Auditing and Assurance: Inventory and Intellectual Property Intangible Assets

This paper discusses two key assertions at risk in relation to inventory and intellectual property intangible assets, along with substantive audit procedures and the requirement of ASA 701 for communicating key audit matters.

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AUDITING AND ASSURANCE
By (Name)
Name of the Course
Professor
Name of University
City and State
Date

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Executive Summary
Audit assertions are claims or representations made either implicitly or explicitly by the
management of a company who are held responsible for the preparation of financial reports of
their company regarding the appropriateness of the various disclosures and elements of financial
statements. There are various categories under which audit assertions can be classified, such as
transactions, classifications, account balances, as well as disclosures. Auditors are required to
confirm whether or not each and every assertion is recorded appropriately in accurate account
with proper amount or valuation.
There are various assertions at risk in relation to inventory and intellectual property
intangible asset. Furthermore, it is set out by ISA 701 that auditors need to communicate or
disclose key maters of audit in their reports of audit. This standard gives a mandate to auditors to
disclose or communicate the key matters of audit in their audit reports with regard to audits of
financial statement listed entities or companies. This standard is also purposed for enabling
auditors of other companies which are not listed in determining and ascertaining whether or not
key matters of audit should be included in the audit opinions contained in their reports of audit.

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TA T TBLE OF CON EN S
APTCH ER PAGE
ntrod ctionI u .................................................................................................................................................5
e tionQu s 1...................................................................................................................................................5
a. T o e A ertion at i n elation To n entorw K y ss s R sk I R I v y……………………………………………………………………5
i. al ation o n entorV u f I v y……………………………………………………………………………………………………5
ii. ompletene o n entorC ss f I v y…..………………………………………………………………………………………..6
b. tanti e A dit Proced re t at o ld e Per ormed in e pon e to acSubs v u u s h C u b f R s s E h
i denti ied A o eR sk I f b v ………………………………………………………………………………………………………………….6
i. al ation o n entorV u f I v y ………..…………………………………………………………………………………………7
ii. ompletene o n entorC ss f I v y .…………………………………………………………………………………………..8
c. T e e irement o A A omm nicatin e A dit Matter in t e A ditorh R qu f S 701 C u g K y u s h u ’s
eport and t e ationale or T i A ditin tandardR h R f h s u g S ..............................................................….....9
i. t i tandard a introd cedWhy h s s w s u …………………………………………………………………………………9
ii. o to determine e a dit materH w k y u s……………………………………………………………………………….9
iii. o to di clo e or comm nicate e a dit matterH w s s u k y u s……………………………………………………..10
e tionQu s 2…………………………………………………………………………………………………………………………………………….11
a. T o e A ertion at i n elation To ntellect al Propert ntan i le a etw K y ss s R sk I R I u y I g b ss s……………………..11
i. i tenceEx s ………………………………………………………………………………………………………………………11
ii. i t and o li ationR gh s b g s………………………………………………………………………………………………….12
b. tanti e A dit Proced re t at o ld e Per ormed in e pon e to acSubs v u u s h C u b f R s s E h

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i denti ied A o eR sk I f b v ………………………………………………………………………………………………………………..12
i. i tenceEx s …………………..………………………………………………………………………………………………….12
ii. i t and li ationR gh s Ob g s………………………………………………………………………………………………….13
c. T e e irement o A A omm nicatin e A dit Matter in t e A ditorh R qu f S 701 C u g K y u s h u ’s
eport and t e ationale or T i A ditin tandardR h R f h s u g S ..............................................................…...13
oncl ionC us .................................................................................................................................................16
e erenceR f s.................................................................................................................................................17

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Introduction
This paper is primarily aimed at identifying and explaining two key assertions which are
at risk with regard to inventory as well as identifying and describing two procedures of
substantive audit which should be carried out by the auditor in responding to each and every
identified risk of assertion. In addition to this, the paper gives an explanation and description of
the requirement of ASA 701 with relation to communicating and disclosure of key matters of
audit. In addition to this, the paper is purposed for identifying and explaining two assertions
which are considered to be at risk with regard to intellectual property intangible asset.
Furthermore, this paper is also aimed at identifying and describing a procedure of substantive
audit which the auditor should carry out in an effort to respond to each and every risk identified.
The requirements of ASA 701 are also explained in this paper with regard to disclosure of
intellectual property intangible asset.
Question 1:
a. Two Key Assertions at Risk In Relation To Inventory
There are two key assertion which are considered at risk regarding the inventory of
Computing Solutions (Eilifsen, Messier, Glover and Prawitt 2013, pp. 27). These are valuation
and completeness. Each of these risks have been described in detail in the following sections.
i. Valuation of Inventory
Valuation of inventory is considered at a high risk because Computing Solutions engages
and deals with computer packages and computer software which may often become obsolete and
outdated with time. This could possibly make their value to be significantly impaired. There is

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also a possibility that the computer packages and software may not be appropriately valued. This
due to the fact that Computing Solutions has been earning high returns resulting from the
company’s best-selling packages of computer presentation which have been experiencing
software problems and issues. Furthermore, there is a likelihood that Computing Solutions will
face difficulties and challenges in returning obsolete and outdated computer packages and
software to the specific suppliers involved due to certain issues and technicalities which may not
be avoided due to its nature of business. This therefore, puts the inventory of the company at a
possible risk of being disvalued (Hayes, Gortemaker and Wallage 2014, pp. 145).
ii. Completeness
Computing Solutions faces an assertion risk of completeness with regard to its inventory.
Completeness relates to appropriate recording of inventory in correct amounts in the financial
records. In the process of management of inventory, there is a possibility that the inventory could
have been under-stated in the books of the company thus rendering completeness of inventory at
a high risk. This can be explained due to the fact that a purchase may be initiated by Computing
Solutions but the inventory is not appropriately recorded in the accounting books upon receipt of
the inventory (Knechel and Salterio 2016, pp. 231). This risk may be caused by poor or weak
controls regarding inventory. For instance, Computing Solutions transferred its inventory from a
central warehouse to other six warehouses. There is a possibility that the employees of
Computing Solutions could have teamed up and stole the inventory and may not have recorded it
in its correct amounts in the inventory account. Also, the consigned inventory which was on
consignment should have been appropriately accounted for from the books of the company
(Eilifsen, Messier, Glover and Prawitt 2013, pp. 27).

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b. Substantive Audit Procedures that Could be Performed in Response to Each
Risk Identified Above
Substantive procedures are those that are carried out by the auditor with a view to
verifying or ascertaining the actual figures reported on the financial reports of the client. With
regard to the identified assertions risks relating to inventory, the auditor can perform a number of
substantive procedures of audit. These have been discussed below in detail (Messier, Glover and
Prawitt 2008, pp. 14). These are explained below.
i. Inventory Valuation
Regarding valuation of inventory, the auditor must inspect the various terms of the
various suppliers of the company in order to confirm that there were provisions or terms relating
to return of unsold computer packages and other items that were received in imperfect conditions
(Louwers, Ramsay, Sinason, Strawser and Thibodeau 2015, pp. 214). Additionally, he must seek
to carry out an inspection of inventory records of Computing Solutions with a view to
ascertaining if any items or computer packages had become obsolete due to being held for
extremely long periods (Hopwood, Leiner and Young 2011, pp. 52). He must confirm that any
impairments in the inventory are recorded appropriately and accordingly in the financial records
of the company (Eilifsen, Messier, Glover and Prawitt 2013, pp. 27).
Furthermore, according to the requirements of AASB 102, the auditor must consider
ascertaining that Computing Solutions has made a valuation of its inventory based on the
approach of Lower of Cost or Market value (LCM), which requires inventory to be valued at the
lower of cost or market value (Net Realizable Value). To accomplish this, he should recalculate
the cost of inventory of the company in order to confirm and ascertain that it has determined the

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pricing accurately. The auditor must also examine the prevailing trends in the market with a view
to gaining an understanding of the current market prices. A comparison of the inventory cost and
the prices in the market should be made for purposes of ascertaining whether the inventory was
sold for less or more (Hargie and Tourish 2009, pp. 104). Apart from vouching and testing the
pricing of inventory, the auditor must also consider carrying out a verification on the quality of
inventory of Computing Solutions since some of its computer packages and software have been
experiencing problems.
ii. Completeness
The following procedures must be performed by the auditor with regard to the
completeness assertion of the inventory of Computing Solutions (Eilifsen, Messier, Glover and
Prawitt 2013, pp. 29).
a. Performing cut off tests for purchase returns, purchases, sales and sale returns. He
should make sure that the amounts of these transactions have been recorded
appropriately, if any.
b. Carrying out tests for transactions which are possibly omitted as well as testing for
transactions which have been regarded invalid with respect to the tagged inventory of
the company, Computer Solutions.
c. Verifying the numerical and clerical accuracy of the listing of the items of inventory
of Computer Solutions.
d. The perpetual records of the company’s inventory must be reconciled with its
physical inventory.

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e. The auditor must also consider reconciling the physical counts of the inventory of the
company with the totals of the general ledger control account (Hayes, Gortemaker
and Wallage 2014, pp. 145).
c. The Requirement of ASA 701 Communicating Key Audit Matters in the
Auditor’s Report and the Rationale for This Auditing Standard
i. Why This Standard Was Introduced or Issued
ASA 701 was issued or introduced in pursuit of the requirements of the provisions and
strategic direction of the legislation that are described below. This standard was set by the
AUASB, which is mandated by the Corporations Act of 2001 to make any amendments in the
standards of auditing for the primary purposes set out by the legislation of the corporations Act
(Moeller 2009, pp. 145). This auditing standard highly conforms to ISA 701. According to the
strategic direction that was issued to AUASB by FRC, the former is required to pursue
development of standards of auditing which have a clear interest of the public as its major focus,
and which are of the best quality (Eilifsen, Messier, Glover and Prawitt 2013, pp. 27). Therefore,
this standard was issued or introduced by AUASB with a view to representing the Australian
equivalent of ISA 701, which requires independent auditors to communicate or disclose in their
audit reports key matters of their audit. As such, this standard was introduced to:
 Mandate disclosure of Key matters of audit in the audit reports of independent auditor for
listed firms (Singleton and Singleton 2010, pp. 78).
 Enable independent auditors providing audit services to other non-listed firms to make a
decision as to whether or not to disclose the key matters of the audit in their reports.
 To set the guidelines on how the auditor should determine the key audit matters (Eilifsen,
Messier, Glover and Prawitt 2013, pp. 27).

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ii. Determining the Key Audit Matters
According to paragraph 9 and 10 of ASA 701, the auditor should determine key matters
of audit by examining the matters which are communicated or disclosed by the individuals who
are charged with the responsibility of governing the firm (Singleton and Singleton 2010, pp. 78).
From these matters, he should identify those which require significant attention in the
performance of the company’s audit. With regard to this, the auditor must consider the following
in determining the key matters of audit (Eilifsen, Messier, Glover and Prawitt 2013, pp. 27).
 Areas which have a higher assessment of material misstatement risk, as well as
significant risks according to ASA 315.
 Significant judgment of the auditor with regard to financial statement areas in
which significant judgment of the company’s management has been involved.
This includes areas such as estimates of accounting which may have been
highlighted to have a high uncertainty of estimation (Singleton and Singleton
2010, pp. 78).
 The impact on significant events’ audit as well as on transactions which took
place in the course of the financial period of the company.
 Evaluating matters that are most essential for inclusion in the report of the
independent auditor.
Therefore, the independent auditor must seek to determine the matters of audit which
required significant attention in the audit of Computing Solutions for the financial period
concerned (Porter, Simon and Hatherly 2008, pp. 45).
iii. How to Make the Disclosure or Communication

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According to section 11 of ASA 701, the auditor is required to make a description of each
and every key matter of audit with an appropriate sub heading “Key Audit Matters” under a
separate section of his audit report (Elder, Beasley and Arens 2011, Pp. 14). In the introductory
statement, the auditor must mention that “Key audit matters are those which in his professional
judgment, were of most significance in the financial audit of the company’s reports and that
those matters were addressed in the audit of the financial statement of the entity taken as a
whole”. However, it is not a requirement for the auditor to make a report on the situations in
which a particular audit matter was regarded as key. The auditor must also give a description of
the audit documentation with regard to the key matters of the audit (Nigrini 2012, pp. 123).
According to the requirements of ASA 701, there are a number of disclosures that the
auditor must include in the section of Key Audit Matters of his audit report regarding valuation
and completeness of inventory of Computing Solutions. For instance, he must make an adequate
disclosure on the method of inventory valuation used by Computing Solutions because it is a key
audit matter. In addition to this, the auditor must make disclose adequately the completeness of
the inventory of Computing Solutions since it appears that it is not appropriately entered in the
accounting books of the company in the correct amounts (Cosserat and Rodda 2009, pp. 102).
Question 2:
a. Key Assertions Most At Risk In Relation To the Intellectual Property Intangible
Asset
The main assertions which are at risk with regard to intellectual property intangible asset
of Beautiful Hair Ltd are existence and valuation. These two assertions have been described fully
in the following sections.

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i. Existence
The existence assertion of intellectual property intangible assets of Beautiful hair ltd is at
a high risk. The firm faces a potential risk that the intellectual property intangible assets such as
copyrights and production formulas that were held by the acquired firm, Shimmer Pty Ltd, have
not been received by Beautiful Hair Ltd and therefore cannot be included in its financial records.
This is due to the fact that the secrets of ingredients of production are still concealed and
documented by Shimmer’s solicitors, instead of being controlled by the acquiring firm, Beautiful
Hair Ltd (Zadek, Evans and Pruzan 2013, pp. 15). This therefore puts the existence of such assets
at a risk since it is not certain that they are actually received by the company (Beautiful hair ltd).
ii. Valuation
Valuation of intellectual property intangible asset is also considered at a high risk
because the management of Beautiful Hair Ltd has been advised that is related to the formulas of
production is potentially a material and valuable asset of the company (Coderre 2009, 31). The
management has therefore recognized it as an intangible asset that has arisen from the acquisition
of Shimmer Pty Ltd as required by AASB 3. However, it is clear that the secret ingredients of
production are only known to the owner, Shimmer Pty Ltd, and have been documented
apparently by their solicitors. Although the intellectual property intangible assets have been
recognized as assets by Beautiful hair Ltd in its financial records, they have not yet been passed
to the company. This therefore results into a risk that the company could have inappropriately
valued the assets and made an incorrect recognition and disclosure.
b. Substantive Audit Procedures That Could Be Performed In Response to Each
Risk Identified Above

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i. Existence
Regarding existence assertion of intellectual property intangible assets, the auditor
inspect and examine the purchase vouchers of Beautiful Hair ltd and perform tests of audit with a
view to ascertaining if the company actually owns the intellectual property intangible assets as
recognized in their financial records. Additionally, the auditor must review the board minutes
with regard to acquisition of Shimmer Pty Ltd in order to ascertain whether or not the formulas
of production were actually acquired by Beautiful hair ltd (Bodnar and Hopwood 2012, pp. 21).
iii. Valuation
The auditor must carry out an inspection of intellectual property intangible asset records
of Beautiful Hair Ltd with an aim of ascertaining and confirming the amounts which have been
recorded in the financial record of the company. With regard to this, he must seek to make a
confirmation as to whether or not the company has consequentially recorded appropriately the
impairments that could have occurred to the intangible assets of intellectual property (Eilifsen,
Messier, Glover and Prawitt 2013, pp. 27). Furthermore, according to the requirements of AASB
3, the auditor must ascertain that Beautiful Hair Ltd has valued the Intellectual property
intangible assets appropriately as per the provisions of this standard (Chan and Vasarhelyi 2018,
pp. 25). He should make a confirmation that the intellectual property intangible assets have been
valued by the company using either cost-based method of valuation, cost-based approach or
income-based approach.
c. The Requirement of ASA 701 Communicating Key Audit Matters in the
Auditor’s Report and the Rationale for This Auditing Standard

AUDITING AND ASSURANCE 14
ASA 701 is a standard which was set by the AUASB, a body that is mandated by the
Corporations Act of 2001 to make any amendments in the standards of auditing for the primary
purposes set out by the legislation of the corporations Act. This auditing standard highly
conforms to ISA 701. This standard was issued or introduced by AUASB with a view to
representing the Australian equivalent of ISA 701, which requires independent auditors to
communicate or disclose in their audit reports key matters of their audit. As such, this standard
was introduced to mandate disclosure of Key matters of audit in the audit reports of independent
auditor for listed firms (Singleton and Singleton 2010, pp. 78). The standard also enables
independent auditors providing audit services to other non-listed firms to make a decision as to
whether or not to disclose the key matters of the audit in their reports. Furthermore, it sets or
establishes guidelines which should be used by the auditor determining key audit matters
(Eilifsen, Messier, Glover and Prawitt 2013, pp. 27).
Paragraph 9 of the standard sets out guidelines on how the auditor should determine key
audit matters. For instance, the auditor can determine key matters of audit by examining the
matters which are communicated or disclosed by the individuals who are charged with the
responsibility of governing the firm (Singleton and Singleton 2010, pp. 78). From these matters,
he should identify those which require significant attention in the performance of the company’s
audit. With regard to this, the auditor must consider several areas in determining the key matters
of audit. For instance, he must consider the areas with a higher assessment of material
misstatement risk, as well as significant risks according to ASA 315. He must also take into
account audit areas which require significant judgment of the auditor with regard to financial
statement areas in which significant judgment of the company’s management has been involved
(Singleton and Singleton 2010, pp. 78).

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With regard to the audit of Beautiful Hair Ltd, valuation and existence of the intellectual
property intangible assets are both considered key matters of the audit since they must be
significantly focused on by the auditor. This is because the level of production made by Beautiful
Hair Ltd is highly impacted by the formulas of production which have not yet been disclosed to
the company by the acquiree, Shimmer Pty Ltd. (Bodnar and Hopwood 2012, pp. 12). As per the
requirements of ASA 701, the auditor must therefore make appropriate disclosures which seek to
explain or describe the key audit matters to the intended users of the company’s financial
statements. For instance, he must consider making sufficient disclosures with regard to existence
and valuation of the intellectual property intangible assets for purposes of assuring the users that
such assets are actually controlled by the company and their valuation has been appropriately
made as per the requirements of AASB 3 (Arens, Elder and Beasley 2013, pp. 23).

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Conclusion
According to the above discussion, the two key assertions with regard to inventory of
Computing Solutions are completeness and valuation. In addition to this, the two key assertions
which are at most risk regarding the intellectual property intangible assets of Beautiful Hair Ltd
are valuation and existence. With regard to these risk assertions, the auditor must perform
substantive audit procedures as discussed in the above sections. He should also determine if the
assertions are key audit matters and make necessary adequate disclosures as set out by the
requirements of ASA 701 (Singleton and Singleton 2010, pp. 77).

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AUDITING AND ASSURANCE 19
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