A Comprehensive Audit Plan on PepsiCo (PEP)

A Comprehensive Audit Plan on PepsiCo (PEP)

AComprehensive Audit Plan on PepsiCo (PEP)

AComprehensive Audit Plan on PepsiCo (PEP)

PepsiCoIncorporation is a public and a multinational company that is basedin Purchase, New York. PepsiCo was founded in 1898 Herman Lay andDonald Kendall (PepsiCo, 2015). The company has an interest inmanufacturing and distribution of beverages, and grain-based snacks,but it is classified as a multinational company that operates in thebeverage industry. PepsiCo has mainly expanded through theacquisition of different companies (such as Tropicana in 1998) andmerging with companies that produce different products, including theQuaker Oats that produced Gatorade brand in 2001 (PepsiCo, 2015). Thecompany generated net revenue of about $ 66.68 billion in thefinancial year 2014 (PricewaterhouseCoopers LLP, 2003). PepsiCo’sstock is traded on the New York Stock Exchange as PEP, which meansthat the independent auditor should be guided by rules set by thePublic Company Accounting Oversight Board and Securities ExchangeCommission.

Industryanalysis

Thebeverage industry has been grown continuously over the years and itis estimated that the industry has about 7 billion potentialcustomers across the globe (Bhatnaga, Espinas, Moniruzzaman, Ghareeb&amp Guan, 2014). The beverage industry is characterized by twomajor trends. First, the industry is highly competitive where bothlarge and small firms manufacture products that are similar or servethe same purpose (Green Hasson Janks, 2014). For example, players inthe beverage produce non-alcoholic drinks with limited opportunitiesto differentiate their respective products. Secondly, trends showthat there is an increase in health consciousness among consumers,which is a challenge affecting all players in the beverage industry(Ethical Investment Research Services, 2006). Companies are underpressure to produce healthy drinks that are free of uncertifiedadditives and other ingredients.

Comparedto its close competitors, Coca Cola Enterprises Inc. and MonsterBeverages, PepsiCo is less profitable as indicated in Figure 1.

Figure1: Profitability, return on assets ratio

Figure1 indicates that PepsiCo ranks the least in terms of the management’scapacity to utilize the available assets to increase net profit. Thisindicates that PepsiCo may be less preferable to investors than othercompanies in the beverage industry.

Similarly,trends indicate that PepsiCo has the least level of liquidity asshown in Figure 2.

Figure2: Levels of liquidity

Althoughthe level of liquidity of PepsiCo has been increasing as shown inFigure 2, the liquidity of PepsiCo competitors has been increasing ata higher rate. This indicates that PepsiCo could be at a higher riskof meeting its obligations compared to its competitors.

Figure3: Efficiency, asset turnover ratio

Theturonver ratio shows that level of efficiency, which means thatPesiCo is the least efficieny company when compared with Coca Colaand Monster Beverages, as shown in Figure 3. This means that PepsiCocould be less attractive to investors than its competitors.

Figure4: Debt to equity ratio

Thedebt to equity ratio analysis indicates that PepsiCo has the leastreatio followed by Coca Cola and Monster Beverages repectively. Thismeans that the management of PepsiCo has managed to use more ofshareholders funds than creditors’ funds to finance investmentcompared to it competitors. Equity financing is more sequire thandebt, which implies that the management of PepsiCo has a suitableinvestment financing policy than its copetitors.

Scopeof the audit

Auditobjectives

Theprimary objective of the auditor will be to develop and express anopinion regarding the status of the financial statements of PepsiCobased on the results of an independent audit. However, it must benoted that the auditor does not relieve the company’s management ofits responsibilities of preparing financial statements. The main roleof the audit team will be to plan and perform an independent auditguided by the International Standards on Auditing with the objectiveof obtaining a reasonable, not absolute assurance, of the financialstatements and whether they are free of significant misstatements.Therefore, specific objectives of the audit will be to provide anindependent opinion indicating whether

  • The financial statements of PepsiCo present a fair financial position, cash flows, and financial performance in accordance with the provisions of the Public Company Accounting Oversight Board.

  • Accounting standards were followed on a basis that is consistent with that of the previous financial year, but taking account of any updates.

Termsof engagement

Theauditor will periodically require a written confirmation from themanagement, which will outline the common understanding of, terms of,agreement on engagement for the anticipated audit as required byprofessional standards. The audit team will be willing to discussissues of interest as the management may require in order clarifyingthe terms of engagement.

Ourdeliverables

Atthe end of this audit, the audit team aims at providing thefollowing

  • An independent auditor’s report, which will include the opinion of the auditor regarding the fairness and accuracy of the financial statements

  • A report (audit results) will be issued to the board of PepsiCo, which will guide the board members in reviewing the financial statements

  • A management letter discussing issues that do not call for the board’s involvement.

Auditapproach

Overview

Theaudit will be guided by the International Standards on Audit, whichwill help the auditor execute an efficient and quality audit. Thiswill be accomplished by:

  • Gaining an in-depth understanding of the company, its environment, business issues affecting it, and management’s efficiency in monitoring business processes and controls

  • Identifying critical audit risks, sharing auditor’s perspective, getting the feedback, and tailoring the audit to the risks

  • Using reasoned professional judgment in areas that require estimates or perceived to be subjective

  • To an extent that is considered practical, relying on the work of the company’s internal auditor

Theaudit approach will also include substantive analytics, key controlreliance, and detailed testing. The auditor’s understanding of thecompany will drive the assessment of materiality and theidentification of the key audit risks.

Riskanalysis

Theaudit procedure will be risk-based. The key audit risks considered inthis section have been identified based on the auditor’s knowledgeof the company, discussion with the previous auditor, and theassessment of the company as well as the industry trends andenvironment.

Auditrisks that are specific to the beverage industry

Inventoryis one of the most significant assets and inventory controls shouldensure that the inventory represented in the statement of thefinancial position actually exists. The auditor will determinewhether PepsiCo has a proper segregation of duties so that eachtransaction, preparation, authorization, and payment is handled bydifferent individuals. The audit procedures will also determine ifthe management of PepsiCo has put in place adequate detect andprevent the misuse of inventory in order to ensure that the financialstatements are properly adjusted and stated fairly.

PepsiCooperates in an industry that is characterized by aggressivemarketing, market consolidation, intense price competition, and theentry of non-traditional players (Bhatnaga etal.,2014). In addition, the company is affected by uncertainties thatresult from frequent changes in the price of raw materials,challenges in the financial market, and the availability of creditservices that has increased volatility of the financial market andthe global economy. The general awareness among consumers aboutpotential health risks that are attributed to sweetened drinks is asignificant risk for the company and the industry.

Implicationsof the industry and company specific audit risks

Theaudit team will build expertise in specific areas that increase theprobability for material misstatements and audit risk. Industry aswell as the company specific risks can impact audit procedures indifferent ways. Persistent increase in the level of competition islikely to affect the going concern of PepsiCo (Bhatnaga etal.,2014). Audit teams will determine whether there is a substantialdoubt regarding the going concern, which might be indicated bydefault in loan agreements, negative cash flows, work stoppages, andadverse financial ratios.

Secondly,inventory is one of the largest components of the company assets.This implies that the disclosure approaches adopted might affect thefinancial position, cost of sales, and profit significantly (Bhatnagaetal.,2014). In addition, the inventory is located in different countrieswhere PepsiCo has operations, which means that disclosure is likelyto be affected by differences in accounting standards. The audit teamwill evaluate the consistency of the accounting methods used indifferent branches and subsidiaries and adopt the one that isconsistent with provisions of the PCAOB.

Anaudit of the financial statements and cash flow will give the auditteam an insight into audit risks. For example, cash flow is aparameter of efficiency in company operations while expenses,liabilities, and revenues will help in substantiation of differentitems and transactions in the financial statements.

PepsiCoemploys a reasonable number of people (about 274,000 employees) inthe manufacturing, administrative, bottling, and the distributionchain operations. This calls for additional audit procedures sincepayroll is the largest item in the operating cost.

Table1: Potential audit risks and audit procedures

Risk area

Financial statement impact

Audit approach

Revenue recognition

Errors in the amount recorded as net revenue.

Trace a sample of inventory to ensure that they are recorded correctly.

Compare a sample of invoice dates with the shipment dates recorded in the sales journal

Inventory

Might affect the cost of sales and profits

Assess consistency in approaches used to account for and value inventory.

Examine a sample of inventory items and their supporting documents.

Payroll

Might affect the operating expenses

Ensure that all payroll costs are recorded.

Take a sample of employees’ names from the payroll and request to see them physically.

Management estimates: Some accounting estimates affect financial statements significantly and events may change from the expectations of the management.

Errors may occur on items recorded in the financial statements when due diligence is not applied in making estimates.

The audit team will determine the reasonableness of estimates by discussing them with the executive officer. The completeness, accuracy of the data, and assumptions used to make the estimates will be reviewed. The audit team will also review all disclosures made in the final financial statements.

Materiality

Themateriality level set in this audit plan represents the auditor’sjudgment on the perceived degree of misstatement that might influencedecisions of users of the financial statements. The audit team willconsider both the qualitative and quantitative factors whendetermining materiality. The overall materiality will be 2 % ($ 524)of the total expenses of the last financial period. Misstatementsthat are relatively small, but could affect the financial statementswill be considered as qualitative factors. This includesmisstatements that have the effect of turning losses into income,altering performance trends, or increase compensation.

Fraudand error

Theauditor considers the possibility that an error or fraud could affectthe opinion given in the financial statements, especially if it issufficiently material. In order to fulfill responsibilities withregard to fraud, the auditor will perform the following

  • Discuss with the management on issues (such as negligence, dishonesty, fraud, and disregard of directives) raised before the committee on accountability.

  • Inquire from internal auditor, management, and other relevant parties about the measures taken to prevent the risk of fraud.

  • Determine whether fraud could exist as part of the auditor’s client acceptance.

  • Perform analytical procedures on key items (such as revenue) in order to determine the possibility of unexpected or unusual relationships.

  • Include the elements of unpredictability when electing the timing, nature, and the extent of the audit procedures that should be performed annually.

  • Perform additional procedures to evaluate the management’s override of the company’s controls, including the bias in accounting estimates and evaluation of adjustments in the journal entries.

Theaudit team will notify the management about any case of suspectedfraud that will be discovered when performing the audit procedures.

Compliancewith authorities

Alltransactions that will be reviewed with the objective of expressingthe auditor’s opinion will also be assessed for compliance with thecompany’s authority and financial regulations. This part of theexercise will be integrated into the rest of audit procedures.However, the outcome of this work will be included in the auditor’sreport in a separate paragraph.

Relianceon internal control

Afterassessing the control environment of the company as well as itscontrol activities that are relevant to the audit, the auditor hasdecided to adopt a control-reliance approach for the company’spayroll cycle. The auditor will communicate in writing thesignificant deficiencies existing in internal controls to themanagement of PepsiCo on a timely basis as required by professionalstandards (New Zealand Institute Chartered Accountants, 2010). Forexample, the auditor will address deficiencies that were communicatedin the last audit report, but have remained unsolved. The previousauditor identified some key opportunities for streamlining ofoperations and improvement of internal control systems during thelast financial year. The auditor will update this information afterauditing the current financial statements.

Internalaudit

Financialregulations of the company require the board of directors tofacilitate an internal audit that has the capacity to provide aneffective examination as well as a review of the current financialtransactions (PepsiCo Incorporation, 2014). The auditor will identifythe key areas where the report of internal audit could provide auditassurance and determine the possible impact of internal audit on theprocedures of the external audit. The auditor will also obtain theAudit Planning Memorandum for the current financial year, whichindicates the key areas (such as accountability, segregation ofduties, and internal governance) that the internal auditor intends tofocus on.

Auditor’sresponsibility on other information published in annual reports andother documents

Theauditor takes account of the fact that the management of PepsiCo maywish to publish the auditor’s report together with the financialstatements. In this regard, the auditor will review these reportsbefore they are published in order to confirm that they are accurateas required by the International Standards on Audit (NZICA, 2010). Inaddition, the auditor will read other pieces of information containedin the publications in order to identify any material inconsistency.

Otherservices offered to PepsiCo by the external auditor

Theexternal auditor has not been allocated any other function other thanauditing the financial statement of PepsiCo. Any additional serviceallocated by the company will only be accepted if it does not impairindependence of the external auditor (NZICA, 2010).

Table2: Development in accounting

New developments

Implications to the entity

Financial audit implication

FASB update number 2014-08: Presentation of financial statements, property, equity, plants, and discontinued operations.

The updates on the presentation of financial statements became effective during the first quarter of 2015 for all public companies, such as PepsiCo. PepsiCo should review the way it has been presenting different items in its financial statements.

The auditor will review the financial statements to determine whether the PepsiCo has used the new FASB provisions in presenting property, equity, plants, and discontinued operations in its financial statements.

Auditorreport

TheInternational Auditing and Assurance Standards Board (IAASB) underISA 700 holds that a quality audit should be followed by an auditor’sreport that is informative and has the capacity to deliver value tothe stakeholders of the company (PricewaterhouseCoopers LLP, 2003).This section allows the auditor to form an opinion about the accuracyand the fairness of the financial statements of the company. Apartfrom expressing the opinion, the auditor will also include thefollowing in an expanded auditor’s report

  • An auditor commentary explaining the information contained in the auditor’s report, especially sections that give the auditor’s judgment.

  • A conclusion on the appropriateness of the assumptions of the management regarding the going concern of the company

  • A prominent auditor’s opinion on whether the financial statements are qualified or unqualified.

  • Any other information that might increase transparency regarding the audit performed.

Independence

Theauditor will maintain independence from PepsiCo as required by theInternational Standards on Audit (NZICA, 2010). The term independencein this case means that the auditor will avoid any engagements withthe company that might influence the final judgment regarding theaccuracy and the fairness of the financial statements prepared byPepsiCo. In identifying the relationships that should be reported,the auditor shall be guided by the International Standards on Audit.Some of the matters that the auditor will disclose include

  • Direct or indirect financial interest in the PepsiCo

  • Holding a leadership position that gives the auditor the right to exert some influence over accounting or financial policies

  • Business or personal relationships of a close relative, family, retired officer, or a senior officer

Atthe moment, there are no significant relationships, to ourprofessional judgment, between members of the audit team and PepsiCo.

Auditmanagement

Auditteam

Theaudit of PepsiCo’s 2015 year end will be accomplished by a team ofsenior personnel, who will be involved in the processes of planningand coordinating as well as directing the staff audit and the auditprocedures. Senior members of the team will provide guidance to theaudit team on complex, sensitive, and difficult issues.

Audittimetable

Theaudit will take about seven and half weeks as shown in figure 3.

Table3: Audit timetable

Month

October

December

Week

Week 1

Week 2

Week 3

Week 4

Week 5

Week 6

Week 7

Week 8

Preparation steps:

Review of audit contract

Review of previous audit reports

Assembling the audit team, materials, and workspace

Audit phase I:

Audit financial statements

Develop and discuss questions with the client

Audit phase II:

Audit internal controls and high risk areas

Develop and discuss questions with the client

Audit phase III:

Audit accounting and financial operations

Develop and discuss questions with the client

Audit consolidation:

Consolidate findings and recommendations

Prepare audit report

Complete the audit

Audithours and cost

Thefees the audit is set at $ 150,000, which includes the travel cost.The fees have been calculated on the basis of the number of hoursthat the audit team is expected to spend as well as the level ofskills involved in different tasks. Different components of the feehave been discussed with the management of PepsiCo in order todetermine the most economical and effective approaches.

Conclusion

Theanticipated audit will focus on the analysis of the accuracy as wellas the fairness of the financial statements of PepsiCo. The auditteam will give an independent opinion expressing whether thefinancial statements of the client present the fair view of thecompany’s financial position and performance. The audit team willneed to work in collaboration with the management and other membersof staff in order to ensure that the team gets all informationrequired to make a reasonable opinion. However, it must be emphasizedthat any form of collaboration or interaction with the client that islikely to impair the independence of the audit team should be avoidedby all means.

References

Bhatnaga,S., Moniruzzaman, M., Ghareeb, S., Espinas, S. &amp Guan, W. (2014).The Coca Cola Company. SlideShare.Retrieved September 5, 2015, fromhttp://www.slideshare.net/MdMoniruzzaman9/audit-project-audit-risk-analysis-of-the-cocacola-company

EthicalInvestment Research Services (2006). Obesityconcerns in the food and beverage industry.London: Ethical Investment Research Services.

GreenHasson Janks (2014). 2014industry snapshot. Los Angeles, CA: Green Hasson Janks.

NewZealand Institute of Chartered Accountants (2010). InternationalStandards on Auditing (Isa) Implementation in New Zealand.Wellington: NZICA.

PepsiCo(2015). Who are we? PepsiCo.Retrieved September 5, 2015, from http://www.pepsico.com/

PepsiCoIncorporation (2014). Auditcommittee chapter.New York, NY: PepsiCo Incorporation.

PricewaterhouseCoopersLLP (2003). Universityof California audit and communications plan: For the year ending June30, 2007.London: PricewaterhouseCoopers LLP.

Appendix

Comparisonwith competitors

PepsiCO

Profitability

Returnon assets = Annual net income / Average total assets

Year2012:

Annualincome = 6,178,000,000

Averageassets = (74,638,000,000 + 72,882,000,000) / 2

=73,760,000,000

ROA= 6,178,000,000 / 73,760,000,000

=0.084

Year2013:

Averagetotal assets = (74,638,000 + 77,478,000) / 2

= 76,058,000

ROA= 6,740,000 /76,058,000

=6,740,000 / 76,058,000

=0.089

Year2014

Averagetotal assets = (77,478,000 + 70,509,000) / 2

=73,993,500

ROA= 6,513,000 / 73,993,500

=0.088

Liquidity

Year2012

Currentratio = current assets / current liabilities

=18,720,000 / 17,089,000

=1.049

=1.05

Year2013

Currentratio = 22,203,000 / 17,839,000

=1.244

Year2014

Currentratio = 70,509,000 / 18,092,000

=3.897

=3.90

Activityratio

Assetsturnover ratio = net sales / Average total assets

Year2012

ATR= 65,492,000 / 73,760,000

=0.887

=0.89

Year2013

ATR= 66,415,000 / 76,058,000

=0.873

=0.87

Year2014

ATR= 66,683,000 / 73,993,500

=0.90

Debtratio

Debtto equity ratio = total liabilities / total equity

Year2012

Debtto equity ratio = 52,344,000 / 22,417,000

=2.34

Year2013

ATR= 53,199,000 / 24,409,000

=2.18

Year2014

ART= 53,071,000 / 17,578,000

=3.019

=3.02

Coca-ColaEnterprises Inc.

Profitability

Year2012

Averagetotal assets = (9,094,000 + 9,510,000) / 2

=9,302,000

ROA= 677,000 / 9,302,000

=0.073

Year2013

Averagetotal assets = (9,525,000 + 9,510,000) / 2

=9,517,500

ROA= 667,000 / 9,517,500

=0.070

Year2014

Averagetotal assets = (8,543,000 + 9,525,000) / 2

=9,034,000

ROA= 663,000 / 9,034,000

=0.0733

Liquidity

Year2012

Currentratio = current assets / current liabilities

=2,762,000 / 2,579,000

=1.071

Year2013

Currentratio = 2,568,000 / 2,195,000

=1.1699

Year2014

Currentratio = 2,460,000 / 2,608,000

=0.943

Activityratio

Assetsturnover ratio = net sales / Average total assets

Year2012

ATR= 8,062,000 / 9,302,000

=0.867

Year2013

ATR= 8,212,000 /9,517,500

=0.862

Year2014

ATR= 8,264,000 / 9,034,000

=0.9145

Debtratio

Year2012

Debtto equity ratio = total liabilities / total equity

=6,817,000 / 2,693,000

=2.531

Year2013

Debtto equity ratio = 7,245,000 / 2,280,000

=3.1776

Year2014

Debtto equity ratio = 7,112,000 / 1,431,000

=4.970

MonsterBeverage Corporation

Profitability

Year2012

Averagetotal assets = (1,362,399 + 1,043,325) / 2

=1,202,862

ROA= 2,060,702 / 1,202,862

=1.712

Year2013

Averagetotal assets = (1,420,509 + 1,043,325) / 2

=1,231,917

ROA= 2,246,428 / 1,231,917

=1.823

Year2014

Averagetotal assets = (1,938,875 + 1,420,509) / 2

=1,679,692

ROA= 2,464,867 / 1,679,692

=1.467

Liquidity

Currentratio = current assets / current liabilities

Year2012

Currentratio = 835,068 / 288,545

=2.894

Year2013

Currentratio = 1,183,043 / 316,014

=3.743

Year2014

Currentassets = 1,693,429 / 355,716

=4.76

Activityratio

Assetsturnover ratio = net sales / Average total assets

Year2012

ATR= 2,060,702 / 1,202,862

=1.713

Year2013

ATR= 2,246,428 / 1,231,917

=1.823

ATR= 2,464,867 / 1,679,692

ATR= 1.467

Debtratio

Debtto equity ratio = total liabilities / total equity

Year2012

Debtto equity ratio = 398,928 / 644,397

=0.619

Year2013

Debtto equity ratio = 428,230 / 992,279

=0.431

Year2014

Debtto equity ratio = 423,725 / 1,515,150

=0.2796

Figure5: Summary of ratios

Company

Year

Ration

ROA

Current ratio

ATR

Debt to equity ratio

PepsiCo

2012

0.084

1.05

0.89

2.34

2013

0.089

1.24

0.87

2.18

2014

0.088

3.90

0.90

3.02

Coca Cola Enterprises Inc.

2012

0.073

1.071

0.867

2.53

2013

0.070

1.170

0.862

3.178

2014

0.073

0.943

0.915

4.970

Monster Beverage Corporation

2012

1.712

2.894

1.713

0.619

2013

1.823

3.743

1.823

0.431

2014

1.467

4.76

1.467

0.280