The reasons why the auditor independence requirement of the Corporation Act, 2001 did not comprise the non audit services are:
Inherent risks are the risks that are posed due to the errors and omission in the financial statements by the factors that cannot be controlled. The likelihood to the occurrence of such risks is attributable to the requirement of high degree of judgment and transactions complexities. The two components of inherent risks comprise of failure risk and fraud risk. Any omission in the financial statements of entity might be due to the fraudulent activities conducted by any internal party to the organization. Failure risk on other hand can be detected on the financial statement of business (Hay 2015). The three inherent risks faced by Wicked Witch Watches Ltd are listed below:
Inventories- Wicked Witch Watches limited being the manufacturer of fine watches specialize in wristwatches made with precious stones and invaluable gold pocket watches. The precious stones for manufacturing such watches are purchased from overseas suppliers and sourced from Australian suppliers as well. The diamond mines in some countries in Africa are being closed by government due to factors concerning environment. In addition to this, the watchmaker employed by WWW is less interested in knowing about the trend as they are nearing the retirement age (Demirakos 2018). Therefore, it is experienced by WWW that they would run the risk of their inventories becoming obsolete. Hence, business running the risk of their inventories becoming obsolete bears high level of inherent risk.
Staff transactions- Staffs of WWW are provide with the facility of supplying them with coffee and tea. Staffs are instructed to take the cash from register to purchase biscuits, coffee and tea when the company runs low on their supplies. It is certainly possible that there can be fraud activities on part of staffs by way of drawing excess amount than it is being recorded in the register. Management would be required to make estimates on the amount withdrawn and assumptions for preparing the financial statements and accounting records. There exists lack of transparency since this related party transaction between two independent parties does not take place on equal footing or on arms length (Wong and Millington 2014). Auditor in such scenario would not have enough confidence and probably, high inherent risk would be set by the auditor.
Demand of customers- WWW runs the inherent risk attributable to customer demand for watches. Since, classic watches are manufactured by WWW and they do not follow the latest trend, there is low inclination on part of customers to buy such watches. In addition to this, an increase in cost of living has also been responsible for lowering the sales of expensive watches (Mahdavi and Daryaei 2017). Therefore, this economy related factor can also be attributable to generating inherent risk.
Control risk can be referred to as the function of operation and design of internal control and it is the risk that there will not be prevention or detection of any misstatement due to fraud or errors on timely basis by the internal control of company.
Point of sale computer system- The simplicity of point of sale computer system can be regarded as one of the inherent risks as they are vulnerable to information security. Despite the installation of such system, customers are provided with the option to make payment in cash. Moreover, there is no nearby bank to bank the cash received by customers. In such situation, there might exist the risk of occurrence of fraud activities that auditor might fail to detect (Ramanan 2014).
Risk regarding stock takes of jewellery- It is certainly possible that monthly stock takes of jewellery might not be conducted regularly. In addition to conducting the stock takes, the data on stock takes might not depict true and fair number of stocks that is possessed by company. Stock takes have become less frequent because of manager being on intermittent sick leave. Such risks would happen due to weak internal control system of WWW so that it fails to detect any such error relating to jewellery stock takes.
Internal control strengths help in ensuring the achievement of objectives of company according to the procedures and policies of company. Such control strengths include wide acceptance, simplicity and effectiveness of organization in achievement of organization’s objective. Internal control helps in detecting and preventing fraud, timely financial statements preparation, conducting business in an efficient manner and safeguarding of assets along with accuracy and completeness of financial records (Elbardan and Kholeif 2017). Some of the strengths of internal control system of WWW as identified by the auditors are listed below:
Perpetual inventory recording method- Under the perpetual method of recording inventory, there exist low level of risk of material misstatement. The top finance department authority is responsible for approving and reviewing the cost build up and pricing of inventories. Such method would have reduced level of physical count on inventories and therefore, there would be lower risk of errors and fraud.
Conducting regular monthly stock takes- Conducting stock takes on regular basis come with several advantages as it helps in discovering additional issues relating to shrinkage of stocks, uncovering any theft and ensuring that the target is met by business.
Security system of WWW- The security system of WWW intends to prevent occurrence of any theft and fraud activities. There has been security alarm installed by organization that has direct connection to the police station. However, the security fraud that left the company needs to be replaced with another efficient security personnel’s.
The audit risk model depicts the presentation of three components of audit risks comprising of inherent risk, detection risk and control risk.
Audit risk = Inherent risk * Control risk * Detection risk
Inherent risk- Such risk is the susceptibility of an assertion about any material misstatement disclosure, accounting balance and any class of transactions prior to consideration of any related controls. Such risks arise due to any error pertaining from the errors in report by individual or group on the assumption that there was not adequate internal control system. The financial statements of WWW can be affected by the environmental condition and its effect on the relationship between customer and enterprise. Such factors can be the reduced demand of watches due to changing economic conditions and manufacturing of classic watches that are not in trend (Schaltegger et al. 2017). Therefore, some accounts are susceptible to irregularities and errors.
Detection risk- Detection risk is failure on part of substantive procedures of auditors to detect existence of any material misstatement existing in a class of transactions or account balance that could be material either aggregated or individually with the misstatements in other balance. It is the likelihood of existence of errors which independent analytical procedures fail to detect and the details are required to be tested additionally.
Control risk- Control risk is the risk that there will be failure on part of internal control to detect any material misstatements. Such material misstatement can occur in the class of transactions or in account balance which has the possibility of not being prevented, corrected and directed on timely basis. In order to control the accounting system of company, auditor conducts the inspection of internal controlling system and after that they tend to control the factors affecting the environment. Control risk level is considered as low if it is assessed that the controlling system is efficient and effective (Wynder and Dunbar 2016). However, the subjected personal attitude of auditors forms the basis of determining the exact level of estimated risk.
Evaluation of control and inherent risks are done together as there exist high degree of positive correlation and mutual independence between them. Contrary to this, there is an inverse correlation concerning the risk of detection. It is therefore indicative of the fact that auditor has to accept lower risk of detection is there is sufficient reliability on internal control system (Kassem and Higson 2016).
For the development and engagement of audit plan, it is required to establish an overall audit strategy. Such overall strategy would assist the auditors in determining the procedures of risk assessment.
Planning materiality is the preliminary estimation of materiality in the financial statements of organization. Materiality of considered as the matter of professional judgment and for the computation of planning materiality, three steps are required to be considered.
In the first step, it is required to determine the base and compute the number. Second step involves tracking the material misstatement by the auditors and presenting it as the summary of unadjusted errors (Turley 2015). In the third step, the total of preliminary materiality should be compared by estimating the likely misstatement. Computation of planning materiality for the year ending 2018 is determined by calculating the range of percentage and considering highest of the two values.
1 – 2% of assets = 1- (2%* 3300000)= 44000-84000
0.5 – 1% of revenue = 0.5 – (1% *160000)=16500-33000
Therefore, from the above value, it can be said that the level of planning materiality is at 64000.
Mike Killian was skeptical about the money made by one staff than rest of the staffs of bank Barings as depicted from the case study. The approach from the view point of assessor is that it has questioned the reliability of being attentive to circumstances and information presented that is an indicative of the fact that such fraud activities is an attitude of auditors. Such type of attitude is called as professional skepticism and it is the attitude that make individual auditor being alert to conditions and questioning mind indicating the occurrence of possible misstatement due to errors and fraud leading to critically assessing the audit evidence (Helfaya et al. 2018).
The attitude of profession al skepticism is required by auditing standard that helps in enhancing the performance of auditors. Such attitude helps in inculcating several attributes amongst auditors such as interpersonal understanding, searching for knowledge, suspension of judgment, self determining and self confidence. Auditors as per the auditing standard are required to apply the professional skepticisms throughout the procedures of audit (Soltani and Maupetit 2015).
There are several circumstances that lead to threatening of compliance of organization with the fundamental principles. Being a floor manager, Nick Leeson was able to settle down his own trades by passing the internal control of banks. Since, he was able to influence the change due to the power he enjoys in his own personal interest, it can be inferred that he faced the self interest threat.
Self interest threat is the threat that is the consequence of financial or other interest of the professional accountant or any of the immediate family members. In order to reduce such threat to an acceptable level, it is required to implement such safeguard measures that fall into the categories of safeguarding in the work environment and safeguard created by profession, regulation and legislation. For reducing the threats faced by Baring bank, they are required to implement measures such as maintenance of professional standards, regulations of corporate governance, continuing requirement of professional developments and implementation of disciplinary procedures and regulatory and professional monitoring (Green 2016).
Unqualified opinion is the judgment of an independent auditor about appropriate presentation of financial statements and financial records of company and such information is presented according to the generally accepted accounting principles. Such opinion is a general forecasting about the findings of audit. It is revealed from the analysis of the given case of Barings bank that financial documents were suppressed by Lesson due to the bank assessor and therefore, he contributed in making internal control system of bank ineffective. The total amount of loss generated at the end of year 1994 was roughly close to the half value of capital of bank. In addition to this, forged declarations were presented by Lesson to the regulatory bodies that averted the margin call and allowed to present the loss amount which was supposed to be audited (Elbardan et al. 2015). Therefore, such forged documents have concealed the losses incurred by bank. All such facts should have drawn the attention of Lesson.
The unqualified audit report presented by banking organization makes them open to conjecture along with making any financial difficulties publicly evident. Such report is representative of the most common report in practice and it is considered as clean opinion because it does not incorporate any opinion on part of auditors. Issuing of qualified report does not create any reservation or uncertainty regarding the presentation of the financial matters of organization (Honggowati et al. 2017). In such scenario, banks are required to file for bankruptcy.
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