Audit: Key Assertions and Substantive Procedures for Inventory and Intellectual Property

This audit report discusses the key assertions and substantive procedures for inventory and intellectual property. It covers the occurrence and accuracy assertions for inventory, and the occurrence and accuracy assertions for intellectual property. It also includes key audit matters and their disclosures in accordance with ASA 701.

Running head: AUDIT
Audit
Name of the student
Name of the university
Student ID
Author note

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Table of Contents
Introduction................................................................................................................................2
Question 1..................................................................................................................................2
Answer (a)..............................................................................................................................2
Answer (b)..............................................................................................................................4
Answer (c)..............................................................................................................................5
Question 2..................................................................................................................................6
Answer (a)..............................................................................................................................6
Answer (b)..............................................................................................................................7
Answer (c)..............................................................................................................................8
Conclusion..................................................................................................................................9
Reference..................................................................................................................................11

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Introduction
Material misstatement risk is the risk that financial statement of the organization had
been misstated to the material level. The risk of material misstatement is analysed by the
auditors at 2 levels – assertion level and financial statement level. Risk at the assertion level
is segregated into control risk and inherent risk. Inherent risk is the risk that the susceptibility
of assertion to misstatement owing to fraud or error. On the other hand, control risk is the risk
that the misstatement cannot be prevented by the internal control level of the entity. Risk at
the financial level determines the possibility of fraud (Kharisova & Kozlova, 2014).
Auditors in Australia are obliged to follow the regulations and guidelines presented in
“ASA 701 Communicating Key Audit Matters in the Independent Auditor’s Report. It
provides the procedures those must be followed by the auditors while carrying out the audit.
It further deals with the responsibilities of the auditors for communicating the key audit
matters under the auditor’s report. Main purpose of communicating the key audit matters is
improving communicative value of auditor’s report through delivering more transparency
regarding the performed audit (Auasb.gov.au, 2019).
Question 1
Answer (a)
From the given scenario of Computing Solutions Limited it is identified that 2 key
assertions related to inventory are as follows –
 Accuracy – this assertion states that the amounts and other associated data with the
recorded events and transactions have been inappropriately recorded and the
associated disclosures have been described and measured inappropriately. While

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valuing the inventories the management shall take proper measures to value it
accurately as accurate valuation of the inventories plays important role in business.
Persons involved with valuation of inventories are responsible to ensure that the
business inventories have been valued properly and the accurate figures have been
recorded in the financial statement based on the valuation (Köhler, Ratzinger-Sakel &
Theis, 2016). As in the given scenario, the entity moves its inventory from its central
warehouse to 6 new regional warehouses. Hence, likelihood is there mathematical
error is there when dispatching the inventory from central warehouse and receiving
the same in the regional warehouse. Further, likelihood is there owing to error the
inventory turnover of the entity has been reduced from 5.8 times to 3.8 times over the
time period from 2017 to 2018 (Vik & Walter, 2017).
 Completeness – it refers that all events and transactions associated with inventory
those shall have been recognized have not been recorded and all the associated
disclosures those shall have been recorded under the financial statement have not been
included. As per the completeness assertion, understatement of the inventory will also
be considered as a key assertion associated with completeness. As per the given
scenario the inventory on hand for the entity has been increased from 18% to 22%
over the years from 2017 to 2018. Hence, likelihood is there the person in charge with
maintenance of records have not recorded the sales transaction for inventory which in
turn will show the inventories still in hand. Hence, risk assertion increases of
understatement or overstatement of the inventories as compared to actual inventories
available on hand. Further, the insufficient and ineffective control of the inventories
will lead to assertion associated with completeness.

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Answer (b)
Substantive procedures are those activities which are performed by auditors for
detecting the fraud or material misstatement at level of assertion. Substantive procedures
those can be performed with regard to the risk mentioned above are as follows –
 Accuracy risk – before performing the inventory count by the client, auditor shall
review the proposed procedures and policies of the client related to inventory count.
Some of the policies those must be checked are – (i) 2-3 person team for counts (ii)
proper sequencing and pre-numbering of inventory purchase and sells (iii) receiving
the goods and halting the shipping procedures (iv) separation of the goods those are
based on the consignment (v) master count sheet controlled by supervisor. The auditor
further may select in advance sample for the items for testing on the day of the count.
Auditor shall use both specific as well as representative item testing wherever
possible. Further, during inventory count the auditor shall observe whether the client
is complied with all the proposed procedures and policies. Moreover the dispatch
quantity from central warehouse shall be matched with the regional receipt records.
 Completeness – the auditor shall assure that the inventories, if any, held by the third
party on behalf of the 3rd party are included in final figure of the inventory. Copies of
the inventories sheets shall be matched with final figures of inventory for assuring
that no additions or omissions are there. If the inventory count is taken before balance
sheet date, a roll forward calculation shall be carried out considering the opening
balance and movements during the period under concern for arriving at closing value
of the inventories. Further, on sample basis the auditor may choose 10 goods receipt
notes and 10 goods despatch notes and matched with the recorded data to assure that
the inventories are recorded at proper value. Further, the auditor shall check that the
client is following a specific method like FIFO or LIFO for inventory.

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Answer (c)
In accordance with Para 9 of ASA 701 for communicating the key audit matters, after
carrying out the audit the auditor shall determine the matters those require significant
attention from the management who are associated with the preparation of financial statement
and handling of inventories. Further, the auditors shall describe each key audit matters
through appropriate heading, subheading under the separate section of the audit report.
Further, the auditors are required to mention the scope of audit they responded to key audit
matters. Introductory language for communicating the key audit matters section shall
represent –
 Key audit matters are those matters which in accordance with professional
judgements of the auditor are considered as most important as per the financial report
for the period under concern.
 Key audit matters are reported with regard to the entire financial report. Further,
forming the pinion on key audit matters the auditors do not form any separate opinion
solely for those matters.
Following matter with regard to the above will be regarded as the key audit matter –
Inventory return rate were considerably high
The company is experiencing high return level due to suspected problems in software.
It will lead to high amount of inventory in hand and lower inventory turnover rate. The
disclosure for this key audit matter will be as follows –
High return of inventories

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Return of inventories amounting to $ 525 million disclosed under Note 11 represents
the value of inventory returned from various buyers sold between the dates of 1st January
2018 to 31st December 2018 by Best Computing Solutions.
Significant clarification required from management for clarifying the suspected
problems associated with software. Management further required clarifying what actions
have been taken to solve the issue.
Question 2
Answer (a)
Intellectual property is the non-physical asset that grants potential for certain
privilege, rights and economic benefits to owner. Various key assertions involved with the
intellectual property intangible assets are as follows –
 Occurrence – this assertion states the risk that the business transactions recorded in
association with intellectual property has actually been taken place and the intellectual
property actually owned by the company. In the given scenario it is identified that
Shimmer uses the special formula for creating the product and only its owner know
secret ingredients applied to the formula. Hence, likelihood is there that the
intellectual property is not actually owned by the company or the intellectual property
does not qualify for getting ownership (Andersen & Hansen, 2018).
 Accuracy - this assertion states that the amounts and other associated data with the
recorded events and transactions for intellectual property have been inappropriately
recorded and the associated disclosures have been described and measured
inappropriately. Valuation brings together economic and legal concept of the
property. Presence of the asset is function of its ability to generate the return and

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discount rate applicable to the return. General rule for commercial valuation is that the
value of any item cannot be represented in abstract form and all that stated is value of
the item at particular time in particular place, in particular circumstance. This
principal further states that disposals or additions (Cordoş & Fülöp, 2015). As per the
given scenario, management of Beautiful Hair is considering recognizing the
intangible asset from acquiring Shimmers Pty Ltd as per AASB 3. However,
likelihood is there that while recording the intangible asset the company valued it
wrongly and recorded the wrong value in its financial statement.
Answer (b)
Substantive procedures those can be performed with regard to the risk mentioned
above are as follows –
 Occurrence – all the documents associated with ownership shall be verified with
regard to the ownership deed and title. Auditors shall further verify Shimmer Pvt
Ltd’s ownership regarding secret ingredient for the special formula. The auditor shall
further verify that the recognition criteria for the intangible asset in accordance with
AASB 138 are met by Beautiful Hair Ltd for recognizing the intangible asset under
their balance sheet. Further, the auditor must check that the transactions are complied
with the acquisition criteria in accordance with AASB 3 for qualifying to be recorded
as the asset acquired under the financial statement of Beautiful Hair Ltd
(Kachelmeier, Schmidt & Valentine, 2017). In accordance with AASB 10, if the
entity is not considered as acquirer it shall not record the intangible asset under the
balance sheet. The auditors are further responsible to check the documents regarding
the addition or de-recognition of the intangible asset (Sirois, Bédard & Bera, 2018).
Further, while valuing the intangible asset it shall be capable of being segregated from

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acquiree and shall be transferred, rented, sold or licensed with recognizable asset or
liability for the associated asset.
 Accuracy – 2 primary methods of gathering the evidences regarding the
management’s assertions for intangible asset are going through the documents and
papers associated with acquisition of intangible asset. Main objective of going
through the documents are to check the actual existence, ownership and value of the
intangible asset (Carson, Fargher & Zhang, 2016). The value then shall be matched
with the recorded value in the balance sheet of the company. Further, the company’s
policy shall be checked for valuing the intangible asset and shall asses that the
specific method is used for valuing the intellectual property. If the intellectual
property is insured, the insurance documents shall be verified properly to assure that
appropriate value of the asset is mentioned in insurance papers (Sultana, Singh & Van
der Zahn, 2015). The auditor shall further calculate the amortization expenses related
to intangible asset shall verify that the asset is recorded after giving effect to
amortization expenses. Further, if any lawsuits or any defects exists for the
intellectual property that shall be properly disclosed through notes to the account after
providing an amount as provision.
Answer (c)
Key audit matters help the users of financial statement to understand it in better way
through delivering additional information. It encourages better conversation among the
auditor and those people charged with the governance which in turn lead to better
governance. Further, it helps the auditor focussing on the areas of audit those requires careful
judgement to provide the audit with higher quality. Further, the key audit matters assists the
preparers to revisit the disclosures and financial reporting for the areas identified as key audit

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matters which in turn lead to higher and better quality financial reporting (Knechel &
Salterio, 2016).
Following matter with regard to the above will be regarded as the key audit matter –
Shimmer uses the special formula for creating its product and only its owner know
secret ingredients applied to the formula. Management of Beautiful Hair is considering
acquiring Shimmers Pty Ltd and recognizing the intangible asset from acquiring Shimmers
Pty Ltd as per AASB 3. However, likelihood is there that the intellectual property does not
meet the recognition criteria (Gimbar, Hansen & Ozlanski, 2015). Hence, the disclosure for
related key audit matter will be as –
Recognition of intellectual property intangible asset
The company recognized acquisition of Shimmers Pty Ltd as intellectual property in
their balance sheet amounting to $ 125 million disclosed under Note 15 represents.
Significant estimates and judgements required from management for recognising the
acquisition of intellectual property as intangible asset in their balance sheet. Further, the
management are required to clarify the valuation method and criteria used for valuing and
recording the asset under the balance sheet (Cordoş & Fülöp, 2015).
Conclusion
From the above discussion regarding the case study of Computing Solutions Limited
and Beautiful Hair Limited it is concluded that ASA 701 communicating the key audit
matters under the report of the auditor plays an important role to deliver the auditor report in
transparent and better way. Key audit matter shall be recognised by the auditor after
completing the audit of the financial statement. Major key assertion involved with the
business of Computing Solutions Limited are accuracy and completeness whereas the Major

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key assertion involved with the business of Beautiful Hair Limited are accuracy and
occurrence. Hence, the auditors shall comply with the principles and regulation of ASA 701
while addressing the key issues involved with the companies.

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Reference
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foretak (Master's thesis, Handelshøyskolen BI).
Auasb.gov.au. (2019). Retrieved 13 January 2019, from
https://www.auasb.gov.au/admin/file/content102/c3/ASA_701_2015.pdf
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