ASA 701: Communication of Key Audit Matters - Green Machine Ltd and Advanced Computer Solutions

This report discusses the risks of material misstatements and the importance of accurate valuation and completeness in the cases of Green Machine Ltd and Advanced Computer Solutions. Substantive audit procedures and ASA 701 are also discussed. Subject: ACC 707 Auditing & Assurance Services

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ACC 707 Auditing
&
Assurance Services

Audit
Executive summary
In the current corporate environment, preparation and presentation of financial statements are
vital for users to make proper decisions. ASA 701 was framed in order to allow auditors
communicate important matters to the stakeholders through their audit report. This can allow
users in making effective decisions based on such material disclosure and therefore, the
company’s goodwill can be enhanced on a whole. Through this report, the cases of two
companies namely Green Machine Ltd and Advanced Computer Solutions shall be reflected
wherein one is related to PPE and other is related to risk of material misstatements.
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Audit
Contents
Introduction...........................................................................................................................................3
Risk of material misstatements.............................................................................................................4
b. Substantive audit procedures........................................................................................................5
c. ASA 701 (Communication of key audit matters)............................................................................5
Green Machine Ltd................................................................................................................................7
a. Two prime assertions.....................................................................................................................7
b. Substantive audit procedures........................................................................................................8
c. ASA 701 (Communication of key audit matters)............................................................................8
Conclusion.............................................................................................................................................9
References...........................................................................................................................................10
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Audit
Introduction
Auditors can easily communicate key matters to the stakeholders through the audit report and
this requirement is emphasized by ASA 701. However, it is also the management’s liability to
oversee whether the exact scenario and affairs of the company have been reflected in their
financials. Moreover, stakeholders can make appropriate decisions if the adopted
communication measure is effective in nature. Disclosures should happen at the proper
course of time because disclosures lead to transparency (Badolato, Donelson & Ege, 2014).
It not only supports and helps the users of the financial statement but ensures a strong
goodwill of the entire company. Further, it is vital to understand that the auditor must ensure
decision making in an unbiased manner as it will led to independent decision making.
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Audit
Risk of material misstatements
a. Two prime assertions
Assertions are those claims that the management exerts during the presentation and
preparation of financials. Therefore, if such claims are untrue, then the company can become
liable to penal provisions and can lose their goodwill as well. From the given case, the
software problems encountered by Advanced Computer Solutions Ltd has been highlighted
that has generated further problems like secondary sales, increasing returns, and
accumulation of stocks.
 Accurate valuation
Due to software issues prevailing in the system of Advanced Computer Solutions Ltd, there
has been major deterioration of sales and increasing returns that has resulted in degradation of
the company’s goodwill. Moreover, if reporting of cost is not greater than the actual cost,
then accurate inventory valuation cannot be achieved (Baldwin, 2010). Further, if such cost is
not greater than the NRV (net realizable value), such valuation must be achieved at the same
NRV and not the costs. In addition, all costs must be rightfully aligned to their respective
inventories and thereafter, the valuation must be undertaken at NRV if the costs are lower.
The reason behind this can be to ensure that such valuation can assist in recording the exact
amount realized from the sales and no untrue amounts are recorded (Niemi & Sundgren,
2012). Therefore, proper computation of cost is crucial in the given scenario as it generates
immense amount of risk for such assertion. If the cost is computed in an effective manner it
will lead to proper result and decision making.
 Completeness
In the given case, it is visible that the inventories of Advanced Computer Solutions have been
transferred from a centralized area to different regional warehouses situated at different
places. Therefore, there are chances that inventories at every area is taken due care of and the
same is calculated properly. In addition, there can be stocks of other companies in such
warehouses if the same are not under ownership scheme (Gajevszky, 2014). Hence, due care
must be exerted to ensure that these scenarios are monitored effectively and inventory
valuation is undertaken by including the company’s own costs and not of other companies.
Overall, claims of ownership and completeness are totally complementary to each other.
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Audit
b. Substantive audit procedures
The evidence that acts as a support of the assertions made by companies are signified as audit
evidence. Besides, any procedure performed to accumulate these evidences is commonly
known as substantive audit procedure. The procedures in relation to the above-mentioned
risks are:
 Against inaccurate valuation
In order to tackle inaccurate valuation, procedures like thorough scrutiny of segments like
overheads, nature of expenses, costs aligned to such overheads, human resource salaries and
wages, etc can be performed that can play a role in minimizing wastage and scrap. Further, a
thorough market evaluation can be also adopted to obtain a proper NRV in relation to
inventory valuation.
 Against completeness
Substantive procedures like cut off assessment can be adopted to get rid of such risk wherein
the auditors can determine a particular date outside of which any inclusion or exclusion from
the warehouse shall not be considered. In addition, by being physically present at the site can
also assist in supervising the entire process effectively, thereby ensuring completeness on a
whole (Hoffelder, 2012). Further, cross-checking of books of accounts to ascertain
discrepancies can be also done to make sure any risk does not exist.
c. ASA 701 (Communication of key audit matters)
The AUASB has framed the standard of ASA 701 that necessitates both listed and non-listed
companies to communicate their key audit matters to the stakeholders through a proper audit
report. The reason behind this can be attributed to the fact that communication of material
matters can allow users to make proper decisions. However, it must be noted that the
judgement of an auditor is crucial in this regard to ascertain what matter is considered
material and what is not. The increasing level of inventories is a matter of serious concern in
the given scenario and hence, must be duly communicated by the auditors (Matthew, 2015).
This is because all the utilized analytical methods reflect that there has been an increment in
the value of closing stock not due to increment in production but due to major issues in the
software of the company resulting into secondary sales. Moreover, this can also affect the
government tender that is a negative indicator (Coram et.. al, 2011). Nevertheless, the
objective is to intimate the users that they must cross-check through other means and
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Audit
thereafter, take decisions based on the same. Since, propriety funds are associated in the
given case, the same is material in nature and must be duly reported.
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Audit
Green Machine Ltd
a. Two prime assertions
Assertions are based on preparation and presentation of financial statements and any false
assertions can be troublesome for the company and therefore, there must be strict avoidance
of the same. In relation to the given case, the prime matter for the company is its property,
plant, and equipment (PPE) as the same is assumed to be a manufacturing company an PPE
forms a major part of such company’s assets. Moreover, classification and valuation of these
assets is equally important because financial outcomes can be altered to defraud the
stakeholders (Coram et.. al, 2011). The risks related to the company are as follows:
 Classification
The assets of the company must be accurately classified so that users get a true and fair view
of the financial outcomes. Further, all expenses must be appropriately aligned to their own
heads so that there is no error in the financials. For instance, maintenance and repairs must be
allocated to the revenue expense, fresh purchases must form part of block of assets, etc.
Nonetheless, these classifications must be based on generally accepted accounting principles
(GAAP). In the case of Green Machine, all its costs of past year are totally mixed up, which
means that its revenue and capital expenses are interpreted inappropriately, thereby
portraying a wrong picture of the overall accounts as the carrying values of PPE are either at
inflated or degraded figures.
 Accuracy
Such assertion highlights the fact that proper computation of accounts has not been done and
that may not gather an unqualified audit judgement on the auditors’ part. Besides, from the
company’s management report, it is visible that the rate of depreciation has been considered
very less that has paved a path for the destruction of correctness and fairness of books of
accounts. Nonetheless, considering lesser depreciation rate can have the following outcomes
namely exaggerated value of assets, increased financial figures, creation of additional
liabilities like deferred taxes, etc (Asien, 2015). Hence, considering a lesser depreciation rate
can affect the financial health of the company in the upcoming tenure that is a major risk
factor.
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Audit
b. Substantive audit procedures
As mentioned earlier, substantive audit procedures play a key role in gathering audit evidence
to support the assertions or claims offered by companies. Further, these procedures can assist
in identifying any false claims or assertions on the part of companies that can assist in
preventing future problems.
 Against classification
In the given scenario, it is visible that errors persist in the past computations that necessitates
due caution and care on the part of auditors towards the current year computation. Therefore,
the entire audit team must scrutinize the past calculation and analyse the present year’s
computation to arrive at appropriate figures. Nevertheless, the entire procedure is lengthy and
time consuming in nature but the same must be undertaken to mitigate the risk of
classification assertion (Arens et. al, 2013). Moreover, for such purpose, a unique team must
be framed to check the capital assets and monitor any changes or additions in the documents
related to the company’s PPE. In addition, proper care must be undertaken to advise the
finance department so that such errors are not repeated in the future (Arens et. al, 2013).
 Against accuracy
This assertion is very relevant in this scenario because major errors can incur in the future
owing to improper calculation, inappropriate judgements or estimates, and inaccurate
valuation. In order to mitigate the issue of accuracy, all the assets of the company must be
carefully supervised and checked and thereafter, their depreciation rate must be understood.
c. ASA 701 (Communication of key audit matters)
As mentioned earlier, ASA 701 is primarily related to an auditor’s judgement regarding
whether a matter is of material nature or not. In relation to Green Machine, its fixed asset
(PPE) forms a significant part of its total assets and therefore, errors associated with the same
can be considered as a key audit matter. Further, these errors are not of minor nature that can
be overlooked and proceeded further. Therefore, reporting of the same must be duly done.
Therefore, disclosure of errors, reasons behind the cause of such errors, actions taken in the
current year to mitigate the past issue, etc must be done by the auditors in their report so that
users can make efficient decisions based on the same.
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Audit
Conclusion
It is very significant for companies to follow requisite accounting policies and standards to
assist users in their decision-making processes. Further, auditors are also bound to oversee
this entire process so that in the event of material issues, the same can be highlighted at the
primary stages itself and major risks can be mitigated on a whole. Besides, companies can
safeguard themselves from penal provisions if the advice of auditors are considered while
preparing and presenting the financials. Nonetheless, this can assist in maximization of
goodwill as well.
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Audit
References
Arens, A. A, Best, P. J, Shailer, G. E. P & Loebbecke, J. K. (2013) Assurance Services and
Ethics in Australia, 9th ed, Australia: Pearson.
Asien, E.N., (2015). Firms' attributes determining auditors' remuneration: empirical evidence
from Nigeria. International Journal of Auditing Technology, 2(4), pp.297-315. Doi:
https://doi.org/10.1504/IJAUDIT.2015.076440
Wright, M.K. & Charles, J. (2012). Auditor independence and internal information systems
audit quality, Business Studies Journal. 4(2), 63-84.
Coram, P., Mock, T. J., Turner, J. & Gray, G. (2011). The communicative value of the
auditor’s report. Australian Accounting Review 21(3): 235-252. Doi:
https://doi.org/10.1111/j.1835-2561.2011.00140.x [Accessed 22 January 2019]
Hoffelder, K. (2012) New Audit Standard Encourages More Talking. Harvard Press.
Matthew, S. E. (2015) Does Internal Audit Function Quality Deter Management
Misconduct?. The Accounting Review. [online]. 90(2), pp. 495-527. Available from
https://doi.org/10.2308/accr-50871 [Accessed 22 January 2019]
Niemi, L., and Sundgren, S. (2012). Are modified audit opinions related to the availability of
credit? Evidence from Finnish SMEs. European Accounting Review, 21(4), 767-796.
https://doi.org/10.1080/09638180.2012.671465
Baldwin, S. (2010). Doing a content audit or inventory. Pearson Press.
Badolato, P.G., Donelson, D.C. and Ege, M., (2014). Audit committee financial expertise and
earnings management: The role of status. Journal of Accounting and Economics. 58(2-3),
pp.208-230. Available from: https://utexas.influuent.utsystem.edu/en/publications/audit-
committee-financial-expertise-and-earnings-management-the-r [Accessed 20 September
2018]
Gajevszky, A. (2014)The Impact Of AuditorS Opinion On Earnings Management: Evidence
From Romania. Network Intelligence Studies, 2(1), p.3. Available from:
https://EconPapers.repec.org/RePEc:cmj:networ:y:2014:i:3:p:61-73 [Accessed 20 September
2018]
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Geoffrey D. B., Joleen K., K. K.S., and David A. W. (2016) Attracting Applicants for In-
House and Outsourced Internal Audit Positions: Views from External Auditors. Accounting
Horizons. [online]. 30(1), p.143-156. DOI: https://doi.org/10.2308/acch-51309
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