Auditing is the process by which examination of the books of accounts of an entity is being carried out, be it profit making or non profit making, small or big, public or private with the objective of expressing an opinion on the financial statements of the entity as to whether they showing true and fair view of affairs of the business. It is the process which gives the reasonable assurance to te users of the financial statements that the financial statements are showing true and fair view and that they are free from frauds and errors and that all the material misstatements have been highlighted (Alexander, 2016). It also assures the users that the auditor has given his opinion based on sufficient and appropriate audit evidences collected through a series of audit procedures which includes planning, documentation of the audit working papers and the audit evidences, reporting of the same in the audit report and closure of the same. Audit is being conducted through a variety of procedures like the susbstantive and analytical audit procedures. Auditors generally employ substantive audit procedures which includes vouching of incomes and expenses and verification of the assets and the liabilities or analytical audit procedures which includes ratio analysis, trend analysis, variance analysis, etc. The test of detail and the test of controls are also being used so as to improve the quality of the financial information. These topics have been extensively discussed below through the help of the case studies (Bizfluent, 2017).
Here, in the given case since the property is being developed on a major scale and there is a downturn in the property sector due to which there are no buyers of the property, the major risk in the planning document of developer is testing of rules and regulations that needs to be complied in relation to provision of the property development services. The given company City Limited is in the the real state factor which is mainly being driven by the market forces of demand and supply but off late there has been an industry downturn and office space city is available in abundance(Belton, 2017). The major audit issues which may be highlighted here is the nature and type of transactions in which the company has been involved, whether they only deal in the commercial properties or even the residential properties also forms the part of their portfolio, the rates that are being charged from the clients, whether it is as per market rates or excessive and finally what are the kind of services being provided by the builder.
There may be various audit issues which may be included here in the audit planning document for the purchase of the new computer software like conducting substantive testing which evidentiates the need for the software, validating the invoice for the purchase, checking the annual maintenance contract for the same with the vendor of the software, whether or not the purchase of the software has been made at the correct market rate or excessive payment has been made(Bromwich & Scapens, 2016). Another audit issue may be with respect to the accounting of the software as an intangible asset in the books and what are the provisions or steps being taken by the company in regard to the physical verification of the asset as per the financial reporting framework and IFRS framework. The management representation letter may also be asked from the management which is to justify the purchase of the software increasing the efficiency in reporting and effectiveness in the business operations. As a part of the audit process, the liasoning with the legal team with respect to the licensing agreement of the software and compliance with the other regulations and guidelines might also be checked as a part of audit. Besides this the term of the software is very critical as it will help in determining whether it should be charged to P/L on straight line basis or it should be capitalised in books (Werner, 2017).
Beauty Pty Limited is a company which is opening an overseas sales branch or outlet and is engaged in the manufacturing of the healthcare, skincare and cosmetic products and therefore the main audit points would be compliance with the health and safety standards which are applicable on the manufacturing entities as per the laws of the land. Also, since it is an overseas branch, so the regulatory and legal compliance procedures may be checked along with the government policies of the country in which the branch is opened as well as the parent organization country. The FDI norms needs to be taken care off and physical verification of the inventory needs to be ensured as the same is being directly transferred from Australia(Trieu, 2017). The proper stock count should be maintained in Australian books even though the same will be used as sample in the new overseas branch. Furthermore, the audit planning document should also incorporate the checking of the marketing policy of the company as to whether or not there is a need for the distribution of samples for marketing of the product. The audit should also include the check on the internal controls being set up by the company for the new sales outlet being opened. This will help in detection of the risks upfront (Raiborn, Butler, & Martin, 2016).
Given below is the difference between the use of the test of controls and the susbstantive approach and what the general issues with respect to the use of the same:
Test of controls: It is generally testing of the internal controls being implemented by the company in order to ensure accuracy, minimum errors and misstatements and better control on the operations as well as reporting of the business performance. In case this is being used by the auditor it shows the efficiency with which the internal operations within the company are being performed as these test of controls are primarily aimed at ensuring smooth and effective organizational processes. These are effective in identification of the control risks and inherent risks in the business (Chron, 2017).
Substantive approach: On the other hand, these are few procedures being performed by the auditors to check the material misstatements or fraud in the financial statement analysis. This includes comparison of the actual data with the assertion level and includes procedures like vouching of incomes and expenses and verification of the assets and liabilities notwithstanding what is being shown or provided directly by management (Defond & Lennox, 2017).
The general issues which are being considered as to whether the test of control should be used or substantive procedures should be used while auditing depends on the materiality level set by the auditor as per their judgement or the level of error tolerance. The effectiveness of the internal control in the organization is also critical to deciding whether test of control will be enough for audit opinion or the test of detail would also be required for appropriateness and sufficiency of the audit evidences. Audit procedures undertaken are also influenced by the level of inherent, control and detection risk pertaining to an entity (Heminway, 2017). The more the inherent and control risk, the more the need to perform the substantive audit procedures.
The choice of audit approach is influenced by the risk assessments as inherent risk is the risk of presence of the mistatatment in financials when the internal controls are not in place for an entity, on the other hand, control risk is the audit risk which arises when even though the internal controls are in place but they are not as effective and efficient to prevent the occurrence of frauds and errors in the financial statements. Lastly, detection risk is the risk that the internal controls are strong due to which the frauds and errors would not be identified by the audit procedures. All these risks directly affect the choice of the audit approach as more the inherent and control risk, more will be substantive and analytical audit procedures required alongwith the test of controls. More the detection risk, more intensive the audit procedures to identify the errors and frauds(Dichev, 2017). The level of risk in entity determines the level of materiality assumed by the auditor and if the internal control is strong, less will be substantive procedures required. Thus, the risk assessment for each of the above mentioned transactions like the disclosure and existence of the leased assets, depreciation expense accounting, risghts and obligations w.r.t. vehicles and valuation of the vehicles will use different audit procedures in order to form an opinion on the same.
Depreciation may be defined as the true up in the value of the asset as the asset undergoes the wear and tear while being used in the business and the same should be charged to expense periodically. The approach which is generally being set out in the planning document to verify the accuracy and completeness of the depreciation expenses is employing test of controls instead of substantive procedures as on the balance sheet date. In the given case, the inherent as well as the control risk with respect to the charging of the depreciation on assets is low which indicates that the internal control is strong but at the same time there may be a huge detection risk too(Goldmann, 2016). Therefore, in this case, the auditor needs to adopt the test of details alongwith the extensive substantive procedures as the chances that the frauds and errors will not be identified is high. Hence, the approach set out in the planning document should be different here as initially it was more test of details instead of substantive procedures. Some of the substantive procedures which will be employed here are checking the rates of depreciation, date of capitalization of assets, the period being considered for depreciation, the historical cost of the fixed assets and the disclosures with regards to depreciation amount being considered in financial statements.
Financial Reporting is the process of generating and presenting the financial information with regards to an entity in the form of the financial statements which is generally beuing prepared as per the local GAAP, IFRS or the accepted financial accounting framework. It is a very critical process and essential in terms of communicating the performance of the entity or the organization to the users of the financial information (Knechel & Salterio, 2016). The users may be internal or external. Internal stakeholders include the shareholders of the company, the employees, the debtors, creditors, etc. External stakeholders include the bank, financial institutions, the government, tax authorities, etc. The management of the company is responsible for the preparation of the financial statements and their final generation and presentation in the annual report of the company. This needs to be prepared in the manner which meets the needs of the users of the financial statements and which suffices the financial reporting framework. All this information of the financial transactions are being included in the financial statements for effective and accurate financial reporting.
On the other hand, auditing is the process which is a post facto activity to the preparation of the financial statement and is undertaken by the auditor to check whether the financial statements are free from misstatements, frauds and errors. This is aimed at providing assurance to the users of the financial statements that the same is showing the true and fair view of the state of accounts of the entity as on the given presentation date (Raiborn, Butler, & Martin, 2016). The auditor who is an external party to the company does this actity applying the professional skill and care and judgement and scepticism. He checks the appropriateness and sufficieny of the audit evidences collected and tehn expresses his opinion thereof. This serves just as an assurance and not the guarantee on the financial statements of an entity as the preparation is the responsibility of the management of the company.
There is big correlation between communicating of the financial information to the relevant statekholders and auditing of the financial statements as it is auditing which forms the basis of communicating the financial information. Reporting is being donw so that the accurate and relevant financial information can be passed on to the intended users for decision making purposes. Auditing is a stage or process which starts after reporting or presentation cum preparation of the financial statements and the reliability of the same is formed through the audit opinion (Jefferson, 2017). Thus, there is an integration between the reporting of the financial information in the logical and sequential manner supported by audit which gives reasonable assurance about the reliability of the information which is being reported and that there are free from errors and fraud. The decision of the major stakeholders, be it internal or external depends on the financial information communicated. Hence, not only reporting of information but the ensuring the reliability of the same through audit is equally important.
References
Alexander, F. (2016). The Changing Face of Accountability. The Journal of Higher Education, 71(4), 411-431.
Belton, P. (2017). Competitive Strategy: Creating and Sustaining Superior Performance. London: Macat International ltd. Retrieved from https://www.routledge.com/Competitive-Strategy-Creating-and-Sustaining-Superior-Performance/Belton/p/book/9781912128808
Bizfluent. (2017). Advantages & Disadvantages of Internal Control. Retrieved december 07, 2017, from https://bizfluent.com/info-8064250-advantages-disadvantages-internal-control.html
Bromwich, M., & Scapens, R. (2016). Management Accounting Research: 25 years on. Management Accounting Research, 31, 1-9.
Chron. (2017). five-common-features-internal-control-system-business. Retrieved december 07, 2017, from https://smallbusiness.chron.com/five-common-features-internal-control-system-business-430.html
Defond, M., & Lennox, C. (2017). Do PCAOB Inspections Improve the Quality of Internal Control Audits? Journal of Accounting Research, 55(3), 591-627.
Dichev, I. (2017). On the conceptual foundations of financial reporting. Accounting and Business Research, 47(6), 617-632. Retrieved from https://doi.org/10.1080/00014788.2017.1299620
Goldmann, K. (2016). Financial Liquidity and Profitability Management in Practice of Polish Business. Financial Environment and Business Development, 4, 103-112. Retrieved from https://doi.org/10.1007/978-3-319-39919-5_9
Heminway, J. (2017). Shareholder Wealth Maximization as a Function of Statutes, Decisional Law, and Organic Documents. SSRN, 1-35.
Jefferson, M. (2017). Energy, Complexity and Wealth Maximization, R. Ayres. Springer, Switzerland . Technological Forecasting and Social Change, 353-354.
Knechel, W., & Salterio, S. (2016). Auditing:Assurance and Risk (fourth ed.). New York: Routledge.
Raiborn, C., Butler, J., & Martin, K. (2016). The internal audit function: A prerequisite for Good Governance. Journal of Corporate Accounting and Finance, 28(2), 10-21.
Trieu, V. (2017). Getting value from Business Intelligence systems: A review and research agenda. Decision Support Systems, 93, 111-124.
Werner, M. (2017). Financial process mining – Accounting data structure dependent control flow inference. International Journal of Accounting Information Systems, 25, 57-80.
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