Accounting and Audit Framework: Risks, Controls, Fair Value, Internal Control, Audit Plan, and Auditor's Consent

This article discusses the risks and controls associated with the application of electronic data interchange, general IT controls found in a computer-based information system, problems associated with using fair value accounting, why fair value method is more relevant than historical accounting method, limitations of internal control, problems that may arise due to dependence on senior management, audit plan, and auditor's consent.

Accounting and Audit
Framework

Contents
Question 1........................................................................................................................................3
a. Discuss risk and controls associated with application of electronic data interchange.......3
b. Explain general It controls that are found in a computer based information system by an
auditor.....................................................................................................................................4
Question 2........................................................................................................................................5
a) Three problem associated with using fair value of accounting..........................................5
b) Discuss why fair value method is more relevant than historical accounting method........5
c) Mention three benefit of conventional historical cost method...........................................5
Question 3........................................................................................................................................6
a) Mention five limitation of internal control.........................................................................6
b) Explain some of the problem that may arise because of the dependence on senior
management............................................................................................................................6
Question No 4..................................................................................................................................7
a) Audit Plan...........................................................................................................................7
b) Auditor’s consent...............................................................................................................8
Question 5........................................................................................................................................9
Gross profit margin:...............................................................................................................9
Return on capital employed..................................................................................................10
Operating profit margin........................................................................................................10
Asset turnover ratio..............................................................................................................11
Gearing ratio.........................................................................................................................12
REFERENCES..............................................................................................................................13

Question 1
a. Discuss risk and controls associated with application of electronic data interchange.
Electronic Data Interchange is the electronic exchange of business information by utilising
a standardized form. It is a procedure which permits one organisation to transfer data to another
organisation electronically instead of using paper. Business concerns running business
electronically are termed as trading partners (Albawwat, 2021). General examples of EDI include
purchase orders (EDI 850), shipping statues (EDI 214), confirmations of payment (EDI 820) and
documenting inventory. The customary EDI format permits systems to generate EDI documents.
Risk associated with application of EDI
 Security and confidentiality: Advanced reach and transferring data usually requires
opening of information system so that data can be accessed and shared. This may also
lead to presentation of sections of organisation to digital security threats that can results
in disrupt the accessibility, honesty and confidentiality of information system on which
economic and social activities of Wise Limited depends. Unauthorised access, decline of
purchase transactions, hacker and other network break-inn are also a threat to company.
 Violation of privacy: In case where individuals and companies agrees and give consent
to particular terms for data sharing which includes the motive for which the data should
be accessed, still there is a level of risk associated to third party that whether intentionally
or unintentionally they will utilise data in a different manner. Certain threats have been
framed as ethical, to permit the requirement to identify the significance of problems such
as fairness, respect for human dignity etc.
 Processing Integrity: Sometimes invalid data entered by the vendors also creates
possibilities of risk in Wise Limited. Errors associated with back end system and
incomplete audit trail also creates situation of risk in the organisation (Dai, He, and Yu,
2019). Availability: Failure of system due to technical errors and attacks by viruses and worms
can also leads to creation of risk in Wise Limited. Sometimes denial of services by
hackers also generated risk in the organisation.
Effective Controls to minimize risks

 Authentication: Controls can be exercised by monitoring and accessing the user Id,
passwords of the employees and also keep an eye on the log-in procedures, level of
access and authority tables to reduce the impact of risk associated with security.
 Input Controls: It includes routine filed check, validity check, limit check and
reasonableness check of Wise Limited. It also focusses on software testing and computer
logs to reduce the effect of risk (Eierle, Hartlieb, and Ojala, 2021).
 Business planning: Backup data and systems are planned in such a way that they assist
Wise limited in a situation of risk. Firewall, encryption, detection of intrusion,
penetration test and vulnerability assessment are taken place to reduce risk.
 Network controls: In order to communicate in an effective and efficient manner,
network participants must be capable of transferring and receiving valid business
documents on which both the parties of an agreement agrees. In order to accomplish this
goal, organisation must ensure that fraudulent activities which are using EDI technique
are done at a controlled level.
b. Explain general It controls that are found in a computer based information system by an
auditor.
IT controls used by an Auditor
In order to safeguard the business of Wise Limited against cyberattacks and breaches of
data a number of information controls are used by an auditor. Basic information security controls
fall into three categories namely Preventive controls, Detective controls and Corrective Controls
(Faccia, De Lucia, and Pio Leonardo Cavaliere, 2020). These Controls are further grouped
below:
 Physical access controls
 Cyber access controls
 Procedural controls
 Technical controls
 Compliance controls

Question 2
a) Three problem associated with using fair value of accounting
There is different way of accounting cost of a possession in books of account such as
market value of the asset or its original acquired cost. All the method has its own benefits and
drawbacks. Fair value accounting is the method in which assets and liabilities are recorded at
current value prevailing in the market (Kend and Nguyen, 2022). But this method has certain
problem associated with usage they are as following: Risk of losing investors interest- when the fair value method is used there is income loss
when the value of the asset goes down. This reflects in the investor’s portfolio as net loss,
since most of the investor are trading everyday this would bring them loss. Company have to face lot of fluctuation- This accounting method is not at all useful for
some business. There are times when due to some reason assets and liabilities value
fluctuate a lot either becomes too high or too low. Due to this reason accounting them
would result in misleading in short term. When things could be different if long term
financial picture is taken.
 Historical valuation is lost- If company is showing net loss due to its asset being valued
at reduced amount. Historical value should have some relevance so that accurate results
are produced. Due to fair valuation organisation would face a artificial loss when actually
it is in profit.
b) Discuss why fair value method is more relevant than historical accounting method
The books of accounts of an organisation provide full information to the investor which is
considered fair and original. Fair value of method gives more appropriate value of the assets and
liabilities. This is because valuation should be given after adjusting goodwill, depreciation and
impairments. This might increase the volatility but is essential for effective decision making.
And also important for transparency and fair disclosers to the stakeholders (Khalid, Haron, and
Masron, 2018). Hence, fair value method is more relevant than historical cost method.
c) Mention three benefit of conventional historical cost method.
 Objectivity and reliability of accounting information- This method increases the
accuracy and reliability of the data. Since there is no room for adjustment no
increase decrease in the original value takes place manipulation is not possible.

 Simplicity and convenience- This concept is more simple while reporting the
assets and liabilities in accounting. There is no requirement of changing the value
every year and adjustment of the values. Next it does not mislead investor by
giving an amount that is not reliable in long term financial picture (Kotze, 2022).
 Consistency and comparability- this reporting method make comparability easy
as statements of one financial year can be compared to the financial records of the
other year. Also comparison with other entity is also simplified. Both inter and
intra comparison is easy and financial position can be ascertaining conveniently.
Question 3
a) Mention five limitation of internal control
Internal control is controls, policies and rules that is use for effective management to
minimize risk. Reasonable Assurance- Such measures a meant for preventing, detecting and rectifying
errors existing in current system. The organisation believes that it is enough however
such controls are not effective in each areas in which the company operates. Inappropriate management override controls- The management of the company should
not override the controls implemented. The controls are successful only if its
management and employees follow them. This system lacks in proper applicability in the
organisation.
 Human error- Other disadvantage of internal controls are that they are dependent on
human input. Due to this factor error and mistakes are possible any time. This would
result in inaccurate results and proper management of organisation.
b) Explain some of the problem that may arise because of the dependence on senior
management.
Senior management of the company is responsible for effective management, proper
utilisation of the resources, framing policies and maintaining internal control system for the
organisation (Latan, Chiappetta Jabbour, and Lopes de Sousa Jabbour, 2019). However heavy
dependency on the top level management may lead to:

 Delayed results – being depended on the top level management may result in late
decisions, because they have tot to do. But due to all the burden and responsibility
manager may suffer ignorance of important matters. Delegation of authority increases
accuracy in the business entity.
 Reduces productivity– when the employees are fully dependent on the senior
management for each and every decision they avoid creativity. Employees do not use
creative approach to solve a problem and dependence on the seniors to accomplish a task
which effects the overall productivity of the organisation (Miftahol Horri, 2018).
Question No 4
a) Audit Plan
The auditor should plan his work to enable him to conduct an effective audit in an e cientffi
and timely manner. Plans should be based on knowledge of the client’s business.
Plans should be made to cover, among other things:
 Acquiring knowledge of the client’s accounting systems, policies and internal control
procedures;
 Establishing the expected degree of reliance to be placed on internal control;
 Determining and programming the nature, timing, and extent of the audit procedures to
be performed; and
 Coordinating the work to be performed.
Plans should be further developed and revised as necessary
Matters to be consider by auditor in development of audit plan:
 The nature, timing and extent of planned risk assessment procedures, as determined under
relevant standards of auditing named as “Identifying and Assessing the Risks of Material
Misstatement through Understanding the Entity and Its Environment” (Rozario and
Vasarhelyi, 2018).
 The nature, timing and extent of planned further audit procedures at the assertion level, as
determined under SA named as “The Auditor’s Responses to Assessed Risks”.
 Other planned audit procedures that are required to be carried out so that the engagement
complies with SAs.

 The audit plan is more detailed than the overall audit strategy that includes the nature,
timing and extent of audit procedures to be performed by engagement team members.
Planning for these audit procedures takes place over the course of the audit as the audit
plan for the engagement develops.
Benefits of Audit Planning:
 It provides the assistant carrying out the audit with total and clear set of instructions of
the work generally to be done.
 It is essential, particularly for major audits, to provide a total perspective of the work to
be performed (Widuri, Handoko, and Prabowo, 2019).
 Selection of assistants for the jobs on the basis of capability becomes easier when the
work is rationally planned, defined and segregated.
b) Auditor’s consent
Situation where client information will be shared by the auditor to third party are being
mentioned below:
 Where in case the Government department such as tax authority would require the same
specially when the client case is under supervision with tax authority’s
 Sometime the requirement of law states that the information must be shared by the
auditor. In that case it is essential for the auditor to share the information.
 The professional codes states that it is mandatory for an auditor to disclose the
confidential information when there is professional duty for him or there is a right to
disclose the same when it is not prohibited by the statute in order to comply with ethical
standards and ethical requirement.
The obligations imposed by ethical principles of professional competence and due care on
chartered accountants are being mentioned below:
The auditor shall comply with relevant ethical requirements, including those pertaining to
independence, relating to financial statement audit engagements (Wu and Xie, 2021).
 Professional Skepticism: The auditor shall plan and perform an audit with professional
skepticism recognising that circumstances may exist that cause the financial statements to
be materially misstated.
 Professional Judgment: The auditor shall exercise professional judgment in planning and
performing an audit of financial statements.

 Sufficient Appropriate Audit Evidence and Audit Risk: To obtain reasonable assurance,
the auditor shall obtain sufficient appropriate audit evidence to reduce audit risk to an
acceptably low level and thereby enable the auditor to draw reasonable conclusions on
which to base the auditor’s opinion.
 Conduct of an Audit in Accordance with Professional Standards: It is essential for an
auditor to conduct an audit in accordance with standards of auditing. The audited
financial statement is being reliable for the users who are using the same (Zhou, Li, and
Zhao, 2022).
 Complying with standards Relevant to the Audit: The auditor shall comply with all SAs
relevant to the audit. An SA is relevant to the audit when the SA is in effect and the
circumstances addressed by the SA exist. The auditor shall have an understanding of the
entire text of an SA, including its application and other explanatory material, to
understand its objectives and to apply its requirements properly
Ethical rules to be followed by auditor while handling the client money:
It is essential for the auditor to kept money of the client in a separate bank account in order
to ensure that such money must be kept separately and could be used for the purpose for which it
has been obtained such as payment of tax dues etc.
Question 5
Gross profit margin:
The gross profit margin provides a correlation between gross profit and operating revenues i.e.
sales of net. This ratio is measured and seen in proportion. It measures the percentage of each
sale in rupees remaining after payment for the goods sold. It’s one of three major profitability
ratios, the others being operating profit margin and net profit margin. Arguably, it’s the most
important of the three profitability measures. The gross profit margin is calculated by subtracting
direct expenses or cost of goods sold (COGS) from net sales which gives gross profit. That
number is divided by net sales, then multiplied by 100% to calculate the gross profit margin
ratio.
Formula:

Interpretation:
Gross profit margin depends on the relationship between sales price, volume and costs. A high
gross profit margin is a favourable sign of good management.
Return on capital employed
Return on capital employed is calculated by dividing net operating profit, or earnings
before interest and taxes (EBIT), by capital employed. Another way to calculate it is by dividing
earnings before interest and taxes by the difference between total assets and current liabilities. It
is another variation of ROI.
Formula:
Where,
Capital employed = Total Assets – Current Liabilities
or
Fixed Assets + Working Capital
Interpretation:
ROCE should always be higher than the rate at which company borrows. Intangible assets (assets
which have no physical existence like goodwill, patents and trade-marks) should be included in
the capital employed. But no fictitious assets (such as deferred expenses) should be included
within capital employed. If information is available, then average capital employed shall be
taken.
Operating profit margin
Operating Profit Margin is a profitability or performance ratio that reflects the percentage of
profit a company produces from its operations before subtracting taxes and interest charges. It is

calculated by dividing the operating profit by total sales and expressing it as a percentage. The
margin is also known as EBIT (Earnings Before Interest and Tax) Margin. Operating profit
margin is also calculated to evaluate operating performance of a business. It differs across
industries and is often used as a metric for benchmarking one company against similar
companies within the same industry.
Formula:
Interpretation:
Operating profit ratio measures the percentage of each sales in Pounds that remain after
the payment of all costs and expenses except for interest and taxes. This ratio is followed
closely be analysts within the organisation because it focuses on operating results.
Operating profit is often referred to as earning before interest and taxes or EBIT.
Asset turnover ratio
The asset turnover ratio, also known as the total asset turnover ratio, measures the efficiency
with which an organisation uses its assets to produce sales. The asset turnover ratio formula is
equal to net sales divided by the total or average assets of a company. A company with a high
asset turnover ratio operates more efficiently as compared to competitors with a lower ratio,
hence, higher then ratio, better it is.
Similarly, fixed asset turnover ratio measures the efficiency with which the firm uses its
fixed assets. A high fixed assets turnover ratio indicates the efficient utilization of fixed assets in
generation of sales. A firm whose plant and machinery are old may show a higher fixed asset
turnover ratio than the firm which has purchased them recently.
Formula:

Interpretation:
A high total assets turnover ratio indicates the efficient utilization of total assets in
generation of sales. Similarly, a low asset turnover ratio indicates total assets are not
efficiently used to generate sales.
Gearing ratio
A gearing ratio is a measure used to establish financial leverage, in this context, leverage is the
amount of funds acquired through creditor loans – or debt – compared to the funds acquired
through equity capital.
Formula:

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