Auditing can be defined as a process of evaluating the accuracy of financial transactions recorded by the company during a year. All the stakeholders in a business are dependent on financial statements to take important decisions in relation to their investment in the company. For example shareholder of the company will examine the financial statement of the company in which he or she has a made an investment to evaluate whether such investment should be continued or shareholder should extract his/her money from the company. Shareholders are the investors in the business and it is not essential every investor has financial and economic knowledge. It is very difficult for a shareholder to understand financial data presented in financial statements (Louwers et.al, 2015). In addition to that shareholder of the company has no way in which we can evaluate the accuracy of financial data presented in the statements along with the operational aspect of the company. This is the reason that auditors of the company appointed by shareholders and board of directors to make sure that the financial data presented in the financial statement are accurate. Shareholders base their investment decision on these financial statements. Attestation and approval from the auditor of the company give the sense of credibility to the financial statement of the company. In the last two decades, there have been various changes in the function of auditing due to various reasons. One of the reason is a number of accounting scandals executed by the management of the company even when the auditor of the company has evaluated the financial statement. In the cases like Enron material misstatement should have been identified in the process of operating. Various accounting experts have identified that the mistakes were apparent from the record and auditing function could have easily identified this material misstatement (Cohen and Simnett, 2014). Introduction of Sarbanes-Oxley act 2010 was one of the changes that happened in function of auditing.
One of the most important factors that should be identified by the auditor of the company is a risk of material misstatement. Risk of material misstatement can be defined as the risk of material misrepresentation of facts and data in the financial statement of a company. The financial statement can be considered as at risk of material misstatement when such misstatement can affect the decision taken by shareholders and other stakeholders of the company. Generally, the risk of material statement is divided into two levels that are assertion level and financial statement level. There are various auditing standards given by various accounting authorities that are adopted by the auditor of the organization to identify this material misstatement (Mališ and Novak, 2016). These accounting authorities’ have we put special consideration on the identification of material misstatement as in past there have been various incidences in which management of the organization have easily manipulated their shareholders by representing wrong facts and data in the financial statements even when financial statements were audited.
The level of auditing functions have improved over the period of time and accounting authority is over the world has also become more involved in the process of auditing. Regular amendment and updates it is accounting and auditing authorities over the world to make sure that to the financial position of the company is depicted in their financial statements. This report is concerned with material misstatement at the assertion level. A case study is provided and material misstatement is to be identified from the perspective of an auditor.
In the assessment of inventory of the company, auditor of the company identified that returns on sales have been very high and inventory turnover ratio of the company has also decreased from 5.2 in last year to 3.8 in the current financial year. The main reason behind these returns is excessive software problems identified by customers after sales. In addition to that, the percentage of stock to total sales of the company has also increased from 18% to 22% in a current financial year. The company has also agreed to provide various products to government department at 10% below their cost to prevent competitors to gain market share in the government sector.
Two key assertions at risk are as follows-
It can be identified according to the information given in the case study that the net sales of the company are decreasing on a regular basis. Sales of the company are regular but the sales returns are increasing constantly. The demand for the product in the market can be identified with the help of inventory turnover ratio. Inventory turnover ratio shows the number of times whole Inventory of the company has been sold in a particular financial year. If inventory turnover ratio is higher and it shows that there is circulation of inventory in the market and the company is selling their inventory on regular basis due to demand of the product in the market. In the given case study turnover ratio of the company has decreased to 3.8 times in 2018 as compared to 5.2 in 2017. It shows that the company was selling its whole inventory 5 times in 2017 whereas in 2018 management was not able to even sell its inventory four times in a financial year. This figure shows that demand for the product in the market has decreased and the reason for this decreases is the inferior quality of goods provided to the customer (Knechel and Salterio, 2016).
Total inventory left at the end of the financial year of the company has also increased. This is also a negative sign for the company as more manufactured inventory is remaining unsold at the end of the financial year. This outstanding inventories will increase the carrying the cost of inventory for the company. In addition to that software industry is an industry in which product and services become outdated very quickly as every organization wants to adopt the latest technology. Stock at the end of one financial year might not be as per the recent technology in the next financial year. This will result in a financial loss on the inventory that has been already manufactured.
The company has taken the contract to provide different product to government department at ten percent less than the cost of manufacturing. The main reason behind this decision is to prevent other competitors to enter into the government market. It is common for business organizations to provide product and services at a price lower than its competitors to acquire certain market share. These steps are taken by the management of a company to increase their market share which would be profitable in the future. But in these contracts selling price is not left lower as then its cost price. In the given scenario Computing Solutions Limited is providing their product to government departments at price lower than its cost. The decision taken by the company is not in favor of the financial position of the company (Chan and Vasarhelyi, 2018). Currently, shares of the company and not very effective and if goods and services are sold is lower than its cost price then it would put excessive pressure on the financial position of the company.
In addition to that, there have been the various productions of the company that is not up to the quality as they have been regularly returned by customers. If defective products are delivered in such a big government contract then it would ruin the reputation of the company in the market and it would affect the going concern of the company. It means that in future no organization would be willing to do business with the company due to their reputation in the market. According to current pricing strategy of the company, it would not even able to meet its variable cost of production as product and services are provided cost lower than its production cost. The amount of loss incurred on every product is also very substantial that is 10 % of total manufacturing cost. is this pricing strategy are executed then the company would not have enough money to manufacture a sufficient amount of inventory in the coming financial years which would impact the financial position of the company in long run.
Decrease in sales
Purpose of the audit is to present to the financial position of the company and ASA 701 enable auditor to present true and fair position of the company in the market along with the key areas that shareholders should understand about the company. Key audit matters are the matters that required significant attention from auditors conducting the process of audit.
There is a separate subheading in audit report named “Key audit areas”. All the audit areas that are identified by the auditor as key audit areas should be mentioned under the subheading. In addition to the detailed statement should be enclosed along with every key audit area explaining the reason that such an audit area is included in Key audit matters. Shareholders will be able to well you make the decision according to and that could effective overall financial position of the phone.
It is very essential for every auditor to include these matters under the heading key audit matters shareholders of the company has a right to know areas that could affect the financial statement of the company. It is the duty of the auditor to present true and fair position of the company in the market. is there are certain areas that could not be properly identified by the auditor and they could affect the financial position of the company then they should be reported and communicated to shareholders so that they could make an investment decision on the basis of all the information.
Both of the risk identified in the about section of the report should be included in key audit matters as they can affect the future financial position of the company. The company is providing goods to a government contract act for a cost lower than its manufacturing cost and sales of the company are decreasing due to the rejection of inferior quality products. Both of these situations have a direct impact on the financial position of the company (Cordo? and Fülöp, 2015). Providing products at price lower than its manufacturing cost would affect future available funds for the production of goods and services and this it could affect the operability of the company in future as the company would not be able to operate if they even do not have money for production of its core products. In such a scenario, no investor would be willing to invest in the business and company would not be able to operate.
On the other hand the quality of products and services is also a key matter that could affect the operability of company in future. No business organization will be willing to going business with computing solutions Limited if the quality of product and services are not as per industry standard.
In the last financial year, Beautiful hair has acquired the business of Shimmer Private Limited. Both of these organizations are working in the industry of hair styling products and it is advice to the management of Beautiful Hair that business of Shimmer Private Limited would complement the business of the company and it would release some Synergy benefits for the company. There is a specific formula that is used by Shimmer Private Limited to manufacture their products and this formula is patented by them. Management of Beautiful Hair has been advised to record this formula as an intangible asset as it can be a very productive asset for the company.
Two key assertions at risk are as follows-
1.Accounting for business acquisition
In the given scenario, Beautiful Hair Limited has acquired the business of Shimmer Private Limited. There are a specific set of rules and regulation that a business organization is required to follow while accounting for business acquisitions. In this case, the set of rules and regulations would be followed by Beautiful Hair Limited. As business activation has occurred in the current financial year, therefore it is important that proper accounting should be conducted in a current financial year. The main purpose of financial statements is to present the true value of the business in the industry (Arens et.al, 2015). In a current financial year, the financial statement includes financial data for two business organizations rather than one organization, and so it is important that proper accounting is done. AASB 3 is issued by accounting authority of Australian accounting standard board for enabling management of an organization to deal with accounting in case of business acquisitions.
Assets can be divided into two categories on the basis of their nature that are a tangible asset and intangible asset. Both of this asset have their own characteristics and they are recorded in a specific manner. A tangible asset is recorded on cost when it is purchased and immediately included in the financial statements of the company. Accounting for an intangible asset is a little different and complex as intangible assets are not physically available with an organization. Intangible assets are recorded only when such asset is expected to generate revenue for the company in future. AASB 138 has been provided by Australian accounting standard board to help management of an organization to record the intangible assets. This accounting standard was also included an accounting to be done in case of asset intangible asset acquired in process of business acquisition. This can be considered as a risky area for business because the inaccurate valuation of an intangible asset can create a wrong representation of the position of business in market (Arens et.al, 2014). If value of intangible asset is overestimated than value of business will also increase but in reality, business does not have such assets.
Accounting for business acquisition
Key audit matters are the matters that are listed by the auditor of the company in its report under the subheading “key audit matters”. There are certain matters in business on which the auditor of the company cannot perform adequate audit procedures and form of a conclusive opinion. It is essential to specifically mention these matters as it would have a material impact on the decision taken by shareholders of the company. Shareholders of the company should understand the risk that they are taking while investing in the company and these key audit matters explains risky matters that cannot be identified with the help of financial statements (Segal, 2017).
Both of the risk identified in the about section of the report should be included in key audit matters as they can affect the valuation of company provided in the financial statements. Error in accounting for business acquisition and recording of intangible assets can result in overvaluation or undervaluation of the company in the balance sheet. In addition to that proper explanation should also be provided on why these matters are considered as key audit matters.
Conclusion
Financial statement of a company are prepared by management of the company and it is very important for shareholders to make sure that financials data presented in the financial statement are accurate and relevant. Therefore it is important that an organisation get their accounts audited from an external auditor so that accuracy of the financial statements can be evaluated. There are various risks that are to be managed by an auditor while executing the function of audit. Every auditor has to follow certain rules and regulations while conducing audit of any organisation. This report has explains some of the functions of audit with the help of two different scenario. Solution of questions asked in the case study are given by following principles of auditing standards issues by Auditing and Assurance Standards Board (AUASB).
References
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Arens, A.A., Elder, R.J., Beasley, M.S. and Jones, J., 2015. Auditing: The Art and Science of Assurance Engagements. Pearson Canada.
Bryan, D., Rafferty, M. and Wigan, D., 2017. Capital unchained: finance, intangible assets and the double life of capital in the offshore world. Review of International Political Economy, 24(1), pp.56-86.
Chan, D.Y. and Vasarhelyi, M.A., 2018. Innovation and practice of continuous auditing. In Continuous Auditing: Theory and Application (pp. 271-283). Emerald Publishing Limited.
Cohen, J.R. and Simnett, R., 2014. CSR and assurance services: A research agenda. Auditing: A Journal of Practice & Theory, 34(1), pp.59-74.
Cordo?, G.S. and Fülöp, M.T., 2015. Understanding audit reporting changes: introduction of Key Audit Matters. Accounting & Management Information Systems/Contabilitate si Informatica de Gestiune, 14(1).
Dickinson, V., Wangerin, D.D. and Wild, J.J., 2016. Accounting Rules and Post-Acquisition Profitability in Business Combinations. Accounting Horizons, 30(4), pp.427-447.
Griffiths, P., 2016. Risk-based auditing. Routledge.
Ho, W., Zheng, T., Yildiz, H. and Talluri, S., 2015. Supply chain risk management: a literature review. International Journal of Production Research, 53(16), pp.5031-5069.
Knechel, W.R. and Salterio, S.E., 2016. Auditing: Assurance and risk. Routledge.
Lam, J., 2014. Enterprise risk management: from incentives to controls. John Wiley & Sons.
Louwers, T.J., Ramsay, R.J., Sinason, D.H., Strawser, J.R. and Thibodeau, J.C., 2015. Auditing & assurance services. McGraw-Hill Education.
Mališ, S.S. and Novak, A., 2016, January. Assessments of the risks of material misstatement due to fraud. In 5th International Conference “Vallis Aurea”: focus on Research and Innovation.
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