Key West Company: Memo Help

I have the answers for the problems, I just need help with a 800 word memo. I've tried but am having really problems putting it into words. Please help me.

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DATE : September 18, 2009

TO : John Smith
Audit Partner
[Name of Audit Firm]

FROM : [Your Name]
Auditor-in-Charge
Audit Team
Key West Company Financial Audit

SUBJECT : Key West Company's Accounts Receivables Audit

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Upon review of Key West Company's internal control procedures for its accounts receivable, the audit team concluded that this internal control is sufficient as a result of which believed that only few misstatements will be found. The purpose of the audit on Key West Company's accounts receivable, therefore, is to help the audit team assigned to the firm in its decision on whether or not to accept the stated book value of the company's accounts receivable as the adjusted and audited balance of the account.

In this regard, the following parameters were identified as regards the audit of the firm's accounts receivable:

Sampling method: probability proportional-to-size
Sample size: 66 accounts
Sampling interval: $44,455
Maximum tolerable misstatement: $150,000
Anticipated misstatement in the population: $30,000
Risk if incorrect acceptance: 10%

Moreover, the team intended to seek positive confirmation of accounts included in the sample and to apply alternative procedures to accounts for which no reply is received.

The following information pertain to Key West Company's accounts receivables:

Number of customer accounts: 4,000
Accounts receivable balance: $3,000,000

From the 66 sample accounts, 4 were misstated as presented below:

Sample Item Book Value Audit Value
1 $800 $0
2 $1,500 $1,350
3 $13,000 $0
4 $15,000 $14,250
Total $30,300 $15,600

From these samples alone, the misstatement amounts to $14,700.

Based on the above, the audit concludes that the projected accounts receivable misstatement is $97,727.27 while the incremental allowance for sampling risk is valued at $48,704.55. The accounts receivable upper misstatement limit is $251,431.82.

Thus, the audit team is 90 per cent confident that the maximum overstatement of the Key West Company's accounts receivable for the audit year ended December 31 is $251,431.82 or 8.38 per cent of the unaudited balance of the account. Given that the maximum tolerable misstatement is $150,000, the population overstatement is too high. However, there are known errors which are immaterial which increases the risk that the audit team might be incorrectly rejecting the population.

Given the results of the audit procedures and the conclusions made there from, the audit team identified the following alternative courses of action.

1. Increase the sample size, or
2. Communicate the misstatements to client and recommend that the errors be investigated further and a decision on whether the book value of the accounts receivable be adjusted or ot should be made.

Analysis of Alternatives
The two identified alternative courses of action are analyzed, as presented below, before the final recommendation is made.

Alternative No. 1: Increase sample size
First, a disadvantage of increasing the sample size of the audit of Key West Company's accounts receivable is this increases the audit resources spent for this account. These resources would primarily involve junior audit staff man hours and a few by the Auditor-in-Charge. Second, however, increasing the sample size and a redo of the audit as regards the additional sample accounts would greatly enhance the credibility of the audit conclusion.

Third, an increase in sample size can either validate the original audit findings that the overall population is misstated by an amount well beyond the specified tolerable misstatement for the accounts receivable. It may also overturn that initial findings resulting to a conclusion that the reported accounts receivable balance if misstated is misstated well within the tolerable allowance of $150,000.

Alternative No. 2: Communicate misstatement to Key West Company
Merely communicating the misstatements to the client for Key West Company to decide, by itself, whether to make further investigation on the errors and for the company to, again, decide by itself whether to adjust the book value of its accounts receivable or not might not be a good defense if it turns out that the company's accounts receivable is really misstated.

However, this alternative was made in light of the audit procedures made which were performed and dispatched properly. On one hand, the client may simply dismiss the issue in regards the relatively small portion of the number of misstated accounts (as found in the sampling) to the total number of customer accounts the company has - only a 0.10%.

Final Recommendation
Based on the above discussion, the audit recommends that the sample size be increased and the audit procedures be performed on just the additional sample accounts such that the audit team's resources will not be over burdened.

Whether or not the increased sample size validates the original findings, the errors would still be reported to Key West Company. However, if the additional accounts corroborate the original findings, then it will be strongly recommended that the client adjusts the book value of its accounts receivable. In both cases however the client needs to investigate the occurrence of the errors.