Describe about the Auditing for Inherent Risk Auditing.
1: Inherent risk in the auditing refers to the material misstatements that has been contained din the financial statements and may be caused by the error or omission as the result of the failure in the controls and this could cause the misstatement due to the absence of the controls that are considered to be separate in the assessment of the control risk. This is the risk which is considered to be high due to the presence of a higher amount of judgement and the estimation of the transactions that are considered to be very complex in nature. In order to illustrate, the inherent risk in the financial institutions is considered to be higher when compared with a manufacturing concern that has bene operating in a more stable environment (Accounting simplified, 2016).
The following are the factors that affects the inherent risk of the company:
Nature of the business of the client: in case, an entity has been changing fat with the use of the higher technology and faces the risk of the obsolescence of the inventory. This is the risk that is inherent inside the organization.
Results of the previous audits: there have been many innovations in the products of the entity and hence, has become obsolete very quickly and the inventory may go undervalued. This is the risk that is inherent inside the organisation. In order to illustrate, in case, an auditor has found that there have been mistakes in the valuation of the inventory, then he has to keep this in mind during the current year (MCCC, 2016).
Initial and the repeat engagement: an auditor is able to exercise his judgement when it comes to knowing the areas wherein there could be a fault and he would be more confident when conducting the audit of this company.
Related parties: there are always transactions that takes place between the parent and the subsidiary company and between the management and the entity. These are termed as the related party transactions. These transactions have to be entered into at the arm’s length price, otherwise there is a lack of transparency.
Transactions that are not regular in nature: these are the transactions that are not routine in nature and may be caused due to losses, fires etc. the client has to be very cautious when it comes to recording these transactions.
Judgment requirement: an auditor is duty bound to exercise an increased amount of judgement when it comes to recording some of the transactions, estimating the same and recording the same. The examples includes the investments being recorded at the fair values, allowances for the trade receivables that go uncollected.
Making up of the population: from the point of view of an auditor, there are many of the items that make up for the total population that affects the likelihood of the material misstatements. When there is a higher likelihood of these misstatements, then it leads to an investigation and testing.
In the given case as well, an auditor sets the inherent risk to be high and also questions the tarde receivables that are overdue. Hence, while preparing the audit plan, he must assess all the relevant risks (HKIAAT, 2016).
2: Inherent risk in the auditing refers to the material misstatements that has been contained din the financial statements and may be caused by the error or omission as the result of the failure in the controls and this could cause the misstatement due to the absence of the controls that are considered to be separate in the assessment of the control risk. This is the risk which is considered to be high due to the presence of a higher amount of judgement and the estimation of the transactions that are considered to be very complex in nature. In order to illustrate, the inherent risk in the financial institutions is considered to be higher when compared with a manufacturing concern that has bene operating in a more stable environment.
The following are the factors that affects the inherent risk of the company:
Nature of the business of the client: in case, an entity has been changing fat with the use of the higher technology and faces the risk of the obsolescence of the inventory. This is the risk that is inherent inside the organization. In the given case, One Tel is performing in a competitive environment and hence, there are risks at the account level. The company has many competitors that are older than this company.
Results of the previous audits: there have been many innovations in the products of the entity and hence, has become obsolete very quickly and the inventory may go undervalued. This is the risk that is inherent inside the organisation. In order to illustrate, in case, an auditor has found that there have been mistakes in the valuation of the inventory, then he has to keep this in mind during the current year. There is no data pertaining to this available.
Initial and the repeat engagement: an auditor is able to exercise his judgement when it comes to knowing the areas wherein there could be a fault and he would be more confident when conducting the audit of this company. There is no data pertaining to this available.
Related parties: there are always transactions that takes place between the parent and the subsidiary company and between the management and the entity. These are termed as the related party transactions. These transactions have to be entered into at the arm’s length price, otherwise there is a lack of transparency.
Transactions that are not regular in nature: these are the transactions that are not routine in nature and may be caused due to losses, fires etc. the client has to be very cautious when it comes to recording these transactions.
Judgment requirement: an auditor is duty bound to exercise an increased amount of judgement when it comes to recording some of the transactions, estimating the same and recording the same. The examples includes the investments being recorded at the fair values, allowances for the trade receivables that go uncollected.
Making up of the population: from the point of view of an auditor, there are many of the items that make up for the total population that affects the likelihood of the material misstatements. When there is a higher likelihood of these misstatements, then it leads to an investigation and testing.
In the given case as well, an auditor sets the inherent risk to be high and also questions the trade receivables that are overdue. Hence, while preparing the audit plan, he must assess all the relevant risks.
Further, the management experience is quite limited as has been stated therein the question and hence, they are not aware as to how the accounting is to be done and may be this is the main cause of the high inherent audit risk.
3: The assumption of going concern is the most important accounting assumption that relates with the remaining of the business in the near future. This just means that the entity shall not be forced to end the operations and liquidate its assets in the near future at the lower sales prices. By the way of assuming this assumption. The accountant seeks to defer the recognition of the expenses until the later period. This takes place in the business and uses these assets in the most effective and efficient manner that is possible for the purposes of carrying on the business. The entity is never assumed to have problem with the assumption of going concern when there is an absence of the information to the contrary. It is always assumed that the entity would be able to meet all its expenses without any hassles and that the company would not be required to sell its assets or restructure its debt for the purposes of paying off its expenses and bills. And if this is not the case, then the entity will acquire the assets with an intention of closing down its operations and also resell its assets to another party.
In case, if the entity does not believe that its going concern assumption has been affected, then that would just mean that the assets have been impaired that calls for the writing down the carrying values of the assets of the company to their liquidation values. Hence, the value of the entity in that case would be assumed to be going concern which is higher than its break-up value due to the reason that the going concern would not be able to earn the profits.
The concept of going concern has not been clearly defined anywhere in the generally accepted accounting principles and hence, is subject to the considerable amount of the interpretation when it comes to the reporting of an entity. Therefore, as per the generally accepted auditing standards, an auditor is never forced to consider this factor. But the company must ensure the compliance with this assumption (Accounting simplified, 2016).
An auditor is duty bound to report on the going concern of the company and ensure that the financial statements of the company have been duly audited. The following are some of the considerations in the financial statements:
Negative operating results and trend when compared with the previous years. The net operating results of the company are increasing (Accounting course, 2016).
Default in the repayment of the loan by the company. No repayment of the loans since the cash flows does not have any outflow of this and the balance sheet shows borrowings.
No giving of the credit to the company by the suppliers
The long term commitments that are not economical and the company is subjected to the same. No information with regard to this is available.
Legal proceedings as against the company. No information with regard to this is available.
An auditor has to report on the above assumption since this is something that affects the company in the future and the company must never lose its liquidity. If the company is endangering its going concern assumption, then the fact must be stated in the auditor’s report since this fact has to be reported to the management of the company and to the shareholders (Accounting tools, 2016).
References:
Accounting-simplified.com. (2016). Audit Risk Model | Inherent Risk, Control Risk & Detection Risk. [online] Available at: https://accounting-simplified.com/audit/risk-assessment/audit-risk.html [Accessed 18 Sep. 2016].
Accounting-simplified.com. (2016). What is Going Concern? Explained with list of going concern problems indications. [online] Available at: https://accounting-simplified.com/financial-accounting/accounting-concepts-and-principles/going-concern.html [Accessed 18 Sep. 2016].
Accountingtools.com. (2016). Going Concern Principle – AccountingTools. [online] Available at: https://www.accountingtools.com/going-concern-principle [Accessed 18 Sep. 2016].
https://www.hkiaat.org/. (2016). Risk in Auditing – Inherent Risk. [online] Available at: https://www.hkiaat.org/images/uploads/articles/PBEPIII_inherent_risk.pdf [Accessed 18 Sep. 2016].
My Accounting Course. (2016). Going Concern Concept | Examples | My Accounting Course. [online] Available at: https://www.myaccountingcourse.com/accounting-principles/going-concern-concept [Accessed 18 Sep. 2016].
www.mccc.edu. (2016). A U D I T I N G A RISK-BASED APPROACH TO CONDUCTING A QUALITY AUDIT. [online] Available at: https://www.mccc.edu/~horowitk/documents/Johnstone_9e_Auditing_Chapter7_PPtFINAL.pdf [Accessed 18 Sep. 2016].
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