Discuss about the Sustainability Auditing Reporting and Assurance.
There are a host of factors which can be identified in the case about One Tel which has direct relevance for the inherent risk concerned with financial reporting. One of first ones in this regards is the lack of management integrity which poses a sizable inherent risk in context of financial reporting. Due to lack of integrity on the part of management, it is highly likely that there is lack of transparency and also there are intentional impediments to access of information by the external auditor so that the wrongdoings and misrepresentations are not detected. Besides, the involvement of management in auditor appointment could directly lead to issues pertaining to auditor independence and hence diminish the overall audit work quality. Besides, direct intervention, it is likely that the auditor is not given requisite leeway and is under constant supervision of management which enhances the overall risk of misrepresentation in the financial statements (Purdy, 2010). The interference of key management personnel cannot be ruled out as it is pivotal for the management to atleast match the shareholders expectations.
Yet another factor that contributed to the increase in the financial reporting related inherent risk is the lack of knowledge possessed by the management coupled with their respective experience levels. As a result of this, it is highly likely that the financial statements so prepared may be misrepresented and the same would not be detected by the management. Besides, this also has indirect effect as efficient employees do not want to be associated with such a management and hence make an exit which makes the organisation more susceptible to frauds in reporting (Elder et al., 2011). The information provided in the case makes it apparent that there is lack of industry experience on behalf of the directors and thus this could directly as well as indirectly contribute to the increased risk of financial misrepresentation.
Yet another factor which contributes to increased inherent risk levels in financial reporting domain is the high management involvement. Hence, this could potentially lead to financial misrepresentation which has support from the highest echelons and therefore difficult to rectify internally. As a result of these frauds, it is quite possible that in the long run, the company may face issues related to liquidity and may face bankruptcy. This risk is worsened because of the linkage established between EPS (Earnings per Share) and the remuneration drawn from the various top management executives. The concentration of power is evident from the case study relating to One Tel and clearly this leads to enhanced inherent risk (Covello et al., 2012). Further this power concentration leads to the higher chances of mismanagement as the board reviews are superficial and thus ineffective.
At the time of entry, any new player tends to experience a high degree of inherent risk due to its quest for revenue generation and brand building amongst the consumers. In addition, the transactions with related party particularly management and their companies also increase the inherent risk associated with reporting (Tuncel and Alpan, 2010). Based on the information provided, it is apparent that One Tel is a relatively new entrant in the telecommunication industry which is highly competitive due to the presence of players such as Vodafone and Telstra. As a result, there is significant degree of uncertainty as to whether the company would be able to create a niche for itself or not. Also, the fact that the company has a host of offices for operational reasons also tends to enhance the overall financial statements complexity. Usually, such issues need to be faced using a domain expert but if the management does ahead and makes attempts to manage internally, the likelihood of misrepresentation may rise (Junior et al., 2014). With regards to One Tel, it is apparent that the company is experiencing pressure with regards to revenue creation and branding which may enhance the likelihood for misreporting so as to satiate the shareholders (Griffiths, 2012).
Besides, the management also exerts pressure on the personnel who are directly involved in the financial statements preparation. One of the common ways to achieve the same is through time pressure which can potentially enhance the likelihood for errors. This pressure is also apparent in One Tel based on the case study given and therefore enhances the overall inherent risk. Additionally, management pressure may also require alterations in the financial statements with the intent of incentive maximisation. The management does not always overstate the EPS and may also understate the EPS so as to being the stock price down and hence accumulate huge piles of stocks which could be liquidated at an opportune time (Merna and Al-Thani, 2011).
Besides, the impact of underlying economic conditions on the misrepresentation in the financial statements cannot be undermined. Besides, at times, the management intentionally uses calculations that are complex in nature which ensures that there is high risk with regards to interpretation of the information contained in the financial statements. Besides, with consideration to the ever evolving technology in the telecom industry, there is high likelihood of inventory misstatement primarily caused due to high rate of inventory obsolescence thus leading to losses (Knechel et al., 2012). In order to hide these losses, it is quite possible that the management engages in financial statement misrepresentation thereby adding to the overall inherent risk.
Therefore, from the above discussion, it may be inferred that high amount of inherent risk in relation to financial reporting is caused by excess management interference and control besides lack of integrity on their part which is worsened by limited exposure to the industry. Besides, these factors tend to lead to the interference with unbiased and efficient working of various control measure and hence contribute to the risk. Additionally, the situation also worsens due to the industry dynamics and One Tel being a new entrant in the space. Hence, immediate measures need to be considered by the company in order to manage these burgeoning sources of inherent risk which could prove disastrous for the company going forward (Louwers et al., 2013).
In relation to the inherent risk with regards to the account balance, one of the potential risk is the likelihood of usage of faulty practices and procedures on part of the auditor which eventually would lead to higher misrepresentation risk in the various balances pertaining to different accounts (Arens et al., 2010). In line with the information provided, it is clear that the management tends to have a high interference with regards to the auditor appointment and the functioning of the same especially in terms of the available information and hence leads to high incidence of inherent risk related to account balances misstatement dictated by the self-serving intention of the management.
Further, the account balances are adjusted so that the true extent of losses are hidden from the shareholders and the company ends up indicating high profits that support the share price and hence result in high inherent risk of balances misstatement. The high stock prices enable the management to arrange for incremental financing by way of equity dilution. It is apparent based on the case facts provided that the company for making new clients is offering very low prices which commercially are not viable and hence leading to humongous losses which could not be reflected in the financial statements as it would dent the investor confidence in the stock and would have adverse impact on the incentives of the key executives (Hayes et al., 2014).
Based on the current industry position of the company, another critical aspect which requires to be highlighted is the accounts receivable balance which is particularly susceptible n the given environment. The main intention of inflating this could be to highlight the fact that company has indeed generated revenue which would be collected over due period of time. Thus, this gives the impression to the shareholders that indeed the company’s business indeed is successful with regards to revenue generation and market penetration (Alali and Yeh, 2012). For a new player like One Tel, clearly this poses significant inherent risk dedicated towards the aim of generation of revenue for business.
It is imperative that once the account receivables are stated, they must be promptly converted into cash but it is highly unlikely for the company that this transformation would actually take place. As a result, overdue on the account receivables would tend to swell. This is apparent for One Tel company and thereby hints towards the manipulation of financial statements pertaining to the performance of the company which has been misstated with the intention of misguiding the potential and current investors in the company. One of the contributory reasons for the same are the lacklustre controls (both internal and external) whose efficiency has been hampered due to interference from the management (Florea and Florea, 2012).
Yet another risk that is faced is with relation to the account balance of inventory which can potentially be misstated considering the innate nature of the industry where technology obsolescence is common. Hence, it is likely that inventory after a particular time duration would lose value as the users tend to switch to a new technology and therefore losses are encountered by the company which instead of being captured in the financial statements are actually concealed. Also, the processing system functioning at the One Tel company is not effective and its dynamics are not fully appreciated or understood by the users but attempts have been made by the company to hide the same (Griffiths, 2012). Also, in relation to the inventory account balance being misrepresented, the impact of the same would also be reflected in the COGS (Cost of Goods Sold) and hence the income statement would be misrepresented at each level thus undermining the accuracy and utility of financial statements (Bratten et al., 2013). This is apparently one of the concerns being faced by the company.
With regards to the going concern principle, the intention is to establish the continuity of the business in the foreseeable future taking into consideration the underlying liquidity and solvency issues that may be confronting the business. Depending upon the underlying level of risk associated with the given business, the going concern has three main levels i.e. low, medium and high which is indicative of chances of continuity of business (Knechel et al., 2012). For arriving at a conclusion in this regard, it is required that operational & financial review of the business must be done keeping in mind the long term horizon.
The parameters that reflect upon the operational performance of the business can opine on the likely impact of various business actions or situations that crop up. For example, in the case of any major dealer leaving the dealership of the company, the firm would be impacted and the same needs to be ascertained with regards to the going concern level. Further, the firms during its operations must function in a manner that is consistent with the law of the land so as to ensure that legal liabilities are minimised and thus do not lead to the business liquidation. With regards to company i.e. One Tel, since the prime focus is on customer acquisition being the new entrant, hence the underlying technology along with marketing initiatives are key to the determination of the going concern of the company going ahead (Vona, 2012).
Also, the balance sheet of the company tends to highlight the outstanding liabilities for the company and the asset level it has to meet these liabilities on a sustainable basis which enables an opinion on going concern. Additional factor is the extent of leverage as the business operational cash flows should be sufficient to meet the interest and repayment liabilities associated with the same. In case, that the company’s balance sheet has high outstanding debts which the company cannot afford to pay based on the assets that it has, it clearly indicates that for the business there is low going concern since the business may become insolvent. Also, the dividend payment along with prompt repayment of debt acts as critical factors for determination of level of going concern (Arens et. al., 2013).
References:
Alali, FA & Yeh, CL 2012, ‘Cloud computing: Overview and risk analysis’, Journal of Information Systems, Vol. 26, No.2, pp.13-33.
Arens, A, Best, P, Shailer, G & Fiedler,I 2010, Auditing, Assurance Services and Ethics in Australia, 3rd eds., Pearson Australia, Sydney.
Bratten, B, Gaynor, LM, McDaniel, L, Montague, NR & Sierra, GE 2013, ‘The audit of fair values and other estimates: The effects of underlying environmental, task, and auditor-specific factors’. Auditing: A Journal of Practice & Theory, Vol. 32, No.1, pp.7-44.
Covello, VT, Flamm, WG, Rodricks, JV, & Tardiff, RG (Eds.) 2012, The analysis of actual versus perceived risks (Vol. 1). Springer Science & Business Media, Berlin
Elder, RJ, Beasley, MS, & Arens, AA 2011, Auditing and Assurance services, 4th eds., Pearson Higher Education, London
Florea, R & Florea, R 2012, ‘The Implications of Inherent Risks’ Assessment in Audit Risk Limitation’. Economy Transdisciplinarity Cognition, Vol. 15, No.1, p.45
Griffiths, MP 2012, Risk-based auditing, 2nd eds., Gower Publishing, Ltd, London
Hayes, R, Wallage, P, & Gortemaker, H 2014, Principles of auditing: an introduction to international standards on auditing, 3rd eds., Pearson Higher Education, London
Junior, RM, Best, PJ & Cotter, J 2014, ‘Sustainability reporting and assurance: a historical analysis on a world-wide phenomenon’. Journal of Business Ethics, Vol. 120, No.1, pp.1-11.
Knechel, WR, Krishnan, GV, Pevzner, M, Shefchik, LB & Velury, UK 2012, ‘Audit quality: Insights from the academic literature’. Auditing: A Journal of Practice & Theory, Vol. 32, No.1, pp.385-421.
Louwers, TJ, Ramsay, RJ, Sinason, DH, Strawser, JR, & Thibodeau, JC 2013, Auditing and assurance services, 4th eds., McGraw-Hill, New York
Purdy, G 2010, ‘ISO 31000: 2009—setting a new standard for risk management’. Risk analysis, Vol. 30, No.6, pp.881-886.
Tuncel, G & Alpan, G 2010, ‘Risk assessment and management for supply chain networks: A case study’. Computers in industry, Vol. 61, No.3, pp.250-259.
Vona, LW 2012, Fraud risk assessment: Building a fraud audit program, 4th eds., John Wiley & Sons, New York.
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