Audit and Assurance Report: Financial Risk and Misstatement Analysis

This report provides a detailed analysis of an audit and assurance case study involving Homes South Ltd and Darfield Electronics. The report examines potential material misstatements in financial statements, including issues related to mortgage valuations, interest rate volatility, internal controls, and revenue recognition. It identifies specific risks, such as overstating profits, inaccurate inventory valuation, and misrepresentation of asset values. The report also offers recommendations for auditors to improve evidence gathering and provide appropriate opinions, including vouching sales and expenses, verifying cash outflows, and conducting physical inventory counts. The analysis highlights the importance of transparency and accurate reporting for maintaining investor confidence and making informed financial decisions. The report also analyzes the audit risks for Darfield Electronics.

Running head: AUDIT AND ASSURANCE
Audit and Assurance
Name of the Student:
Name of the University:
Author’s Note:

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Table of Contents
Answer to Question 1.................................................................................................................1
Part 1......................................................................................................................................1
Part 2..........................................................................................................................................2
Part 3......................................................................................................................................3
Part 4......................................................................................................................................3
Part 5......................................................................................................................................4
Answer to Question 2.................................................................................................................5
Introduction............................................................................................................................5
Analysis of the Organization..................................................................................................5
Recommendations..................................................................................................................6
Conclusion..............................................................................................................................7
Reference....................................................................................................................................8

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Answer to Question 1
Part 1
The material misstatements which are associated with a financial statements needs to
be identified by the auditor and reported in the auditor’s report so that the investors have
access to all information. The business of Homes South Ltd is engaged in the operations of
offering mortgage solution to customers. As per the analysis of the auditor, the company has
generated significant profits from marketing mortgages in rural areas and the same is more
than the industry average. The company sells its mortgage products to an investment trusts so
that the business can earn more revenues from its lending operations. It is to be noted that the
business is currently performing better in the segment in comparison to other businesses
which are offering similar solutions in the market.
The auditor needs to check whether the amount of profits which is generated by the
business from selling mortgages is accurate and the amounts needs to be analysed in details
which is portrayed in the financial reports of a business. The amounts which are portrayed in
the financial reports can be overstated which make the company would reveal more profits
than it has actually earned (Pcaobus.org. 2020). One other aspect which needs to be
recognised is the interest rate volatility which has a direct impact on the finance costs and
also on the profits. The auditor from Pearce Green needs to ensure that the financial
statements which are prepared have taken all these factors into consideration. If the same are
not considered and misrepresented by the management of the company than the entire
financial position of the business would be affected. Another area where misstatement is
likely to take place is in the valuation process which is used for the mortgages and how
values of the same are reflected in the balance sheet (Mock and Fukukawa 2016). If the
values of the same are shown to be overvalued than naturally the financial position of the
business would be affected in terms of accuracy.

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Part 2
One of the factors which affect the reporting process for a business is the internal
control which is associated with the business. In auditing as well, the auditor considers the
internal control of the business for the purpose of relying on the evidences which the business
accumulates from internal sources. As per the case which is portrayed, the board of directors
is controlled by George Watson which looks after the decision which is taken jointly by the
board of directors. The different branches record their own profits and the management also
charge their respective remuneration on the basis of the profits which the business is able to
generate.
The risks is associated with the control risks as the business needs to ptepared a
consolidated statement for all the branches and due to the internal control procedure which is
followed by the business, there is a high chance that the books of accounts would be
including some material misstatement which would be affecting the reporting framework
which is followed. There is a risk of material misstatement in the profits which are reported
for each of the branches as there is a possibility that the same can be overstated. This would
also mean that the remuneration which is charged might also be overcharged (Florin, Daniel
and Florina 2013). This qualifies as a significant material misstatement. The auditor in such a
situation needs to assess all the risks which are associated with the branches and ensure that
the financial reporting process of each of such branches is accountable. Therefore, in such a
case, there is a risks that the internal control for the business might not be appropriate and this
also suggests that the reporting process might also be affected.
Part 3
The material misstatements takes place when matters which are relevant to the
operations if the business intentionally or accidently withheld some key information which
are of value to the investors. As per the case which is shown in the case, the business of HS

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has accumulated tosses which need to be incorporated in the books of accounts. The advice of
the auditor was to make changes in the reporting for losses also increase. The business wants
to increase the allowances for the purpose of covering the losses which is sustained by the
business.
In such a case, the material misstatement risk arises if the losses or the allowances
which the management of the company is entitled to effectively portray is not shown in the
books of accounts of the company (Knechel and Salterio 2016). The auditor also needs to
check if the losses are properly covered and if the same actually exists and are not cooked up
by the business. Any material misstatement which has the required level of significance needs
to be reported by the auditor in the books of accounts.
Part 4
As per the case which is provided, the business of HS ltd has opened a new branch for
the purpose of expanding the operations of the business. The analysis shows that the new
branch has not been able to generate required level of profits as expected which is mainly due
to high competition in the market. The risk of material misstatement in such a case is from
the reporting for profits which can be easily be cooked so that the business is consistent with
the industry average. The profits of the business can be cooked so that the new branch is able
to show the customers, that the business has potential and thereby draw more investments
from the same.
The auditor of the company needs to ensure that the profits which is portrayed in the
financial statement is showing accurate so that the investors get access to correct information
which would assist them to take proper decisions. In addition to this, the auditor also needs to
verify the expenses as there is also a risk of material misstatement in the expenses (Paino,
Razali and Jabar 2015). The management of the new branch might be supressing expenses so

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that the profits are shown at a desired level. The aim of the management is to expand the
operations of the business and therefore, the business must use appropriate reporting process
for maintaining transparency and build a strong relation with the investors of the business.
Part 5
It is to be noted that it is the responsibility of the auditor to look for material
misstatement and also advise the management regarding how improvements can be brought
about in the reporting process of the business. As per the case which is presented, the
management of HS ltd has purchased a new computer system which would be forming part of
the assets of the business and the same needs to be reported in the balance sheet of the
company.
The risk of material misstatement is that the amount which is represented to be the
value of computer equipment might be overstated so as to increase the asset base of the
company and thereby show a more favourable financial statement for the business. Tin
addition to this, the new computer would also be subjected to depreciation and impairment
charges as the applicability of relevant standards (Bhattacharjee, Maletta and Moreno 2016).
There is a risk that the management has not provided appropriate disclosures and treatment
requirement for the new computer. The value can be misrepresented in the balance sheet of
the company and therefore, in such a case the role of an auditor is quite important.
Answer to Question 2
Introduction
The main purpose of the assessment is to analyse the audit risks which can be
identified for the business of Darfield Electronics which is engaged in providing electronic
products for the customer. The analysis would be considering the recent reporting framework
which is followed and provide recommendation as to how improvements can be brought

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about in the reporting process of the entity (Han et al. 2016). The assessment would be
identifying the different types of risks which is associated with the reporting form which is
used by the business.
Analysis of the Organization
The business is engaged in providing electric goods to the customers and the financial
projections which is available for the company from previous year shows that the business
has a capacity to generate profits in large amounts. The projections also show a draft
performance estimates for 2021. The draft is considered for identifying risks of material
misstatement and what steps can be taken by the auditor and management to resolve the
situation.
The revenue for the company has shown to have risen significantly and therefore the
auditor needs to check the amounts so that it can be confirmed that the business was actually
able to achieve such a high per cent turnover. It is to be noted that any misstatement in the
sales figure would have a direct impact on the profits which is generated by the business
(Contessotto and Moroney 2014). Further, the expenses of the business have also increased
which can be due to increase in the sales of the business but the auditor needs to confirm this
by applying extensive audit procedures. The financial projections further shows in the draft
section that the business has no cash in hand which is a matter of concern from the
perspective of liquidity of the business. Instead of liquid cash balance, the business shows
bank overdraft which is a clear indicator that significant cash outflows has taken place. This
is a matter which the auditor of the company meeds to investigate (Graham, Bedard and
Dutta 2018). The balance of cash is one of the areas where material misstatements can be
done and therefore the auditor of the company needs to investigate the same so that it can be
made clear that the business does not have any liquid cash in hand considering the
projections. One other area where significant doubt arises is the inventory value which is

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portrayed (Askary, Arnaout and Abughazaleh 2018). The reason for doubt is because
inventory are most susceptible to misstatement as in most cases valuation of the inventory is
not done properly which creates material misstatement in the financial statement of the
company.
Recommendations
The recommendation which can be suggested to the auditor of Darfield Electronics
for the purpose of effectively collecting evidences and also for providing appropriate opinion
on the financial statements.:
 The auditor needs to apply vouching practices on sales and expenses and thereby also
check all necessary receipts, invoices, bills and orders so that appropriate value can be
achieved for the figures of sales.
 In the case of cash balance, the auditor needs to verify all cash outflows for the
business and also verify any purchases and buyback which the company undertakes
(Baldauf, Steckel and Steller 2015). The auditor here only needs to confirm that the
bank overdraft balance which is shown is actually correct or not.
 The auditor would be applying verification of inventory and would be checking all
receipts, invoices and return inwards register so that it can be ascertained that the
reporting framework is accurate. If a situation arises, the auditor can also take
physical counting of the stocks so that an accurate estimation of the valuation can be
achieved.
 In addition to this, the auditor also needs to use tools like analytical review for
estimating the trends from previous year and also external confirmation for ascertain
items such as account receivables.

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Conclusion
The above analysis appropriately shows the audit risks which is faced by Darfield
Electronics during the period and also shows the steps which the auditor would be taking for
making improvements in the reporting process of the business. The risks which are identified
in the analysis is based on the financial projections which is available for the company
showing performance of 2021. Some of the risks which are identified are sales, expenses,
cash balance and inventory also provided with recommendations so that the auditor can
effectively collect evidences and form an opinion whether the financial statements are
showing a true and fair view or not. The items which are analysed for the purpose of risk
assessment would be based on the estimation of materiality of the item and how misstatement
of the same would impact the financial statement.

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Reference
Askary, S., Arnaout, J.P.M. and Abughazaleh, N.M., 2018. Audit evidences and modelling
audit risk using goal programming. International Journal of Applied Decision
Sciences, 11(1), pp.18-35.
Baldauf, J., Steckel, R. and Steller, M., 2015. The Influence of Audit Risk and Materiality
Guidelines on Auditor’s Planning Materiality Assessment. Accounting and Finance
Research, 4(4), pp.97-114.
Bhattacharjee, S., Maletta, M.J. and Moreno, K.K., 2016. The role of account subjectivity and
risk of material misstatement on auditors' internal audit reliance judgments. Accounting
Horizons, 30(2), pp.225-238.
Contessotto, C. and Moroney, R., 2014. The association between audit committee
effectiveness and audit risk. Accounting & Finance, 54(2), pp.393-418.
Florin, D., Daniel, V. and Florina, P.A., 2013. Financial Reporting under XBRL and the
Impact on the Financial Audit. Ovidius University Annals, Series Economic Sciences, 13(1).
Graham, L., Bedard, J.C. and Dutta, S., 2018. Managing group audit risk in a
multicomponent audit setting. International Journal of Auditing, 22(1), pp.40-54.
Han, S., Rezaee, Z., Xue, L. and Zhang, J.H., 2016. The association between information
technology investments and audit risk. Journal of Information Systems, 30(1), pp.93-116.
Knechel, W.R. and Salterio, S.E., 2016. Auditing: Assurance and risk. Routledge.
Mock, T.J. and Fukukawa, H., 2016. Auditors' risk assessments: The effects of elicitation
approach and assertion framing. Behavioral Research in Accounting, 28(2), pp.75-84.

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Paino, H., Razali, F.M. and Jabar, F.A., 2015. The influence of external auditor's working
style, communication barriers and enterprise risk management toward reliance on internal
auditor's work. Procedia Economics and Finance, 28, pp.151-155.
Pcaobus.org. (2020). AS 2110: Identifying and Assessing Risks of Material Misstatement.
[online] Available at: https://pcaobus.org/Standards/Auditing/Pages/AS2110.aspx [Accessed
26 Jan. 2020].