ASA 701 and Auditing Procedures for Material Misstatement and Green Machine Ltd

This report discusses ASA 701 and auditing procedures for material misstatement and Green Machine Ltd. It covers key assertions, substantive audit procedures, and communication of key audit matters. The report highlights two cases, one on the risk of material misstatement and determination of appropriate response about Advanced Computer Solution Ltd, and the other on the identification and explanation of the two major assertions of Green Machine Ltd in tune to PPE.

Trimester 3, 2018
ACC 707 Auditing and Assurance Services Individual
Assignment
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Auditing and Assurance
Executive Summary
The main aim behind the introduction of ASA 701 is to provide the auditor assistance regarding
calculation of the primary audit matters. Hence, it is essential that the auditor should
communicate material information and build an independent audit report for proper
understanding. It is the management duty to stress upon the story as it is important to have
material disclosure and if there is an issue in the actual financial performance, then the users will
not put confidence and trust on the company. In this report, two cases are highlighted one being
the risk of material misstatement and determination of appropriate response about the Advanced
Computer Solution Ltd and the other being the identification and explanation of the two major
assertions of Green Machine Ltd in tune to PPE.
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Contents
Introduction.................................................................................................................................................3
Material Misstatement................................................................................................................................3
a. Two key assertion................................................................................................................................3
b. Two substantive audit procedures..........................................................................................................4
c. ASA 701 Communicating Key Audit Matters........................................................................................5
2. Green Machine Ltd..................................................................................................................................6
a. Two key assertion................................................................................................................................6
b. Two substantive audit procedures......................................................................................................7
c. ASA 701- Communicating Key Audit Matters.......................................................................................8
Conclusion...................................................................................................................................................9
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Auditing and Assurance
Introduction
ASA 701 is mainly introduced so that whole actual audit matter can be ascertained and
computation can be done. Moreover, after such procedure, communication on the auditor part is
needed to develop a report that is unbiased. Further, the management should have a direct focus
on the story because such disclosure can help in reflecting the genuine state of the company
(AUASB, 2015). About this, an investor can take investment decision that can be tagged as the
main purpose of communication strategy.
Material Misstatement
a. Two key assertion
Earlier on are claims made by management which has been entrusted with the preparation and
presentation of financial statements? These claims are assumed to be true and fair. Any false
assertion can put the management into trouble by making them answerable to the audit team. In
the given case, Advanced Computer Solutions Limited has been experiencing high returns due to
software issues. There is increasing returns, secondary sales and stocks piling up. The two key
assertions at risk, in this case, are as follows:
1. Correct Valuation Assertion- There is huge stockpiling up because of returns of the software
and the decreasing sales. Also, since the reputation is at a loss, the company would try to win the
tender by all means. If they report a cost which is lower than actual cost, which implies a false
way of getting the tender, the correct valuation of inventory won’t be done. Also, if the cost is
lower than the NRV (Net Realizable Value), the valuation needs to be done at NRV at not at
cost. The company or for this matter any company assets correct valuation of its stocks. And that
the valuation is done as per the applicable accounting principles. Here, care has to be taken that
all costs need to be correctly apportioned to inventory and if applicable, the valuation has to be
done at NRV or net realisable value in case the costs are lower. This is to ensure that the
inventory is valued at what can be realised from its sales and no unrealistic profit or loss is
booked. In the given case, since the package sold by the company was a best seller, its NRV
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would be high. However due to increasing returns and lower sales, proper cost computation is a
must or else the correct valuation assertion will be at risk (CAANZ, 2016).
2. Completeness Assertion- The inventory stock of Advanced Computer Solutions Limited has
been moved from a centralised location to six new regional warehouses located at different
locations, i.e. regional warehouses. There are chances that while evaluating the inventories, all
the stocks at all locations are taken care of and the inventory is computed thoroughly. There are
also chance that there are stocks of other companies held at warehouses and the chances are
higher f the warehouses are not self-owned (Caanz, 2016). Care has to be taken to ensure both
scenarios do not occur and in the valuation of inventory, all that belongs to the company is
included, that too at true costs and all that does not belong to the company is carefully excluded
(CAANZ, 2016). Completeness and ownership are two assertions that are complementary to
each other.
b. Two substantive audit procedures
Any evidence to support the assertions are called substantive audit shreds of evidence. All the
activities performed to procure these pieces of evidence is termed as substantive audit
procedures. To confirm the assertions, substantive audit procedures have to be undertaken. These
mitigate the risk of false or unfulfilled assertions (Baldwin, 2010). The following substantive
procedures can be undertaken against each risk identified in (a) above:
- Against the risk of incorrect valuation- some procedures or actions can be taken to eliminate
the risk of incorrect calculation. Firstly, thorough checking of the overheads, cost allocation to
overheads, the nature of expenses, the pricing of raw materials, human resources wages and
salaries, all such costs need to be checked to ensure wastages and redundancy. After that, market
analysis to understand the fair market value, the market surveys to ensure the net realisable
value, impairment analysis, these extra computations, can help in efficiently understanding the
NRV.
- Against risks related to completeness assertion – there are many procedures by which this risk
can be mitigated. Firstly a cut off analysis can be done. The audit team can select a cut off period
during which nothing can go in and come out from the warehouses. And during this period the
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stock count is taken so that anything coming to and fro during the count does not create any
confusion (Roach, 2010). Secondly, observing the physical count- The physical count of
inventory can be observed my being present on the location and supervising the counting
process. This is the best way to ensure correctness. Thirdly, matching the count with the accounts
books to find out discrepancies and whether these discrepancies are valid or not is an important
way to ensure no risk (Cappelleto, 2010). Also, checking for correctness of normal and abnormal
wastages is one important procedure, but in this case, for software, there are fewer chances of
these.
c. ASA 701 Communicating Key Audit Matters
‘ASA 701- Communicating Key Audit Matters in the Independent Auditor’s Report’ as issued
by the AUASB has requirements mainly for listed companies. However, non-listed companies
are also covered in this. This standard to a great extent relies on the auditor’s judgment of what
comprises of key audit matter and what can be avoided from being communicated. All key
matters that can affect the prudence of the user of audit reports and what can affect the
independent auditor’s qualifications should mandatorily be a part of the auditor’s report. In the
given scenario, the increasing inventory is a key audit matter which deserves elaboration in the
report (Gay & Simnet, 2015). This is because all the analytical tools used suggest that the closing
stock is increasing, not because of any boom in production but because of increasing defect
beyond detected in the software and increasing returns, leading to secondary sales. This can
greatly impact the large government tender. The motive is to issue a warning to the users of the
auditor's report that they should do further checks and analysis to decide their future action
(Beasley et. al, 2009). When the auditor is aware that there is something which is material
enough to harm someone's financial health, because of incorrect reporting done by him, it
becomes an obligation on his part and questions his qualifications. And in this case, propriety
money is involved, and hence needs all the more caution whole reporting (Geoffrey, Joleen &
David, 2016).
The method of inventory calculation, the reason for its increase in inventory, the reason for the
decrease in sales, estimate of costs and determination of NRV should form a part of the
disclosure.
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2. Green Machine Ltd
a. Two key assertion
(a) As discussed earlier, assertions are claims made by management which has been entrusted
with the preparation and presentation of financial statements. These claims are assumed to be
true and fair. Any false assertion can put the management into trouble by making them
answerable to the audit team. property plant and equipment is the most important asset for a
manufacturing company. It forms a larger part of the assets of a manufacturing company. Also,
most of the work of a manufacturing company is done with its Property, plant and equipment. It
is very important to value and classify these assets properly. Else there are huge chances of
fabrication of the financial results of the company (Glover & Reidenbach, 2012). The following
are the two risks to assertion related to Green Machine Limited, as per the given case.
1. The risk to classification assertion- the assets should be clarified correctly. The expenses
should also be classified properly. All capital and revenue expenses should be correctly classified
and charged according. All repairs and maintenance expenses to be charged to revenues, and
major expenses to improve the current state of the assets to be capitalised, and all new purchases
to be included in the block of assets. All classification to be done as per the generally accepted
accounting principles (Hoffelder, 2012). However, in the given case of Green Machine Limited,
the expenses in the last year have been all mixed up. The capital and revenue expenses have been
misinterpreted and have been respectively charged to wrong accounts, thereby giving wrong
information about the current carrying value of the property, plant and equipment. Also, the
value of profit or loss would also have been incorrect because of the charge of capital
expenditures to revenue (Brant et. al, 2012).
2. The risk to accuracy assertion- this risk entails that there is a calculation which is not done
efficiently and accurately, and this calls for a qualified audit report. As mentioned in the
management report of the previous year, the depreciation rate on some assets has been applied
too low. This damages the existence of fair and correct value of assets in the books of accounts.
Inaccurate valuation can be very detrimental to the financial health of the company (Beasley et.
al, 2009). Lower depreciation leads to the following consequences- inflated financial results, the
creation of deferred tax liability, inflated carrying the number of assets. These affect the Funchal
health in the coming years (Niemi & Sundgren, 2012). A risk to accuracy in the current year, and
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that too if the case is like that of Green Machine Limited, where the depreciation rate application
is lower than prescribed, the bigger impact will be in future years (Elder, Beasley & Arens,
2010).
b. Two substantive audit procedures
Any evidence to support the assertions are called substantive audit evidence. All the activities
performed to procure these evidence is termed as substantive audit procedures. To confirm the
assertions, substantive audit procedures have to be undertaken. These mitigate the risk of false or
unfulfilled assertions. In the given case of Green Machine Limited, the following substantive
procedures have to be adopted to mitigate the risk to the assertion:
1. Mitigation of risk to classification assertion- in the given case, there had been an error of
computation in the past. Thus, in the current year, the audit team needs to authenticate last year's
as well as this year's information so that a cumulative effect can be given and arrived at the
correct values. Checking of the last year's computation and then giving effect in the current year
and then the computation of the current year's figures (Sikka, 2009). The task is tedious but
needs to be done properly. Classifications to be checked. Correct values to be classified into the
review and capital expenses. A separate team can be alotted to physically check for capital
assets, verify the additions and changes, and also check for all expense reports and supporting
purchase documents related to property plant and equipment. Care to be taken to educate the
finance personnel responsible for the computation, to avoid such mistakes in future. Also, ask for
internal control mechanisms applicable within the company to keep checks in these transactions
of capital nature (Brant et. al, 2012).
2. Mitigation of risk to accuracy assertion- accuracy assertion is all the more important because
there are chances of great mistakes because of incorrect computation, incorrect estimates and
incorrect valuation. Classification is an error at a macro level. But at the micro level, accuracy
plays a vital role. To avoid this risk, the list of assets have to be checked for, the purpose of those
assets to be understood and then the depreciation rate has to be understood properly (Church ,
Davis & McCracken, 2008). Incorrect depreciation rates can as discussed before hamper in the
long run, the financial health of the company. Therefore, deep down analysis and computation is
an important substantive measure.
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Auditing and Assurance
c. ASA 701- Communicating Key Audit Matters
‘ASA 701- Communicating Key Audit Matters in the Independent Auditor’s Report’ as issued
by the AUASB has requirements mainly for listed companies. However, non-listed companies
are also covered in this. This standard to a great extent relies on the auditor’s judgment of what
comprises of key audit matter and what can be avoided from being communicated. All key
matters that can affect the prudence of the user of audit reports and what can affect the
independent auditor’s qualifications should mandatorily be a part of the auditor’s report. With a
major portion of asst of Green Machine Limited being fixed asset,( this is an assumption since it
is a manufacturing company) the computation of depreciation, accumulated depreciation, the
casting amount of assets, Viz property, plant and equipment, is a very important activity.
Mistakes in it are a key matter that requires a reporting or qualification in independent auditor's
report (Matthew, 2015). This is because these are not errors that can be overlooked or that have
low impact. They can affect the financial decisions of a great section of stakeholders. Hence the
auditor must report about them.
Disclosure about the period or errors, the reason for the same, the correct computation in the year
of failure, the and the respective effect in the current year and a comparison between the
incorrect and correct figured should be properly projected in the independent auditors report.
There should also be disclosure regarding the method of computation used (Sharp, 2006).
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Conclusion
It can be commented that the company should pay heed to the relevant accounting standards so
that it can have access to the financial concern needed to be implemented during the financial
statement preparation. Hence, it can be commented from the discussion, that the main
responsibility of the auditor is to help the companies in projecting the true financial position so
that the companies are protected from the legal issues. This can aid in increasing the reputation
of the company in the long run.
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References
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