ACC 707 Auditing: Risk Assessment of Inventory and PPE Assertions

This report provides an analysis of audit assertions related to inventory and property, plant, and equipment (PPE) for two case studies. The first question focuses on Advanced Computer Solutions, identifying accuracy/valuation and cut-off as key assertions at risk due to inventory movement, software issues, and inclusion of prior-year sales. Substantive audit procedures are suggested, and the rationale for considering these as Key Audit Matters according to ASA 701 is explained, including required disclosures. The second question examines Green Machine Ltd, highlighting accuracy and valuation risks related to incorrect classification of expenses and depreciation. The report details appropriate audit procedures and explains how to address these risks, again considering ASA 701 requirements and disclosures. The document is available on Desklib, a platform offering a range of study tools and solved assignments for students.

Running head: AUDITING AND ASSURANCE SERVICES
Auditing and Assurance Services
Name of the Student
Name of the University
Author’s Note

1AUDITING AND ASSURANCE SERVICES
Table of Contents
Introduction................................................................................................................................2
Answer to Question 1.................................................................................................................2
Requirement (a)......................................................................................................................2
Requirement (b).....................................................................................................................3
Requirement (c)......................................................................................................................4
Requirements of ASA 701.....................................................................................................4
Rationale for Determination...................................................................................................5
Disclosure of Key Audit Matters as per ASA 701.................................................................5
Answer to Question 2.................................................................................................................6
Requirement (a)......................................................................................................................6
Requirement (b).....................................................................................................................7
Requirement (c)......................................................................................................................8
Requirement of ASA 701.......................................................................................................8
Rationale for Determination...................................................................................................9
Disclosure of Key Audit Matters...........................................................................................9
Conclusion................................................................................................................................10
References................................................................................................................................11
Introduction

2AUDITING AND ASSURANCE SERVICES
Auditing is considered as the process to examine as well as insect the financial
statements of the business organizations with the aim to find any kind of material
misstatements in them that can hamper the decision making process of the key stakeholders
(Simnett, Carson and Vanstraelen 2016). At the time of the preparation of the financial
statements and reports, the managements of the audit clients utilize certain unspoken and
unambiguous claims and these claims are called the Audit Assertions. It is needed for the
auditors of the companies to take into consideration the analysis as well as examination of
these audit assertions as there are many instances where the auditors have found errors or
other issues in the used audit assertions (Burton et al. 2014). In case the auditors find any
kind of issue in the assertions, they need to declare that particular assertion or assertions at
risk. Then, with the aim to minimize this risk in audit assertions, the auditors are required to
perform the suitable substantive audit procedures. At the same time, it is on the auditors to
decide whether these issues can be considered as Key Audit Matters or not. In case they are
Key Audit Matters, the auditors are needed to ensure the proper communication of them with
description in the audit report so that the key stakeholders become aware of them (Simnett,
Carson and Vanstraelen 2016). The aim of this report is to consider the analysis of the audit
assertions related to inventory and property, plant and equipment for the companies in the
provided case studies.
Answer to Question 1
Requirement (a)
Accuracy or Valuation
This assertion ensures that there is not any error in the inventory transactions. At the
time to deal with this assertion, it is needed for the auditor to ensure the physical inventory
figures are accurate and to ensure the flow of appropriate inventory to the income statement

3AUDITING AND ASSURANCE SERVICES
as cost of goods sold from the balance sheet (Titera 2013). In case of Advanced Computer
Solutions, there was movement in inventory to six different warehouses on March 2018. For
this reason, physical inventory count of the company can be wrong as there can be error in
the inventory counting process. In addition, the suspected problem in software could be a
barrier in the correct inventory flow to the income statement from the balance sheet of the
company. These reasons lead to this particular assertion at risk (Kharisova and Kozlova
2014).
Cut Off
The use of this particular assertion ensures the correct reporting of the inventory
values in the correct accounting books. Hence, the need for the auditors is to undertake
examining the inventory shipping and receiving documents for ensuring the correct register
of inventory movement (Knechel and Salterio 2016). For example, the companies cannot
record the goods received of the last year in the current year’s book. According to the case of
Advanced Computer Solutions, 18 per cent sales of 2017 are included in the inventory for the
year 2018. By applying the principles of cut off assertion, it can be said that failure of the
company in properly calculates the inventory contributed towards the inclusion of 2017 sales
in the inventory of 2018. At the same time, it could also be happened due to the issues in
software (Finkbeiner 2014). Hence, the auditors of Advanced Computer Solutions can
consider this assertion at risk.
Requirement (b)
In response to the first assertion at risk, it is needed for the auditor of Advanced
Computer Solutions to thoroughly observe the physical inventory counting process of the
client (Feng et al. 2014). While doing this, the auditor need to discuss the methodical
physical inventory count process with the responsible staffs in order to be familiar with the

4AUDITING AND ASSURANCE SERVICES
process; to scrutinize the process when they are being conducted; to examine the physical
count of inventory to outline the inventory amounts in the company’s book; and to examine
the tags of inventory. Apart from this, the auditor is needed to undertake the inventory tests in
all the recently moved warehouses while it is needed for him to tally the results with the
inventory confirmation from the central warehouse (Feng et al. 2014). Lastly, it is needed for
the auditor of Advanced Computer Solutions to test the cost calculation process of inventory
and ensure the fact that the company has complied with the required accounting standards for
inventory calculation.
The auditor is needed to carefully conduct the cut off related tests as this risk can lead
to major issue in inventory computation for the company. The need for the auditor is the
examination of the notes of goods received in warehouses and goods delivered to suppliers
(Elder et al. 2013). Analytical procedures need to be conducted to find any unreasonable
incidents in inventory transactions that can cause inventory slow moving and abnormally
high or low amount of inventory in the warehouses. As the inventory of the company has
been moved to six different warehouses from a central one, the auditor needs to scrutinize the
presence of any stop in receiving the inventory from the central warehouse at the time of
physical inventory counting process. This needs to be done for the identification of needless
items in the inventory with the aim to exclude them from the inventory counting process
(Elder et al. 2013).
Requirement (c)
Requirements of ASA 701
As per ASA 701, the auditors are needed to follow the following requirements:

5AUDITING AND ASSURANCE SERVICES
1. They are needed to determine the Key Audit Matters while considering the
assessment of the areas of material misstatement, significant judgments of the client’s
management and the effects of significant incidents on audit (auasb.gov.au 2019).
2. After that, they are needed to ensure the proper communication of the key audit
matter in the auditor’s report (auasb.gov.au 2019).
3. The auditors are needed to communicate these with the staffs charged with
governance.
4. They are needed to effectively document these key audit matters (auasb.gov.au 2019).
Rationale for Determination
According to the ruling of ASA 701, error in the calculation of inventory of Advanced
Computer Solutions can lead to the material misstatements as it can majorly affect the
liquidity as well as efficiency position of the company. After that, the inventory valuation
process involves the judgment and assumptions of the management in the areas of coat
calculation and physical inventory count; and there can be uncertainty in them. Lastly, the
movement of inventory to the six warehouses along with the issues in the software can be
considered as significant events having effects on audit. For these reasons, this risk can be
considered as Key Audit Matter as per ASA 701 (Draft 2013).
Disclosure of Key Audit Matters as per ASA 701
Why Significant How Audit Addressed the Key Audit
Mattes
On March 2018, Inventory moved to new
warehouses
As the company has moved their inventory in
six regional warehouses, there can be error in
physical inventory count and inventory
calculation process. This can be considered
as significant for the audit.
The audit procedures are:
- thoroughly observe the physical inventory
counting process
- discuss the methodical physical inventory
count process
- scrutinize the process when they are being

6AUDITING AND ASSURANCE SERVICES
conducted
- inventory tests in all the recently moved
warehouses
- test the cost calculation process of inventory
Inclusion of the sales of 2017 in the
inventory of 2018
The inventory of 2018 includes 26% sales of
2018 and 18% sales of 2017. However, it is
not correct to include previous year’s sales in
current year’s inventory. This is a significant
event for the audit of the company (Sirois,
Bédard and Bera 2018)
The audit procedures are:
- Examination of the notes of goods received
in warehouses and goods delivered to
suppliers
- Analytical procedures for tracing irrational
incidents
- Scrutinize the presence of any stop in
receiving the inventory from the central
warehouse at the time of physical inventory
counting process
Answer to Question 2
Requirement (a)
Accuracy
The analysis of this assertion assists the auditors to tackle any error that took place
during the transactions of property, plant and equipment. Hence, the need for the auditors is
to analyze the procedures in which the company has classified the depreciation, repair
expenses and impairment (Hall 2015). In case of Green Machine Ltd, there are certain
mistakes in the distinction between capital and revenue expenses. The company has recorded
certain revenue expenses as capital expenses and done the inclusion of certain capital
expenses in repair and maintenance. It indicates towards the failure of the company in
correctly classifying the property, plant and equipment related expenses and these aspects can
lead to this particular audit assertion at risk (Mock and Fukukawa 2015).

7AUDITING AND ASSURANCE SERVICES
Valuation
With the assistance of the analysis of this assertion, the auditors become sure about
the fact that whether the clients have correctly recorded the values of their property, plant and
equipment in the correct accounting books (Houmes, Foley and Cebula 2013). Hence, the
client needs to report the property, plant and equipment at cost less accumulated depreciation
where depreciation is a crucial part and the company needs to utilize the effective
depreciation rate. In case of Green Machine Ltd, too lower rate of depreciation has been
charged on the property, plant and equipment. This wrong application of depreciation rate
leads to the reduced operating expenses that overstate the net profit. In addition, in the
presence of wrong application of the depreciation rate leads to the incorrect reporting of the
value of property, plant and equipment in the accounting books (DiGabriele 2016). In the
presence of all these aspects, it can be said that this particular assertion is at risk.
Requirement (b)
It can be noted from the above discussion that Green Machine Ltd has certain issues
in the distinction between the revenue and capital expenditures. For the auditor, the
substantive audit procedure is to ensure the review of the capital and revenue expenses of the
company (Chi et al. 2017). More specifically, the auditor needs to undertake reviewing the
capital and revenue expenses related to property, plant and equipment after acquiring the list
of property, plant and equipment. Apart from this, it is needed for the auditors to review the
capital expenditure policies of Green Machine Ltd. The undertaking of all these substantive
audit procedures will assist the auditor of Green Machine Ltd to recognize the revenue
expenses which are wrongly capitalized and the capital expenditure which have been wrongly
added in the repair and maintenance of property, plant and equipment (Chi et al. 2017).

8AUDITING AND ASSURANCE SERVICES
In case of the next assertion at risk related to property, plant and equipment, it is
needed for the auditor of the company to investigate the position of property, plant and
equipment in relation to depreciation expenses. The need for the auditor is to identify
unnecessary and dismantled property, plant and equipment that need to be removed from the
list (O’Donnell et al. 2015). Most importantly, the auditor needs to undertake the
recalculation of the depreciation related to property, plant and equipment. It demands the
testing of depreciation in relation to the property, plant and equipment’s residual value and
loss or profit from the sales of property, plant and equipment. Comparison of ratios of
depreciation needs to be done in this stage. The auditor must test the adherence of Green
Machine Ltd with the needed policies and standards of depreciation. All these procedures will
assist the auditor to recalculate the actual rate of depreciation so that they can charge it
against the property, plant and equipment for obtaining the actual depreciation expenditures
(O’Donnell et al. 2015).
Requirement (c)
Requirement of ASA 701
It is needed for the auditor to comply with the below requirements of ASA 701 while
dealing with the Key Audit Matters:
1. Determination of the key audit matters is the first requirement by considering the risk
of material misstatements, judgement of the auditors and significant events
(auasb.gov.au 2019).
2. Communication of the derived key audit matters is another major requirement as per
ASA 701 where these matters need to be disclosed in Auditor’s Report (auasb.gov.au
2019).
3. Communicating the key audit matters with the governance department is another
major requirement (auasb.gov.au 2019).

9AUDITING AND ASSURANCE SERVICES
4. The auditors need to ensure the documentation of key audit matters as per ASA 701.
Rationale for Determination
While complying with the standards of ASA 701, it can be seen that the application of
low rate of depreciation along with the incorrect classification of expenditures can affect the
expenses while misstating the company’s profit and can lead to material misstatements.
Hence, the application of low depreciation rate and incorrect classification of expenses
includes uncertain judgements and assumption of the management. Lastly, these aspects can
be considered as significant events that have significant effects on the audit process of the
company. For these reasons, this risk can be considered as Key Audit Matters as per ASA
701 (Simnett and Huggins 2014).
Disclosure of Key Audit Matters
Why Significant How Audit Addressed the Key Audit
Mattes
Incorrect Classification of the
Expenditures
It can be seen that the company has wrongly
capitalized certain revenue expenses where
included capital expenses in income
statement. This involves the judgments of the
management and can create material effects
on the company. Thus, it is significant for the
audit.
The audit procedures are:
- Review of the capital and revenue expenses
of the company
- Undertake reviewing the capital and
revenue expenses related to property, plant
and equipment after acquiring the list of
property, plant and equipment
- Review the capital expenditure policies
Application of Too Low Rate of
Depreciation
The company has applied low rate of
depreciation on property, plant and
equipment that involves significant
judgements and assumption of the
management. Hence, it is considered as a
The audit procedures are:
- Investigate the position of property, plant
and equipment in relation to depreciation
expenses
- Identify unnecessary and dismantled
property, plant and equipment
- Testing of depreciation in relation to the

10AUDITING AND ASSURANCE SERVICES
significant incident for the audit of the
company.
property, plant and equipment’s residual
value and loss or profit from the sales of
property, plant and equipment
- Recalculation of the depreciation related to
property, plant and equipment (Bédard,
Gonthier-Besacier and Schatt 2014)
Conclusion
At the time of the determination of the key audit matters, it is needed for the auditors
to consider the analysis of the used management assertion in the preparation of the financial
statements. As per the above discussion, the assertions at risk for Advanced Computer
Solution are accuracy or valuation and cut off. In case of Green Machine Ltd, the assertions
at risk are accuracy in the distinction between the capital and revenue expenses and correct
valuation of the depreciation on property, plant and equipment. It can be understood from the
above that the selection of the substantive audit procedures wholly depends on the types of
audit assertions at risk. In addition, the auditors are needed to take into consideration the
adherence to the requirement of ASA 701 at the time to determine the key audit matters.

11AUDITING AND ASSURANCE SERVICES
References
Auasb.gov.au. 2019. [online] Available at:
https://www.auasb.gov.au/admin/file/content102/c3/ASA_701_2015.pdf [Accessed 18 Jan.
2019].
Auasb.gov.au. 2019. ASA 701 . [online] Available at:
https://www.auasb.gov.au/Pronouncements/Australian-Auditing-Standards/ASA-701-
2015.aspx [Accessed 18 Jan. 2019].
Bédard, J., Gonthier-Besacier, N. and Schatt, A., 2014, January. Costs and benefits of
reporting Key Audit Matters in the audit report: The French experience. In International
Symposium on Audit Research. Available at: http://documents. escdijon.
eu/pdf/cig2014/ACTESDUCOLLOQUE/BEDARD_GONTHIER_BESACIER_SCHATT. pdf.
Burton, F.G., Starliper, M.W., Summers, S.L. and Wood, D.A., 2014. The effects of using the
internal audit function as a management training ground or as a consulting services provider
in enhancing the recruitment of internal auditors. Accounting Horizons, 29(1), pp.115-140.
Chi, W., Myers, L.A., Omer, T.C. and Xie, H., 2017. The effects of audit partner pre-client
and client-specific experience on audit quality and on perceptions of audit quality. Review of
Accounting Studies, 22(1), pp.361-391.
DiGabriele, J.A., 2016. The expectation differences among stakeholders in the financial
valuation fitness of auditors. Journal of Applied Accounting Research, 17(1), pp.43-60.
Draft, E., 2013. Reporting on Audited Financial Statements: Proposed New and Revised
International Standards on Auditing (ISAs).