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Running head: AMAZON FINANCIAL CASE STUDY

Case Study: AMAZON.COM, INC.


ACC 640
Deddy Prio Ekwandono

Professor Bryan Strang, CPA, CGMA


Southern New Hampshire University
July 22, 2016

AMAZON FINANCIAL CASE STUDY

Introduction
Auditing entails the independent and systematic examination of corporate accounts,
books, and documents to ascertain whether the financial statements are true and fair (Henry &
Robinson, 2015). As such, it ensures that all books of accounts are correctly maintained as
required by law. It entails maintaining a close working relationship between the companys
finance department, its audit committee, and infrastructure, as well as engaging the services of an
independent auditor. However, the external auditor must be acquainted with the client or
organization to comprehend its workings. It also entails planning and strategizing on how to
implement the audit process, and how to obtain financial information and evidence. In addition,
it includes evaluating the evidence, documenting and reporting on the auditing procedures and
findings. The report addresses these factors and provides memos that validate the financials of
Amazon.
Procedures and Field Work:
a. Description of the Audit Process
The audit process, since it is a formal check of the financial books of an organization, is
composed of various processes. With this being an internal audit, incorporation of audit
procedures and planning is paramount. In the first step, financial documents are requested and
the organization is notified of the audit. These documents include the previous audit report,
balance sheets, financial statements, ledgers, and receipts. In addition, the auditor can request for
organizational charts, as well as copies of board meetings held in correlation with the auditing
processes. In step two, the audit plan is prepared, which entails looking over the information
presented in the documents, as well as planning on how the audit will be conducted.

AMAZON FINANCIAL CASE STUDY

Consequently, a risk workshop is conducted, which involves the identification of possible


problems. Consequently, an audit plan is drafted. In step three, an open meeting is scheduled
with the top management and key administrative staff. In the meeting, the scope of the audit is
presented. Consequently, a timespan for the audit is set. In the fourth step, fieldwork is
conducted, where information gathered in the meeting is used in finalizing the audit plan. The
procedures and processes of the company are reviewed and the auditor tests or their compliance.
Internal controls are evaluated to ascertain whether they are adequate. The fifth stage entails
drafting a report about the audit findings. Included in the report are posting problems and errors
among other discrepancies. Any solutions are recommended. Lastly, a closing meeting is held,
where the auditor solicits a response on whether the management has agreed or disagreed with
the report.
The type of analytical procedures that will be used in this report include trend analysis,
ratio analysis, and reasonableness testing. They provide a preliminary analytical review, where
risk assessment is done to comprehend the financial performance of the company to develop an
audit strategy. Also, they substantiate the analytical procedures, where tests are detailed to reduce
the risks. The final analytical review is performed to ascertain the consistency of the auditors
comprehension of the firm. They encompass different steps. Firstly, developing an independent
expectation, such as prediction of a certain ratio, which is usually achieved through business and
industry trends. Also, the auditor should consider the threshold, which is the amount of
difference that is acceptable without any further investigation. Computations between expected
value and the recorded one conducted. Consequently, investigation of these differences is done
and formulation of conclusions made. However, explanations of the differences must be sought
for.

AMAZON FINANCIAL CASE STUDY

b. Explanation of the field work Procedures for Reviewing high-risk business


transactions
For high-risk business transactions, such as in the Amazon case, where the business
operates on a global scale, the auditing process can be termed as highly challenging. As such,
this will entail the use of auditing revenue recognition, as well as internal control over financial
reporting (ICFR) and accounting estimates. Also, because cash and revenue accounts are
involved with significant risks, the auditor will need to know and understand all the firms
business processes. The auditor should also obtain appropriate audit evidence and test controls
over the corporations revenue. Also, because these financials are of high-risk, the auditor needs
to assess any possible misstatements. Therefore, comprehending the source of revenue is
necessary. The auditor will also need accounting estimates involved. The auditing revenue will
also entail testing whether the recognized revenue is for the correct period. As such, quarterly or
annual revenue documentations is required to conduct the audit (Hoskin et al., 2014). This will
facilitate the auditor to perform procedures that address any instance of fraud risk, as well as the
other related statement disclosures. Also, the auditor will need to assess the reasonableness of the
estimates, thereby examining whether they conform to GAAP.
Also, because Amazon is a global firm, cross-border transactions may be considered as
high-risk for revenues particularly because each country in which the company has
establishments may deal with different currencies, and therefore, currency conversions are
necessary. Since Amazon deals with US dollars, it warrants that all other currencies must be
converted, such as euros (EUR) to dollars (USD), which on many occasions is a subjective
process. For this reason, the auditor should ensure that the accounts are valued at the end of the
year conversion rate. Also, since the auditor is dealing with international financial records, the

AMAZON FINANCIAL CASE STUDY

book of accounts should not be prepared in correlation to the US GAAP. Also, the auditor should
be able to ascertain whether the accounting principles were changed or switched. In essence,
when these are changed, then the accounting procedures should also be changed so that
inconsistencies that might arise from misstatements do not arise.
In addition, to investigate high-risk business transactions for Amazon would require the
use of internal controls. Deficiencies can be obtained via journal entries. For this reason, as
Hoskin et al., (2014) point out, the auditor should understand the flow of business transactions,
and thus, be able to instantly identify any risks that are posed by material misstatements.
Particularly, selecting the controls for testing will require them to routinely and infrequently use
them so as to identify cash and revenue misstatements. In addition, the auditor needs to
comprehend the information technology the company employs for financial reporting, which
entails automated and manual controls, the specific risks that result from the use of IT, as well as
the control over completeness and accuracy of the system-generated financial reports. For this
reason, any misstatements identified in the process warrants an evaluation of the system to
ascertain whether the internal controls are ineffective or deficient and whether these deficiencies
are as a result of material weakness.
For this reason, this information can be conveyed via charts and tables to show where
misstatements arose from, and thus, be able to map where deficiencies and inconsistencies arose
from. These are often accompanied by the audit report, and in many instances, they are detailed
in the appendix section of the report. In addition, graphs may also be effective in showing the
trend of revenues and cash over a certain span of time, such as showing the four quarters of a
year or comparing the trend of revenues over a span of five years. In essence, these charts, tables,
and graphs are helpful as they help an auditor note any discrepancies in the financial data.

AMAZON FINANCIAL CASE STUDY

c. Create a Test
According to Hoskin et al., (2014), risk assessment procedures test can be used in
obtaining an understanding of Amazons environment, including the internal controls employed
by the company. Essentially, this test ascertains and assesses any risk of material misstatements
in the corporates financials. Secondly, tests of controls will be performed to assess the control
risk for each high-risk transaction about the auditing objectives. Thirdly, analytical procedures
will be used to provide substantive evidence, particularly on how Amazon is performing in
comparison to competitors and the industry. Fourthly, to gather evidence for test controls, the
auditor will make inquiries from client personnel, as well as examine records, documents, and
financial reports. Fifthly, collecting evidence from analytical procedures will warrant the
truthfulness of the reported financials. This entails the use of profit margins and other ratios to
compare the operation of the company relative to the competitors, as well as making predictions
of the ending balance of revenues (Peress, 2010).
Risk Factors
a. Analyzing Income Statement
Amazon in its annual reports uses non-GAAP principles. The company preferred the nonGAAP principles because they best reflect the financial position of the firm (Amazon.com, Inc.
(2014); Amazon.com, Inc. (2015). However, the financial statements for Amazon can still be
analyzed using non-GAAP principles for auditing. Internal auditing entails the consideration of
various elements, such as the control environment, fraud risk assessments, control activities
communication and information, as well as monitoring. For the income statement, and as per the
Generally Accepted Accounting Principles (GAAP), various aspects are considered. However,

AMAZON FINANCIAL CASE STUDY

Amazon uses non-GAAP standards. These include the revenue, which is considered as a highrisk aspect for the business. Considering the 2014 and 2015 annual report, manual testing for
overstatement and understatement was done. There was an availability of quarterly and annual
revenues documentations of the revenue is required to conduct the audit. After manual tests had
been conducted, no misstatements were identified. The income statements were correct, and this
was confirmed by doing calculations to conduct checks. Since revenue is obtained by summing
up the amount of goods sold in a certain period, that is the price of each item multiplied by the
quantity sold. Checks from the annual reports revealed that services or sales rendered met four
criteria: a delivery must have occurred, or service had been rendered, there exists a persuasive
evidence that such an arrangement existed, the selling price was fixed determinable, and whether
collectability was reasonably assured. In addition, since the business is conducted online, the
company evaluated whether there was an appropriate record of gross product sales, as well as the
related costs, such as net amount earned as commissions. The company also acknowledged that
product sales represented revenue from the sale of goods and shipping fees. Service sales were
represented in terms of shipping fees and commissions. Furthermore, the company deducted
return allowances, which as expected, reduce the revenue. Incentive offers for encouraging the
customers were also deducted, which meant that the revenues were accurate.
The cost of sales were accurately documented, which entailed the purchase of digital
media, consumer goods, as well as revenue gross. This entailed, as reported on the annual report,
an inclusion of packaging supplies, delivery and sortation centers that are related to inbound and
outbound shipping costs, as well as Prime Video and Prime Music (Amazon.com, Inc. (2014);
Amazon.com, Inc. (2015). In 2014, the cost of sales increased, and this was clarified in the
annual report as caused by increase in product and shipping costs, which resulted in an increased

AMAZON FINANCIAL CASE STUDY

sales. Also, the difference between the revenues and the expenses were verified in the equity
section, and thus, it evidenced that the income statements were free of misstatements. In
addition, as the annual reports purported, the transaction reports that were obtained from the
general ledgers for revenue accounts were accurate, as well as free from any form of
misstatement. In addition, the operating expenses were all accounted for, and as asserted in the
reports, since they were audited, random expense transactions were obtained and documentation
retrieved. The balance sheets were accurate and in conformity to the non-Generally Accepted
Accounting Principles (GAAP). It can be concluded that even though non-GAAP principles were
used, the statements were accurate and truthful. However, GAAP principles were observed,
including the principles of non-compensation, prudence, continuity, sincerity, regularity,
consistency, permanence of methods, materiality, and good faith was upheld. As such, using the
non-GAAP principles in the annual reports removed any limitations posed by the GAAP
principles, thereby, increasing the accuracy of the corporates financials.
Evidence was further retrieved from financial ratios. As Albrecht et al. (2010) purport,
the gross profit margin assesses a companys financial health by indicating the proportion of the
money that is left over from revenues, which comes after accounting for the cost of goods sold
within the period. It is calculated by subtracting the cost of goods (COGS) from the revenue, and
then dividing the resulting figure by the revenue. This is simplified as indicated below:

In
have been indicated below:

the case of Amazon, the gross profit margins

AMAZON FINANCIAL CASE STUDY

Year
2015
2014
Gross Profit Margin
33%
29.5%
As indicated in the table, the gross profit has increased. Therefore, Amazon has an
effective pricing strategy, thereby a good financial health. Since the company has an adequate
gross profit margin, the financial risk is very low in the near future.
The Earnings per Share ratio is an expression of the companys net income that is
expressed on a per share basis. It is arrived at by dividing the net income by the weighted
average outstanding shares. The formula is simplified as follows:

For Amazon, it was calculated as follows:


Year
EPS

2015
1.25

2014
-0.52

As such, the ratio reveals that the company is profitable and thus, it has more profits that can be
distributed to its shareholders (Martani and Khairurizka, 2009). The increase in EPS ratio
ascertains that the company is poised to have low financial risk in the next couple of years.
b. Analyzing risk factors
The annual reports acknowledge the availability of risk factors. Firstly, the reports
acknowledged that the risk factors could adversely affect the business, operating results,
financial performance, as well as cash flows (Weygandt et al., 2015). The company
acknowledged that one of the risk factors it was exposed to include intense competition from ecommerce services, electronic devices and digital content. It also acknowledges the fact that

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some of its competitors have greater resources and more customers. As such, this might be used
as a reference in auditing whenever the financials have deteriorated. Its global expansion
endeavors, as acknowledged in the reports, might also strain the management, financial control,
reporting functions and operational resources. The expansion into new services, products,
technology, as well as geographic areas is also subject to financial, competitive, business, and
legal risks. For this reason, the company acknowledges the fact that these endeavors might also
affect the company financially. Also, these give rise to new challenges which might affect future
revenues, either negatively or positively.
Considering GAAP principles, Amazon upheld them in the consolidated balance sheets.
Considering the principle of materiality, the consolidated balance sheets for the 2014 and 2015
annual reports fully disclose the financial reports for the company. These include a
documentation of the companys current assets, such as marketable securities, inventories, as
well as cash and cash equivalents (Needles and Powers, 2010). In addition, since the balance
sheet for each annual report incorporated accounts for the previous year, the principle of
periodicity was upheld. The business also used the principle of permanence because the balance
sheets were consistent for both the 2014 and 2015 annual reports. Also, both negatives and
positives were accounted for, and thus, the principle of non-compensation was upheld. In
addition, since the annual reports were acknowledged to be accurate in bot reports, the principle
of sincerity was upheld. In addition, the financials of the annual report, as tested manually were
correct, meaning that the balance sheets for both years were accurate.
Various ratios can ascertain the availability of financial risk on the balance sheet. Looking
for evidence from the current ratio ascertains the availability of financial risk. According to
Henry and Robinson (2015), the current ratio determines the efficiency of a company, as well as

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how liquid it is, thereby enabling the determination of how capable it is to pay off its short-term
liabilities using its current assets. The ratio is an important to measure of a firms liquidity
because the short-term liabilities are usually due within the next financial year. As such, this
translates to the fact that the company has a limited time to raise funds capable of paying these
liabilities. It is imperative to correlate that the current assets can be converted to cash in the
short-term, such as marketplace securities, cash, and cash equivalents (Juma'h & Pacheco, 2008).
The ration is calculated by dividing the current assets by the current liabilities. It is usually stated
in numeric format. This can be simplified into the following formula

For Amazon, these can be obtained as follows:


Year
Current Ratio

2015
1.08

2014
1.12

As seen from the current ratios, in 2014, the value was high but plunged in 2015.
However, it is vital to know that the value always remained more than one. For this reason, it can
be derived that the company has more assets than liabilities, and for this reason, the company can
easily make current debt payments (Needles and Powers, 2010). Hence there is little financial
risk.
Considering the debt-equity ratio, which is obtained by dividing the total liabilities by the
shareholders equity was calculated as follows:

Year

2015

2014

AMAZON FINANCIAL CASE STUDY


Debt-Equity Ratio

1.31

12
1.50

The debt-equity ratio improved from 2014 to 2015. As such, this means that Amazon has
increased its use of equity to finance its assets, instead of debt. In essence, indicates that the
company has reduced financial risks.
c. Use of Internal Controls
The management, as stipulated in the annual reports, establishes and maintains adequate
internal controls in its financial reporting. These are basically defined within the precincts of
Rule 13a-15f of the 1984 Act (Amazon.com, Inc. (2014); Amazon.com, Inc. (2015). As such,
it is compliant with regulatory bodies. In addition, the internal controls effective as they were not
changed between 2014 and 2015. However, the internal controls, as acknowledged in the annual
reports, may not prevent all fraud or detect all error because all financials are based on certain
assumptions.
Concerning risks, the only financial risk imminent for the company in the two financial
years is that the current assets have reduced significantly in the timespan. As such, this signifies
that the current assets are reducing, which is not good for the firm. The following ratios
represents the financial health for eBay, which is Amazons main competitor.

EBay Financial Health. Source: Morningstar Financials (n.d)


In comparison, the following ratios are for Amazon.

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Amazon Financial Health. Source: Morningstar Financials (n.d)


It can be derived that Amazon has a better current and quick ratios, meaning that its
financial position in the market is strong. However, looking at the financial leverage, which is
obtained by dividing the total debt by the total equity, Amazon seems to have huge total debt
compared to equity, which poses a high risk to the company.
d. Audit Universe
The audit universe is basically an aggregation of all areas available for auditing. As such,
the auditor must divide the organization into manageable and auditable activities, which are
called auditable units. From the auditing process conducted in this report, auditable activities
include business functions, such as finance, accounting, and purchasing, analyzing policies,
practices and procedures, major contracts, information systems, and lastly, business units.
e. Sampling Program
Based on the risk analysis conducted, the best sampling program for the audit universe
will be the use of analytical procedures in ascertaining whether the cash and revenues are correct.
For this reason, the sample that can be used for analysis includes ascertaining the business
functionalities, such as financing, accounting, and purchasing. Also, analysis of the practices,
processes, and procedures used in auditing is necessary, as well as consideration of the business
units.
f. Preferable audit testing procedures

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The preferable audit testing procedures entail performing analytical procedures, which
involves trend analysis, ratio analysis, and reasonableness testing. They provide a preliminary
analytical review, where risk assessment is done to comprehend the financial performance of the
company to develop an audit strategy.
Memos
a. Memo of Internal Audit
The chief financial officer (CFO),
Amazon.com, Inc.
The consolidated balance sheets of Amazon have been audited as of December 31, 2014 and
December 31, 2015, as well as the related statements of operations, income, cash and revenues,
debt and stockholders equity. Since the companys management is responsible for the financial
statement, this internal audit is meant to solely express an opinion on the financial statements
based on the audit.
The audit was conducted in accordance to GAAP principles. The financial statements, as per
the sampling done, are free of misstatements. The audit included various tests that portrayed the
financial health of the company. Also, the income statements and balance sheets for the two
years have been correctly presented, and thus, their accuracy was not compromised. Also, the
sampling entailed the use of ratios, such as the gross profit margin, earnings per share, current
ratio, as well as debt-equity ratios. In addition, trend analysis for Amazon financials were used,
which were compared to the main competitor Amazon faces, which is eBay. In essence, using
this rations was necessary as they provide the financial health and risks of the firm about the
competitors. It was found out that the company is enjoying favorable financial health compared

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to the major competitor, eBay owing to the current, earnings per share, and gross profit margin.
As such, the company has a strong financial health. However, one major risk that was identified
is the use of debt to finance the assets as compared to equity. This is an indication that the future
financials may be adversely affected.
As such, it is recommended that other pathways of financing the assets should be acquired,
such as increasing the number of investors. Also, preferring equity to debt financing is a
worthwhile step towards mitigating any risk that may arise from the use of debt to finance the
assets. Lastly, it is important to note that most of the financials were in conformity with GAAP
principles, as well as based on the Integrated Framework set by Internal Audit Control.
Deddy Priyo Ekwandono,
Internal Auditor.
b. Memo to Board of Directors,
The Board of Directors,
Amazon.com, Inc.
After ascertaining the credibility of the recent internal audit, it is clear that the financial
health of the company is not in jeopardy. The findings indicated that the company has enhanced
its financial strength from the year ended on December 31st, 2014 to December 31st 2015. This is
as per the analysis of various analytical procedures which evidenced that the gross profit margin,
earnings per share, current ratio, as well as debt-equity ratios have increased significantly
between the two financial years. However, in comparison with the competitors, the company is at

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a financial risk particularly because the leverage ratios indicated that the company uses debt to
finance its assets. This alone can impact on the company negatively.
As such, formulation of a strategy that will mitigate this financial risk is necessary. One
strategy that might work is reducing the amount of debt and increasing the number of assets so
that the leverage ratio falls significantly. By doing this, the company will be able to finance its
assets using equity, rather than debt.
However, a rough idea of how this strategy will be implemented is necessary. Firstly, gaining
more investors so that the corporates equity increases significantly, and lower the debts. As
such, the company should capitalize more on equity financing. Also, in line with this, Amazon
should stop soliciting for debt to finance its assets. Rather, it should use its equity more in
financing the business. Also, expansion is necessary as it will enable the company to gather more
assets, and thereby bring the leverage ratio down to match that of competitors. Also, expansion
will also accompany the increase in equity because more investors will be willing to invest in the
company.
Deddy Priyo Ekwandono
The Chief Financial Officer (CFO). Amazon.com, Inc.
References
Albrecht, W., Stice, E. and Stice, J., 2010. Financial accounting. Cengage Learning.
Amazon.com, Inc. (2014). Form 10K: Amazon.com, Inc. Annual Report. United States
Securities and Exchange Commission.
Amazon.com, Inc. (2015). Form 10K: Amazon.com, Inc. Annual Report. United States

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Securities and Exchange Commission.


Henry, E., & Robinson, T. R. (2015). Chapter 1. Financial Statement Analysis: An
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Juma'h, A.H. and Pacheco, C.J. (2008). The financial factors influencing cash dividend
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2016, from http://financials.morningstar.com/ratios/r.html?t=EBAY
Morningstar Financials, (n.d). Growth, Profitability, and Financial Ratios for Amazon.com
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Weygandt, J.J., Kimmel, P.D. & Kieso, D.E., (2015). Financial & Managerial Accounting.
John Wiley & Sons.