THE OVERALL OBJECTIVE OF AN AUDIT ON MICROSOFT INC PRIOR TO THE FIRST STEP OF AUDIT PLANNING

“The objective of an audit of financial statements is to enable the auditor to express opinion whether the financial statements are prepared, in all material respects, in accordance with an identified financial reporting framework” (IFAC Handbook 1998)[1] . These phrases are used as an expression of an opinion on the “true and fair view”, or “fairly presented” of financial statements. In order for us to form and give an opinion, we must perform audit procedures which are designed to obtain sufficient audit evidence to support the opinion. We must have an adequate audit plan; a plan which are properly executed according to professional standards, sufficient competent evidence collected and all questionable findings were pursued.

We will starts with the financial statements (Form 10K, Sec Filing)[2] prepared by our client, Microsoft INC and submitted to SEC (Form 10-K Filing) as at fiscal year ended 30 June 2013. In these financial statements, management has made assertions about the classes of transactions and related accounts, completeness of an account and valuation of an account. We must obtain sufficient evidence that the assertion is materially true and gather evidence that accounts are classified correctly and proper disclosures have been made based on International standards.

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Under Form 10-K, Part II, Item 7, STATEMENT OF MANAGEMENT’S RESPONSIBILITY FOR FINANCIAL STATEMENTS (Form 10K, Sec Filing); management states that the classes of transactions, accounts and disclosure have been present in conformity with accounting principles generally accepted by United States of America, internal controls are good and financial records are reliable. Once we have set the audit objectives based on the Management Assertions, we must obtain sufficient appropriate audit evidence to support all management assertions by accumulating evidence in support of some combination of transaction-related audit objectives and balance-related audit objectives. We will design the audit procedures to accomplish each specific audit objectives. After setting the audit objectives, we will proceed to plan an Audit and design an Audit approach.

There are 8 steps under an Audit approach as shown above. The main reasons is to help us to plan the engagement properly, enable us to obtain sufficient appropriate evidence for the circumstances, to keep audit costs reasonable, to maintain good working relationship with client and avoid misunderstanding with the client.

STEP 1: CLIENT ACCEPTANCE & PERFORM INITIAL AUDIT PLANNING

Assuming that Microsoft INC is our new client in our firm and continuing client in the industry, before we can decide whether to accept this engagement, we will have to investigate the company to determine its acceptability by examining Microsoft’s standing in the business community, financial stability and its relationship with its previous CPA firm. We also have to determine Microsoft has the competency such as industry knowledge and satisfy all independence requirements. This is because to avoid our firm to expose to any significant potential liability if the businesses fail financially.

Based on Form 10-K, Page 15-17, “CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM” which was issued for the financial year ended 30 June 2013, the assertions which was made by the management has proven to satisfy all independence requirements. “IFAC Code of Ethics for Professional Accountants and United States’ SAS No. 7 (IFAC Ethics Committee, 1998)[3]” requires us, as a new auditor to communicate directly with their previous auditor, DELOITTE & TOUCHE LLP[4], to help us to evaluate Microsoft’s integrity such as any disputes over accounting policies, accounting procedures or fees etc. We have to obtain permission from Microsoft as the predecessor auditors have no legal obligation to provide any information and do not normally allow access to their working papers as per United Kingdom SAS 450 (SAS 450)[5].

We also have to consider the nature of this entity, the purpose and nature of the financial statements and whether it is compliance by laws or regulations prescribe a “particular financial reporting framework in order to determine if the financial reporting framework which is used by Microsoft is appropriate”. (AICPA, 2012)[6] Not only considering the nature of Microsoft’s entity, we also have to identify their reasons for audit and obtain an understanding with them. Identifying the reasons for Audit helps us to determine the level of the acceptable audit risk. “Acceptable audit risk refers to the amount of risk which an Auditor can accept that the financial statements may be materially misstated after completion of an Audit; such risk is affected by the statement users and the intended users of these statements. Example: if the statements are to be used extensively, we are likely to accumulate more evidences during the audit process” (Aren et al, 2006)[7]

After understanding the reasons for the audit, we should be able to develop an audit strategy that sets the scope, timing and the direction of the audit. Such strategy considers business and industry including areas where there is a chance to increase the risk of significant misstatements.

Obtain an Understanding with the Client should be made when comes to engagement terms such as objectives, responsibilities of auditor & management, schedules & fees must be understood between CPA and Client. “According to ISA 210[8] says that both auditor and client should agree on the terms of engagement, ISA 210 provide guidance on the preparation of an audit engagement letter. Client should be informed that auditor cannot guarantee all acts of fraud will be discovered such as petty frauds” (IFAC Handbook Technical Pronouncements, 1998).

STEP 2: UNDERSTAND MICROSOFT’S BUSINESS AND INDUSTRY

In order to conduct an adequate audit, it is essential for us to understand Microsoft’s business and Industry. Without having a thoroughly understand towards the company’s businesses, it will be difficult for us to assess the level of Inherent risk, Control risk and determining the level of acceptable audit risk. ISA 310, International Standard on auditing stated that:

In performing an audit of financial statements, the auditor should have or obtain knowledge of the business sufficient to enable the auditor to identify and understand the events, transactions and practices that, in the auditor’s judgement, may gave significant effect on the financial statements or on the examination or audit report.[9]

In terms of obtaining business knowledge from Microsoft, examples of documents that should be reviewed, material sent to shareholders or filed with regulatory authorities, promotional literature, prior years’ annual reports, management policy manual, manuals of accountings and internal control systems, chart of accounts, job description, marketing and sales plans.[10]

United States Securities Exchange and Commission, Annual report of perusal on Section 13 or 15(d) of the Securities Exchange Act of 1934 for the fiscal year ended 30 June 2013[11], Form 10-K, Microsoft Corporation, we understand that Microsoft was founded in 1975, they created technology in changing the way people work, live, play and communicate by developing and selling of market software (Cloud based computing and Microsoft 365), products and services (Microsoft Office 2013, Xbox), hardware and devices (Personal PCs, Servers) which delivers new opportunities, greater convenience, and enhancement to both business and individuals. They trade their business worldwide and generate their revenues from their research and development, as at 30 June 2013, they have almost more than 100 offices around the world. They have multiple sources of raw materials (integrated central processing unit/graphics processing unit from IBM), supplies (the supporting embedded dynamic random access memory chips are purchased from Taiwan Semiconductor Manufacturing Company), components (supplies providing key components of our Surface devices) and are often able to acquire component parts and materials on a volume discount basis. Example: Microsoft Xbox 360. We need to have a good understanding of the business and types of transactions involved, the relationship with the suppliers, and most importantly, the accuracy of the currency and exchange policy reported.

In Audit point of view, a tour to Microsoft’s local facilities (Aren et al, 2006)[12] is helpful to have a better understanding of their business operations to provide an opportunity for us to obtain first-hand operations and to meet their key personnel, since Microsoft has raw materials, we can assess physical safeguards over assets equipment so that we are able to identify inherent risks such as unused equipment or potentially unsalable inventory. Microsoft practises effective operation management by implementing life cycle policy so as to provide customers and up-to-date information or versions according to the period of agreement. We also need to be aware of the possible & pending lawsuits in order to give a proper opinion when performing audit.

ISA 550 defined “related parties” given in (International Accounting Standard)[13] says:

Parties are considered to be related if one party has the ability to control the other party or exercise significant influence over the other part in making financial and operating decisions (Rick Hayes et all, 1999).

Similarity the US Statement of Auditing Standard No. 45[14] also says that:

Affiliated companies, principal owners of the company or any other party which company deals where one of the parties can influence management or operating policies of the other (AICPA, AU 334).

Related Party Transaction most commonly refers to the transfer of resources or obligations between related parties regardless of whether a price is charged.

As per Form 10-K of Microsoft Corporation, under Part II, Item 8, page60 (Form 10-K, 2013)[15], Microsoft have not adopted the recent accounting guidance including disclosure relating to intercompany transactions and such guidance will be effective for them with effect from July 01, 2014 and Under Part II, Item 8, page54 Form 10K, 2013)[16], Notes to Financial Statements, The financial statements include the accounts of Microsoft Corporation and its subsidiaries, Intercompany transactions and balances have been eliminated. Therefore we assess Inherent risk as high as there are chances of lacking independence between involved parties in the transactions and the opportunities of engaging in fraudulent financial reporting.

Form 10-K, Part III, Item 10, Directors, Executive Officers and Corporate Governance[17]

A list of our executive officers and biographical information appears in Part I, Item 1 of this Form 10-K. Information about our directors may be found under the caption “Our Director Nominees” in our Proxy Statement for the Annual Meeting of Shareholders to be held November 19, 2013 (the “Proxy Statement”). Information about our Audit Committee may be found under the caption “Board Committees” in the Proxy Statement. That information is incorporated herein by reference.

The information in the Proxy Statement set forth under the caption “Section 16(a) Beneficial Ownership Reporting Compliance” is incorporated herein by reference.

We have adopted the Microsoft Finance Code of Professional Conduct (the “finance code of ethics”), a code of ethics that applies to our Chief Executive Officer, Chief Financial Officer, Chief Accounting Officer and Corporate Controller, and other finance organization employees. The finance code of ethics is publicly available on our website at www.microsoft.com/investor/MSFinanceCode. If we make any substantive amendments to the finance code of ethics or grant any waiver, including any implicit waiver, from a provision of the code to our Chief Executive Officer, Chief Financial Officer, or Chief Accounting Officer and Corporate Controller, we will disclose the nature of the amendment or waiver on that website or in a report on Form 8-K.

Above information shows that Microsoft have effective board of directors to assist by ensuring the company takes only appropriate risks while the audit committee through oversight of financial reporting which can reduce the likelihood of overly aggressive accounting. However we should gain knowledge of the company’s code of ethics in order to disclose any amendments of the code of conduct which will have significant impact about the governance system, related integrity and ethical values of senior management.

Item 9A, Controls and Procedures, Page 90, Reports of Management on Internal Control over Financial Reporting[18], it states that

Microsoft Corporation has conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control – Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Tread way Commission. Based on this evaluation, management concluded that the company’s internal control over financial reporting was effective as of June 30, 2013. There were no changes in our internal control over financial reporting during the quarter ended June 30, 2013 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. Deloitte & Touché LLP has audited our internal control over financial reporting as of June 30, 2013; their report is included in Item 9A. We can test by following up with their meeting of minutes to see if the responsibilities are being met.

Microsoft Corporation is a large organisation with many locations, millions of turnover yearly, high value of assets and high headcount of employees.

Other than the employees, shareholders and executive officers of the registrants[19] whom are closely associated with Microsoft Corporation, there are other companies like Taiwan Semiconductor Manufacturing Company and IBM who supplies them with raw materials are deemed to be closely associated with the company, The suppliers’ income are based on the inventory turnover in Microsoft, the higher the inventory turnover, the better the revenue will be derive and cost of revenue will be increase which gives high profit on suppliers’ point of view.

The following names which were found on Form 10-K are also consider board of directors whom are closely associated with Microsoft Corporation.[20]

We, as an auditors, the knowledge of Microsoft’s objectives and strategies helps us to assess business risk and Inherent risk in the financial statements, and we have to understand the objectives related to compliance with law and regulations such as long terms notes and bond payable in order to have a better perspective of the organization and better assess Inherent risk. We have to make sure that any contingent liabilities have to be disclosure in the financial statement under notes to financial statement or notes to accounts.

STEP 3: ASSESS CLIENT’S BUSINESS RISK

Client business risk is the risk that the client will fail to achieve its objectives. Most common factors affect Client and their environments are significant declines in the economy that threaten the cash flow or client failing to execute its strategies as well as its competitors. However, in auditor point of view, their primary concern is the risk of material misstatements in the financial statements occur due to client business risk. For example; Goodwill recorded in the acquisition may be impaired which affect the fair presentation in the financial statements if planned synergies by Microsoft Corporation do not develop. According to Form 10-K, Part IV, Item 15; we can tell that management of Microsoft Corporation have conducted thorough evaluations of business risks that affect financial reporting as per required by Sarbanes Oxley Act of 2002 so that it will be able to certify quarterly and annual financial statements and to evaluate the effectiveness of disclosure controls and procedures. It also ensures that material information about business risks are communicated to management and disclosure to external stakeholders such as investors. We can exchange information about the business risk and likelihood to material misstatement due to fraud or error. (We have done a chart for Risk Factors Chart as per attached)

Microsoft Corporation’s operations and financial results are subject to various risks and uncertainties, including those described below, that could adversely affect our business, financial condition, results of operations, cash flows, and the trading price of our common stock. Table 3.1 summarizes the relationship between Microsoft’s business and industry and their business risk and auditor’s assessment of the risk of material financial statement misstatements. From the chart, we able to know that Microsoft faces a high inherent risk due to technology changes, currency rate risk, contingent liabilities, competitor risk. By looking at the industry and its risk are not sufficient enough, therefore performing preliminary analytical procedures can help us to have better understanding towards Microsoft Company and assess the materiality of the business risk.

STEP 4: PERFORM PRELIMINARY ANALYTICAL PROCEDURES

We will perform analytical procedures by comparing client ratios to prior year and industry benchmarks to provide a significant performance of Microsoft Corporation. Such comparison can help us to identify the areas with increased risk of misstatements that will require further attention during the audit.

Liquidity related ratios are one of the most widespread indicators of a company’s solvency. The current ratio shows the capacity of a company to meet current liabilities with all available current assets. Quick ratio describes solvency in the near future. Cash ratio shows if there is enough means for uninterrupted execution of current transactions. All three ratios for Microsoft Corporation are calculated in the following table.

Liquidity ratio

Value

Change

(col.3 – col.2)

Description of the ratio and its recommended value

30.06.2012

30.06.2013

1

2

3

4

5

1. Current ratio (working capital ratio)

2.60

2.71

+0.11

The current ratio is calculated by dividing current assets by current liabilities. It indicates a company’s ability to meet short-term debt obligations.

Normal value: no less than 2.

2. Quick ratio (acid-test ratio)

2.41

2.56

+0.15

The quick ratio is calculated by dividing liquid assets (cash, cash equivalents and short-term investments, current receivables) by current liabilities. It is a measure of a company’s ability to meet its short-term obligations using its most liquid assets (near cash or quick assets).

Normal value: 1 or more.

3. Cash ratio

1.93

2.06

+0.13

Cash ratio is calculated by dividing absolute liquid assets (cash, cash equivalents and short-term investments) by current liabilities.

Normal value: no less than 0.2.

For the whole period reviewed, the current ratio was observed to grow slightly from 2.60 to 2.71 (+0.11). On the last day of the period analysed (30.06.2013), the ratio demonstrates a very good value.

The quick ratio was equal to 2.56 on the last day of the period analysed. The quick ratio increased slightly (by 0.15) for the whole period reviewed. The value of the quick ratio can be specified as very good on 30 June, 2013. This means, Microsoft Corporation is seen to have a normal relationship between liquid assets (current assets minus inventory) and current liabilities (liabilities with a maturity of less than 1 year). Liquidity ratio of Microsoft shows us that on an average, Microsoft is able to settle its debts in the event of liquidation smoothly. They also have its ability to cover its short term assets into cash in the event of emergency and in a quick manner.

Similar to the two previous ratios, the cash ratio has a normal value (2.06) on 30 June, 2013 which demonstrates that the company has enough liquid assets (cash and cash equivalents) to meet current liabilities.

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