in
significant audit decisions. A partner is an owner of
the firm therefore has the ultimate responsibility
for coordinating the audit and serving the client.
Specialist 5+years Help each team in solving some problems that
require professional judgment in certain fields.

Personnel involved in Turner Rugs’ audit

Turner Rugs is a privately owned firm with four full-time employees (and four part-time
employees). To audit a small size firm, we usually assign one audit team which includes two
staff assistants and one senior auditor. One of our partners and a manager will responsible for
auditing your company and issuing the audit report. To maintain the quality of audit work
planning and the following auditing process we typically make sure our auditors have audit
experiences with similar companies or in similar industry.

At first, the partner and the manager will evaluate the information a potential client provides to
decide whether to accept the audit or not. Once Synergy Audit accepts an audit plan, we perform
initial planning. To gather information of Turner Rugs’ business and industry, an audit firm like
ours will have several meeting with you and set the preliminary audit plan. After obtaining
sufficient information, the manager will develop overall audit plan and audit program. Our
manager will explain the auditing process with you extensively before we start audit work.

During the time our team performs audit work, the senior auditor will assign the detail audit
work to staff assistant based on their work experiences. The detail audit work includes expenses
inspection, invoice verification etc. Senior auditors usually perform more complex audit work
such as tests of details of balances. In order to accumulate audit evidence and perform the detail
audit work, the audit team will try to work in the client company’s best convenience to perform
the work.

After accumulating sufficient evidences and evaluating the results, the partner will issue report
based on our auditing results and communicate with your management. Thus, the audit work is
completed.

Section Three: Description and Explanation of Work Involved

Key Elements and Overall Objective in Audit Work

When a bank considers small business financing by applicant’s financial reports, two items
would be emphasized, revenue and inventory. The bank must always consider, no matter how
well a company performs, the possibility of its default on the loan. In the event of default, banks
have the right to force companies to transfer their cash on hand or sell their inventory or
Synergy Audit
April 27, 2010
4

equipment to generate cash and pay the bank with that cash. Therefore, revenue, the major
source of cash, might be an indicator for bank to estimate debt-paying ability. In addition, cash,
the revenue’s contra account would also be evaluated. The resale value of a company’s assets
may also be evaluated.

For Turner Rugs, inventory might be the most relevant asset to evaluate regarding cash
generation. Of all non-cash assets with small retail companies, inventory is typically the best
asset to measure to cash because it is the easiest to liquidate. Production equipment typically
does not have the same large markets to trade in. Real Estate would have large value, however
would have significant selling costs. Therefore, the review of cash, inventory and revenue might
be the key process in our audit work.

So in our audit work, we must assure that the inventory on balance sheet could be fairly
expressed. For example, all of the inventory belonging to Turner Rug should be included.
Besides those stocked in the warehouse, inventory which directly ship from distributors to
customers might be counted as Turner’s assets before the obligations transfer to customers.
However, if Turner Rugs uses the cash method of accounting instead of accrual method, we
wouldn’t include rugs that cash has been received for. To further understand the status of
inventory, our personnel will visit and conduct physical examination, which is also called
stocktaking. To assist our professionals, please place a tag with the product name and number on
every item of inventory the day before stocktaking. Also, please stack similar kinds of inventory
together. A list of inventory including item number, product name, and quantity should be
prepared advanced for audit personnel to conduct physical examination. We will inform you the
date to conduct stocktaking after we get an understanding of your company and design a
preliminary planning for the overall audit work.

In order to comply with Auditing standards set forth by the ASB, we would prepare an
Engagement Letter. This letter would explain the objective and responsibilities of the auditor and
the management so we both understand the function and purpose of the audit. Both parties sign
the obligation and are protected by the detailed outline of rights and obligations

Get an Understanding of Your Company

We understand the negative consequences to your business of conducting unnecessary audit tests
and will greatly minimize this risk. To do so, our audit team will carefully plan the audit work in
a both efficient and effective way to ensure minimal distraction to your personnel so they may
focus on their ordinary operations. Audit fees will also be saved and the quality of audit work
can still be maintained. To save the resources input in audit, we would thoroughly evaluate the
effectiveness of internal control to determine the minimal amount of evidence we should
accumulate to reach our conclusion. We understand that formal internal control systems do not
fit in your operation type. However, what you don’t perceive is that there are still some internal
controls already implemented in your business. For example, your Sales Manager might prepare
monthly sales reports to have you sign. This is an internal control we would benefit from using.
To get an understanding of internal controls, auditors might observe daily operation in your store
and request your personnel to answer basic questions on a questionnaire. What will also be very
important is that auditors will take time to discuss internal controls with the owners and sales
Synergy Audit
April 27, 2010
5

managers. This background of business and the supervision of management are critical factors of
effectiveness of internal control. Those evaluations would help to decrease the audit work we
will conduct in the following period, such as stocktaking or confirmation.

Solutions to Computerized Accounting Environment

After our evaluation, we will decide to “audit around the computer.” When we “audit around the
computer” we print out the daily journal entries, general ledgers and financial reports to conduct
audit work. Your accounting system would not affected by our audit work. However, sometimes
auditors might request to log in your system or see your records to follow the “audit trail” which
is kept in the system. The audit trail is a chronological sequence of audit records, each of which
contains evidence directly pertaining to and resulting from the execution of a business process or
system function, such as sequence number in the document or the date noted in sales invoice and
bill of lading for the same order. The audit trail helps auditors assure that transactions proceed
appropriately from beginning to end. In our investigation, the QuickBooks system has full
function in keeping audit trail so don’t have to worry about collecting that information. Besides,
for your online store operation, our expert would visit and discuss with your personnel who
administer the system to discuss and find any deficiencies of the system and related security
issues on ecommerce. For example, we will secure valuable areas of your business such as your
distributers and customers so customers can’t simply go to your distributors cutting you out of
the equation and adversely impacting your business.

Set Materiality and Complete Preliminary Audit Planning

After we get an understanding of your company, to allocate our audit work, we will perform
analytical procedures. We will review your financial Statement in 2009 and 2008 and compare
ratios between the two years, such as current ratio, inventory turnover, or net income rate. At the
same time, figures from the industry and competitors would also be considered in our analytical
procedure. For those significant changes, we would find the reason and put more concern in our
audit work. Since this would be your company’s first audit, we might ask for financial statements
of preceding years to analyze. Also, company documents of continuing importance such as
articles of incorporation, bylaws, or contracts would help us in our analytical procedures. Those
files would help us to understand your company and accelerate the audit work in the next year.
After this, we set a preliminary concept about how much evidence we should gather to complete
our work. We will design an audit program, which includes what kind of tests we will conduct,
when and where we would perform the tests, how much evidence we should gather, and the
result of the test. The program will update continuously according to our judgment and the
results of various tests.

Substantive Tests of Transactions and Test of Details of Balances

When we conduct audit work, Sampling is a typical technique that we would use. For example,
auditors would only pick and measure a limited amount of items of inventory to complete
stocktaking procedure. However, for some kinds of transactions, we choose to review all of those
transactions one by one. One example would be the payroll account. One reason is that there are
few transactions happening in the whole year. Another reason is that for private-owned
company, payroll expense is the item vulnerable to manipulate, affecting the fairly express of net
income.
Synergy Audit
April 27, 2010
6

When we conduct Test of details of balances, Cash and Inventory are the two major items we
should focus. Since Turner Rugs does not extend credit sale and only accepts credit card for sales
on credit, the default risk on cash receipt is very low. Therefore, the necessity of reviewing on
Account Receivable account is largely diminished. For the cash balance, the most important
evidence which we should gather is Confirmation. We will mail to the bank and credit card
companies with the balance recorded on your book and request them to reply whether this is
exactly the same figure on their book. This evidence would be persuasive to proof that the
balance recorded in the account is existed. We would also want to perform a Cut-off test to
assure that year-end cash balance is correct.

For inventory, physical examination is the critical evidence we should gather. The existence of
inventory can be assured by this procedure. In addition, stocktaking is also used to check the
status of inventory to make sure net realized value that the inventory is not obsolete and still able
to be sold. As with the case with cash, a cut-off test is also necessary for inventory.

Our focus is not only on the account balance but also on each kind of transaction happening in
the entity. As a result, Vouching and tracing would be used in the audit work. When auditors use
documentation to support recorded transaction or amounts, the process is often called vouching.
It supports management’s assertion of existence. For example, to vouch for a recorded sales
transaction, auditors should examine the sales order, invoice copy, inventory stock list and bill of
lading.

Tracing refers to when the auditor traces forward from supporting documents to journals and
then to ledgers and finally to financial statements. Auditors are basically looking that all items in
the source documents are recorded in the financial statement. This supports management's
assertion for completeness. For instance, if auditors selected a sample of ten invoices, we might
trace the invoices into the sales journal and vouch the invoices to the ten related shipping
documents and then to the related sales orders.

Review on Subsequent Event and Issuance of Report

In addition to review the balance and transactions happening as of 2008 year end, we will also do
review for Subsequent events. For example, deposit in transit included in the cash account in
12/31/2008 should be appear on statement of account on January, which was issued from bank.
Similarly, when the company recognized the sales revenue as of 12/31/2008 for the shipped
inventory with FOB shipping point, we would trace whether the inventory has been delivered to
customers in 2009.

After accumulating all the evidence and the results of tests, the partner will do the analytical
procedure again to review the whole audit work and discuss with audit manager. Usually, several
adjusted entries would be suggested to make financial statement fairly expressed. In this part of
audit, we need the participation of owners and your managers to discuss the appropriateness and
necessity of those entries. In most audits, the auditors issue an unqualified report. At the same
time, our auditors will communicate with your management issues discovered in the audit
process, such as internal control deficiency or indication of fraud or illegal acts. For those
Synergy Audit
April 27, 2010
7

significant items, A Management Letter would be prepared for your company to specify the
CPA’s recommendation and suggestion for improving your business.

Section Four: Time Requirements

Generally, the financial statements audit is conducted in four phases:

1. Plan and design an audit approach;
2. Perform tests of controls and substantive tests of transactions;
3. Perform analytical procedures and tests of details of balances;
4. Complete the audit and issue an audit report.
However, we will adjust these processes for your company and we can set up a new and
appropriate timetable for you. You are asking us to audit your financials for the 2009 fiscal year
and complete it by June 30, 2010 for securing the bank loan by September 2010.

In this respect, if we reach an agreement, estimated date of completion and release of the
financial statements, as well as the general guidelines for the timing of the audit work are stated
in the following table. We are going to start audit work on June 1, 2010. The entire process takes
about 12 business days since you are a small size retail company and we have a considerable
experience on this field. We will issue the audit report no later than June 20, 2010. The following
table shows the timeline of the auditing work.

Table : Timetable of the Audit

Description of work Period

Planning and designing an audit approach 2 days

Documenting and understanding of accounting system

1 day
and controls
Field work, physical inventory count, mail requests for
4 days
confirmation

Performing audit procedures 4 days

Completing the audit and issue an audit report 1 day

We look forward to full cooperation with your CPA and staff, and we trust that they will make
available to us whatever records, documentation and other are requested in connection with our
audit.

On the other hand, circumstances encountered during the performance of the audit may prevent
us to be unable to complete the audit within the above estimates. We will notify you in case of
such circumstances.

Section Five: Fee Determination

Synergy Audit
April 27, 2010
8

Our fees, which will be billed as works in progress, are mainly based on the time required by the
engagement team, the levels of skill and responsibility involved and out of pocket expenses.
However, the following issues are also used by our firm to determine fee and acceptance of a
client by comparing audit risk and reward.
- Whether the client is initial or continuing,
- Size of the company and/or revenues,
- Whether the company is public or private,
- Perceived risk of bankruptcy and litigation risk,
- Presence and effectiveness of internal control and code of conduct,
- Client’s significant ratios such as ROA, Book Value to Market Value, debt to equity
ratio.

In 2009, limited financial and other information show that Turner Rug is a small size private
company with its total assets of $320,000. Since short-term debt of $20,000 and long-term debt
of $50,000 are not too significant to the company and company is not involved in any pending or
ongoing tax problems, its financial condition seems very healthy. The company is not involved
in any pending litigation or regulatory proceedings. The company hasn’t internal control or code
of conduct because of its structure and size. However, you and your husband, as owners of the
company, are very active in the day-to-day operations which leads to a decrease in control risk.
$750,000 loan for purchasing a building is 2.3 times bigger than total assets of the company and
it will increase our Firm’s litigation risk, since the bank is a foreseen party in case of fail to pay
loan.

In this respect, the total fees for our audit engagement will be minimum $10,000. ($105 per
hour*12 days*8 hours per day) Finally, we would like to point out that it is in your interest to
ensure that your accounting records and all other relevant records are completed to the agreed
stage. Invoices are payable in full before the audit report will be signed.

Section Six: Communications expectation

First, we are going to describe the principal purposes of communication with those charged with
governance and stress the importance of effective two-way communication. We are required to
determine the appropriate person in the entity’s governance structure with whom to communicate
all matters. That person may vary depending on the nature of the matter to be communicated. As
mentioned in PCAOB Release No. 2010-001; one way the audit committee may be informed of
accounting and disclosure matters is through the communication of the auditor's evaluations of
matters that are significant to the financial statements. Effective two-way communication
between the auditor and the audit committee on such matters might also benefit the auditor in
performing the audit (PCAOB No. 001-2010). We recognize the diversity in governance
structures among entities (including the existence of audit committees or other subgroups
charged with governance) and encourage the use of professional judgment in deciding with
whom to communicate particular matters. To recognize the unique considerations for
communicating with those charged with governance when all of those charged with governance
are involved in managing the entity, which may be the case with some small entities, necessitates
Synergy Audit
April 27, 2010
9

closer relations with the customer. Since we will keep in touch with Turner Rugs, we will inform
you about an overview of the planned scope and timing of the audit and representations the
auditor is requesting from management. We will assign the audit goals and outcomes. Goals and
outcomes are going to be well defined, measurable, and help guide a defined plan of action. This
will provide additional guidance on the communication process, including the forms and timing
of communication. Significant findings from the audit should be in writing when, in the auditor’s
profession judgment, oral communication would not be adequate. Other communication may be
in oral or written form. This will also require our rim to evaluate the adequacy of the two-way
communication between the auditor and those charged with governance and establish a
requirement to document these communications.

Section Seven: Final product description

If you choose us to audit your company, we will assign one audit team including two staff
assistants and one senior auditor, responsible for the audit work at the Turner Rugs. One of our
partner and a manager will be responsible for auditing your company and issuing the
corresponding Audit Report. Since we have audited the companies in the same industry, our
audit team has significant experience in your industry and understands many of the challenges
your business faces. We could begin work on May 1, 2010. The entire process would take
roughly 12 business days since you are a small size retail company and we have a considerable
experience on this field. We would issue the audit report no later than May 15, 2010. During our
audit performance, we would examine inventory, account receivables and sales, offer you extra
value-added services, and check your internal controls. The total fees for our audit engagement
would be a minimum of $10,000. The findings from the audit process would be presented in both
written and oral form for the owners of the company. After our audit performance, we would
present our Auditor's Report. This would be our formal opinion, or disclaimer thereof, issued by
an independent external audit team as a result of an external audit. It may be an Unqualified
Opinion report, Qualified Opinion report, Adverse Opinion report or Disclaimer of Opinion
report. It all depends on the financial statements presented are free of material misstatements and
are represented fairly in accordance with the Generally Accepted Accounting Principles
(GAAP).

Once again we appreciate your interest in viewing Synergy Audit audit services. We feel
Synergy could be a compelling business partner and would be thrilled to work alongside of you
as you pursue your business goals in Champaign. Please do not hesitate to contact our office at
217.344.4300 for any assistance.

SOURCES CITED

Dickins, Denise E., Higgs, Julia L., and Skantz Terrance R., Estimating Audit Fees Post SOX,
Current Issues in Auditing, Volume 2, 2008, P A9-A18.

Elder, Randal J., Beasley, Mark S., Arens, Alvin A. Auditing and Assurance Services: An
Integrated Approach. 13th ed.
Synergy Audit
April 27, 2010
10

PCAOB Release No. 2010-001 March 29, 2010 Page 3

http://en.wikipedia.org/wiki/Audit_trail

http://www.cpanet.com/cpa_forum/forum_posts.asp?TID=19253&get=last

www.ioma.com