Increased Inherent Risk At Finalcial Reporting Level And Its Contributing Factors
Every business has its own kind of risk whether it is related to purchase or related to sales or related to customers or related to the foreign currency exchange. All businesses have defined risks according to the nature and type of the business and more importantly the size of the business. As per the auditing standards, three types of risks that have been defined for each and every business namely inherent risk, control risk and detection risk. Although these risks have been defined in the auditing standards, are purely applied in describing operations and functions of company.
Out of three risks the inherent risks have been discussed in detail. Inherent risk is defined as the risk which entails that there has been the material misstatement in the working of the company as well as in the financial statements of the company. This presence is mainly due to the inherent limitations that the company is facing in its operations and the internal control procedures since its inception. The inherent risks are generally evaluated by the auditor while performing the audit of the company. He evaluates the same after exercising his professional care and appropriate judgment. In the given case, following factors have been contributed towards the increased inherent risk assessment at the financial reporting level:
Inexperienced Team– The Company can run in an efficient and effective manner only when the company will have sufficient and appropriate management teams which can enable the company to perform its functions well. The management team shall have requisite experience as required by the nature and type of the business entered. In the given situation, it has been very clearly and precisely mentioned that the board of the company are not equipped with the daily changing environment and has not come up with the rapid growth of the industry due to the presence of the limited managerial experience (Cohen, Krishnamoorthy and Wright, 2007). It depicts that the company is suffering from the major inherent limitation of the in experienced staff at the top management level which has increased the assessment of inherent risk at the high level and requires measure to mitigate the same. Otherwise the presence may lead to the failure of the business.
Improper management of composition of the Board: The board shall comprise of the members who shall be able to take part in the decision making of the company or any other matter which is directly related to the smooth function and growth of the company. As per the current situation of the company, the composition of the board consists of the five non executive directors and the four executive directors which indicate that majority of the directors are not taking part in any decision making activity of the company. Also as per the corporation’s act 2001, there shall be some independent directors who can give their opinion on the decision making activity of the company on an independent basis (Leong, 2009). Since the company also does not have the independent directors then the whole functioning of the company is being done on ad hoc basis and which again has raised an alarm of getting the inherent risk increased at an increasing rate.
Increased Competition since Formation of the company– The Company has been facing the severe competition since its formation. In the current scenario, though the company has been operating in the country but the major market share has been acquired by their competitors in the higher level. Their major competitors are Telstra, Optus and Vodafone which has jointly captured the ninety nine percent of the market share and leaving only the area of one percent. This depicts that the company has been facing the risk of expulsion from the market at the very high level and the said risk has not emerged suddenly rather have been present with the intent to form and operate company in this field. Thus, this factor has further increased the assessment of inherent risk at the higher level.
Reliance on Traditional Technologies– As the company consist of the team who is not equipped with the sufficient experience and with the rapid change in the environment the company is not having the expertise to get the company adapt according to the changes in the environment and the company has admitted on self that the company has expertise which is very limited and is not in commensurate with the nature and size of the business. In the country of Australia, the industry in which the company operates is changing rapidly and day by day it has come up with the new and innovative technologies. Due to this the company has been suffering from the major limitation and due to this the company’s assessment of inherent risk will be high.
Apart from the above inherent risk that has been assessed by the auditor of the company, the auditor has to consider the factors which are contributing towards the business risk of the company and helps in assessing the strategic business risk level of the company (Knechel, 2007). These factors include inexperienced members of the board of directors and high reliance on the traditional technologies. These are identified as the factors for assessing the strategic business risk of the company because these factors are related to the strategies that the company shall define and follow in order to do ensure smooth functioning of the company.
Increased Inherent Risk At Account Balance Level And Its Contributing Factors
Apart from the factors listed in the financial reporting level the company and the auditors shall consider the factors which contribute towards the assessment of inherent risk at the account balance level. These factors have been listed below for your reference:
Higher Level of Inventory– Each company shall maintain the adequate level of inventory known as the economic order quantity or minimum order quantity. It is because of the fact that in case the company maintains the high level of inventory and suddenly the demand for that product falls then the inventory of the company will start get piling and the company will face the position of the short term solvency in the near future (Miller, Cipriano and Ramsay, 2012). Thus, the level of inventory that the company keeps on daily basis is one of the factors that contribute towards the account balance level.
Irregular Depreciation– Depreciation is the charge made to the assets for loss of wear and tear in the normal course of business. This is due to the change in technology and the taste of the customers that keeps on changing with the technology. The company as charged the depreciation at the increased rate because of the increase in development of new and innovative technologies. If the same situation prevails for more than few years then there will be day when the assets of the company will erode its book value and leaving the company at the long term solvency risk as the balance sheet will then be prepared on liquidation basis. This factor is important to consider while framing the inherent risk at account level.
Increase in Equity– Equity of the company consists of the equity share capital of the company and the reserves that the company as on the current date. Equity of the company represents the net worth of the company and the same shall be maintained consistently and every company usually strives to make the equity at the higher level. In the given case the company has issue the shares of the company and in lieu of that has obtained the cash. Through this cash the company is operating its functions and at the end the company has reported the net loss for the year ending 2000. This is the situation which shall be considered as the major factor which contributes the inherent risk at account level. Also the company in the near future will not be able to pay to its customers and employees and thus will lead to long term solvency in the near future. (Shariff and Chan, 2008).
Areas Of Going Concern
One of the basic requirements for the preparation of the financial statements is that the financial statements are prepared using the assumption that the business will never stop and never come to end and always earns profits for maximization the shareholders investment value. As per Corporation Act, 2001 and conceptual framework of accounting, it has been said the recognition of assets liabilities, income and expenses are done keeping in mind the business will run for many future years. If the company’s going concern assumption is hurt, then the company’s financial statements are prepared on cash basis showing that the company to going to be dissolved soon in near future. The auditor has to see whether the company is using its assets sensibly and does not have a motive to sale or liquidate any asset. And if the company’s working is hampering the going concern assumption, the auditor has to take into the factors like sale of assets, reducing the expenses and closing or shifting business segments. (Ryu and Roh, 2007)
In give example of One Tel Corporations which is working in telecommunications industry in Australia along with 6 six different places in the world. The telecommunication industry are growing at a faster pace leading to very high competition for One Tel Corporation. The factors affecting the going concern of the company are assessed on very high basis and have significant impact on the future financial performance and solvency of the company. The followings aspects show the risky areas which damage the going concern assumption in One Tel corporation:-
Continuous loss reported by the company- The company has reported huge loss (considering after tax effect) of $ 291.10 million in 2000 as compared to the profits in 1999 of $ 7 million. The huge loss in the current year making the retained earnings to decreases and reported at $ 282.10 million in 2000 as compared to $ 9.10 million in 1999. This indicates that overall share capital has been decreased considerable in the current year of 2000. This affects the interest of shareholders in making investment in the company and there may chances in future than the shareholders will sell all the investment acquired in the company. Also, assuming no new issue of shares has been made the company and losses are occurring at this pace, the shareholders funds become negative in three to four years.
Cash Used in Operating Activities- The total cash used in operating activities of the company is $ 168.9 million in 2000 as compared to $ 28.9 million in 1999. This shows that the company is not able maintain its operational strategies wisely. The payments for expenses are more which shows that company is acquiring high level of inventory as compared to fewer sales of the same. This is reason of the volatile nature of the industry in which the company is operating. The current liquidity position is at risk as the company is not able to earn the level required to meet its short term obligations.
Huge number of the Australian Customers – The Company is working mainly Australia and has a customer base for its 64% revenue in Australia only. There were three major players who are working in the telecommunications industry in Australia as key players holding 99% of market. This shows that if these key plays introduced some new technologies in the field then it is difficult of the company to attract the customers and its major customer base gets diverted hurting its major portion of operating revenues. This shows that any little change by the competitor can create the chances of closure of the company
Excessive Purchase of New Licenses– the Company has acquired intangibles of $ 525.6 million in 2000 as compared to $ 9.5 million in 1999. This shows that funds acquired by the company from stakeholders have not invested in proper manner. The industry is changing at the faster pace and the new license and technologies are becoming obsolete soon. The assets are not giving proper returns to the company making the danger of solvency position in the company. This creates the risk of continuation of the operations of the company in near future. (Blay and Geiger, 2013).
The above factors which are identified are complete in list. There are many other factors which can create the red danger signal in path of the company to work towards the stakeholders’ wealth maximization goal as set by the company.
References
Blay, A.D. and Geiger, M.A., 2013. Auditor fees and auditor independence: Evidence from going concern reporting decisions Contemporary Accounting Research, 30(2), pp.579-606.
Cohen, J.R., Krishnamoorthy, G. and Wright, A.M., 2007 “The impact of roles of the board on auditors’ risk assessments and program planning decisions. Auditing: A Journal of Practice & Theory, 26(1), pp.91-112.
Knechel, W.R., 2007. The business risk audit: Origins, obstacles and opportunities Accounting, Organizations and Society, 32(4), pp.383-408.
Leong, C.T., 2009, “Inherent risk assessment—a new concept to evaluate risk in preliminary design stage- Process Safety and Environmental Protection, 87(6), pp.371-376
Miller, T.C., Cipriano, M. and Ramsay, R.J., 2012 Do auditors assess inherent risk as if there are no controls? Managerial Auditing Journal, 27(5), pp.448-461
Ryu, T.G. and Roh, C.Y., 2007, the auditor’s going-concern opinion decision- International Journal of Business and Economics, 6(2), p.89
Shariff, A.M. and Chan, T.L., 2008, Inherent Risk Assessment- In the 2008 Spring National Meeting
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