Key Audit Matters In Relation To Inventory: Advanced Computer Solutions

Advanced Computer Solutions Limited

Auditing is defined as the procedure of investigating the financial reports of the organisations so that any type of material misstatements could be identified, as they could have adverse impact on the decision-making process of the significant stakeholders (Baatwah, Salleh and Ahmad 2015). When the financial reports are prepared, the management of the audit client use various unambiguous and unspoken claims and such claims are deemed to be the audit assertions. The auditors of the organisations are required to take into account the evaluation and investigation of the audit assertions, since there are various situations where the auditors have identified errors and other issues in audit assertions (Backof 2015). If the auditors detect any type of issues related to assertions, they are required to declare the specific assertions at risk.

After this, with the objective of reducing the risk in audit assertions, appropriate substantive audit procedures need to be performed by the auditors. Along with this, the auditors have the liability of determining whether the issues could be identified as key audit matters. If they are identified as key audit matters, the auditors require communicating the same effectively along with explanation in the audit report for making the stakeholders aware of the situation (Bédard et al. 2016). The objective of the report is to take into account the evaluation of the audit assertions associated with inventory and property, plant and equipment for the two provided organisations.

The objective of this assertion is to ensure that the inventory transactions do not contain errors. In order to deal with the assertion, the auditor requires assuring the physical stock count are accurate and appropriate inventory flow to the income statement in the form of cost of sales from the balance sheet (Brasel et al. 2016). Advanced Computer Solutions has moved its inventory to six different warehouses in March 2018. This creates the chance of inaccurate physical stock count, as there could be errors in the stock counting procedure. Moreover, the estimated issue in software could act as impediment in the accurate flow of inventory to the income statement from the balance sheet of the organisation. All these reasons have resulted in this specific assertion at risk.

Cut off:

When this assertion is used, it assures accurate reporting of stock values in the correct books of accounts. Therefore, the auditors are required to undertake investigation of the shipping of inventory as well as receiving documents to assure the accurate register of stock movement (Chambers and Odar 2015). For instance, it is not possible for the organisations in recording the goods obtained of the previous period in the stock of the current period. As per the provided case, 18% of the sales in 2017 are included in the stock of 2018. When the cut off assertion is applied, it could be stated that the failure of the organisation in effective inventory computation has added towards the inclusion of sales in 2017 in the stock of 2018. Moreover, the failure might have occurred owing to issues in software. Therefore, the auditors of the organisation could take into account this assertion at risk.

Requirement

In relation to the initial assertion at risk, the auditor of Advanced Computer Solutions needs to undertake thorough observation of the physical counting process of stock of the client. In order to conduct the same, the auditor is required to discuss the methodical procedure of the physical stock count with the responsible employees for maintaining familiarity with the procedure. In addition, the auditor needs to scrutinise the process conducted, investigates physical stock count for outlining the amount of inventory in the books of accounts along with examining the inventory tags. Besides, the auditor is required undertaking the stock tests in all the currently moved warehouses, while it is necessary to match the outcomes with the stock confirmation from the main warehouse (Christ et al. 2015). Finally, the auditor of the concerned organisation needs to verify the cost computation procedure of inventory for assuring the compliance of the organisation with the needed accounting standards to compute inventory.

The cut off related tests need to be carried out carefully, since this risk could result in significant issue in computing inventory for the organisation.  The auditor needs to investigate the notes of goods obtained in warehouses and those delivered to the suppliers (Christensen, Glover and Wolfe 2014). There is need to carry out analytical procedures for identifying unreasonable incidents in inventory-related transactions, which could lead to slow inventory movement or abnormal increase or decrease in the warehouses. Moreover, since stock has been shifted to six different locations, it is necessary for the auditor to examine if any stop is faced in obtaining the inventory from the main warehouse during the counting process of physical stock. This step is necessary so that the unnecessary items could be identified and accordingly, they could be excluded from the counting process of stock (Czerney, Schmidt and Thompson 2014).

In accordance with ASA 701, the auditors need to adhere to the below-stated requirements:

• The key audit matters are to be ascertained at the time of taking into account the analysis of the material misstatement areas, considerable judgements of the management of the client and the impact of important incidents on audit (Auasb.gov.au 2019).
• The auditors have the responsibility of assuring effective communication of the key audit matters in the report of the auditor
• The above information needs to be communicated with the employees responsible for managing company governance.
• The identified key audit matters need to be documented effectively.   

In accordance with the ASA 701 ruling, if any error is found in computing inventory, the impact would be unfavourable on efficiency and liquidity position of Advanced Computer Solutions owing to the creation of material misstatements. Moreover, the valuation process of inventory takes into account the assumptions and judgement of the management in the cost computation areas and physical stock count and uncertainties might be associated with them. Finally, stock movement to six different warehouses coupled with software problems could have adverse impact on audit, as these are significant events. Due to all these reasons, the risk falls under the key audit matter in compliance with ASA 701.   

Requirements of ASA 701

Why significant?	How the key audit matters are addressed in audit?
Movement of inventory to new warehouses in March 2018: Since the organisation has shifted its stock to six different locations, errors might take place in physical count of stock and computation method of inventory. This event is deemed to be significant from the audit perspective.	The significant audit processes include the following: · Thorough observation of the physical counting procedure of stock · Discussion of the methodical physical count process of stock · Scrutiny of the process conducted · Test of inventory in all currently shifted warehouses · Test of the cost computation procedure of stock
Sales inclusion of 2017 in stock of 2018: The 2018 stock value contains 26% of the sales in 2018 and 18% of the sales amount in 2017. However, it is not accurate to incorporate the sales of the past year in the inventory of the existing year. This event is deemed to be significant for the audit of the organisation.	The significant audit processes include the following: · Investigating the notes of goods obtained in warehouses and those provided to the suppliers · Analytical processes for identifying irrational incidents · Examination of whether any stop in obtaining inventory from central warehouse during the physical counting process of stock

By seeking the analysis of the assertion, the auditors are ensured regarding the fact whether the clients have accurately recorded the values related to property, plant and equipment in the books of accounts of the organisation (Ege 2014). Therefore, the client is required to report property, plant and equipment at historical cost after deduction of accumulated depreciation, in which depreciation plays a crucial role and the organisation is required using the effective rate of depreciation. For Green Machine Limited, the depreciation rate charged is lower on property, plant and equipment. Such incorrect application of the rate of depreciation has resulted in minimised operating costs that have the potential of profit overstatement. Moreover, when the rate of depreciation is wrongly applied, it results in inaccurate reporting of the property, plant and equipment values in the accounting books of the organisation (Gaynor et al. 2016). By combining all these aspects, the assertion is deemed to be at risk.

By analysing this assertion, the auditors gain the ability of managing any error that might occur during the transactions related to property, plant and equipment. Therefore, the auditors are required to evaluate the processes where the organisation has categorised depreciation, impairment and repair costs (Gimbar, Hansen and Ozlanski 2015). For Green Machine Limited, certain mistakes are found to be in the differentiation of revenue and capital expenditures. The organisation has recorded some revenue expenditures in the form of capital expenditures and it has included a portion of capital expenditures in repair costs. It denotes the failure of the organisation in accurate classification of property, plant and equipment expenses and such aspects could result in this specific assertion at risk (He and Yang

From the above assessment, it could be observed that Green Machine Limited has faced issues in separating revenue expenditure and capital expenditure. In case of the auditor, the substantive audit process is to assure the evaluation of revenue and capital expenditures of the organisation (Kikhia 2014). Hence, this mandates the need for the auditors to conduct review of revenue and capital expenditures associated with property, plant and equipment after the acquisition of the property, plant and equipment list. Besides, the auditors are needed to analyse the capital expenditure policies of the organisation. With the assistance of all these substantive audit processes, the auditor of Green Machine Limited would realise the revenue expenditures, which are capitalised inaccurately and the capital expenditures are included inaccurately in the repair expenses of property, plant and equipment (Knechel and Salterio 2016).

Disclosure of Key Audit Matters as per ASA 701

For the next risk assertion in relation to property, plant and equipment, the auditor of Green Machine Limited is needed to examine the position of property, plant and equipment associated with depreciation expenses. Therefore, the auditor has to identify dismantled and unessential property, plant and equipment that require removal from the list (Litjens, Van Buuren and Vergoossen 2015). More significantly, it is necessary for the auditor in undertaking recalculation of depreciation pertaining to property, plant and equipment. This needs deprecation test of the residual amounts of the property, plant and equipment along with the gain or loss from the sale of property, plant and equipment. The depreciation rates need to be compared in this phase. In addition, the auditor is required testing the conformance to Green Machine Limited with the required guidelines and principles of depreciation. All such procedures would aid the auditor in recomputing the actual depreciation rate so that it could be charged against property, plant and equipment in order to arrive at the actual depreciation expenses (Sirois, Bédard and Bera 2018).

Maintaining adherence to ASA 701 is mandatory for the auditors when they are working on key audit matters:

• Firstly, the key audit matters are to be ascertained by taking into the material misstatement risk, auditor judgement and important events.  
• Secondly, the key audit matters need to be communicated in accordance with ASA 701, in which the matters are to be published in the report of the auditor (Tysiac 2014).
• Thirdly, the key audit matters ate to be communicated to the governance department of the organisation.
• Finally, ASA 701 needs assuring proper documentation of key audit matters.

At the time of adhering to the guidelines mentioned in ASA 701, it could be witnessed that applying the low depreciation rate and categorising expenditures wrongly could have impact on expenses. This is because misstatement of business profit increases the chance of material misstatements. Therefore, when the low rate of depreciation is applied and the categorisation of expenses is made incorrectly, there have been uncertain management assumptions and judgements. Due to these reasons, the risk could be adjudged in the form of key audit matters in accordance with ASA 701 (Sultana, Singh and Van Der Zahn 2015).

Why significant?	How the key audit matters are addressed in audit?
Inaccurate categorisation of expenditures: It could be observed that Green Machine Limited has made incorrect capitalisation of some revenue expenditures in the income statement. This takes into consideration the management judgements and it could result in material impact on the organisation. Hence, it is important for audit.	The audit processes are discussed as follows: · Reviewing revenue and capital expenditures of the organisation · Undertaking evaluation of revenue and capital expenditures associated with property, plant and equipment after obtaining the acquisition list of property, plant and equipment · Analysis of the policies related to capital expenditure
Application of lower depreciation rate: The organisation has made the application of low depreciation rate on property, plant and equipment, which takes into account considerable judgements as well as management assumptions.	The audit processes are discussed as follows: · Examining the position of property, plant and equipment with reference to depreciation expenses · Detecting dismantled and unessential property, plant and equipment · Testing depreciation with reference to the residual amounts of property, plant and equipment along with gains or losses from the sale of property, plant and equipment · Recomputing the depreciation expenses associated with property, plant and equipment

Conclusion:

In order to ascertain the key audit matters, the auditors have to bear the responsibility of taking into account the evaluation of the assertions that the management has used at the time of developing the financial statements. In accordance with the above discussion, the risk assertions identified for Advanced Computer Solutions Limited include valuation or accuracy and cut off. For Green Machine Limited, the identified risk assertions mainly constitute of accuracy in separating the revenue and capital expenditures along with accurate valuation of property, plant and equipment. It could be observed that Green Machine Limited has made incorrect capitalisation of some revenue expenditures in the income statement. This takes into consideration the management judgements and it could result in material impact on the organisation. Hence, it is important for audit. On the other hand, since Advanced Computer Solutions Limited has shifted its stock to six different locations, errors might take place in physical count of stock and computation method of inventory. This event is deemed to be significant from the audit perspective.

It could be evaluated from the above discussion that choosing the substantive audit processes entirely rely on the kinds of audit assertions, which are at risk. Finally, it is crucial for the auditors to take into account the compliance with the guidelines laid down in ASA 701 when they ascertain the key audit matters.  

References:

Auasb.gov.au., 2019. ASA 701 . [online] Available at: https://www.auasb.gov.au/Pronouncements/Australian-Auditing-Standards/ASA-701-2015.aspx [Accessed 18 Jan. 2019].

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