1AUDITING AND ASSURANCE SERVICES Executive Summary: The report would intend to evaluate the certification of audit risk as well as assertions from the two provided case studies. The managements of both the provided organisations have utilisedanumberofassertionsthatconstituteofaccuracy,valuation,existenceand classification in relation to their different classes of assets. Thus, the auditors of both the organisationsareneededtoadheretotheguidelineslaiddowninASA701for communicating the key audit matters by taking into consideration a variety of requirements. Moreover, the auditors need to design substantive audit procedures after they have identified the significant assertions, which are at risk.
2AUDITING AND ASSURANCE SERVICES Table of Contents Introduction:...............................................................................................................................3 Question 1: Advanced Computer Solutions Limited.................................................................3 (a) Assertions at risk in relation to inventory:........................................................................3 (b) Substantive audit procedures to the identified risks:........................................................4 (c) ASA 701 Communicating Key Audit Matters:................................................................5 Question 2: Green Machine Limited..........................................................................................7 (a) Assertions at risk in relation to property, plant and equipment:.......................................7 (b) Substantive audit procedures to the identified risks:........................................................8 (c) ASA 701 Communicating Key Audit Matters:................................................................9 Conclusion:..............................................................................................................................12 References:...............................................................................................................................13
3AUDITING AND ASSURANCE SERVICES Introduction: The auditors have the obligation of verifying and evaluating the financial statements of the organisations for assuring that material misstatements are not inherent in the same so that the stakeholders could be provided with accurate information that would aid in their decision-making process. When these financial reports are developed, it is necessary to make a number of assertions (Bédard et al., 2016). The audit assertions are inherent proclamations made by the organisations at the time of developing the financial statements. The primary reason that these assertions are used includes assuring the suitability and accurate disclosure of financial information with the help of the financial statements (Boolaky & Quick, 2016). The auditors need to test the ways through which the organisations use the assertions, since it might lead to audit risk owing to unsuitable use of audit assertions. If the assertions are found to be at risk, they need to ascertain whether they could be categorised under key audit matters in accordance with ASA 701 (Chambers & Odar, 2015). The report would intend to evaluate the certification of audit risk as well as assertions from the two provided case studies. Question 1: Advanced Computer Solutions Limited Accordingtotheprovidedinformation,thefinancialstatementsofAdvanced ComputerSolutionsLimitedcontainmaterialmisstatementsininventory,whichhave resulted in audit risk. The following two assertions are made in relation to inventory: (a) Assertions at risk in relation to inventory: Accuracy and valuation: According to this assertion, it is the statement, in which all figures represented in a financial statement are free from errors and they are based on appropriate valuation of assets, liabilities and equity balances. In the provided scenario, Advanced Computer Solutions
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4AUDITING AND ASSURANCE SERVICES Limited has agreed to supply items at a price, which is lower than 10% of the cost price. Hence, it is necessary to conduct inventory valuation accurately at net realisable amount. Along with this, the computer presentation package of the organisation is suffering from suspected software issue. Therefore, it is crucial for the organisation to find out the net realisable amount of those selling products in ending inventory (Christ et al, 2015). Existence: As per this assertion, inventory transactions need to be reported accurately. More precisely, recording the transactions at the exact dates is critical. The receipt and supply of product documents related to inventory aid the companies in conducting the same (Sultana, Singh & Van Der Zahn, 2015). It is not correct to include the past year sales in the stock of the current year, since this would result in improper inventory valuation. As per the provided case, 18% of the sales of 2017 and 26% of the sales of 2018 are included in the stock of 2018. This might be due to the return inward because of the software issues. Moreover, the accounting estimates and judgements of the management are involved in valuation of inventory, which puts this assertion at risk (Christensen et al., 2016). (b) Substantive audit procedures to the identified risks: Substantive audit procedure for accuracy and valuation: For analysing this audit assertion, the auditors need to observe the procedures under the physical stock count methodically (Gaynor et al., 2016). This would help the auditors to obtain a detailed knowledge of the internal control system within the organisation in relation to inventory count. Moreover, the physical presence of the auditor is necessary at the time of conduction of inventory valuation process. Along with this, the auditors need to assure the certification of all tags associated with stock count. Finally, the auditor needs to test the
5AUDITING AND ASSURANCE SERVICES inventories shifted to the new places by asking count confirmation from the main location (Christensen, Glover & Wolfe, 2014). Substantive audit procedure for existence: In case of the existence assertion, the auditors need to assess and examine the inventory tags for receipt of goods obtained and those delivered to the suppliers. Besides, it is necessary to evaluate whether any irrational events occurred in inventory count that resulted in the particular issues. Furthermore, the auditor could analyse the assertion of existence by reviewing the register of property, plant and equipment in the initial year of the audit client. Finally, the management judgements are needed to be examined as well as accounting estimations utilised by the organisation for conducting inventory valuation (Ege, 2014). (c) ASA 701 Communicating Key Audit Matters: Requirements of ASA 701: According to “Section 7 of ASA 701”, key audit matters are crucial to be ascertained alongwithformingtheauditopinionanddisclosingthesameintheauditreport. Accompanied by “Section 8 of ASA 701”, key audit matters are described as the issues that the auditors are liable to mention at the time of auditing the financial reports of an entity (Auasb.gov.au 2019). For this, the governance authority of the entity is to be approach for discussion. “Section 9 of ASA 701” requires the auditors in maintaining conformance to certain objectives for analysing the key audit matters. They include those areas in the financial reports prone to high material misstatement risk, presence of doubts on accounting judgements and estimates and effects of main events on the financial statement audit. Finally, as per “Section 10 of ASA 701”, the auditors are liable to consider the main events critical for the financial statement audit (Auasb.gov.au 2019).
6AUDITING AND ASSURANCE SERVICES Rationale for key audit matters: The above-identified risk assertions include three rationales, which are deemed as key audit matters. Firstly, die to the wrong inventory valuation, the possibility of material effect is inherent in the financial reports of Advanced Computer Solutions Limited. Secondly, there are a number of doubts expressed in the accounting assumptions and judgements used by the management for inventory valuation. Finally, inventory transfer to six locations could have a considerable effect on the financial statement audit (Gimbar, Hansen & Ozlanski, 2015). Disclosure of key audit matters: Key audit matterHow the scope of audit responded to the key audit matter Inventory transfer: There has been transfer of inventory from one place to six places, which is a main event for inventory valuation. In addition, such valuation includescertainmanagementestimatesand assumptions as well. The following procedures need to be performed for inventory valuation: 1.Re-performingthecalculationofweighted average cost and the same needs to be contrasted with the previous purchase invoices for a sample of inventory goods 2. Testing the ageing report of the management by taking a sample of inventory goods to the last recorded invoice Inclusionoflastyearsalesincurrentyear inventory: The following procedures need to be performed for inventory valuation: 1.Testingthenetrealisablevalueoflinesof
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7AUDITING AND ASSURANCE SERVICES Due to the inclusion of previous year sales in the current year inventory, it has turned out to be a significant audit matter. inventory to current selling prices 2.Re-performingthecomputationofinventory write-down Increased return level owing to software issues: Due to the complex software system, there has been varying integration levels, which could have impact on the financial reporting integrity and thus, it is crucial for audit. The following procedures need to be performed for this issue: 1. Discussion with the management regarding the IT environment and significant financial processes 2. Testing the IT control designs associated with its system of financial reporting Question 2: Green Machine Limited This case study provides an overview of Green Machine Limited, in which there has been an issue related to property, plant and equipment (PPE) in terms of cost, accumulated depreciation carried forward, disposals and additions in the period and depreciation expenses. The following assertions are at risk in relation to the above-stated asset: (a) Assertions at risk in relation to property, plant and equipment: Classification: According to the audit assertion, the organisations are committed towards right classification of their PPE (Kikhia, 2014). Moreover, with the help of this assertion, the organisationscouldassureappropriatedivisionofrevenueandcapitalexpenditures associated with PPE. Thus, it is necessary to maintain all expense-related information for
8AUDITING AND ASSURANCE SERVICES accurate classification. According to the provided case, the inaccurate classification of capital and revenue expenditures could be identified and this affects the classification assertion of audit. Therefore, it could be stated that the used estimates and judgements might be wrong owing to inaccurate expense classification, which places this assertion at risk (Kilgore, Harrison & Radich, 2014). Valuation: In accordance with this particular assertion, the organisations are needed to record all their balance sheet items after correct valuation. Moreover, PPE is to be recorded at cost after the subtraction of accumulated depreciation (Knechel & Salterio, 2016). The computation of accumulated depreciation is made with the help of straight line method for Green Machine Limited. However, the organisation has applied a depreciation rate, which is much lower than the actual rate. Hence, the valuation of non-current assets would not be correct in this case. Such inaccurate valuation might lead to inflated net profit and thus, the impact would be material on the financial statements. Finally, the management judgements and accounting assumptions are used for calculating depreciation, which could be inaccurate as well (Lenz & Hahn, 2015). (b) Substantive audit procedures to the identified risks: Substantive audit procedure for classification: For this assertion at risk, the auditor has to conduct review of both capital and revenue expenditures related to PPE for understanding the same in a better manner. Secondly, the policies pertaining to expense capitalisation of the organisation require re-investigation (Nicoll, 2016). Along with this, the source documents associated with PPE expenditures is another crucial step needed to be undertaken by the auditors.
9AUDITING AND ASSURANCE SERVICES Substantive audit procedure for valuation: For this specific risk assertion, the substantive audit procedure would be to review the mechanisms and policies of the organisation so that the depreciation rate could be ascertained effectively (Paterson, 2014). Apart from this, the depreciation rates are to be computed again for correct valuation of PPE. In addition, further investigation is required in relation to the residual amounts related to PPE and profit or loss from sale of portion of PPE. Finally, the auditor has to undertake the certification of the accounting assumptions and management judgements in the method of depreciation (Salleh & Jasmani, 2014). (c) ASA 701 Communicating Key Audit Matters: Requirements of ASA 701: As per “Section 7 of ASA 701”, determination of key audit matters is crucial along with providing the audit opinion and by combining the two aspects, the information is to be communicated and disclosed in the report of the auditor (Auasb.gov.au 2019). “Section 8 of ASA 701” defines key audit matters as the issues considered to be inevitable by the auditors at the time of auditing the financial reports of the organisation. For this, it is necessary to engage in conversation with the management teams of the concerned organisations (Weirich & Reinstein, 2014). “Section 9 of ASA 701” mentions that the auditors need to follow certain objectives for investigating the key audit matters. This is because such investigation would help them in identifying the material misstatements and audit risk (Simnett & Huggins, 2014). These objectives primarily include the following: Financial report areas containing increased material misstatement risk
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10AUDITING AND ASSURANCE SERVICES Presenceofconcernsintheaccountingassumptionsandjudgementsofthe management Influence of critical events on the financial statement audit Finally, as per “Section 10 of ASA 701”, the auditors are obliged to consider the critical events or issues deemed to be essential while auditing the financial statements of the organisation. Rationale for key audit matters: With reference to ASA 701, the identified risk assertions could be adjudged in the form of key audit matters because of certain reasons. The first reason is that the wrong use of depreciation rates and incorrect segregation of revenue expenditure and capital expenditure could cause material impact in the form of understatement of operating expenses and overstatement of net income (Sirois, Bédard & Bera, 2018). Secondly, the above-mentioned aspects in case of Green Machine Limited take into account the significant accounting assumptions made by the management as well as its judgments containing uncertainties. Finally, due to the wrong utilisation of the rate of depreciation and expense categorisation, significant events or transactions have occurred, which are deemed to have material impact while auditing the financial statements of the organisation (Sultana, 2015). Disclosure of key audit matters: Key audit matterHow the scope of audit responded to the key audit matter Wrong segregation of revenue expenditure and capital expenditure: The following procedures need to be performed for this issue: 1.Understandingthemethodologiesofthe
11AUDITING AND ASSURANCE SERVICES After consideration of all relevant aspects, there has been capitalisation of a portion of revenue expensesalongwithinclusionofcapital expenditure in the consolidated statement of profit or loss and this event is deemed to be crucial for audit operations. Moreover, this takes into account the assumptions and judgements critical to audit. organisation as well as their documented bases for significant assumptions and judgements 2. Reviewing both revenue and capital expenditures related to PPE 3. The policies have to be examined again for expense capitalisation 4. Authorisation of source documents pertaining to PPE Useoflowerdepreciationratesrelatedto property, plant and equipment: The organisation has applied lower than the actual rate of depreciation for arriving at its net property, plant and equipment. Such rate application could have considerable material effect on the financial statements of the organisation. The following procedures need to be performed for this issue: 1. Evaluation of the main estimates used to arrive at the recoverable amount of PPE and whether any leases are categorised in the form of onerous lease contracts 2. Test to be made based on sample to find out the mathematical accuracy related to the models of cashflowandassuringpertinentdatatolatest forecasts and approved budgets 3.Conductingsensitivityanalysisforkey assumptionslikeemphasisonthedriversof operating profit, growth rates in revenue and the rateofdiscountutilisedinthemodelsof
12AUDITING AND ASSURANCE SERVICES impairment 4.Analysisofthesuitabilityofdisclosures included in the financial statements Conclusion: To conclude, it could be stated that the role of audit assertions is extremely significant in the entire process of audit owing to the fact behind the ascertainment of the key audit matters. The managements of both the provided organisations have utilised a number of assertions that constitute of accuracy, valuation, existence and classification in relation to their different classes of assets. Thus, the auditors of both the organisations are needed to adhere to the guidelines laid down in ASA 701 for communicating the key audit matters by taking into consideration a variety of requirements. Moreover, the auditors need to design substantive audit procedures after they have identified the significant assertions, which are at risk. Finally, key audit matters and disclosures needed are highlighted in the above discussion for mitigating the audit issues of the concerned business organisations.
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15AUDITING AND ASSURANCE SERVICES Sirois, L.P., Bédard, J. & Bera, P. (2018). The informational value of key audit matters in the auditor's report: evidence from an Eye-tracking study.Accounting Horizons,14(5), 102-115. Sultana,N.(2015).Auditcommitteecharacteristicsandaccounting conservatism.International Journal of Auditing,19(2), 88-102. Sultana, N., Singh, H., & Van Der Zahn, J. L. M. (2015). Audit committee characteristics and audit report lag.International Journal of Auditing,19(2), 72-87. Weirich, T. W., & Reinstein, A. (2014). The PCAOB's Proposed New Audit Report.CPA Journal,84(4), 24-29.