Auditing can be considered as the procedure for the inspection and examination of the financial statements and reports of the business entities with the aim to find any kind of material misstatements in them that is caused from errors and frauds (Louwers et al. 2015). It is needed for the auditors to consider different aspects while providing the auditing services and thus, they are needed to take into accounts the assertions of the managements of the client organizations at the time to prepare and present the financial statements of their business. As per the definition of the audit assertions, they can be regarded as the implicit and explicit claims of the management of the audit clients at the time of the preparation and presentation of the financial statements (Knechel and Salterio 2016). After that, it is one of the major responsibilities of the auditors of the companies for the application of the required substantive audit procedures in case their analysis indicates towards the presence of any assertion risk in the financial statements. In Australia, it is the responsibility of the auditors to follow and comply with the principles of ASA 707 Communicating Key Audit Matters as this standard has provided the auditors with the required guiding principles for dealing with the key audit matters. The main aim of the report can be find in the analysis and evaluation of different dimensions of audit assertion risks.
The analysis of the provided information of Computer Solution indicates towards the fact that two management assertion related to the inventory valuation can be at risk. These two assertions are Completeness and Accuracy; and the discussion is shown below:
Completeness: The management of the companies along with the auditors consider completeness as one of the most crucial assertion related to the inventory valuation. According to this assertion, it is the requirement of the managements of the business entities to keep proper record of all transactions related to inventory valuation in the proper financial statements. In this context, it is required to be mentioned that one major risk related to inventory valuation is the understatement of inventory (Kharisova and Kozlova 2014). As an example of this risk, a particular business entity buys some amount of inventory for their business, but they are not recorded in the books of the company due to the mistake of the accountant. The major reason contributes towards this risk is the weakness in the internal control of the companies related to inventory management. Ac per the provided information in the given scenario, the amount of inventory in hand of Computer Solution at the end of the year represents 22% sales in the financial year 2018 and 18 percent sales for the financial year 2014. It can be said from this information that there may be unintentional error or fraudulent activity in the balance of the inventory. For this reason, there may be the presence of incompleteness in the correct financial treatments of the inventory of the company (Titera 2013).
Accuracy: Auditors and management of the companies also consider accuracy as another major assertion that is used at the time of the inventory management of the companies. It needs to be mentioned that this assertion plays a crucial part for the management of the companies to find out errors and faults in the inventory management process. This assertion helps the managements of the companies in treating a major issue in inventory management that is to ensure the correct physical count of the inventory along with the correct flow of inventory to the income statement of the companies in the form of cost of goods sold and others (Bumgarner and Vasarhelyi 2018). As per the provided information in the given scenario, it can be seen that the management of Computer Solution has moved their inventory to six new regional warehouses from the central warehouse in March 2017. While moving the inventory to the warehouses or after the completion of the move to the warehouses, it can be happened that the accountable employees for inventory management involve in mathematical error while counting the inventory. In case this happens, it has the ability to reduce the inventory turnover from 5.2 in 2017 to 3.8 in 2018. For this reason, this can be regarded as a crucial audit assertion related risk for Computer Solution (Antonio 2014).
It can be seen from the above discussion that there are two major audit assertion risks in Computer Solution that are completeness and accuracy. After identifying these audit assertion risks, the next responsibility of the auditors is to apply the appropriate substantive audit procedures for the identified audit risks.
The involvement of the first risk can be seen with the accuracy of the process of inventory management in Computer Solution. With the aim to address this risk, the requirement for the auditors of Computer Solution is applying substantive audit procedures in the form of the reconciliation of the inventory count with the general ledger (Hall 2015). At the time of conducting this, the major responsibility of the auditor is to trace down the inventory valuation according to the physical inventory count to the general ledger of the company. The main aim of this technique is the verification of the physical balance in the inventory for making it sure that there is not any error in the inventory valuation process (Hall 2015).
After that, the relation of the next assertion risk also has relation to the inventory management mechanism of the business organization. In order to ensure the correct treatment of this risk, the auditor of Computer Solution needs to apply a specific substantive audit procedure that is to observe the physical inventory counting process of the company (Elder et al. 2013). As a part of this substantive audit process, it is needed for the auditor of Computer Solution to do necessary discussion about the physical inventory counting mechanism of the company, to carefully observe the counting process, to test the sample of the inventory with the aim to detect any kind of errors in the inventory counting and valuation process. According to the provided situation, it can be seen that Computer Solution possesses multiple storage location for strong inventory. For this reason, the responsibility of the auditor of Computer Solution is to ensure the testing of inventory in all of those locations (Elder et al. 2013). At the same time, the auditor can also adopt the strategy to verify the confirmation of the inventories from the central warehouse with the aim to find any kinds of error in them.
According to ASA 707 Communicating Key Audit Matters, it is needed for the auditors of the companies to take into account four specific requirements at the time of the assessment of the assertion risks.
As per the first requirement, it is the responsibility of the auditors to determine the key audit matters in the financial statements of the client companies in which they are needed to analyze the potential material misstatement areas of the financial statements. As per the second requirement, it is needed for the auditors to effectively communicate the assessed key audit matters and thus, they are needed to provide the necessary description of the key audit matter along with the adopted mutative procedures for minimizing them (auasb.gov.au 2018). As per the third requirement, it is needed for the auditors are needed to effectively communicate the key audit matters with the staffs accountable for governance mechanism. As per the last requirement, it is needed for the auditors to ensure effective documentation of the assessed key audit matters in the relevant documents like annual report and others. Auditors have the obligation to comply with these requirements of ASA 701 (auasb.gov.au 2018).
On the basis of the above discussion, it can be said that the earlier discussed issue of Computer Solution can be considered as the key audit matters as ASA 701 supports the rationale behind these. The above-discussed issues related to the inventory valuation of Computer Solution can contribute towards material misstatements in the financial statements due to its ability to wrong interpretation of the financial position of the company. Moreover, the involved judgments in the inventory valuation of Computer Solution have uncertainty and lack of transparency that can contribute towards material misstatements in the financial statements. For all these rationales, these issues can be regarded as key audit matters (Vik and Walter 2017).
ASA 701 puts the obligation on the auditor to disclose the information related to the key audit matters in the annual report of the companies under auditor’s report. For this reason, it is needed for the auditor to disclose certain aspects. It is needed for the auditors of the companies to provide the reasons behind considering these issues as crucial issues in the process of auditing and thus, the auditors are needed to provide rationale for their decision (Xu et al. 2013). After this, it is required for the auditors for providing detailed information on the substantial processes that have applied for the minimization of the key audit matters.
As per the given scenario of Beautiful Hair, the presence of two risks can be seen in the assertion of management related to intellectual property of formula and the discussion is shown below.
Ownership: Ownership can be regarded as one of the major assertion related risk for the valuation of the intellectual property of the formula. The main intention of the management for using this assertion is to ensure the fact that whether there is the presence of lawful claim of the intellectual property by the company in the balance sheet (Cowan and Newberry Jr 2013). It can be observed from the provided information of Beautiful Hair that the intellectual asset related to formula can become valuable at the same time material to the financial position of the company. For this, there is a potential of the development of audit assertion risk in the absence of sufficient ownership (Cowan and Newberry Jr 2013).
Occurrence: The management of the companies consider ownership as another crucial assertion in order to test the fact that whether the transactions for the acquisition of the intellectual properties have correctly occurred or not. As per the provide information of Beautiful Hair, the management of the company has considered the secret formula as a crucial intellectual property of their business considering its major impact (Olivier and Ndlovu 2013). For this reason, incorrect acquisition or occurrence of the deal of this secret ingredient can lead to audit assertion risks for Beautiful Hair.
The next process after the identification of the assertion risk is the adoption and application of substantive audit procedures to address these risk and they are shown below.
The auditor of Beautiful Hair needs to conduct certain procedures for the first assertion risk and the auditor is needed to conduct the inspection of the document related to the title of the intangible asset of formula so that it can be made sure that Beautiful Hair possesses all the required title documents in their name (Kinney Jr, Martin and Shepardson 2013). These documents include deed of title and registration document of the intellectual property. These documents are curial to the auditor as they carry the evidence related to the acquisition of the intellectual property by the company. In the absence of these documents, Beautiful Hair does not possess any right for the ownership of the intellectual property (Cannon and Bedard 2016).
The relation of second risk can be seen with the transaction occurrence for the intellectual property of secret ingredients. For the test of this assertion, the requirement for the auditor is the verification of the fact that whether the acquisition of this intellectual property from Shimmers Ltd. has correctly occurred or not (Dowling and Leech 2014). In order to ensure this fact, the requirement for the auditors is to take assistance of the inspection of all the documents while acquiring the intellectual property of secret ingredients. For example, the inspection of all the documents related to the acquisition of the intellectual property of secret ingredients can ensure the acquisition of the intellectual property (Bierstaker, Janvrin and Lowe 2014).
The standards of ASA 701 Communicating Key Audit Matters state that it is needed for the auditors to make compliance with some basic requirements for the assessing the management assertions. It is a major requirement for the auditors of the companies to determine the key audit matters while taking into consideration the impotence of material misstatements of the financial statements (Carson, Fargher and Zhang 2016). After the determination of these matters, the requirement for auditors to ensure the effective communication of these issues along with their professional judgment. After that, they are also needed to ensure the communication of these issues to the staffs accountable for internal control and governance. It is equally crucial for the auditors ensure the documentation of the key audit matters in the required documents of the company (auasb.gov.au 2018).
In this context, it must be mentioned that the key assertion risks of the intellectual property of Beautiful Hair need to be considered as key audit matters due to its potential material impact on the financial position and financial statements of the company. The removal of this intellectual property from the balance sheet will have major impact on the financial standing of Beautiful Hair (Azim 2013).
One prime responsibility of the auditors of Beautiful Hair is to provide the disclosure of the required rationale for considering these assertion risks as material on the financial statements of the company. After this, it is also the prime responsibility of the auditors of Beautiful Hair to provide the information related to the application of certain substantial audit procedures in order to address these assertion risks related to the acquisition of the intellectual property of the secret ingredients (Tarr and Mack 2013).
Conclusion
The above discussion indicates towards the importance of the assessment of the used management assertion by the auditors in order to detect any kind of assertion risk in them. It can be seen from the above discussion that the management of the companies has to use different kinds of assertions at the time of the financial treatment of inventory and the intangible assets. for example, the valuation of inventory involves assertions like completeness, accuracy and others; while the valuation of intellectual property involves assertions like ownership, occurrence and others. It can also be seen from the above study that the auditors are needed to perform substantial audit procedures for addressing these audit assertions risks. The above discussion indicates towards the fact that the auditors have to select the substantive audit procedure based on the valuation mechanism appropriateness. For example, auditors can perform the physical count of inventory for addressing the inventory valuation assertion risks and they can perform the verification of acquisition documents for addressing the intellectual property related assertions. It can also be seen from the above study that it is the prime responsibility of the auditor to comply with all the requirements of ASA 701 for addressing the key audit matters related to audit assertion risks.
References
Antonio, G.R., 2014. Continuous auditing: Developing automated audit systems for fraud and error detections. Journal of Economics, Business & Accountancy Ventura, 17(1), pp.127-144.
ASA 701. 2018. Auditing Standard ASA 701 Communicating Key Audit Matters In The Independent Auditor’S Report. [online] Available at: <https://www.auasb.gov.au/admin/file/content102/c3/ASA_701_2015.pdf> [Accessed 11 Sep. 2018].
Azim, M.I., 2013. Independent Auditors Report: Australian Trends From 1996 to 2010. Journal of Modern Accounting and Auditing, 9(3), p.356.
Bierstaker, J., Janvrin, D. and Lowe, D.J., 2014. What factors influence auditors’ use of computer-assisted audit techniques?. Advances in Accounting, 30(1), pp.67-74.
Bumgarner, N. and Vasarhelyi, M.A., 2018. Continuous auditing—a new view. In Continuous Auditing: Theory and Application (pp. 7-51). Emerald Publishing Limited.
Cannon, N.H. and Bedard, J.C., 2016. Auditing challenging fair value measurements: Evidence from the field. The Accounting Review, 92(4), pp.81-114.
Carson, E., Fargher, N. and Zhang, Y., 2016. Trends in auditor reporting in Australia: a synthesis and opportunities for research. Australian Accounting Review, 26(3), pp.226-242.
Cowan, M.J. and Newberry Jr, W., 2013. Reevaluating the intellectual property holding company. Management Accounting Quarterly.
Dowling, C. and Leech, S.A., 2014. A Big 4 firm’s use of information technology to control the audit process: How an audit support system is changing auditor behavior. Contemporary Accounting Research, 31(1), pp.230-252.
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Hall, J.A., 2015. Information technology auditing. Cengage Learning.
Kharisova, F.I. and Kozlova, N.N., 2014. Applying the category of «Assertions (or preconditions)» In audit of financial statement. Mediterranean Journal of Social Sciences, 5(24), p.180.
Kinney Jr, W.R., Martin, R.D. and Shepardson, M.L., 2013. Reflections on a decade of SOX 404 (b) audit production and alternatives. Accounting Horizons, 27(4), pp.799-813.
Knechel, W.R. and Salterio, S.E., 2016. Auditing: Assurance and risk. Routledge.
Louwers, T.J., Ramsay, R.J., Sinason, D.H., Strawser, J.R. and Thibodeau, J.C., 2015. Auditing & assurance services. McGraw-Hill Education.
Olivier, D. and Ndlovu, J., 2013. Brand & trade mark due diligences: intellectual property. Without Prejudice, 13(7), pp.56-59.
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Vik, C. and Walter, M.C., 2017. The reporting practices of key audit matters in the big five audit firms in Norway (Master’s thesis, BI Norwegian Business School).
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