Auditing And Internal Controls: Threats, Safeguards, And Deficiencies

Identifying Potential Threats to Independence

Before taking decision about the acceptance of the engagement the key matter has been described. The ethical matter that has been dealt with the Pharmaceuticals Limited is the public interest. Public interest is referred to as the areas in which public has the substantial interest. In the given case the public interest has been adversely affected which otherwise shall be properly maintained. It is because of the waste materials, the toxic metals and the chemicals that are being dumped into the nearby river without the permission from the relevant authority; the public interest is the more ethical factor to be considered. It amounts to serious offence under the environmental laws.

From the point of view of the management of the company, the key ethical matter has been the code of conduct and the deployment of the employees working in an organization. The said flaw has been conducted by the senior officials of the company and that too with the violation of the environment laws and regulations.

Thus, in this manner the above matters shall be discussed before accepting the engagement.        

Following are the action that the auditor shall undertake in response to the identified errors and risk:

• If the auditors have not received the proper justification regarding the errors and the control weaknesses from the management of the company then he shall disclose to the management and the members of the company that they will mention in the auditor’s report and thus qualify the audit report so issued.
• The second alternative course of action is to find out reasons as to why this have been done and accordingly the risk procedures shall be enabled in the company and find out the results (Rossouw, 2010).
• The third alternative is to understand the reasons of presence of risk and the weak internal control system and informing the system that shall be develop and executed so as to avoid its occurrence.    

As per the generally accepted accounting principles read with the auditing and assurance standards, if any company’s accounts is being audited by any of the chartered accountants firm then the company is required to maintain all the records like sale purchase record with the proper files with the indication that these are export purchases or the export sales. In the given case, the company’s management has mentioned that instead of having the audit engagement letter is the review letter detailing that the auditors will only review the financial statements of the company as the company accounts are not covered under the audit.

If this is the case then the company would have informed the auditors before the start of the audit that the company is not covered under the audit and is engaging the services of the auditors only on the review basis.

In accordance with the provisions of the Corporations Act 2001, the auditor is required to comply with the auditing assurance standards as laid down and accordingly the auditor’s report shall be issued. There are four forms of the audit report:

• Qualified
• Unqualified
• Disclaimer and

In the given case as the company denies giving the documents, instead of issuing the modified, it shall mention the disclaimer of opinion. 

Safeguards for Maintaining Auditing Independence

Potential threats to the independence of the auditor – Independence is the situation where any person can work under any kind of pressure but is limited to the mentality who is taking the contract. Auditors independence is the situation were the judgment of the auditor if any taken on the financial statements of any company will not be biased by any type of the personal interest or relations with the staff of the company present (Ye, 2011).  

Advising Threat- The independence of the auditor has been affected. It is because of the fact that instead of checking the accounts of Hail Pty ltd, the auditor has informed the accountant regarding the impairment of the asset. Under the guidance of the auditor, the impairment is calculated and formed and the same have been accounted for in the books of the accounts of the company (Johnson, 2012).

As the auditor has been involved in the accounting of the company for which he has been appointed as an auditor. By having this relationship the independence of the auditor will be at its risk and he will not be able to issue the report on the impairment of assets and its calculations and hence the independence of the auditor has been hurted in the given case.  

1. Self Interest and Multiple Referrals Threat- In the given case, the Travel Time Limited is the travel agent and is handling all the clients of the audit firm. Till this stage independence will not be hurted. The independence will be hurted only when  the auditor has agreed to recommend the travel agent and in lieu of recommendation, the auditor will receive the  better services. Thus there are two types of threats encountered self interest and multiple referrals.
2. Relationship Threat : Relationship threat occurs when the auditor and auditee firm and through their relatives has the relationship between them In the given case, both the auditor and auditee are related and there may be the chances of issuing unqualified audit report.
3. Advisory Threat : It has been chosen because of the fact that the auditor is required to give his advice to the client other than audit services.   

Safeguards for saving the independence of an auditor- The safeguards for the auditor is that the auditor shall discuss only those items which are not related and in case related issues comes then the auditor shall not come office to make the payment.

S. No.	(a) Deficiency	Explanation	(b) Control	(c )Test of Control
1	Weak Internal control Management	There are many instances where the internal control management is very weak. One of the instances is that a sale order is entered into the sales system correctly but is has not been given to the dispatch for its timely deliverables.   There is the risk of having the higher degree of manipulation with the stock.	Proper reconciliation shall be there between the number of sale orders made and the number of sales orders dispatched during the period.	The test of controls includes the checking of the documents movement along with the goods whether it has been delivered to the customer in time or not.
2	Weak Inventory Management	It has been observed that inventory system is very weak. As of now while placing an orders inventory levels are not checked due to which at the end of the day or end of the month  inventory levels gets down or becomes zero. Thus, there is improper management of the inventory.	Inventory module shall be embedded within the software of the company so as to integrate all the functions of the company.	The test of controls include the checking of the movement of the inventory along with the supportive documents as to how the inventory moves from different stages and to check whether there is any discrepancy regarding this.
3	No Supplier Reconciliations	The company does not have the system where the statement of supplier can be reconciled with the ledger of the supplier in our books because of the change in the employees or staff of the company.	Proper reconciliation shall be made on the regular basis.	The test of controls including the checking of the movement of item from the time when it is loaded from the supplier factory and ends with the time when it reaches the company’s factory. These are to be checked with the bills, invoices, challan if any.
4	Non Involvement of Sales Director or Sales officers	Some customers of the company get their credit risk fixed on the basis of the analysis. None of the top managers or the middle level managers is actively involved in the process of setting the credit limits.	The participation of the either the manager sales of director sales shall be present.	The test of controls begins from the customer’s data analysis and ending up with the awarding of the credit risk.
5	Customer Management	On delivering the goods to the customers, the delivery boy does not get the documents signed by the customers due to which their customers might get lost. In other words customer management is not good.	The customer management system shall be embedded in the main software and it shall be integrated with other functions of the business.	Test of controls will begin from the corrected and newly implemented software by checking the updating of each and every detail.

Two Asset Accounts at Risk of Material Misstatements – Two assets accounts are the Accounts Receivable and Stock. It is because on the basis of the goods sold on sale or return basis whereby the customers are given the 90days credit and mentioned that the product is liable to given back before 30 days of the due date of the payment. In case the Customer who has purchased the asset flees way then the same will become a Non Performing Asset and thus will be at the high risk (Norman, 2010).

Second is the stock. As the customers willfully do not contribute to the payment and does not handover the stock, then there will be chance where the stock is also to be treated as lost. Thus, these two assets are risky assets.

Issue regarding Prior Year Figures – Prior year figures are the figures which are related to the financial year preceding the financial year in which the reporting is being done. In other words, the figure relating to old years shall be treated Prior year figures. At the time of finalizing the financial statements these prior year figures will be given on the face of the financial statements.   

Examples of Deficiencies in Internal Controls

Factors bringing the Going Concern Assumption – In the given case study, it has been mentioned that the company has been incorporated 30 years ago and accordingly have led to the opinion that the going concern assumption for the company has been true and correct.

Second factor that has bring the same assumption is that company has the better current ratio of 1.24 as against the 1.20 current ratio as declared by the bank to be given in order to arrive the futures.  

Third factor is the ratio of shareholders funds to total assets ratio which is 30% and is actual and as per the norms of the statutes. Thus, the company is growing concern.

1. Effects on Audit Planning

The factors so listed in the financial statements of the company along with the other information will affect the planning. At first the sale or return basis shall be checked and for this if require the audit sampling is required to be increased. It is because there may be many cases where the customers would have done the wrong leading to increase in the bad debts amount.    

One Internal Control Issue– The payment of bonuses shall be made only when the actual sales are equivalent to the budgeted figures. In the given case of Unique Company the bonuses have been given to the employees. It has been checked that bonuses have been given for two months since the employees have been able to achieve the target within two months out of six months. The budget is then requires revision (Eilifsen, 2011). This one is the major internal control issue.

Two Fraud Risk factors– One fraud factor is related to the bonus. In order to have the bonus, the employees might engage themselves to increase the sale of the company and accordingly increase the bonus thereon. Therefore, there may be the chances of having the manipulation in the sales figure. The manipulation can be done in any manner. For instance it can be done by inflating the sales at the maximum or by maximizing the selling price per unit which will be higher of the market. The second fraud risk factor is the level of the debtors. The level of the debtors has been more than the budgeted levels but at the yearend it has been manipulated with correct figure (Lou, 2011). After the manipulations it has been lowered down. It depicts that the debtors have been written  off from other accounts or artificially it has been mentioned that the funds have been received. 

Addressing Internal Control Deficiencies with Controls

Account Balance at Risk and Assertions at Risk – Account Balance that is affected by each of the risk is are as follows:

Bonus and Sales. The major assertion that can be placed under this head of account balance is cut offs, completeness and accuracy. Cut offs is related to the accounting of the transactions in the period in which it has occurred. For instance in order to inflate the sales there might be the probability that the company would have booked the sales in the current accounting period but in actual it belongs to the next year. Second assertion is the completeness. With the increase in the bonus and sales correspondingly there is the big question mark on the completeness of the books of accounts and the appropriate ledgers (Sarewitz, 2013). The third assertion that has been placed is the accuracy, as there is the clear doubt on the completeness of the transactions therefore there are the higher chances that the figures as reported are not accurate.  

Sundry Debtors. In the case of the sundry debtors, two assertions have been placed. These are existence, completeness and corresponding rights and obligations. Existence has been asserted in the sense that whether the balances of the sundry debtors that have been reflected in the financial statements of the company in actual exits or not (Kharisova, 2014). It is because the balance of the sundry debtors have been lowered down in the current financial year end and not on the beginning due to which there is the reasonable doubt that the balance would have been much higher as against the reported balance of the sundry debtors. Due to doubt on the existence of the balance of the sundry debtors, the assertion has been placed on the completeness of the accounting transactions relating to the debtor ledger. The third assertion is related to the rights that have been placed on the balance of the sundry debtors whether the company is required to obtain the current amount only from the debtors or something more is required to be received.

At first the audit plan shall be developed keeping in view the observations listed in the previous financial year and then the audit shall be performed accordingly.

The first procedure is to check the revenue one by one entry so that there may be less chances of doubling of any other entry which in turn will results in true balance of sales. At first the sample size shall be selected and then the audit of that sample shall be conducted with the complete verification of the sale bills with the banks statement and of necessary with the ledger confirmation of the debtors (Wright, 2011). If any material mistake is identified then the sample size shall be increased.    

Second audit procedure is related to the debtor’s level. This shall be checked with the ledger confirmation from the debtors of the company (Raghunathan, 2011).

The audit procedure shall include the substantive and compliance procedures wherever necessary as laid down in the Auditing and Assurance standards.

Thus, in this manner the audit shall be conducted.     

S. No.	Event	Description	Impact on Materiality	Explanation
1	Finance Manager Resigned	The finance manager of Sali Company has resigned in June 2017 but no replacement has been found.	Yes, the impact on materiality is very high because of the fact that the position is opened of the finance managers and as per the company details, the key succession plan has not been developed by the company.	It is material because of the transactions that the company is doing is not being properly checked as the finance manager designation is not filled (Bedard, 2012; Hammersley, 2011). Secondly, there will be less control on the financial transactions that is being entered into by the company with the parties. Thirdly, due to vacant position, the comparison of the actual with the budgeted figures cannot be achieved.
2	HR Manager Resigned and joined	The HR manager of Sali Company has resigned in June 2017 but replacement has been found in July 2017..	No, there will not be any high degree impact on the materiality.	It is because the HR manager is already there. Only thing is that the person who is engaged in the management of HR division has been changed and the new personnel is required to consider and understand all the working procedures as start.
3	Two material variances were discovered .	Material Variances have been discussed – Direct Material and Mix variance	Yes, this will impact the materiality with the higher degree.	This requires the data as to how the same can be verified.   The materiality level will be increased because of the material variance which is the regarded as the difference between the standard rate and actual rate with the actual quantity. It exhibits that the cost for the company has been increased with the higher amount.
4	Unlisted Investments – Testing	The test of investments if being done.	Yes, it has higher degree of the materiality level.	Being the part of the investments, very necessary to consider. It is because the audit team has pointed out that out of the 100% of the unlisted investments, 14% counts as for which no documents have been made readily available with the company, Which in turn has created the doubt on the effectiveness of the purchase of investments. Secondly, the response of the company though justifiable but the documentation should have been done before the start of the audit.

 

References

Bedard, J. C,  (2012), “Material weakness remediation and earnings quality” A detailed examination by type of control deficiency. Auditing: A Journal of Practice & Theory, 31(1), 57-78.

Eilifsen, A., (2011), “Application of the business risk audit model: A field study”  Accounting Horizons, 15(3), pp.193-207.

Hammersley, (2011), “How do audit seniors respond to heightened fraud risk?.” Auditing: A Journal of Practice & Theory, 30(3), 81-101

Johnson, E. N., (2012), “Auditor perceptions of client narcissism as a fraud attitude risk factor”. Auditing: A Journal of Practice & Theory, 32(1), 203-219.

Kharisova, F.I, (2014), “Applying the category of Assertions In audit of financial statement”, Mediterranean Journal of Social Sciences, 5(24), p.180.

Lou, Y, (2011), “Fraud risk factor of the fraud triangle assessing the likelihood of fraudulent financial reporting” Journal of Business & Economics Research (JBER), 7(2).

Norman, C. S., (2010), “Internal audit reporting lines, fraud risk decomposition, and assessments of fraud risk”  Accounting, Organizations and Society, 35(5), 546-557.

Raghunathan, B., (2011), “Premature signing-off of audit procedures”, An analysis. Accounting Horizons, 5(2), p.71.

Rossouw, D.. (2010), “Ethics for Accountants & Auditors” OUP Catalogue.

Sarewitz, D., (2013), “Vulnerability and risk: some thoughts from a political and policy perspective”, Risk analysis, 23(4), pp.805-810.

Wright, A., (2011), “Identifying audit adjustments with attention-directing procedures”,  Accounting Review, pp.710-728.

Ye, P, (2011),  “Threats to auditor independence” The impact of relationship and economic bonds. Auditing: A Journal of Practice & Theory, 30(1), 121-148.