Auditing Theory and Practice

This article discusses the key events that can impact the audit process of a business. It covers foreign exchange risk, deferred tax assets and liabilities, accounting for future tax income, and contingent liabilities. The article also provides insights into the inherent risks and control risks associated with each area.

Running head: AUDITING THEORY AND PRACTICE
Auditing Theory and Practice
Name of the Student:
Name of the University:
Author’s Note:

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AUDITING THEORY AND PRACTICE
Table of Contents
Question 1........................................................................................................................................2
Foreign Exchange Risk................................................................................................................2
Deferred Tax Assets and Liabilities............................................................................................3
Accounting for Future Tax income..............................................................................................3
Contingent Liabilities..................................................................................................................4
Answer to question 2:......................................................................................................................4
Reference.........................................................................................................................................9

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AUDITING THEORY AND PRACTICE
Question 1
The audit of a business is a critical process and the purpose for the same is to identify
material misstatements which can affect the quality of financial reporting which is used by every
business for the purpose of recording and classifying financial information of a business. In
many cases, the audit of a business can also be affected by certain key events or disclosures
which are of significant nature. In this case, the annual report of BHP group is considered for the
purpose of identifying certain key events which can impact the overall audit process of the
business and the same are listed below in details:
Foreign Exchange Risk
As per the financial statement which is shown in the annual reports of the company for
the year 2018 reveals that the business faces significant foreign exchange risks in relation to the
debts which is taken by business. The risk is associated with the revaluation of foreign exchange
of the business in relation to debts which are undertaken by the business. As per the annual
report which is presented for the business for the year, the foreign exchanges transactions are
covered in the income statement which is presented for the business for the year 2018. As per
AASB 121, exchange rates are to be translated for the financial statements of the business. As
per para 23 of AASB 121, foreign exchange for monetary items such as cash and cash
equivalents will be translated as the exchange rate on the reporting date of the business (Mancini,
Ranaldo and Wrampelmeyer 2013). Therefore, the business of BHP should translate its cash and
cash equivalents using the exchange on the reporting date. The net foreign exchange loss is
presented to be $ 93 million. While conducting the auditor needs to ensure that the provisions
which are covered in AASB 121 should be adhered to and also the balances which are shown
should be showing true and fair view.

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AUDITING THEORY AND PRACTICE
Deferred Tax Assets and Liabilities
As per the annual report of BHP group for the year 2018, the management effectively
records the deferred tax items of the business. The deferred tax assets and liabilities of the
business is shown on the basis of the temporary difference which arises between the tax bases of
assets and liabilities of the business and their respective balances which are shown in the
financial statement of the business (Chytis 2015). The annual reports specify the risks which the
business faces in relation to deferred tax items. The income statement of the business shows
deferred tax liabilities of the business and also discloses its respective treatments in the notes to
account section of the annual report. As per the provisions of AASB 112, the treatment for
income tax and also deferred tax valuation of the business is shown. As per para 34 of AASB
112, deferred tax asset shall be recognized for any unused tax or tax credit as long as the future
taxable profit. Further the asset is considered to be measured at rates which are applicable on
assets or liabilities depending on the dates when the asset is realized or the liability is settled as
stated by Para 47 of AASB 112. The auditor needs to make sure that all relevant standards are
followed in this respect and the tax amount which is shown in the financial statement are
showing true and fair view.
Accounting for Future Tax income
As per the annual report of the business for the year 2018, the management of the
business has shown in the notes to account regarding the future taxable profits which is
anticipated by the business. The provisions of AASB 112 shows that an entity should provide
appropriate disclosures for deferred tax items of the business considering the future taxable
profits. The auditor needs to estimate that the financial statement are prepared following the
relevant standards of accounting and also the financial statement.

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AUDITING THEORY AND PRACTICE
Contingent Liabilities
The annual reports of the company for the year 2018 also reports about contingent
liability which can arise for the business and the same is disclosed in the notes to account section
of the annual reports of the business. The annual report of the business shows that the
management has to face liability claims related to the site of BHP Billiton Brasil which is shown
to be $ 20 billion for the clean up costs and the damages which is incurred by the business. In
addition to this, the management also faces Federal Public Prosecution Office claim which is
also of a significant amount as shown in the annual report of the business (Hendrickson 2014).
As per the provisions of para 37 of AASB 137 states that a law suit would affect the confidence
of the public on the company and also damage the brand image of the business. The auditor
needs to check the balances of contingent liabilities of the business and also analyze how the
same affect the profitability of the business. The annual report will cover relevant disclosures in
this respect as contingent liabilities and lawsuits as per para 86.
Answer to question 2:
1: Contingent Liability:
The lawsuit, which is better known as contingent liability has the higher inherent risk.
Accounting identification for this contingent liability may require for BHP Billiton to suffer loss
as the company is named as defendants in numerous legal proceedings that are initiated by the
individuals, non-government organization and individual’s entities in the Brazil state court after
the failure of Samco dam (Bhp.com 2018). The probability of loss is very judgemental and hence
greater amount of inherent risk.

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AUDITING THEORY AND PRACTICE
Additionally, the estimation of amount is also treated as the area where manipulation may
take place and involves greater level of inherent risk (Hayes, Gortemaker and Wallage 2014).
This can be specified by explaining that the assertions comprise of completeness and valuation of
contingent liabilities. The lawsuit requires numerous remedies together with the rehabilitation
costs, compensation to the injured and deceased facilities.
Evidence Mix
The measurement of the provision needs the use of significant estimations, assumptions
and judgements that might be impacted by the potential changes in the scope of work and
required funding amounts under the agreed framework.
Because of the size of company, the evidence obtained for test is low with substantive
test for contingent liability is less.
AAR = CR x IR x PDR
Medium to extensive Low High High
Understan
ding of
internal
control Test of Control
Substantive Tests of
Transactions
Analytical
Process
Test of Details of
balances
Extensive
Medium to
Extensive Extensive Extensive Small to Medium
2. Accounting for Future income taxes:

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AUDITING THEORY AND PRACTICE
The accounting for the future income tax is very multifaceted area of accounting. It needs
the knowledge that is related to both the corporate income tax laws and the timing of accounting
for determining the temporary differences (Kumar and Sharma 2015). There are difficult
complex areas of accounting for BHP Billiton involves the accounting for income taxes that
ultimately represents as the inherent risk for the auditor. There are numerous assertions are
involved and ultimately impacts BHP Billiton several account balances however the wider set of
financial statements is not effect. In other words, the risk are limited to the assertions relating to
the accounts on the financial statements.
Evidence Mix:
The nature of BHP Billiton being a mining company is largely exposed to the inherent
risk of valuation of assertion for its inventory. It may be difficult to imagine the inventory size
and quality, results obtained from drilling, price of commodity and production costs are factors
that results in inherent risks in determining the estimation of the minerals, gas and oil reserves.
AAR = CR x IR x PDR
Medium to extensive Low High High
Understan
ding of
internal
control Test of Control
Substantive Tests of
Transactions
Analytical
Process
Test of Details of
balances
Medium
Medium to
Extensive Small to Medium Extensive Extensive
3: Foreign Exchange:

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AUDITING THEORY AND PRACTICE
The increase in the foreign country investments and fluctuation in the exchange risks
results in higher inherent risks and control risks for fluctuation is greater because of the BHP
Billiton higher amount of transactions in the overseas nations (De Paula 2016). As the result of
this, BHP costs and earnings may be materially and adversely impacted by the increasing costs
and interruptions in the supply. These may comprise of the unavailability of the energy, water or
fuel together with the fluctuations in the climate and insufficient capacity of the infrastructure
(Baldauf, Steller and Steckel 2015). The foreign investment currency and fluctuation in the
exchange rates requires translation in the financial report for the BHP by using the numerous
different exchange rates.
Evidence Mix:
The internal control on the operations over the numerous foreign nations may relatively
reduce the higher control risks. The evidence for the control requirement is higher with
substantive test for the transactions will be extensive since greater number of overseas
transactions needs to be translated. This would ultimately impact the strategic detection risk. The
analytical process is extensive because of the fluctuation in the exchange rate.
AAR = CR x IR x PDR
Medium to extensive Low High High
Understanding
of internal
control
Test of
Control
Substantive Tests of
Transactions
Analytical
Process
Test of Details of
balances
Medium to
Extensive Extensive Extensive Low
Medium to
Extensive

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AUDITING THEORY AND PRACTICE
4. Deferred tax:
The inherent risk associated with the deferred tax is generally lower than the few areas of
differences. The changes in the foreign tax law also includes the re-measurement of deferred tax
balance. The deferred tax risks originating from the BHP cross border operations and
transactions gives rise to the tax risks. The other matter that is existent in the deferred tax is the
uncertainty in the implementation of the law (Arens et al. 2015). The inherent risk of the deferred
tax asset states that the carrying amount might change because of the estimations relating to the
recovery of the tax benefits. With the reduced corporate tax rate in US ultimately resulted in
group re-measurement of the deferred tax position.
Evidence Mix:
Since the inherent and the control risk is higher, the evidence of the control is lower. The
analytical process is very much extensive for assessing the financial impact and the liability
which will impact the balance of the BHP Billiton. The analytical process would help in reducing
the substantive test and balances of the deferred tax assets.
AAR = CR x IR x PDR
Medium to extensive Low High High
Understand
ing of
internal
control
Test of
Control
Substantive Tests of
Transactions
Analytical
Process
Test of Details of
balances
Extensive None Extensive Extensive Small to Medium

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AUDITING THEORY AND PRACTICE
Reference
Arens, A.A., Elder, R.J., Beasley, M.S. and Jones, J., 2015. Auditing: The Art and Science of
Assurance Engagements. Pearson Canada.
Baldauf, J., Steller, M. and Steckel, R., 2015. The Influence of Audit Risk and Materiality
Guidelines on Auditors’ Planning Materiality Assessment. Accounting and Finance
Research, 4(4), p.97.
Bhp.com. (2018). Bhp.com. [online] Available at:
https://www.bhp.com/-/media/documents/investors/annual-reports/2018/
bhpannualreport2018.pdf?la=en [Accessed 6 Oct. 2018].
Chytis, E., 2015. Deferred Tax Assets from unused Tax Losses under the prism of Financial
Crisis. In International Conference on Business & Economics of the Hellenic Open University,
Athens. Retrieved from http://193.108 (Vol. 160).
De Paula, F.R.M., 2016. The principles of auditing a practical manual for students and
practitioners. Isaac Pitman & Sons, Ltd (1919).
Hayes, R.S., Gortemaker, H. and Wallage, P., 2014. Principles of auditing: an introduction to
international standards on auditing. Prentice Hall, Financial Times.
Hendrickson, J.R., 2014. Contingent liability, capital requirements, and financial reform. Cato
J., 34, p.129.
Kumar, R. and Sharma, V., 2015. Auditing: Principles and practice. PHI Learning Pvt. Ltd..

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AUDITING THEORY AND PRACTICE
Mancini, L., Ranaldo, A. and Wrampelmeyer, J., 2013. Liquidity in the foreign exchange market:
Measurement, commonality, and risk premiums. The Journal of Finance, 68(5), pp.1805-1841.