2AUDITING AND ASSURANCE SERVICES In the audit profession, it is the main job responsibility of the auditors to conduct examination and inspection of the financial statements of the audit clients with the aim to discover any material misstatements in them due to the presence of errors or frauds as the audited financial statements assist the key stakeholders in various investment decision- making process (Louwerset al.2015). It can be seen that the management teams of the audit clients use certain assertions while preparing the financial reports. These audit assertions can be considered as the implicit or explicit declaration as well as certain representations made by the clients’ management for preparing the financial statements and the main concerns behind the use of these assertions is to ensure the appropriateness and disclosure of the financial information (Knechel and Salterio 2016). The use of these assertions can be seen for various assets and liabilities of the companies like property, plant and equipment, inventory and others. Certain examples of these assertions are accuracy, valuation, completeness, cut off, existence and others. The auditors must consider the analysis and examination of these audit assertions with the aim to find any risks in them. In case there is any risk in the assertions, the auditors are needed to examine whether these assertions risks can develop the key audit matters to not (Redinget al.2013). The main aim of this report is the analysis of the assertions used in the provided case studies with the aim to find the risks in them so that the key audit matters can be determined. Answer to Question 1 Requirement [a] Cut off:This assertion states that all the business organizations are needed to record the inventory transaction at the correct date of the financial year (Titera 2013). It means the managementsofthecompaniesmustputalltheinventoryrelatedtransactioninthe accounting books at the correct date from the documents of inventory received and inventory supplied. In addition, it is incorrect to include the previous year’s inventory in the current
3AUDITING AND ASSURANCE SERVICES year. However, the case of Green Computer Solutions describes that inventory of 2018 includes 26% sales of 2018 and 17% sales of 2017. As per the above discussion, it is the incorrect recording of inventory in the books of the company that indicate towards the presence of error in the process of inventory valuation (Hall 2015). Thus, this assertion is at risk. Accuracy and Valuation:The presence of this assertion indicates that it is the responsibility of the companies to conduct the valuation of inventory in the accurate manner. Hence, the managements of the companies are needed to ensure certain aspects; first, the need to accurately conduct the physical inventory count; second, they are required to take calculate the correct amount of costs of goods sold in the income statements by taking the value from the balance sheet (Bumgarner and Vasarhelyi 2018). It can be seen from the provided information about Advanced Computer Solutions that the company has recently moved the inventory from one central warehouse to six different warehouses. Hence, this movement of the inventory can lead to the error in the inventory counting process. This aspect can affect the computation of costs of goods sold in the income statements as the company reports the inventory value in the balance sheet based on the results in the physical inventory count process (van Buurenet al.2014). Hence, this assertion can be considered at risk. Requirement [b] With the aim to test the cut off assertion of inventory, the auditor is needed to identify the aspect that whether the company has recorded the inventory related transactions at the correct date (Groomer and Murthy 2018). For this, verification of the documents of goods received and good supplied needs to be done by the auditors. After that, the auditor should review the inventory valuation process for recognising any irrational events that can lead to slow moving of the inventories. After that, the auditor needs to review whether there was any
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4AUDITING AND ASSURANCE SERVICES stop in the flow of inventory due to any orders from the management (Groomer and Murthy 2018). For the next assertion at risk, the auditor is needed to systematically observe the inventory valuation process in order to recognize any inaccuracy in the process (Glover, Prawitt and Drake 2014). In this process, the auditor needs to conduct meeting with the employees of inventory section for discussing the physical inventory counting process. The auditor needs to ensure verification of the inventory count tags of the company. Most importantly, it is needed for the auditor to test the inventory counting process in every warehouse and tally the same with the confirmation from the central warehouse (Glover, Prawitt and Drake 2014). Requirement [c] ASA 701 As per ASA 701 Clause 7, three objectives of the auditors are there: they are the determination of key audit matters, development of opinion on financial statements and communication of the same in the auditor’s report (auasb.gov.au 2019). As per ASA 701 Clause 8, key audit matters can be defined as those matter that have major significance in the financial statements as per the auditors. Auditor’s discussion with the governance body is needed for the determination of these key audit matters (auasb.gov.au 2019). As per ASA 701 Clause 9, there are three requirements that the auditors should take into consideration. First, the auditors should consider the higher risky areas in the financial statements that can lead to material misstatements. After that, the auditors are needed to undertake analyzing the management’s used judgements and accounting estimates. Lastly, the
5AUDITING AND ASSURANCE SERVICES auditors are needed consider the effect of crucial events or transactions on the audit of the financial statements of the companies (auasb.gov.au 2019). As per ASA 701 Clause 10, it is needed for the auditors to determine the fact that which of the matters or issues are the most crucial for the audit of the financial statements of the companies (auasb.gov.au 2019). Rationales The first rationale is that the inaccurate valuation of the inventory of Advanced Computer Solutions has be ability to create material misstatements in the financial statements of the company (Sirois, Bédard and Bera 2018). The second rationale is that the valuation of inventory of the company involves crucial judgements of the management of the company that includes crucial accounting estimates and others. Lastly, the occurrence of significant event can be seen as the company has moved their inventories from one central warehouse to six different regional warehouse and this event can have significant impact on the audit of the financial statements of Advanced Computer Solutions (Cordoş and Fülöp 2015). Key Audit Matters Disclosure Why SignificantHow Audit Addressed the Key Audit Mattes Theinventoryinhandofthecompany includes the sales of 2018 and 2017 It can be seen from the case that 26% sales of 2018 and 18% sales of 2017 are included in theinventoryinhandof2018.Thiscan happenduetothepresenceoferrors.In addition, inventory valuation in the company is subject of significant judgements. Hence, this is a material aspect for the audit. The substantive audit procedures are: - Verificationof the documentsof goods received and good supplied - Review the inventory valuation process for recognisinganyirrationaleventsthatcan lead to slow moving of the inventories - Review whether there was any stop in the flow of inventory due to any orders from the management Transfer of inventoriesThe substantive audit procedures are:
6AUDITING AND ASSURANCE SERVICES It can be seen from the provided case that the company has transferred their inventories in six new warehouses from the central one. This can create error in inventory counting process. In addition, this process is subject to judgement and hence, crucial for auditing. -Systematicallyobservetheinventory valuation process - Conduct meeting with the employees of inventory section for discussing the physical inventory counting process - Verification of the inventory count tags of the company -Testtheinventorycountingprocessin every warehouse and tally the same with the confirmation from the central warehouse Answer to Question 2 Requirement [a] Valuation:As per this particular assertion, the companies are needed to report the assets, liabilities and equity in the correct value that is cost value less accumulated depreciation (Kharisova and Kozlova 2014). For this reason, the need is to consider the appropriate rate of depreciation for deriving the actual depreciation expenses on the assets. It can be seen from the case of Green Machine Ltd that appropriate depreciation rates have not been applied on the property, plant and equipment of the company as low rate of depreciation has been considered (Appelbaum, Kogan and Vasarhelyi 2017). For the application for incorrect rates of depreciation, it is not possible to ensure the correct valuation of property, plant and equipment which can create material effects on the financial statements. For this reason, it can be said that this assertion is at the risk. Accuracy:As per this assertion, it is needed for the managements of the companies to accurately conduct all the transactions related to property, plant and equipment that include the proper classification of the revenue as well as capital expenses related to these assets (Byrneset al.2018). The case of Green Machine Ltd shows that the company has not treated
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7AUDITING AND ASSURANCE SERVICES the expenses related to property, plant and equipment in the accurate manner as certain capital expenses are included in the income statement and certain revenues expenses are capitalized (AICPA 2017). As this inaccurate action of the company can create material impact, hence, this assertion needs to be considered at risk. Requirement [b] For the first assertion risk, it is needed for the auditor to methodically observe the depreciation charging process of the company for property, plant and equipment. After that, the auditor needs to undertake the recalculation of the revised rates of the depreciation for the property, plant and equipment (Koganet al.2014). For this purpose, it is needed for the auditor to take into consideration the assessment of the residual values of property, plant and equipment and the amount of profit or loss from the sale of the same assets. After that, the auditor should undertake the comparison of the ratios of depreciation. In addition, the auditor needs to ensure the examination of the adherence of the company with the accounting standards of depreciation (Koganet al.2014). With the aim to address the second audit assertion at risk, the auditor of the company should ensure re-examining the company’s procedures for the capitalization of the expenses related to property, plant and equipment and the auditor needs to ensure this by obtaining the property, plant and equipment lists (Glover, Taylor and Wu 2016). This process will be majorly cooperative for the auditor to recognize the expenses that have been wrongly capitalized and the expenses that have been wrongly included in the income statement. At the same time, the auditor of the company needs to re-examine the judgments of the company’s management for the expenses (Glover, Taylor and Wu 2016).
8AUDITING AND ASSURANCE SERVICES Requirement [c] ASA 701 According to ASA 701, Section 7, there are three objectives for the auditors; they are determination of key audit matters, formulation of opinion on financial statements and communication of the same in the auditor’s report (auasb.gov.au 2019). According to ASA 701, Section 8, key audit matters can be defined as those issues that contain key importance in the financial statements as per the auditors. Auditor’s discussion with the governance body is compulsory for the determination of these key audit matters (auasb.gov.au 2019). According to ASA 701, Section 9, there are three requirements that the auditors should comply with. First, the auditors need to consider the upper risky areas in the financial statements that can contribute to material misstatements. After that, the auditors are needed to commenceanalyzingthemanagement’sutilizedjudgementsandaccountingestimates. Lastly, the auditors are needed consider the consequence of crucial events or transactions on the audit of the financial statements of the companies (auasb.gov.au 2019). According to ASA 701, Section 10, it is obligatory for the auditors to determine the fact that which of the matters or issues are the most central for the audit of the financial statements of the companies (auasb.gov.au 2019). Rationales It can be said as per the first rationale that the inaccurate application of depreciation and wrong division of the expenses are capable in creating material impact on the financial statements of Green Machine Ltd (Christensen, Glover and Wolfe 2014). It needs to be mentioned as per the second rationale that the management team of the company has used certain judgements including accounting estimates in the valuation of property, plant and
9AUDITING AND ASSURANCE SERVICES equipment that can be in the danger of uncertainty. It needs to be mentioned as per the third rationale that the significant events or transactions having impact on the audit are the application of low rates of depreciation and wrong distinction of expenditures (Kachelmeier, Schmidt and Valentine 2017). Key Audit Matters Discloser Why SignificantHow Audit Addressed the Key Audit Mattes Application of low rates of depreciation It can be seen from the case that the company has applied low rates of depreciation and it can lead to the material misstatements in the financial statements. Moreover, the inclusion of significant judgments and estimates has made this matter significant for the auditing. The applied substantive audit procedures are: -Observe the depreciation charging process ofthecompanyforproperty,plantand equipment - Undertake the recalculation of the revised rates of the depreciation -Assessmentoftheresidualvaluesof property,plantandequipmentandthe amount of profit or loss from the sale of the same assets - Comparison of the ratios of depreciation -Examinationoftheadherenceofthe company with the accounting standards of depreciation Incorrect distinction of expenses The company has incorrectly capitalized the revenueexpensesandhasincludedthe capital expenses in the income statement; and thiscancreatematerialimpactonthe company.Moreover,theenclosureof significant judgments and estimates has made this matter significant for the auditing The applied substantive audit procedures are: -Re-examiningthe company’sprocedures for the capitalization of the expenses related to property, plant and equipment -Obtainingtheproperty,plantand equipment lists -Re-examinethejudgmentsofthe company’s management for the expenses
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10AUDITING AND ASSURANCE SERVICES Conclusion To infer, it is needed for the auditors to conduct the examination of the key assertions of the financial statements as it helps the auditors in the determination of the key audit matters. The auditor then needs to express their audit opinion based on the determination of the key audit matters. As per the above discussion, the identified key audit assertions at risk are accuracy, valuation and cut off. The auditors of the two companies should develop the substantive audit procures based on the key audit assertions at risk. In addition, they are needed to make adherence to the principles of ASA 701 for the determination of the key audit matters and the communication as well as disclosure of the same.
11AUDITING AND ASSURANCE SERVICES References AICPA, 2017.Audit guide: Audit sampling. John Wiley & Sons. Appelbaum, D., Kogan, A. and Vasarhelyi, M.A., 2017. Big Data and analytics in the modern audit engagement: Research needs.Auditing: A Journal of Practice & Theory,36(4), pp.1-27. Auasb.gov.au.2019.[online]Availableat: https://www.auasb.gov.au/admin/file/content102/c3/ASA_701_2015.pdf[Accessed18 Jan. 2019]. Bumgarner,N.andVasarhelyi,M.A.,2018.Continuousauditing—anewview. InContinuous Auditing: Theory and Application(pp. 7-51). Emerald Publishing Limited. Byrnes, P.E., Al-Awadhi, A., Gullvist, B., Brown-Liburd, H., Teeter, R., Warren Jr, J.D. and Vasarhelyi, M., 2018. Evolution of Auditing: From the Traditional Approach to the Future Audit 1. InContinuous Auditing: Theory and Application(pp. 285-297). Emerald Publishing Limited. Christensen, B.E., Glover, S.M. and Wolfe, C.J., 2014. Do critical audit matter paragraphs in the audit report change nonprofessional investors' decision to invest?.Auditing: A Journal of Practice & Theory,33(4), pp.71-93. Cordoş, G.S. and Fülöp, M.T., 2015. Understanding audit reporting changes: introduction of KeyAuditMatters.Accounting&ManagementInformationSystems/Contabilitatesi Informatica de Gestiune,14(1). Glover, S.M., Prawitt, D.F. and Drake, M.S., 2014. Between a rock and a hard place: A path forwardforusingsubstantiveanalyticalproceduresinauditinglargeP&Laccounts: Commentary and analysis.Auditing: A Journal of Practice & Theory,34(3), pp.161-179.
12AUDITING AND ASSURANCE SERVICES Glover, S.M., Taylor, M.H. and Wu, Y.J., 2016. Current practices and challenges in auditing fair value measurements and complex estimates: Implications for auditing standards and the academy.Auditing: A Journal of Practice & Theory,36(1), pp.63-84. Groomer, S.M. and Murthy, U.S., 2018. Continuous auditing of database applications: An embedded audit module approach. InContinuous Auditing: Theory and Application(pp. 105- 124). Emerald Publishing Limited. Hall, J.A., 2015.Information technology auditing. Cengage Learning. Kachelmeier, S.J., Schmidt, J.J. and Valentine, K., 2017. The disclaimer effect of disclosing critical audit matters in the auditor’s report. Kharisova,F.I.andKozlova,N.N.,2014.Applyingthecategoryof«Assertions(or preconditions)»Inauditoffinancialstatement.MediterraneanJournalofSocial Sciences,5(24), p.180. Knechel, W.R. and Salterio, S.E., 2016.Auditing: Assurance and risk. Routledge. Kogan, A., Alles, M.G., Vasarhelyi, M.A. and Wu, J., 2014. Design and evaluation of a continuous data level auditing system.Auditing: A Journal of Practice & Theory,33(4), pp.221-245. Louwers,T.J.,Ramsay,R.J.,Sinason,D.H.,Strawser,J.R.andThibodeau,J.C., 2015.Auditing & assurance services. McGraw-Hill Education. Reding, K.F., Sobel, P.J., Anderson, U.L., Head, M.J., Ramamoorti, S., Salamasick, M. and Riddle, C., 2013.Internal Auditing: Assurance & Advisory Services. Institute of Internal Auditors, The IIA Research Foundation. Sirois, L.P., Bédard, J. and Bera, P., 2018. The informational value of key audit matters in the auditor's report: evidence from an Eye-tracking study.Accounting Horizons.
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13AUDITING AND ASSURANCE SERVICES Titera,W.R., 2013. Updating auditstandard—Enablingaudit dataanalysis.Journal of Information Systems,27(1), pp.325-331. van Buuren, J., Koch, C., van Nieuw Amerongen, N. and Wright, A.M., 2014. The use of business risk audit perspectives by non-Big 4 audit firms.Auditing: A Journal of Practice & Theory,33(3), pp.105-128.