Key Audit Matters For Beauty Hair Ltd

Background Information

Material misstatement risk is the risk that financial statement of the organization had been misstated to the material level. The risk of material misstatement is analysed by the auditors at 2 levels – assertion level and financial statement level. Risk at the assertion level is segregated into control risk and inherent risk. Inherent risk is the risk that the susceptibility of assertion to misstatement owing to fraud or error. On the other hand, control risk is the risk that the misstatement cannot be prevented by the internal control level of the entity. Risk at the financial level determines the possibility of fraud (Kharisova & Kozlova, 2014).

Auditors in Australia are obliged to follow the regulations and guidelines presented in “ASA 701 Communicating Key Audit Matters in the Independent Auditor’s Report. It provides the procedures those must be followed by the auditors while carrying out the audit. It further deals with the responsibilities of the auditors for communicating the key audit matters under the auditor’s report. Main purpose of communicating the key audit matters is improving communicative value of auditor’s report through delivering more transparency regarding the performed audit (Auasb.gov.au, 2019).

(a)

From the given scenario of Computing Solutions Limited it is identified that 2 key assertions related to inventory are as follows –

• Accuracy – this assertion states that the amounts and other associated data with the recorded events and transactions have been inappropriately recorded and the associated disclosures have been described and measured inappropriately. While valuing the inventories the management shall take proper measures to value it accurately as accurate valuation of the inventories plays important role in business. Persons involved with valuation of inventories are responsible to ensure that the business inventories have been valued properly and the accurate figures have been recorded in the financial statement based on the valuation (Köhler, Ratzinger-Sakel & Theis, 2016). As in the given scenario, the entity moves its inventory from its central warehouse to 6 new regional warehouses. Hence, likelihood is there mathematical error is there when dispatching the inventory from central warehouse and receiving the same in the regional warehouse. Further, likelihood is there owing to error the inventory turnover of the entity has been reduced from 5.8 times to 3.8 times over the time period from 2017 to 2018 (Vik & Walter, 2017).
• Completeness – it refers that all events and transactions associated with inventory those shall have been recognized have not been recorded and all the associated disclosures those shall have been recorded under the financial statement have not been included. As per the completeness assertion, understatement of the inventory will also be considered as a key assertion associated with completeness. As per the given scenario the inventory on hand for the entity has been increased from 18% to 22% over the years from 2017 to 2018. Hence, likelihood is there the person in charge with maintenance of records have not recorded the sales transaction for inventory which in turn will show the inventories still in hand. Hence, risk assertion increases of understatement or overstatement of the inventories as compared to actual inventories available on hand. Further, the insufficient and ineffective control of the inventories will lead to assertion associated with completeness.

(b)

Substantive procedures are those activities which are performed by auditors for detecting the fraud or material misstatement at level of assertion. Substantive procedures those can be performed with regard to the risk mentioned above are as follows –

• Accuracy risk – before performing the inventory count by the client, auditor shall review the proposed procedures and policies of the client related to inventory count. Some of the policies those must be checked are – (i) 2-3 person team for counts (ii) proper sequencing and pre-numbering of inventory purchase and sells (iii) receiving the goods and halting the shipping procedures (iv) separation of the goods those are based on the consignment (v) master count sheet controlled by supervisor. The auditor further may select in advance sample for the items for testing on the day of the count. Auditor shall use both specific as well as representative item testing wherever possible. Further, during inventory count the auditor shall observe whether the client is complied with all the proposed procedures and policies. Moreover the dispatch quantity from central warehouse shall be matched with the regional receipt records.  
• Completeness – the auditor shall assure that the inventories, if any, held by the third party on behalf of the 3^rdparty are included in final figure of the inventory. Copies of the inventories sheets shall be matched with final figures of inventory for assuring that no additions or omissions are there. If the inventory count is taken before balance sheet date, a roll forward calculation shall be carried out considering the opening balance and movements during the period under concern for arriving at closing value of the inventories. Further, on sample basis the auditor may choose 10 goods receipt notes and 10 goods despatch notes and matched with the recorded data to assure that the inventories are recorded at proper value. Further, the auditor shall check that the client is following a specific method like FIFO or LIFO for inventory.

(c)

In accordance with Para 9 of ASA 701 for communicating the key audit matters, after carrying out the audit the auditor shall determine the matters those require significant attention from the management who are associated with the preparation of financial statement and handling of inventories. Further, the auditors shall describe each key audit matters through appropriate heading, subheading under the separate section of the audit report. Further, the auditors are required to mention the scope of audit they responded to key audit matters. Introductory language for communicating the key audit matters section shall represent –

• Key audit matters are those matters which in accordance with professional judgements of the auditor are considered as most important as per the financial report for the period under concern.
• Key audit matters are reported with regard to the entire financial report. Further, forming the pinion on key audit matters the auditors do not form any separate opinion solely for those matters.

Following matter with regard to the above will be regarded as the key audit matter –

Inventory return rate were considerably high

The company is experiencing high return level due to suspected problems in software. It will lead to high amount of inventory in hand and lower inventory turnover rate. The disclosure for this key audit matter will be as follows –

Risk of Material Misstatement

High return of inventories

Return of inventories amounting to $ 525 million disclosed under Note 11 represents the value of inventory returned from various buyers sold between the dates of 1^st January 2018 to 31^st December 2018 by Best Computing Solutions.

Significant clarification required from management for clarifying the suspected problems associated with software. Management further required clarifying what actions have been taken to solve the issue.

(a)

Intellectual property is the non-physical asset that grants potential for certain privilege, rights and economic benefits to owner. Various key assertions involved with the intellectual property intangible assets are as follows –

• Occurrence – this assertion states the risk that the business transactions recorded in association with intellectual property has actually been taken place and the intellectual property actually owned by the company. In the given scenario it is identified that Shimmer uses the special formula for creating the product and only its owner know secret ingredients applied to the formula. Hence, likelihood is there that the intellectual property is not actually owned by the company or the intellectual property does not qualify for getting ownership (Andersen & Hansen, 2018).
• Accuracy – this assertion states that the amounts and other associated data with the recorded events and transactions for intellectual property have been inappropriately recorded and the associated disclosures have been described and measured inappropriately. Valuation brings together economic and legal concept of the property. Presence of the asset is function of its ability to generate the return and discount rate applicable to the return. General rule for commercial valuation is that the value of any item cannot be represented in abstract form and all that stated is value of the item at particular time in particular place, in particular circumstance. This principal further states that disposals or additions (Cordo? & Fülöp, 2015).  As per the given scenario, management of Beautiful Hair is considering recognizing the intangible asset from acquiring Shimmers Pty Ltd as per AASB 3. However, likelihood is there that while recording the intangible asset the company valued it wrongly and recorded the wrong value in its financial statement.

(b) 

Substantive procedures those can be performed with regard to the risk mentioned above are as follows –

• Occurrence – all the documents associated with ownership shall be verified with regard to the ownership deed and title. Auditors shall further verify Shimmer Pvt Ltd’s ownership regarding secret ingredient for the special formula. The auditor shall further verify that the recognition criteria for the intangible asset in accordance with AASB 138 are met by Beautiful Hair Ltd for recognizing the intangible asset under their balance sheet. Further, the auditor must check that the transactions are complied with the acquisition criteria in accordance with AASB 3 for qualifying to be recorded as the asset acquired under the financial statement of Beautiful Hair Ltd (Kachelmeier, Schmidt & Valentine, 2017). In accordance with AASB 10, if the entity is not considered as acquirer it shall not record the intangible asset under the balance sheet. The auditors are further responsible to check the documents regarding the addition or de-recognition of the intangible asset (Sirois, Bédard & Bera, 2018).  Further, while valuing the intangible asset it shall be capable of being segregated from acquiree and shall be transferred, rented, sold or licensed with recognizable asset or liability for the associated asset.
• Accuracy – 2 primary methods of gathering the evidences regarding the management’s assertions for intangible asset are going through the documents and papers associated with acquisition of intangible asset. Main objective of going through the documents are to check the actual existence, ownership and value of the intangible asset (Carson, Fargher & Zhang, 2016). The value then shall be matched with the recorded value in the balance sheet of the company. Further, the company’s policy shall be checked for valuing the intangible asset and shall asses that the specific method is used for valuing the intellectual property. If the intellectual property is insured, the insurance documents shall be verified properly to assure that appropriate value of the asset is mentioned in insurance papers (Sultana, Singh & Van der Zahn, 2015). The auditor shall further calculate the amortization expenses related to intangible asset shall verify that the asset is recorded after giving effect to amortization expenses. Further, if any lawsuits or any defects exists for the intellectual property that shall be properly disclosed through notes to the account after providing an amount as provision.

(c)

Key audit matters help the users of financial statement to understand it in better way through delivering additional information. It encourages better conversation among the auditor and those people charged with the governance which in turn lead to better governance. Further, it helps the auditor focussing on the areas of audit those requires careful judgement to provide the audit with higher quality. Further, the key audit matters assists the preparers to revisit the disclosures and financial reporting for the areas identified as key audit matters which in turn lead to higher and better quality financial reporting (Knechel & Salterio, 2016).

Following matter with regard to the above will be regarded as the key audit matter –

Shimmer uses the special formula for creating its product and only its owner know secret ingredients applied to the formula. Management of Beautiful Hair is considering acquiring Shimmers Pty Ltd and recognizing the intangible asset from acquiring Shimmers Pty Ltd as per AASB 3. However, likelihood is there that the intellectual property does not meet the recognition criteria (Gimbar, Hansen & Ozlanski, 2015). Hence, the disclosure for related key audit matter will be as –

Recognition of intellectual property intangible asset

The company recognized acquisition of Shimmers Pty Ltd as intellectual property in their balance sheet amounting to $ 125 million disclosed under Note 15 represents.

Significant estimates and judgements required from management for recognising the acquisition of intellectual property as intangible asset in their balance sheet. Further, the management are required to clarify the valuation method and criteria used for valuing and recording the asset under the balance sheet (Cordo? & Fülöp, 2015).

Conclusion 

From the above discussion regarding the case study of Computing Solutions Limited and Beautiful Hair Limited it is concluded that ASA 701 communicating the key audit matters under the report of the auditor plays an important role to deliver the auditor report in transparent and better way. Key audit matter shall be recognised by the auditor after completing the audit of the financial statement. Major key assertion involved with the business of Computing Solutions Limited are accuracy and completeness whereas the Major key assertion involved with the business of Beautiful Hair Limited are accuracy and occurrence. Hence, the auditors shall comply with the principles and regulation of ASA 701 while addressing the key issues involved with the companies.

References

Andersen, J., & Hansen, N. B. (2018). Key Audit Matters: En undersøkelse av norske foretak (Master’s thesis, Handelshøyskolen BI).

Auasb.gov.au. (2019). Retrieved 13 January 2019, from https://www.auasb.gov.au/admin/file/content102/c3/ASA_701_2015.pdf

Carson, E., Fargher, N., & Zhang, Y. (2016). Trends in auditor reporting in Australia: a synthesis and opportunities for research. Australian Accounting Review, 26(3), 226-242.

Cordo?, G. S., & Fülöp, M. T. (2015). Understanding audit reporting changes: introduction of Key Audit Matters. Accounting & Management Information Systems/Contabilitate si Informatica de Gestiune, 14(1).

Cordo?, G.S. & Fülöp, M.T., (2015). Understanding audit reporting changes: introduction of Key Audit Matters. Accounting & Management Information Systems/Contabilitate si Informatica de Gestiune, 14(1).

Gimbar, C., Hansen, B., & Ozlanski, M. E. (2015). Early evidence on the effects of critical audit matters on auditor liability. Current Issues in Auditing, 10(1), A24-A33.

Kachelmeier, S. J., Schmidt, J. J., & Valentine, K. (2017). The disclaimer effect of disclosing critical audit matters in the auditor’s report.

Kharisova, F.I. & 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.

Knechel, W.R. & Salterio, S.E., (2016). Auditing: Assurance and risk. Routledge.

Köhler, A., Ratzinger-Sakel, N. V., & Theis, J. (2016). The Effects of Key Audit Matters on the Auditor’s Report’s Communicative Value: Experimental Evidence from Investment Professionals and Non-Professional Investors.

Mock, T.J. & Fukukawa, H., (2015). Auditors’ risk assessments: The effects of elicitation approach and assertion framing. Behavioral Research in Accounting, 28(2), pp.75-84.

Sirois, L. P., Bédard, J., & Bera, P. (2018). The informational value of key audit matters in the auditor’s report: evidence from an Eye-tracking study. Accounting Horizons.

Sultana, N., Singh, H. & Van der Zahn, J.L.M., (2015). Audit committee characteristics and audit report lag. International Journal of Auditing, 19(2), pp.72-87.

Vik, C., & 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).