ACC707 Trimester 2 Audit Assignment: Inventory and Intangible Assets

This audit assignment report analyzes two case studies: Computing Solutions Limited (inventory) and Beautiful Hair Limited (intangible assets). It identifies key audit assertions (disclosure and valuation for inventory; completeness and valuation for intangibles), outlines substantive audit procedures, and discusses communicating Key Audit Matters (KAMs) as per ASA 701. The Computing Solutions case examines inventory turnover, warehouse changes, and valuation adjustments. The Beautiful Hair case focuses on the acquisition of intangible assets (technical know-how). The report emphasizes the importance of disclosures, valuation techniques, and the auditor's role in verifying financial statement accuracy. The report also includes recommendations for the audit process.

Audit Assignment

1
By student name
Professor
University
Date: 10th Oct, 2018.
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Executive Summary
A report has been prepared on the two audit case studies, one relating to the Computing
Solutions Limited (Computing Solutions) and the other related to the client Beautiful Hair
Limited. The first case study deals on the inventory and the 2nd case study relates to the
intangible assets. With respect to both the case studies, two relevant audit assertions have been
mentioned along with the substantive audit procedures to be employed by the auditor in both the
circumstances. Also, the key audit matters with respect to each of the case studies has been
mentioned along with the rationale of reporting the same. The report ends with the relevant
disclosures to be given in this regard along with the recommendations on the same.
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Table of Contents
Audit Assertions..............................................................................................................................3
Question 1: Inventory......................................................................................................................3
Key Assertions.............................................................................................................................3
Substantive audit procedures.......................................................................................................4
Communicating Key Audit Matters in the Auditor’s Report.......................................................6
Question 2........................................................................................................................................7
Key Assertions.............................................................................................................................7
Substantive Audit Procedures......................................................................................................9
Communicating Key Audit Matters in the Auditor’s Report.......................................................9
References......................................................................................................................................12
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Introduction to Audit Assertions
Audit assertions are the management estimates and judgements and treatment of various
accounting items in respect to various elements and sections of the financial statements of the
entity. It is the responsibility of the management of the company to prepare the books of
accounts of the entity and to place and implement the relevant internal controls in place for the
same. This is one of the way to ensure that the accounts of the entity are free from errors,
omissions and material misstatements. Also, the responsibility can be fixed on the management
of the company. The auditor can verify the same and then based on the professional judgement,
can opt to rely on the same while doing the audit or opt for applying additional audit procedures
to get sufficient and appropriate audit evidences for the audit (Andiola, et al., 2018). The
assertions are mainly categorised into 5 major categories namely the completeness in recording
of transaction, the existence of the asset or liability (substance over form), rights and obligations
in respect of asset or liability, valuation of the asset and finally the disclosures to be made in
respect of something. The two below mentioned case studies discusses the audit assertions, the
audit procedures to be employed and finally the key audit matters to be disclosed in that regards
(Appelbaum, et al., 2018).
Question 1: Inventory
Key Audit Assertions
The given case is on Computing solutions which deals with the computer related inventory
and the auditor has few of the observation while doing the audit for June 2018. Some of the audit
assertions in this regard are as follows:
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1. Disclosure: As per the relevant Australian accounting standards all the critical and
significant information which may affect the decision making of any user should be
disclosed clearly in the financial statements in a manner which is understandable to the
user. The company should comply with the same and disclose all the material
information. In the given case, the company’s inventory turnover ratio has decreased
from 5.2 times in 2017 to 3.8 times in 2018 which clearly shows that the inventory
movement has gone down drastically, also the company has moved the stocks and the
existing inventories from the central warehouse to the six regional warehouses which
might have an impact on the indirect supply chain costs and therefore the same should be
disclosed (Axelsen, et al., 2017). Finally, it is a standard that the inventories should be
valued at cost or net realizable value, whichever is lower but in the given the company is
altering the inventory valuation process by valuing it at 10% lower than the cost to meet
the major tender received from the large government department. This is one of the major
changes in the policy of the company and therefore the same should be disclosed in the
financial statements. All this is required to be transparent with the relevant stakeholders
and therefore it needs to be seen if the company has met the same (Bailey, et al., 2017).
2. Valuation: Valuation is one of the complex areas where a lot of judgements and estimates
are involved. Some companies even take the help of the valuation experts in valuing the
inventory of the company. As per the accounting standards, the inventory must be valued
at net realizable value or the cost, whichever is lower (Bumgarner & Vasarhelyi, 2018).
Besides, that, it also needs to be checked what is the treatment of wastage being done by
the company and how are they treating abnormal things. In the given case, the computing
solutions has valued the material at 10% less the net realizable value. There is always a
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risk that the material or the inventory might become obsolete in case of the technological
improvements in the industry and therefore the company and the management must take
care of this aspect of valuation (Fukukawa & Mock, 2011).
Key Audit Assertions
The substantive audit procedure may be defined as the procedures being employed by the
auditors in the conduction of the audit and it includes vouching of income and expenses and
verification of the asset and liabilities (Garon, 2018). Based on this checking only, further
analytical procedures to be employed by auditor is being determined which forms the basis of the
overall audit opinion. In the given case, the audit assertion to be employed for audit of
Computing solutions has been mentioned below:
1. Disclosures: With regards to the disclosures in the annual financial statements of the
company, the auditors should first check the test of controls as to whether the relevant,
necessary and the compulsory disclosures have been shown in the notes on accounts in
the financial statements. The same should adhere to the provisions of the law and the
Australian Accounting Standards. Furthermore, with respect to inventory, the company
should be disclosing the inventory valuation method, the provisioning norms followed by
the company and what is the bifurcation of the raw material, work in progress and the
finished goods (Heminway, 2017). In case the company has changed the valuation policy,
then the same should be disclosed along with the reason and effect of the change, which
is applicable for the given company.
2. Valuation: With respect to valuation of the inventory, the auditor should be made aware
of the estimates and judgements being used by the entity during the valuation as it is a
subjective concept and can vary from company to company. The auditor should first be
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employing vouching and verification to ensure that the purchases is properly supported
by the bills and the invoices and there are no chances of errors and omission in this. The
value of the inventory should be matching with the ledger books and the auditor should
also be taking the help of the expert on valuation being used. It should be checked if the
management has undervalued or overvalued the stock and if the taken the correct rates for
discounting and valuation and should be in line with the market rates. The auditor here
should also be checking if the inventory has become obsolete and the same should be
provided in the books or not (Sirois, et al., 2018). Since, in the given case, the
management is valuing the inventory at cost price les 110%, it should be checked by
auditors if the same will not result in material misstatements and is allowed by the
accounting standards (Segal, 2017).
Communication of Key Audit Matters in the Auditor’s Report
The communication of Key Audit Matters in the Auditor’s Report is compulsory as per ASA
701 and they should be reporting all the important, critical and significant matters relating to the
company is this section which can prove to be material from the perspective of decision making
(Rimmer, 2017). It is very helpful for the decision makers as it shows what all were the
important key audit matters and what was the audit procedures being applied to check on the
same. In the given case of Computing solutions, inventory has been regarded as one of the key
audit matters as the same constituted 22% of the overall sales in 2018 and 18% of overall sales in
2017. It is the extent of materiality due to which it should be reported as KAM and the
disclosures in regard of the same should be:
1. The rights and obligations with respect to the inventory in hand and whether proper
contractual agreement is in place with all the vendors and the related parties.
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2. What is the valuation method being used by the company for each of the components of
inventory – raw materials, work in progress and the finished goods
3. Whether there is any material change in the policy with respect to inventory – reason and
impact of the same (Mock, et al., 2018).
4. What are additional audit procedures being employed by company for inventory checking
and provisioning and if the same is sufficient and appropriate.
All these points will increase the transparency of the financial statements and will help in several
decision-making measures.
Question 2: Intangible Assets
Key Audit Assertions
This case study deals with the client named Beautiful Hair Ltd, whose audit is being done by the
audit senior from Howard and Associates. As per the given case, the company is planning to
acquire one of the small businesses named Shimmer Pty Ltd as the product of Shimmer is unique
and it goes well with the business model of Beautiful Hair. The company has therefore
approached a regional bank for arranging the funds (Lessambo, 2018). One critical point here is
that the owner of Shimmer is the only person who knows the formula of the product and the
same has been well documented and the company Beautiful Hair is contemplating to buy this as
technical knowhow in the form of intellectual property and will be recognising the same as per
AASB 3 – Intangibles: Recognition and Valuation. The audit assertions in this regard are as
follows:
1. Completeness: Recording of the complete transaction of accounts in the financial
statements is one of the basic requirements which needs to be ensured. IT needs to be
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checked if the company has recorded all the aspects of the transaction in the books and it
is reflecting all the important points about the same. The intangible assets forms one of
the most significant portions of the asset side of the balance sheet and it needs to be
verified as to what is the purchase consideration for purchase of technical know-how by
Beautiful Hair Ltd from Shimmer (Kachelmeier, et al., 2018).
2. Valuation: Valuation of the intangible asset is a very difficult process and there are many
provisions and assumptions that are involved in it. The first major valuation technique is
that valuation is done based on the market value. For every company there are different
kinds of intangible assets and different methods that they follow. In case of these kind of
asset it is very difficult to align the asset with the revenue that they generate and hence
valuation becomes very difficult. In case of Beauty Ltd, they want to buy a technical
know-how from Shimmer Ltd and that is a complex process and for that they need to
undertake help from valuation experts who can guide them accordingly (Kangarluie &
Aalizadeh, 2017).
Substantive Audit Procedures
There are few audit procedures that the auditor need to undertake to form an opinion on the
validation of the above points with respect to intangible assets. These are-
Completeness – To check completeness, the auditor needs to have proper knowledge regarding
the asset and the different types of provisions that are applicable to it. It also need to understand
AAS3 to know whether the asset has been correctly reported in the financial statements or not.
They can also take help from various valuation experts who can help them in forming the
required opinion (Knechel & Salterio, 2016).
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Valuation – To determine whether the value of the asset is correct or not, the auditor should
check the basis on which the company is recognizing the asset in its financial statement. There
are lot of assumptions involved on part of the management so they need to understand that
proper valuation is done or not and proper internal controls are in place or not. It is also
necessary to check whether proper agreement is there in case of assets that are not self-generated
(Mubako & O'Donnell, 2018). All the important market rates should be checked and based on
that valuation should be done. It is important to check whether the assets are proper valued and
what are the areas that the auditors need to check for his self-satisfaction.
Communicating Key Audit Matters in the Auditor’s Report
ASA 701 deals with communication of key audit matters that the auditor needs to do and make
necessary disclosure in the books of account. It helps in making the investors aware about the
areas in which there can be a possible chance of risk and the auditor has checked those areas and
framed an opinion. In case of the given asset the following disclosures need to do –
 The method of valuation that Beauty Ltd has taken into consideration and the relevant
market standards that the company has applied for the asset.
 The company has complied with the relevant auditing and accounting standards as per the
AAS3 and have given relevant disclosure in their books of account.
 The auditor will specify the various steps that have been undertaken for the valuation of
the assets and the opinion of the valuation experts should also be stated.
 The KAM will also include the key audit procedures that the auditor has undertaken for
the valuation of these assets.
 In case there is any impairment cost then same should also be calculated and stated in the
annual report (Bumgarner & Vasarhelyi, 2018).
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An extract from the JB HiFi company has been taken to form an opinion on how auditors have
disclosed the KAM in their audit report –
In the given company, the company is having various cash generating units that are part of their
key audit matter and same has been stated in their annual report under the KAM. In the given
financial year, the company is having impaired goodwill of $14.7 million and impaired plant and
property of $1.1 million. The company has adopted the method of discounted cash flow to value
the goodwill. The auditor has adopted various steps to check the company’s value-in-use model
and has also checked the historical accuracy of the asset that they have provided. The auditor has
also taken help from valuation experts and that have also been stated.
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References
Andiola, L., Lambert, T. & Lynch, E., 2018. Sprandel, Inc.: Electronic Workpapers, Audit Documentation,
and Closing Review Notes in the Audit of Accounts Receivable. Issues in Accounting Education, 33(2), pp.
43-55.
Appelbaum, D., Kogan, A. & Vasarhelyi, M., 2018. Analytical procedures in external auditing: A
comprehensive literature survey and framework for external audit analytics.. Journal of Accounting
Literature, 40(1), pp. 83-101.
Axelsen, M., Green, P. & Ridley, G., 2017. Explaining the information systems auditor role in the public
sector financial audit. International Journal of Accounting Information Systems, 24(1), pp. 15-31.
Bailey, C., Collins, D. & Abbott, L., 2017. The Impact of Enterprise Risk Management on the Audit
Process: Evidence from Audit Fees and Audit Delay. Auditing: A Journal of Practice & Theory, 37(3), pp.
25-46.
Bumgarner, N. & Vasarhelyi, M., 2018. Continuous auditing—a new view.. Continuous Auditing: Theory
and Application, 20(1), pp. 7-51.
Fukukawa, H. & Mock, T., 2011. Audit risk assessments using belief versus probability. Auditing: A
Journal of Practice & Theory, 30(1), pp. 75-99.
Garon, J., 2018. Ownership of University Intellectual Property. Cardozo Arts & Ent. LJ, 36(1), p. 635.
Heminway, J., 2017. Shareholder Wealth Maximization as a Function of Statutes, Decisional Law, and
Organic Documents. SSRN, pp. 1-35.
Kachelmeier, S., Schmidt, J. & Valentine, K., 2018. The disclaimer effect of disclosing critical audit
matters in the auditor’s report. SSRN, 2(1), pp. 1-39.
Kangarluie, S. & Aalizadeh, A., 2017. 'The expectation gap in auditing. Accounting, 3(1), pp. 19-22.
Knechel, W. & Salterio, S., 2016. Auditing:Assurance and Risk. fourth ed. New York: Routledge.
Lessambo, F., 2018. Audit Risks: Identification and Procedures. Auditing, Assurance Services, and
Forensics, 3(1), pp. 183-202.
Mock, T. J., Ragothaman, S. C. & Srivastava, R. P., 2018. Using Evidential Reasoning Technology to
Enhance the Audit Quality Assurance Inspection Process. Journal of Emerging Technologies in
Accounting, 15(1), pp. 29-43.
Mubako, G. & O'Donnell, E., 2018. Effect of fraud risk assessments on auditor skepticism: Unintended
consequences on evidence evaluation. International Journal of Auditing, 22(1), pp. 55-64.
Rimmer, M., 2017. The Trans-Pacific Partnership: Intellectual property, public health, and access to
essential medicines.. Intellectual Property Journal, 29(2), p. 277.
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Segal, M., 2017. ISA 701: Key Audit Matters-An exploration of the rationale and possible unintended
consequences in a South African. Journal of Economic and Financial Sciences, 10(2), pp. 376-391.
Sirois, L., Bédard, J. & Bera, P., 2018. The informational value of key audit matters in the auditor's report:
evidence from an Eye-tracking study.. Accounting Horizons., 32(2), pp. 141-162.
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