Audit Assignment 1: ACC707 - Audit of Inventory and Intangible Assets

This audit assignment analyzes two case studies, Computing Solutions Limited and Beautiful Hair Limited, focusing on inventory and intangible assets. The report identifies and explains audit assertions such as valuation and disclosure requirements, along with substantive audit procedures. For Computing Solutions, the report addresses inventory valuation changes, disclosure of inventory turnover, and the impact of regional warehouses. For Beautiful Hair, the focus is on the valuation of formulas as intangible assets and completeness of transaction recording. Key audit matters, including changes in inventory valuation methods and the completeness of inventory accounting, are highlighted. The assignment provides detailed insights into the audit process, including how auditors approach specific situations and gather evidence to support their opinions.

Audit Assignment

1
By student name
Professor
University
Date: 20th Sep 2018.
Table of Contents
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Audit Assertions..........................................................................................................................................3
Computing Solutions Limited (Computing Solutions)..................................................................................3
Inventory: Audit Assertions.....................................................................................................................3
Inventory: Substantive Audit Procedures................................................................................................4
Inventory: Key Audit Matters..................................................................................................................5
Intangible Assets: Audit Assertions..........................................................................................................5
Intangible Assets: Substantive Audit Procedures....................................................................................6
Intangible Assets: Key Audit Matters.......................................................................................................7
References...................................................................................................................................................8
Audit Assertions
Audit Assertions are those claims by the management of the company with respect to the
preparation of the books of accounts and the financial statements which helps to know the basis
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of preparation of the books of accounts. It can be in the form of internal control, practices or
policies and procedures within the company that has been performed and monitored in order to
ensure that the books are free from misstatements, errors and frauds. It helps to place the
responsibility on the management and directors of the company in case there is any issue with
regards to maintenance of books or internal control within the organization (Bae, 2017). The
auditor may examine all of these audit assertions and may or may not choose to rely on the same
depending on the strength of each of these. In case the audit assertions are weak, the auditor
needs to apply substantial as well as analytical audit procedures to examine the books and find
out the conclusion before expressing an opinion thereon. On the other hand, if the audit
assertions are string, it indicates that the internal control is strong and the auditor would have to
apply less audit procedures. Audit assertions mainly have 5 major kinds namely valuation,
existence, completeness, rights and obligations w.r.t. asset in hand and the disclosure
requirements (Boccia & Leonardi, 2016). Each of these has a separate parameter to check and
test. The two given case studies have been solved below and relevant audit assertion, the
substantive procedures and the Key Audit Matters to be shown in the balance sheet has been
shown below:
Computing Solutions Limited (Computing Solutions)
Inventory: Audit Assertions
The 1st case study is on Computing Solutions Limited (Computing Solutions) which is involved
in selling of computer presentation packages and related goods. With respect to the audit for the
period ended 30th June 2018, two major audit assertions are being shown below:
1. Valuation: Valuation is one of the most technical aspects in the computer and related
industry and sometimes this needs an expertise of valuation experts. As per the relevant
AASB standards, the company should be valuing the inventory at cost or net realizable
value, whichever is lower. Furthermore, the standard also indicates that the normal losses
should be included in the calculation of the inventory values whereas on the other hand,
the abnormal losses incurred during production should be ignored form computation.
However, in the given case, the Computing Solutions Limited has been valuing the
inventory as per the standards but all of a sudden, they want to change the valuation
method to NRV less 10%, which is not ideal and may reflect wrong financial position of
the entity. It will also affect the stock in hand and lead to losses (Bumgarner &
Vasarhelyi, 2018). Besides this, if the inventory is not liquidated in time, it may become
obsolete over a period of time. Since valuation has a direct impact on the financial
results, it qualifies to be one of significant audit assertion and the management should use
the correct practices here.
2. Disclosure Requirements: The other key assertion is disclosures with respect to financial
statements. Everything that is material and has the ability to change the economic
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decision of the user is required to be disclosed in the financial statements via notes on
accounts, There are many estimates and judgements made by the management of the
company and the same needs to be disclosed along with the rationale to the user group so
that they can take informed decision. In the given case, for the accounts to be transparent,
the company should be disclosing that the inventory is hand is 22% of sales in 2018
which was 18% of sales in 2014. Furthermore, it should also be disclosing that the
inventory average is 3.8 times in 2018 as against 5.2 times in 2017 (Das, 2017). All these
issues hints towards one thing being inefficient management of the inventory leading to
high costs for the company. Off late, the company has not be able to liquidate inventory
and that the reason behind increase in these ratios. The company should also be
disclosing the method of valuation of inventories in the financial statements. As
mentioned above, since the company is in the process of changing inventory valuation
method, it should also be disclosing the reason and impact of the same.
Inventory: Substantive Audit Procedures
The substantive audit procedures are the audit procedures which are being undertaken by the
auditors to collect the audit evidences so that they can express an opinion on the financial
statements. Some of the substantive procedures includes vouching of income and expenses and
verification of the assets and liabilities. In the given case study, the substantive procedures which
can be employed are:
1. Valuation: With respect to the valuation of the inventory, the auditor should first be
checking on the test of controls within the entity. He should be vouching the purchase
bills in order to see if the amount recorded as purchases are the one and same that appears
in bills. The auditor should be checking the inventory valuation procedures being
employed by the competitors in the same industry and reconcile if Computing Solutions
has used the correct procedures as it is one of the areas where management may use
assumptions to undervalue or overvalue the closing stock and thereby affecting the profit
(DeZoort & Harrison, 2016). The auditor should also be checking if the relevant
accounting standard for valuation of inventory has been used. Besides this the auditor
should be checking on the ageing of the inventory to assess the value of the write off or
provision to be created in books.
2. Disclosure: Here, the auditor should be applying the test of controls to check if the
requirements of Australian Accounting Standards and the Corporation Act 2001 has been
met for disclosures. For inventory, besides the valuation procedure, the ageing and the
risk of obsolete inventory should always be disclosed in the financial statements. If at all
there is a change in the valuation procedure or there is a provision to be carried in the
books, then the same needs to be disclosed as all these issues are material from
perspective of decision making. It should also be disclosing that the company has started
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moving its inventory from the central warehouse to 6 new regional locations and the
impact it is having on financials.
Inventory: Key Audit Matters
The reporting of the key audit matters in the Independent Auditor Report is being covered in
ASA 701 as per which all those issues and matters which are considered to be relevant, critical
and significant from the perspective of the company’s financial statements should be disclosed
separately. Besides the reason for why the same has been identified as KAM, it should also be
mentioned as to how the auditors approached the situation and collected the audit evidences with
regards to the same. In the given case, inventory should be considered as key audit matter as it
has had a number of changes over the last one year including the movement to 6 locations
instead of one, age old inventory, high closing inventory storage issues, lowering of inventory
days from 5.2 times to 3.8 times. Considering all these issues, it is justified to be classified as
KAM and the disclosures to be given in this regard are as follows:
1. The change in the inventory valuation method from cost to NRV less 10% and what will
be the financial impact of the same (DeZoort & Harrison, 2016).
2. Whether or not the completeness aspect and the period accounting aspect for inventory
has been verified by auditors. If yes, what were the steps being taken?
3. The ageing of the inventory and if there is any provision which has been taken in the
books.
4. The test of controls employed and the efficiency of internal control w.r.t. inventory in the
company.
5. If the reporting and other aspects have followed respective accounting standards.
6. Management estimates and judgements, if any, with respect to inventory.
All these points would help the stakeholders to be well informed about the changes in the
inventory accounting by company as well as the risks w.r.t. to the same.
Intangible Assets: Audit Assertions
In the 2nd case study, the discussion is on the intangible assets in the form of formulas to create
the product. Here the Howard & Associates is planning the audit of the entity Beautiful Hair
Limited which is acquiring of the companies Shimmer Pty Ltd (Shimmer) which is the
manufacturer of the high quality hair styling product. In the given case, only Shimmer’s owner is
having the knowledge of the product and the formula and thus Beautiful hair limited is proposing
to buy this as an intangible asset (kabir, et al., 2017). Since AASB 3 deals with the intangible
asset, all its guidelines with respect to recognition and valuation criteria of intangibles must be
met. Intangible assets can be in the form of copyrights, patents and trademarks and is usually the
right in an asset to produce, reproduce, share or produce copy of something. It needs to be
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registered with the Board of Intellectual Property only then can it be preserved. In the given case,
the most relevant audit assertions are mentioned below:
1. Valuation: With respect to intangibles, valuation is one of the complex and critical topics.
There are many methods of valuation of the intangibles like it ca be valued at cost in case
the same has been acquired from another entity and then later on be amortized. Similarly,
it can also be valued at market value. It depends upon company to company as to which
approach is being used by them and what are the judgements and estimations being
involved. In the given case, since this is a formula, assistance from the valuation experts
can be taken as it would be complex and the same should be disclosed in the financial
statements (Venezia, 2017).
2. Completeness in recording of transaction: Completeness refers to indicating and
accounting of all the transactions related to the assets in the books of the accounts. In
case the same is not recorded, it would result in giving inaccurate results and wrong
indication to the users of financial statements. Suppose in the given case, formula for
making the product is being acquired then there would be incidental costs as well which
should be included in the working (Solicitors, 2016). Also, this can only be done if the
transaction itself has been executed completely and accurately. The auditors should be
checking if all the costs relating to the acquisition of technical knowhow has been
properly recorded in the books of accounts.
Intangible Assets: Substantive Audit Procedures
Some of the substantive audit procedures to be employed by the auditor in this regard are as
follows:
1. Valuation: The auditor should be taking the help of the valuation experts to check if the
assumptions and estimates taken by management while valuation of the intangibles are
true and viable in the circumstances of the case. They should also be checking if the
correct rate of amortization has been taken and the other variables are not leading to
under or over valuation of the intangible assets (Oberoi, 2018). The auditors should also
satisfy themselves on the market rates of interest and the terms on which the company
acquired it from Shimmer.
2. Completeness: The auditor should vouch and verify for all the documents relating to the
acquisition of the intangible assets and should check if all the aspects have been covered
while disclosing the assets in the books. The auditor should also be thorough about the
provisions of AASB 3 on intangible assets and should be checking if all of them has been
adhered to. The auditor should go through the acquisition contract and the other terms
and conditions of the contract as well. Also, the life which has been taken for the
intangible asset should be checked for basis and validity (Appelbaum, et al., 2018).
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Intangible Assets: Key Audit Matters
Key audit matters are those issues which the auditor finds to be critical and important from the
perspective of the financial statements of the company and which may impact the users of the
financials big time. As per ASA 701, the same needs to be reported in the separate section of the
Auditors Report along with the approach which the auditor used or employed in checking and
auditing these areas. In the given case, since Beautiful hair Limited is acquiring intellectual
property in the form of technical knowhow (formula for the product) from Shimmer, it needs to
highlight all the issues with respect to same like the contracts, the valuation, the completeness in
recording the transaction and the estimates and judgement used. Some of the key disclosures in
this regard would be:
1. The key assumptions and the estimates used by the management and how the same was
being verified for its validity and correctness.
2. If the services of the valuation experts were taken for checking the valuation of
intellectual property here (Chaudron, 2018).
3. If the market rates on interest used is in line with valuation done.
4. If all the disclosures requirements for technical knowhow has been correctly done as per
relevant accounting standards.
5. What is the useful life being used for intangible asset and whether the same has been
checked for impairment at year end (Mun, 2018)?
In case all these points are disclosed, it can be said that the auditor has met the criteria of ASA
701.
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References
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.
Bae, S., 2017. The Association Between Corporate Tax Avoidance And Audit Efforts: Evidence From
Korea. Journal of Applied Business Research, 33(1), pp. 153-172.
Boccia, F. & Leonardi, R., 2016. The Challenge of the Digital Economy. Markets, Taxation and
Appropriate Economic Models, pp. 1-16.
Bumgarner, N. & Vasarhelyi, M., 2018. Continuous auditing—a new view.. Continuous Auditing: Theory
and Application, 20(1), pp. 7-51.
Chaudron, R., 2018. Bank's interest rate risk and profitability in a prolonged environment of low interest
rates. Journal of Banking and Finance, Volume 89, pp. 94-104.
Das, P., 2017. Financing Pattern and Utilization of Fixed Assets - A Study. Asian Journal of Social Science
Studies, 2(2), pp. 10-17.
DeZoort, F. & Harrison, P., 2016. Understanding Auditors sense of Responsibility for detecting fraud
within organization. Journal of Business Ethics, pp. 1-18.
kabir, H., Rahman, A. & Su, L., 2017. The Association between Goodwill Impairment Loss and Goodwill
Impairment Test-Related Disclosures in Australia. 8th Conference on Financial Markets and Corporate
Governance (FMCG) 2017, pp. 1-32.
Mun, K. a. S. I., 2018. A close look at the role of regulatory fit in consumers’ responses to unethical firms..
s.l.:s.n.
Oberoi, J., 2018. Interest rate risk management and the mix of fixed and floating rate debt. Journal of
Banking and Finance, Volume 86, pp. 70-86.
Solicitors, S., 2016. The Principles of Contract. Contract, p. 13.
Venezia, I., 2017. Behavioral Finance: 'Where Do Investors'' Biases Come From?'. Singapore: WORLD
SCIENTIFIC.
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