Case Study: Audit Assertions and Financial Statement Analysis

This assignment provides a comprehensive analysis of audit assertions within the context of financial statements, focusing on two case studies involving property, plant, and equipment (PPE) and inventory. It delves into the auditor's role in assessing the valuation and presentation of these items, highlighting key assertions such as valuation, rights and obligations, and completeness. The assignment outlines substantive audit procedures, including tests of details and analytical procedures, used to gather evidence and address potential misstatements. Furthermore, it discusses the importance of ASA 701 in reporting key audit matters, emphasizing the auditor's responsibility to provide transparent and informative opinions on material issues. The case studies illustrate practical scenarios where proper valuation and disclosure are critical for accurate financial reporting and decision-making. Desklib provides students access to similar solved assignments and past papers.

Auditing
Assignment

Prepared By
Student Name:
Date: 17th January 2019
Executive Summary
The following assignment is based on the concept of audit assertions and the auditors needs to analyse
the financial statements and state the same in the audit report. Audit Assertions are part of the financial
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statements as whole and aims to solve any issues that are related to any of the company. In this
assignment there are two case studies that has been given regarding two different items of the financial
statements to analyse and state the audit assertions for those items. The items that are included are
property plant and equipment and inventories and the audit assertions and valuation of the same is
done based on that. The various audit methods that have been done by the auditors have also been
stated in detail.
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Table of Contents
Executive Summary.....................................................................................................................................2
Audit assertion:...........................................................................................................................................4
Question 1...................................................................................................................................................4
Question 2...................................................................................................................................................6
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Audit assertion:
The management of the company feels certain matters to be detrimental for the success of the
company, so it takes upon itself the assertion of these matters while conducting the audit to maintain
the overall fairness. These assertions are also known as audit assertions. These assertions are known as
financial statement assertions because it aims at solving any issues and emphasises on valuation,
presentation and recognition of financial data of the company. These assertions are divided into
different categories such as accuracy, materiality, occurrence, completeness, obligations, valuations, etc.
upon which the auditor depends to solve major issues affecting the audit process. Four categories of
assertions are present in case of balance sheet in the name of accuracy, completeness, rights and
obligations. In this assignment, overall risk related to the valuation and audit assertions of the inventory
is stated along with the valuation of inventories and key assertions relating to the same (Abdullah &
Said, 2017).
Question 1
1 a) Key assertions at risk
One of the key audit assertions in case of inventory which the companies needs to take care is its
valuation. Generally, these are valued at lower of cost or net realisable value. Moreover, valuation of
wastage is also important while valuing inventory. The company should take care that no abnormal
wastage is included in the value of inventory. Valuation of goods that are work in progress is also very
difficult. In this case, Advanced Computer Solutions Limited deals in computer appliances which are
subject to technological updates from time to time, thus raising the chances of inventory becoming
obsolete. So, the company should remove the stock as fast as possible to prevent the reduction in the
value of the goods due to timing (Boghossian, 2017).
Rights and Obligations: - In this case inventories which bears risk in their establishment are asserted
along with the ownership of inventories in progress. In this case, Advanced Computer Solutions Limited
distribute inventories to other locations from their chief warehouse, increasing the chance of loss of
ownership of the company over the goods that are sent under consignment basis or which are in transit.
So, the company should take care that they easily establish their ownership by establishing a legal right
over the inventory because of the risk arising due to the involvement of insurance business,
transporters, etc. which are foreigners for the company.
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1 b) Substantive Audit Procedures
Audit procedures which involves test of details, test of control, analytical procedures, etc. helps the
auditor to check the materiality of various items included in the financial statements. These are useful to
gather audit evidences on substantial matters and substantive and comprehensive information about
such matters (Cayon, et al., 2017).
For valuation risk:
The Auditor should count the inventory twice a year on a fully-fledged basis by getting a list of
inventories from the management. The Auditor should also compare this list with the general ledger.
Valuation of closing stock of inventories has the highest chances of deflated amount as this valuation
takes place only at the end of the period (Charles H, et al., 2015). So, the auditor should take extra care
of such valuation. This can be done through the techniques of vouching and verification. The auditor
should also keep an eye on the value of goods that are in transit or sent through consignment basis as
these can be deflated by the management.
For rights and obligations:
Due to the involvement of other parties the auditor should take care of all the agreements and contracts
in which the company has entered. He should also make sure of agreements relating to insurance
policies which the company should have taken along with the consignment agreements entered by the
company during the audited period. Minutes book of the company should also be read for analysis of
the decisions taken by the company relating to inventories (Coate & Mitschow, 2017).
1 c) As per ASA 701, if the auditor feels any matter to be materiality misstated by the company, he is
responsible to give an opinion on such matter. According to ASA 701, “Key audit matters are matters
that require significant auditor attention in performing the audit”. The auditor should also state the
audit procedures undertaken by him along with his opinion at the end of the audit report to draw
attention on these critical items. These disclosures help in improving the transparency and quality of
audit report. The report can also involve the efforts of the governance people and the management to
help the auditor in making his opinion on different matters in his report.
Valuation of inventory involves many complexities. This is because a huge amount of professional
judgement of the management is involved in valuation of inventory and creating provisions for the
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same. So, the auditor needs to check this valuation. This qualifies the valuation as an important key
audit matter.
As per ASA701, the disclosures relating to inventory valuation are as follows:
All key audit matters should be stated under different sections with proper highlights. Matter of
significance should be stated on part of significance (Cundill, et al., 2017).
Proper explanation relating to the importance of the matter should be given along with an assurance
stating that the valuation of inventory has been done correctly. The auditor and the management should
have proper understanding and high knowledge among themselves for easy conduct of the audit
process.
The auditor should also analyse the overall internal control of the management and keep the company
informed about it.
The auditor should also state briefly about any key audit matter if he feels that there is no need for the
explanation of such matter. Any matter which is not mentioned, disclosures with respect to the same
should be stated clearly. These matters may be important from the user’s end, so the users can analyse
these key matters and take their decisions based on these matters if they think that these matters are
material and can affect their decision. This is because these matters bear a high risk of being materially
misstated as much explanation relating to these matters is not provided in the audit report (Johan,
2018).
Question 2
2a) The importance of property plant and equipment is very high when it comes to preparation of the
financial statements of a company and it is one of the major items in the assets of the company. There
are many accounting standards that have been framed for the overall valuation of the same and
reporting it in the books of accounts (Kang, et al., 2016). It is the duty of the auditors to check that
proper valuation is done and depreciation is charged so that the users can understand the same. There
are different methods as per which the assets can be valued and hence it is important that proper
disclosures are given by the company.
Key Assertions at Risk:
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Valuation – Valuation of property plant and equipment is one of the most important and complex audit
assertions. There are various methods based on which the asset is valued, and it also includes valuation
based on historical cost and fair value. It is also important that in case there is any kind of revaluation
then the companies need to take that also in accountability. The assets are also depreciated over the
years and there are different methods that the companies can apply for depreciation of the assets, it
thus becomes important that in case there are any change in the method of depreciation than that must
be properly communicated to the users through proper disclosures. Thus, valuation is a complex part of
the valuation of the property plant and equipment of the company (Kaufmann, 2017). In case of the
given case we see that the company has not made proper distinction between the capital and revenue
expenditure. Some of the capital items are included in the repair and maintenance in the income
statement, so that leads to wrong valuation. Also, there are various ranges of methods of depreciation
and various rates that the company has used and rates that have been applied to certain assets is very
low, so we see that the overall valuation of the assets is not correct in case of Green Machine Ltd.
Rights and Ownership
It is very important that in case of property plant and equipment proper ownership is established
because in case the same is not done then that will lead to a lot of complications. Like there are certain
properties whose ownerships are based on completion of contracts related to the same, so it thus
becomes important that companies should account the same in their financial statements. There are
also cases where the assets are sold and purchased so proper disclosure and accounting of the profits
and losses that occurs due to the same should be properly disclosed (Pamela & Tamara, 2013). Proper
documents must be there to establish ownership in case the management does not have the same then
that might lead to illegal ownership. Thus, the need is that legality should be maintained, and the
companies should have proper registered documents that would support their claims of ownership of
the property. There have been sale and purchase of property plant and equipment and no proper
reporting of the same has been done, as some items have been included in income statement of the
repair and maintenance. Thus, we see that proper ownership is not established in case of Green
Machine Ltd.
2 b) Substantive Audit Procedures
There are various substantive audit procedures that the auditors can apply for checking the materiality
of the items involved like test of control, test of details, analytical procedures etc. It is important that
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the auditor should gather information about these substantive matters and analyse the items based on
that
For valuation risk:
In the given case the auditors should take proper documents from the management with respect to the
proper summary of the assets with respect to the purchase and sale of the assets and the overall rate of
depreciation that the company has applied should also be analysed. Vouching and Verification of the
property plant and equipment is an important method for the valuation of the assets, by checking the
summary associated with that. Extra care should be given to see that whether there is historical cost or
fair value method that has been taken into consideration. There are high chances that the management
can deflate with the value of the property plant and equipment, so the auditor needs to check the same
and manage the accounts of the company accordingly.
For rights and obligations
In case the auditors find that there are no proper agreements and contracts in place with respect to the
plant property and equipment, as we see that the company is not having proper documents in place and
also proper depreciation has not been done as some of the assets have been booked at very low rates.
In case the management has no proper documents then the auditor should report the same in their
audit report and state it clearly as this will lead to illegal acquisition on part of the company. Vouching
and Verification is also an important method for validating the ownership of the assets of the company
and thus that should also be properly documented by the auditors of the company. They should read all
the agreements and in case they need external help with respect to valuation then that should also be
considered.
2c) As per ASA 701, “key audit matters are matters that require significant auditor attention in
performing the audit”. As per this standard that the auditors should state all the necessary disclosures in
their audit reports in respect to items that they find risky with respect to materiality. The auditor should
also state all the necessary steps that they have undertaken for the auditing the items of the financial
statements and all the audit procedures should be accounted for. All these key matters that are
important are stated at the end of the audit report for the users to analyse and get transparent
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information about the company and its financials status. They can clearly judge which items are critical
and whether the auditor have given proper disclosures with respect to that in their audit report.
The main disclosures that the auditor needs to provide as per ASA 701 are-
Valuation of the property plant and equipment is an important key audit matter for the company, and
the auditors need to give proper disclosures with respect to that in their audit report. The auditor needs
to give explanation why this matter is important and should also use proper explanation and clear terms
in making an assurance that the inventory is valued correctly. It is necessary that there should be proper
coordination between the auditors and management of the company, and in case there are any issues
then the auditor should state the same to the management of the company. It is important that proper
internal controls should be in place and in case there is any issue with the same, the auditor should
check the same and state it in their audit report (Knechel & Salterio, 2016). The users can check these
key audit matter and then take decisions based on that, these matters are important from the user
stand as there are chances that they might be materially misstated, and risk is also involved.
In case the auditor feels that there is no such key audit matter then he should specify the same in his
audit report for the discretion of the users.
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Knechel, W. & Salterio, S., 2016. Auditing:Assurance and Risk. fourth ed. New York:
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