ASA 701 and Material Misstatements in Auditing: A Case Study

This article discusses ASA 701 and material misstatements in auditing through a case study of Advanced Computer Solutions Ltd and Green Machine Ltd. It covers major assertions, substantive audit processes, and communicating key audit matters. The purpose is to assist companies in presenting and preparing their financials effectively.

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ACC 707 Auditing and Assurance Services

Audit
Executive Summary
ASA 701 was introduced to assist auditors in conducting audit processes effectively, and for
such purpose, essential audit matters must be duly communicated by them through the audit
report. Further, the management must supervise the overall process to facilitate material
disclosure, thereby allowing users to exert their trust upon the company. With the help of this
report, a case of material misstatement associated with Advanced Computer Solution and
another example of Green Machine Ltd about their assertions based on PPE has been
highlighted.
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Audit
Contents
Introduction...........................................................................................................................................3
Material misstatements........................................................................................................................4
a. Major assertions............................................................................................................................4
b. Substantive audit processes..........................................................................................................4
c. Communicating key audit matters (ASA 701)................................................................................5
Green Machine Ltd................................................................................................................................6
a. Major assertions............................................................................................................................6
b. Two Substantive audit processes...................................................................................................6
c. Communicating key audit matters (ASA 701)................................................................................7
Conclusion.............................................................................................................................................9
References...........................................................................................................................................10
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Introduction
The reason behind the introduction of ASA 701 can be attributed to the fact that it facilitates
in enhancing the audit procedure. However, communication is essential from the auditor’s
part so that the audit judgement is professional and efficient. Also, the management must also
scrutinise this entire process so that an excellent overall scenario can be depicted (Tadros,
2017). Moreover, stakeholders can also make proper decisions based on such communication
strategy.
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Audit
Material misstatements
a. Major assertions
In the present case, Advanced Computer Solutions Ltd is facing significant issues owing to
its software problems that have resulted in enormous returns, piling of stocks, and secondary
sales. The major assertions that are at risk for the company are:
1. Assertion of completeness
It is observable that the company’s inventory stock has been relocated to six warehouses that
are situated in distinct areas. Due to this, there are feasibilities that all the shares are
monitored effectively and their calculation is undertaken appropriately. Further, there are
possibilities that other companies’ shares are being prevalent at warehouses. Thus, proper
care must be exerted to make sure these feasibilities do not happen, and inventory
computation is undertaken at actual costs (Merchant, 2012).
2. An assertion of correct valuation
Owing to software problems, the company has been encountering declining sales and
enormous piling of stocks. Hence, if the company attempts to report its costs that is lesser
than the real prices, a correct inventory valuation cannot be achieved, and if such charges are
lower than the net realisable value, the valuation must be undertaken at such net possible
values instead of costs. Thus, the company must assert appropriate inventory valuation based
on proper accounting standards or principles. Further, due care must be exerted to apportion
all expenses to the stocks and undertake the valuation process based on NRV whenever the
costs are lesser (Tadros, 2017). This assists in making sure that inventory valuation is done
based on what is realisable from the sales and no inaccurate expenses are recorded. Based on
the current case, the NRV of the company may be higher because its package was considered
the best. Nevertheless, owing to declining sales and increasing returns, the assertion of
appropriate inventory valuation is at risk (Manoharan, 2011).
b. Substantive audit processes
Any process undertaken for gathering substantive audit evidence is referred as substantive
audit process that also assists in confirming all assertions, thereby playing a role in
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preventing the risks of inaccurate assertions (Tadros, 2017). Few substantive audit processes
in relation to previously mentioned risks are:
1. In relation to assertion of completeness, processes like cut off evaluation can be
performed wherein the team of audit can choose a specific cut off tenure beyond which no
inclusion or exclusion can be done from the warehouses. Further, during such tenure, proper
inventory numbering can be done so that inclusions or exclusions during the numbering
cannot create issues (Kaplan, 2011). Furthermore, physical counting or supervising of all
inventories can be undertaken so that appropriateness can be attained. In addition, verifying
appropriateness of all abnormal and normal wastage can also be undertaken if software
problems are mitigated.
2. In relation to assertion of correct valuation, enhanced verification of overheads can be
undertaken together with raw material pricing, nature of costs, and all other expenses that can
assist in verifying redundancy and wastage (Lapsley, 2012). Thereafter, a thorough market
evaluation and impairment analysis must be facilitated to assess the fair market value so that
the NRV can be appropriately understood.
c. Communicating key audit matters (ASA 701)
ASA 701 has been framed especially for the listed entities but non-listed companies also form
part of such standard. The judgement of auditor is significant in such standard to determine
what matters must form part as key audit matters and what is not required to be
communicated. Therefore, matters that can influence the decision-making processes of users
must only be communicated by the auditor in their report. Nonetheless, in the present case,
increasing inventories are a matter of concern that must form part of the audit report because
all analytical tools reflect that there is an increment in closing stock because of defects in the
software and not due to production enhancement (Hoffelder, 2012). Moreover, this can affect
the government tender at large. Overall, the purpose is to intimate the users of audit report
that they must undertake additional verifications and evaluations to frame future courses of
action. Thus, this matter must form part of the report as it bears ample capacity to harm
financial health of other parties.
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Audit
Green Machine Ltd
a. Major assertions
Assertions are offered by companies to ensure true and fair presentation and preparation of
financials and any fake assertion can land the company in extreme trouble. Further,
manufacturing companies must monitor their PPE in an appropriate manner because there are
enormous feasibilities of fabrication of outcomes associated with these (Tadros, 2017). The
following are the risks associated with the assertions of Green Machine Ltd:
1. Assertion of accuracy
There is a risk associated with assertion of accuracy that means inaccurate computation that
can demand a qualified audit judgement. From the company’s management report, the rate of
depreciation on its few assets is seen to be extremely lower in nature. This issue can hamper
the trueness and fairness of company’s accounts in the eyes of stakeholders, thereby resulting
in loss of goodwill too. Moreover, a lesser deprecation rate can also result in issues like
exaggerated financial outcomes, establishment of liabilities like deferred tax, etc. Overall,
this can hamper the company’s financial situation in a very negative manner.
2. Assertion of classification
In relation to this, classification of assets must be undertaken effectively because it assists
users in their decision-making processes. Further, all expenses whether of revenue or capital
nature must also be properly classified based on the GAAP principles. In the case of Green
Machine Ltd, it is observable that costs of the previous year are completely mixed up in
nature. In other words, all revenue and capital costs have not been effectively interpreted and
have been recorded to the wrong accounts, thereby resulting in the provision of inadequate
data related to the present values of the company’s PPE (Geoffrey et. al, 2016).
b. Two Substantive audit processes
Any process undertaken for gathering substantive audit evidence is referred as substantive
audit process that also assists in confirming all assertions, thereby playing a role in
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preventing the risks of inaccurate assertions. Few substantive audit processes in relation to
previously mentioned risks are:
1. In relation to accuracy assertion, substantive audit processes like effective supervision
or checking of assets must be performed so that the nature of assets and their respective
depreciation rate can be effectively interpreted. Since, accuracy plays a key role both at the
micro and macro stages, such substantive processes must be duly adopted to avoid
destruction of financial health of the company owing to inaccurate rates of depreciation being
recorded in the previous years (Carcello, 2012).
2. About classification assertion, it is observable that the company had encountered a
computation error in the previous years. Hence, in the present situation, proper measures
must be adopted so that both the past and the current case can be adequately analysed and
after that, future courses of action can be acted upon. In other words, to arrive at appropriate
values, a cumulative strategy must be framed wherein the information of both past and
present year can be adequately evaluated (Blay, Geiger & North, 2011). Hence, calculation of
the previous year must be undertaken, and after that, its effect must be given to in the present
year to compute the figures of the current year. Nonetheless, this is a humongous task, but the
same cannot be avoided because the decision-making process is altogether related to such
classification of assertion (Sikka, 2009). Moreover, ratings must be adequately verified by
classifying proper values to both capital and revenue expenses. Furthermore, a distinct team
must also be prepared that can play a crucial role in checking all capital assets physically,
checking all alterations and additions, and verifying all the expense reports that include
supporting the purchase documents associated with PPE (property, plant, and equipment).
Nonetheless, prior care must also be adopted to advocate the finance workforce liable for the
calculation to prevent errors and flaws in future (Gay & Simnet, 2015). After that, internal
control mechanisms must also be implemented within the company so that the transactions
that are of capital nature can be efficiently checked.
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c. Communicating key audit matters (ASA 701)
ASA 701 has been primarily framed for the listed companies, but all non-listed companies
are also covered in this standard. The AUASB (Auditing and Assurance Standards Board) has
also mounted significant requirements for these companies wherein the auditor is under a due
obligation to decide what must form part of the audit report as ‘key audit matters’ and what
must not form part (Bedard, Gonthier & Schatt, 2014). In other words, the judgement of the
auditor is crucial to determine whether a matter is significant for the users or not.
Concerning Green Machine Ltd, it is observable that the significant asset part is the
company’s fixed assets. However, it is presumed that the company is a manufacturing
company, else its significant asset would have been different. In addition to the company’s
fixed assets, its property, plant, and equipment, accumulated depreciation, calculation of the
amount of reduction, etc. is also a relevant part of the overall process. In other words, if there
are significant flaws or errors in these segments, then the same must form part of the audit
report as essential audit matters. The reason behind this can be attributed to the fact that these
are not minor flaws that can be just ignored and instead, the impact of these matters can be
huge. Thus, communication of errors, comparative analysis of past and present figures,
reasons for such failures, etc. must form part of the audit report.
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Conclusion
Companies must adopt strict accounting practices and measures so that their financials can
depict a true and fair view of their performance. Further, it is the duty of auditors to assist the
companies in presenting and preparing the financials so that future issues can be mitigated at
the earlier stages itself. Besides, proper presentation and preparation of financial statements
can allow the companies in building their reputation in the entire industry as it can cater to
the requirements of majority of stakeholders in their decision-making processes.
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References
Bedard, J., N., Gonthier, B, & A. Schatt. (2014) Costs and Benefits of Reporting Key.
Harvard Press
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https://doi.org/10.2308/ajpt-50002
Carcello, J. (2012). What do investors want from the standard audit report? CPA Journal 82
(1), 7. Doi: http://dx.doi.org/10.2139/ssrn.2930375
Gay, G. & Simnet, R. (2015) Auditing and Assurance Services. McGraw Hill
Geoffrey D. B, Joleen K, K. Kelli S. & David A. W. (2016) Attracting Applicants for In-
House and Outsourced Internal Audit Positions: Views from External Auditors. Accounting
Horizons. [online] 30(1), pp. 143-156. Available from https://doi.org/10.2308/acch-51309
[Accessed 22 January 2019]
Hoffelder, K. (2012) New Audit Standard Encourages More Talking. Harvard Press.
Kaplan, R.S. (2011). Accounting scholarship that advances professional knowledge and
practice. The Accounting Review, 86(2), 367–383. https://doi.org/10.2308/accr.00000031
Lapsley, I. (2012). Commentary: Financial Accountability & Management. Qualitative
Research in Accounting & Management, 9(3), pp. 291-292. https://doi.org/10.1111/1468-
0408.00081
Manoharan, T.N. (2011). Financial Statement Fraud and Corporate Governance. The
George Washington University.
Merchant, K. A. (2012) Making Management Accounting Research More Useful. Pacific
Accounting Review. [online]. 24(3), pp. 1-34. Available from
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Sikka, P. (2009) Financial Crisis and the Silence of Auditors. Accounting Organizations and
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[Accessed 22 January 2019]
Tadros, E. (2017) Appalling' audit quality could lead to next Enron: ASIC's Greg Medcraft
[online]. Available from: http://www.afr.com/business/accounting/appalling-audit-quality-
could-lead-to-next-enron-asics-greg-medcraft-20171030-gzb5q2#ixzz5BrDh3Ckohttps://
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