Audit is defined as the method where the auditors are liable in applying analytical processes on the financial reports of the organisations so that there could be identification and reporting of material misstatements. In this method, the auditors have to take into account different aspects like assertions used by the management of an organisation for preparing and depicting the financial statements (Arens et al. 2015). The management considers such assertions as implicit or explicit claims. However, the auditors have found instances on certain occasions, in which risks are detected in the assertions associated with material misstatements. Thus, the auditors are required to investigate such assertions so that risks could be identified. Moreover, for analysing the assertions, there are different standards and regulations to be followed by the auditors; as such regulations provide the guidelines for identifying the assertions at risk along with communicating the same (Brown-Liburd and Zamora 2014). The current reports intends to investigate two different cases of Advanced Computer Solutions Limited and Green Machine Limited for detecting assertions at risk, applying substantive audit procedures along with disclosing the same.
By evaluating the situation of the organisation, the auditor could gather knowledge regarding two assertions at risk, which include accuracy and completeness. The primary reasons are listed as follows:
Accuracy:
The management of any organisation needs to ensure accuracy for inventory valuation. It is necessary to detect errors and inappropriateness in inventory valuation using this assertion (Byrnes et al. 2018). As per this assertion, the management of an organisation is committed towards accurate inventory computation and the physical inventory count in order to record the same in financial reports. Based on the provided information of Advanced Computer Solutions, the auditors could identify that the organisation has shifted its stocks from the main warehouse to six regional warehouses in March 2018. The assertion of accuracy states that the liable personnel might conduct error in physical count of inventory before or after shifting the inventory. This specific error might be the reason behind the decline in inventory turnover from 5.4 in 2017 to 3.8 in 2018. By taking into account all these reasons, the auditor could take into account the assertion at risk within the organisation (Chan and Vasarhelyi 2018).
All business organisations need to conduct complete inventory valuation. According to the assertion requirements, the management of an organisation has to maintain all inventory-related transactions in the accurate accounting books. If this is not followed, the inventories could be understated (Chiu, Liu and Vasarhelyi 2018). Moreover, if the responsible staffs do not update the information related to inventory timely after purchases, there might be material misstatement risk. When the internal control of an organisation is not strong, this assertion might be at risk. From the given information, it could be identified that the organisation has inventory on hand amounting to 26% of revenue in 2018 compared to 18% in 2017. This indicates that there might be a chance where inventory valuation is not conducted appropriately leading towards the inclusion of sales in 2017 in inventory of 2018. Due to this reason, completeness is deemed to be at risk for Advanced Computer Solutions (DeFond and Zhang 2014).
All auditors are needed to undertake accurate substantive audit procedures after identifying the assertions at risk and the situation is deemed to be similar for Advanced Computer Solutions. According to the auditor, the assertion of accuracy is at risk for the organisation. In order to deal with this situation, the accurate substantive audit procedure would be methodical observation of the overall procedures while carrying out the physical count of inventory. More precisely, it is essential for the auditor to carry out various procedures, which include communicating with the staffs responsible for inventory count regarding the loopholes in the internal control system, methodical review of the counting procedure and sample testing of inventory in order to detect any error (Cohen and Simnett 2014). In March 2018, the organisation has shifted its inventories to six different locations rather than keeping the same in a single location. Hence, it is necessary for the auditors to assure verification of the physical of count of inventory processes of all the locations in order to align the outcomes with the count confirmation of the main location (Farooq and De Villiers 2017).
Moreover, the assertion of completeness is at risk within the organisation. For controlling the risk related to assertion, it is vital for the auditor to engage in a specific substantive audit process, which is reconciling the results of the physical inventory count with the values in the books of accounts (Kend, Houghton and Jubb 2014). In other words, it is the liability of the auditor to identify the values of inventory obtained from physical count in order to discover any error. When this substantive audit procedure is applied, the auditor gains knowledge on the fact that accurate inventory valuation has been conducted (Knechel and Salterio 2016).
Requirement and rationale of ASA 701:
With the help of the guidelines mentioned in ASA 701, it becomes easy for the auditors in communicating with the major stakeholders and identifying key audit matters. This particular standard has other benefits as well, which are considered to be useful in the auditing profession (Lenz and Hahn 2015). This assists in developing transparency in financial reporting along with improving its overall quality. Besides, the guidelines in ASA 701 has given the auditors with enhanced scope of laying stress on the financial statement areas requiring special attention. This is because it assists in enhancing the overall audit quality (Auasb.gov.au 2019). Finally, the preparers could gather the needed motivation from ASA 701 in order to revise financial reporting while taking into account the key audit matters. This has the ability of improving audit quality along with the transparency in financial reporting.
Reasons behind choosing key audit matters:
In accordance with the guidelines mentioned in ASA 701, the assertions that are at risk in Advanced Computer Solution could be taken into account in the form of key audit matters owing to a number of reasons. The financial reports of the organisation could contain material misstatements at the time these assertions are at risk owing to the fact that it has the ability of manipulating the financial condition and efficiency of the organisation to the stakeholders. Moreover, the management has used certain uncertainties and ineffective transparency in its judgements for inventory valuation, which could lead to material misstatements in its financial reports. Therefore, by combining all these rationales, the key audit matters could be developed in the context of the concerned organisation (Liao, Lin and Zhang 2018).
Disclosures required under ASA 701:
ASA 701 states that it is the obligation of the auditors to identify the key audit matters along with disclosing the same. Therefore, the auditor associated with Advanced Computer Solutions is required to reveal the explanation behind choosing the key audit matters (Lombardi, Bloch and Vasarhelyi 2014). In addition, the pertinent information regarding substantive audit processes are required to be revealed in the audit report from the end of the auditors.
After critical evaluation of the case scenario of Green Machine Limited, the auditor has identified there are assertions at risk and they include valuation and accuracy. The primary reasons are listed down as follows:
Valuation:
All business organisations have to bear the responsibility of conducting valuation related to their property, plant and equipment (PPE). As per the guidelines of this specific assertion, the management is committed towards a number of aspects. These aspects mainly include accurate record of PPE at cost after subtraction of depreciation and impairment losses; disclose any inclusion and sales of PPE and testing impairment of the same by reviewing the indicators of impairment (Louwers et al. 2015). These factors have obliged the organisation in reporting its PPE information accurately and fairly. When low rate of depreciation is applied, the operating expenses of Green Machine Limited could be minimised owing to decline in operating expenses and this could result in material effects on the financial statements of the organisation (Pizzini, Lin and Ziegenfuss 2014). Hence, this assertion is at risk from the perspective of the auditor.
Accuracy:
It is necessary to conduct accurate valuation of PPE for all business organisations. As per this assertion, the management of an organisation has to ensure accurate recording of the amounts and other transaction-related data as well events in relation to PPE accurately in the books of accounts (Rahmina and Agoes 2014). Moreover, it needs accurate segregation of revenue and capital expenditures. As per the case information of Green Machine Limited, the segregation of revenue and capital expenditure has not been conducted appropriately due to the fact that the management of the organisation has capitalised its revenue expenditure along with maintaining few capital expenditures in the form of repairs and maintenance in its profit and loss statement. Therefore, this assertion is deemed to be at risk.
The auditors are liable for conducting the accurate substantive audit processes after identifying the assertions at risk and the situation is deemed to be similar for Green Machine Limited as well. The above discussion emphasises on inaccurate segregation of capital and revenue expenditures on the part of the management of Green Machine Limited. From the viewpoint of the auditor, the methodical review of the audit process of the organisation for expense capitalisation is needed so that this assertion risk could be kept under control and this would act as the accurate substantive audit procedure. Moreover, it is vital for the auditor to review different expenditures of the organisation that take into account overheads, operating costs, costs of labour and other expenses (Simnett and Huggins 2015). This would assist the auditor in providing overview of the expenses, which are not capitalised correctly. Finally, it is necessary for the auditor to assure that Green Machine Limited has adhered appropriately to the doctrines related to revenue expenditure and reporting capital.
Along with this, it has been identified from the case information of Green Machine Limited that the organisation has not applied suitable depreciation rate on PPE. From the perspective of the auditor, the suitable substantive audit procedure for control the assertion at risk is analysing the rate of depreciation in various aspects. These aspects comprise of the residual amount of PPE, losses or profits owing to sale of PPE, economic life of PPE, policy of the organisation to substitute PPE along with maintaining PPE with the accurate standards of accounting in order to depreciate the same (Simnett, Carson and Vanstraelen 2016). After this, the auditor needs to contrast the depreciation ratios associated with PPE, since it would assist in determining the accurate rate of depreciation. Finally, the auditor is required to engage in recalculating the PPE depreciation along with the corrected rate of depreciation for obtaining the actual expenses related to depreciation.
Requirement and rationale of ASA 701:
According to the principles of ASA 701, the auditors are needed to ascertain the key audit matters with the aid of audit opinion on the financial statements of the clients. Moreover, they need to undertake effective communication of key audit matters along with the essential description. According to the guidelines of ASA 701, the definitions related to key audit matters are provided, since the issues have considerable significance in the financial statements of the organisation in accordance with the judgements of the auditor. It is necessary for the auditor to engage in consultation with the governance team of the organisations along with ascertaining the key audit matters.
Moreover, ASA 701 states that the auditors need to take into consideration other requirements at the time of determining the key audit matters. This standard ensures the obligations on the auditor in evaluating the financial statement areas having greater material misstatement risk, as per ASA 315 (Auasb.gov.au 2019). After the completion of this step, the auditors need to take into account the evaluation of the crucial management judgements in order to develop the financial statements along with projection of uncertainties. Furthermore, it is crucial for the auditors to analyse the impact of such judgements as well as assumptions on the results of the audit activities. Finally, the auditors are required to ascertain issues and events having the potential of material effect on the financial reports of the audit clients.
The assertions identified at risk could be deemed as the key audit matters for Green Machine Limited in accordance with ASA 701 owing to a variety of reasons. The operating expenses of the organisation could experience significant minimisation owing to fall in depreciation expense, since the rate of depreciation charged is low (Turley 2015). Such massive reduction could overstate the profit margin of the organisation, which might result in material misstatements in the financial reports of the organisation. When this procedure is over, the similar aspect could occur owing to incorrect segregation of revenue and capital expenditures and the impact would be adverse on the profit margin of the organisation from the perspectives of the stakeholders. Therefore, it could be stated that the identified assertions at risk could lead to material misstatements for the concerned organisation due to which they are taken into account in the form of key audit matters (Arens et al. 2015).
Disclosures required under ASA 701:
In accordance with the guidelines mentioned under ASA 701, the auditors are needed to identify the key audit matters and this would assure disclosure of the same. In this method, the concerned auditor of Green Machine Limited has to take into account two requirements mentioned under ASA 701. The auditor needs to disclose information regarding significant incidents and events contributing towards the formation of key audit matters. After this, the auditor needs to assure the information disclosure regarding the substantive audit processes, which are applied so that the assertions at risk could be controlled (Byrnes et al. 2018).
Conclusion:
It is identified from the above discussion that the key audit matters could result in material misstatements in the financial reports and thus, they require utmost attention of the auditors. The auditors need to identify the assertions at risk along with disclosure of adequate information regarding the rationales by taking into account the key audit matters. Moreover, it has been found that various assertions are at risk for the provided organisations associated with PPE and inventory valuation like completeness, valuation and accuracy. Along with this, it is necessary for the auditors to choose substantive audit processes depending on the nature of audit assertions, which are at risk. For instance, the process for inventory valuation bears no resemblance to that of PPE valuation. Finally, the auditors are required to comply with the norms mentioned under ASA 701 so that they could explain their stand of choosing the key audit matters by adhering to the required guidelines. Therefore, the key audit matters are considered as a crucial aspect in the auditor’s report.
References:
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Auasb.gov.au., 2019. [online] Available at: https://www.auasb.gov.au/admin/file/content102/c3/ASA_701_2015.pdf [Accessed 17 Jan. 2019].
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