Costco Wholesale Corporation Audit Risk Assessment and Procedures

This report is a memorandum prepared for Deloitte Consulting LLP, focusing on the audit risk assessment for Costco Wholesale Corporation. It provides an overview of Costco's background, including its founding, market position, and operational structure, highlighting its membership-based hypermarket model and its significant presence in the retail industry. The report details the company's reliance on technology and the associated inherent risks, particularly concerning revenue recognition and related products. It analyzes inherent risks such as the collectability of receivables, sales returns, and the impact of technology and consumer spending. The document also addresses control risk, detection risk, and outlines substantive analytical procedures, including risk management strategies and the importance of internal controls. Furthermore, the report recommends strategies to mitigate risks related to consumer spending, reputational concerns, intense competition, supply chain failures, and fraud. The report emphasizes the role of auditors in evaluating procedures and policies, and in advising management to achieve retail chain objectives. The assessment includes an evaluation of accounting policies, industry trends, and the company's risk factors, offering insights into the financial performance and operational challenges faced by Costco.

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MEMORANDUM
to: Johnathan Liljegren, Auditor, Deloitte consulting llp
from: Jun Liu, Accountant, Costco Wholesale Corporation Audit Engagement
subject: Costco WholeSale Corporation audit risk
date: December 15, 2019
Dear Mr. Liljergren,
At your request sir, I have compiled all the necessary and required information for the
company’s estimation of its audit risk. The company’s name is COACH Inc. the
memorandum shows an overview of the company’s background information and the
conclusion about the application of proper inherent risks, detection risks and control risks.
Costco Wholesale Corporation Overview and Background
Costco Wholesale Corporation, simply known as Costco was founded in Seattle Washington
in 1983. The company has subsidiaries and store located in 785 stores in major cities in the
United States of America and other countries. As of 2015, Costco was the second largest
retailer in America and across the entire globe only behind Walmart. In 2019, Costco was
ranked at position 14 on the Fortune 500 rankings as one of the largest corporation in the US
by revenue consideration. By 2019, Costco had 546 stores in the U.S, 100 stores in Canada,

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39 stores in Mexico, 29 in the U.K, 26 store in Japan and the rest distributed all over
countries in Asia and Europe (Byrnes et al, 2019),. It is a member’s only hypermarket that
offer high quality products at low costs. It sells its own brand and other brands and its profit
strategy is through membership fees, high sales, high product turnover, low profitability and
large purchases. (Costco Wholesale Corporation 10-K).
Industry, Competitors and Operation
Costco Wholesale Corporations operates in the retail and wholesale industry. It is a
large membership. it is a large membership only hypermarket which offers a wide range of
products from groceries, clothing, alcoholic and non-alcoholic beverages, bakeries,
electronics, pharmaceutical products and many more. By 2019, the company operated 785
stores across the world with an average area of 146, 000 square feet. The warehouses are in
operation every single day of the week. Its marketing strategy is to provide high quality
products at low cost all across its customers and its members. Its competitors include the
largest retail store in the world Walmart, Amazon, Kroger and Target. Costco ancillary
business also provides its members with food courts, gas stations, eyewear and pharmacies.
(Costco Wholesale Corporation Capital IQ).
Management / Auditors conclusion on internal controls
The company’s management and audit committees determined that internal controls
are effective. The audit committee subsequently recommended to the Board of Director’s that
the 2012 audited financial statements be included in the annual report. Our firm expressed an
unqualified opinion with respect to the company’s internal controls and all consolidated
financial statements for 2012.

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Technology Concerns
Costco is heavily dependent on technology. As noted in the 2017 10-K, the company
needs to implement new technologies to remain competitive and mitigate business risk . The
business risk associated with technology includes Costco’s ability to sustain its market share
in the industry and continue to grow. The company must implement new technologies to
maintain its differentiation from other manufacturers and, according to the 2012 10-K, to
achieve financial targets. A firm’s dependence on technology increases inherent risk for
audits (Farooq, & De Villiers, 2017).
Costco is a large, complex organization operating in a dynamic industry. As such,
reliance on technology creates risk for material misstatements. For example, when personnel
are not adequately trained on new information systems, inherent risk increases. Substantial
and timely training is required to minimize human error when entering transactions in
systems that provide data to the financial statements. Additionally, control risk fluctuates
until management and auditors evaluate the operating effectiveness of new information
systems.
Accounting policy and assertions to be evaluated
The significant accounting policy evaluated in this memo is revenue recognition and
Related Products Revenue Recognition. Revenue is recognized by Costco when products are
delivered to dealers or distributors and ownership is transferred. The primary assertion is
existence. Other relevant assertions include occurrence, accuracy, completeness and cut-off.
In this respect, transactions are tested to determine they took place, accounts receivables
exist, sales and accounts receivables are recorded at the proper amount, and all sales
transactions are recorded at the correct amount and in the proper period (Kanjanapradit,
Benos, & Angelidis, 2017)..

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Inherent Risks
Costco Wholesalers generates revenue through two primary activities: sales and
financing. One area of inherent risk is the collectability of accounts receivables and finance
receivables. It is critical to understand the distinction between the two activities when
performing test of details on accounts receivables. The detection risk for accounts receivables
needs to be low in order to determine if any finance receivables are mistakenly classified as
accounts receivables. This is important because this plan is designed to test sales and related
products revenue, not finance revenue.
Sales returns also affect inherent risk. In the case of Costco we must review the
dealers’ terms and identify if any right to return unsold products exist. For example, dealers
may be able to return 2012 unsold models when 2017 models become available for sale. This
could explain any seasonal increases in returns which otherwise appear abnormal.
Inherent risk and the assessment
The expansion of Costco Wholesale Corporation operating under the international and
local trademarks increases the potential of business risks which forces the retail companies in
this industries to come up with policies and actions to curb this risks. This is the inherent
risks involved in the retail industry. The role of the internal auditor further has become more
important in evaluating the effectiveness of procedures and policies and informing the board
and the senior management to assist in achieving the objectives of the retail chain. Proper
management of inherent risks and business risks at Costco boosts its competitiveness. The
management team should view management of risk in making decisions concerning
sustainability and company investments. Accordingly, the review of the risks addresses the
sufficiency and insufficiency of internal controls and how to improve their effectiveness.
The inherent risks in the retail industry include;

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1. A decline in consumer spending- one of the greatest dangers facing the retail stores
include a declining purchasing power from the consumers.
The role of the auditor is to ensure that;
a. The company takes proper procedures to consider and monitor the impact of the
changes in indicators affecting spending such as ; unemployment, government
spending and many others.
b. Monitor confidence levels of the consumer index so as to measure the market
conditions of consumers and their behaviors.
c. Proper strategy implementation on consumer spending should be adopted.
d. They help to monitor the daily sales and the consequences of the decrease in sales.
2. Reputational Risk
Due to the direct contact of customers and the retail chain, the worst risks is when the
customers stop buying from a store like Costco and view them from a negative light. Further,
inherent risk increases due to the advancement of social media and the internet. A
shortcoming in consumer satisfaction will negatively impact the reputation of the store hence
affecting their revenues.
Recommendation
a. The recommendations in this is to ensure that the store takes periodic consumer
satisfaction surveys to predict the needs and expectations of the consumer.
b. Management systems to ensure that complaints from customers are dealt with
c. Provide appropriate training to the employees.
d. The company should ensure that it draws proper policies in dealing with social media to
act swiftly on negative customer feedback and tainting of their image and brand.

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e. Ensure that there is a good consumer –employee relationship and quality interaction.
3. Intense competition
Retail stores and supermarkets have intense competition due to barriers to the entry. Increase
in competition may hinder the growth of the retail company. Competition makes sure that
retail stores like Walmart and Costco influence consumers purchasing decisions through price
reduction (Marques, Santos, & Santos, 2016)..
Recommendations
1. it will be recommended that the company periodically monitors the product prices in
the market with that of the competitors
2. increase customer satisfaction through products like loyalty cards and other customer
friendly concepts
3. adoption of an elaborate product pricing strategy by understanding the behaviors of
the consumer and their purchasing decisions
4. Planning for strategic sales increase by taking advantages of events such as Christmas
holidays, back to school and sports events.
Supply Chain Failure
The lack if goods to display in the supermarket stores is a hindrance to the daily operations of
the store due to failure of the supply chain.
Recommendations
1. The auditor recommends that the outlets may qualify more than one supplier to avoid
depending on one supplier
2. Use of proper sales forecasts

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3. Adopt a proper stock management policy
4. Periodically control stock and maintain a reasonable inventory level. This will ensure
that there is a smooth operation in the retail store without facing any shortage in the
shelves.
5. Adopt automated systems in the store management systems to review the level of
stock available and increase its sales.
Fraud and theft and poor storage is also another inherent risk faced by the retail store
Detection risks and Substantive Analytical Procedures
Risk and money management strategy
The retail industry risk management strategy is the main document that describes the
risk management system in the Retail industry, and defines the basic principles in accordance
with which the Retail industry forms a system for managing risks and the adequacy of its own
funds (capital). The objectives of risk management and capital adequacy are to ensure and
maintain an acceptable level of risk, to provide capital to cover significant risks, and to
comply with the requirements of the state bodies of the American regulating the Retail
industry's activities.
To ensure stability and efficiency of work, the Retail industry has a risk management
system that allows you to efficiently and timely identify, evaluate and limit the risks taken by
the Retail industry, control their volume, structure and identify the main factors affecting the
degree of risk, minimize the consequences if risks occur. The Retail industry has created a
Risk Management Service, which ensures coordination and centralization of management of
all retail industry risks, independent of the activities of other divisions of the Retail industry
that carry out retail industry operations and other transactions that carry retail industry risks.
The risk management service is directly subordinate to the President of the Retail industry

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and has the right to report directly to the Retail industry's Board of Directors on problems
related to retail industry risk management (Knechel, & Salterio, 2016). .
The Retail industry identifies the following types of risks as significant: credit, market
(stock, currency, interest), operational, liquidity loss risk. The Retail industry is also exposed
to regulatory risk, the risk of loss of business reputation, legal, strategic and country risks,
and the risk of legalization (laundering) of proceeds from crime.
In the risk management process, the Board of Directors and the Management Board,
as well as the collegial bodies of the Retail industry (the Credit Committee, the Assets and
Liabilities Management Committee, the Problem Assets Management Committee) and the
Risk Management Service, managers and employees of structural Retail industry divisions.
The Internal Control Service and the Financial Monitoring Service have a number of control
functions in the risk management system.The risk management procedures inherent in the
Retail industry’s activities include identification, analysis, quantitative and qualitative
assessment, proposals to limit and minimize losses, and subsequent control and monitoring of
risk-bearing operations (Simnett, Carson, & Vanstraelen, 2016). Based on the results of the
assessment and monitoring of the level of accepted risks, the management bodies, specialized
bodies of the Retail industry and interested divisions of the Retail industry receive the
relevant management reports necessary for making decisions.
Assessment of Control Risk, Analytical Procedures, and recommended Substantive
Analytical Procedures, and Substantive Test.
In the common sense, the testing process is a sequential system of interrelated tasks
for monitoring the status of something. The question of the need for tests has long been
decided by practice: “Yes, we need it, but in its place, if they solve a certain range of
problems. It should be noted that the massive use of tests in practice occurred simultaneously

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with the intensive development of not so much a theory as testing technology. Today, this
control method is widely used in various scientific fields, including audit. So, at the
preliminary planning stage, the auditor evaluates risk and effectiveness of the accounting
system (Wiebe, Distasio, & Shirtliffe, (2016).. In addition, during the audit, the auditor must
understand the internal control system and evaluate it in terms of reliability, quality and
degree of trust using the testing procedure. Moreover, following the recommendations of
clause 28 of “Risk Assessment and Internal Control. The control system and its individual
tools are tested to obtain factual information on the reliability of the accounting services of
the client, financially responsible employees, etc.
In this case, specially designed tests, questionnaires (questionnaires), special forms
and checklists can be used, flowcharts, graphs, lists of comments and other documents .
“Audit evidence”, under the tests of internal control means “the actions of the auditor
conducted in order to obtain audit evidence regarding the proper organization and
effectiveness of the accounting and internal control system”. Sometimes the term
“compliance tests” is used in the literature, which is most accurately reflected in the
definition of tests of controls in ISA 400 “Risk Assessment and Internal Control”.
Assertion Test of Controls Substantive Procedures
Existence Confirm all purchase were
made
Trace shipping orders back to
purchase orders and verify quantity of
items ordered
Vouch invoices to compare the
quantity of items ordered with the

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shipping slip
Ensure all purchase payments were
made by authorized personnel for
authorized goods from authorized
vendors
Match purchase orders with
authorized vendor names and
authorized staff signatures
Obtain a copy of the final inventory
summary, trace items to tags and
inventory sheets and reconciling
inventory counts with the general
ledger
Completeness Verify item prices
Trace inventory items to the
source documents
Ensure all items purchased were
entered correctly in the invoices and
that the prices agree with COACH’s
pricing list
Match the raw material purchases with
vendor invoices
Trace the inventory number to the
inventory account and reporting

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system
Occurrence
Confirm customer’s method of
payment
Confirm the updating of
inventory receiving floor
sheet, segregation of duties,
and the update of perpetual
records
Match method of payment to
COACH’s retail industry statement to
verify the date of payment, transaction
number, and amount
Ensure floor sheets and recording of
inventory is completed by a different
staff member and ensure that a
voucher package is created after goods
are delivered to the warehouse.
Rights and
obligations
Inquiry of possible
consignment of inventory
Inspection of shipping and
receiving reports from
domestic and international
warehouses
Obtain direct confirmation from the
warehouse custodian in regard to
quantity, price of products, and
condition of inventory held at their
location
Examine shipping and receiving
reports from domestic and
international warehouses to verify that
the goods are being received on the
estimated date, traced to the
appropriate source journal, and
determined that proper cut off was