Understanding Auditing And Key Assertions For Risk Minimization

Auditing: Definition and Role in Business

Auditing can be defined as independent examination of the financial records which is prepared by the management of the company for establishing whether the reporting framework which is used by the management of the company is appropriate and showing true and fair view. Auditing is mandatorily required to be done by public ltd companies as per the regulations which is applicable in the country. The management needs to support the process of audit by providing all the relevant information in front of the auditor of the business (Bédard, Gonthier-Besacier and Schatt 2014). The role of auditor is is ensure that the financial statements are showing true and fair view and also to assess the risks which are faced by the business.

The auditor needs to follow the rules and provisions which are included in “ASA 701 Communicating Key Audit Matters in the Independent Auditor’s Report” while conducting a audit of a business. The standard states the techniques which can be used by the auditor to deal with the risks of assertions which are associated with the business and the auditor needs to report the same in the annual report of the business (Brasel et al. 2014). The assessment also aims to understand the key risk assertions and the key audit matters.

The management assertions of risks which can be identified from Advanced Computer Solutions ltd are listed below:

• Completeness: As per this assertion, the management of an organization needs to consider the valuation of inventory of the business appropriately and it is the responsibility of the management of the company to manage the inventory. In case the inventory, the understatement of the same can result in risk of assertion. A risk assertion generally arise when a person fails to keep records of the inventory even though purchase of stokc has been made by the business. The reason for such risk assertion arises mainly due to the weakness of internal control of the business. As per the records of advanced computer solutions, the inventory in hand balance which is shown for the business is shown to be 26% of sales in 2018 while the same is shown to be 18% of sales in 2017. The accounting professional should include the incorrect valuation of inventory and the same resulted in the inclusion of previous year sales figure in the current year. Therefore, it can be said that the same resulted in ineffective handlings of the inventories of the business.
• Accuracy:The accuracy in the process of valuation is considered to be an important assertion and the management of the company needs to consider the same. The accuracy of the accounting process is considered to be important as errors in reporting framework can be prevented with a certain level of accuracy. The assertion which is on the management is to ensure that the correct count of inventory is available and correct computation of the same. As per the information which is available for Advanced Computer Solutions, the management of the company had separately transported inventories of the business to six regional warehouses and the same was transported from the main office during the month of March 2018. There is possibility that some errors in counting of inventory might have taken place during the period or while the inventory was being moved from one warehouse to the other. This is the reason due to which the count of inventory had reduced and the same is shown to be 3.8 million in 2018 while the figure was 5.4 million in 2017. The risks which are associated with Advanced Computer Solutions is quite genuine.

The above discussion shows that the risks which is associated with the business is actual in nature and the auditor needs to take appropriate steps in minimizing such risks. The auditor of the business needs to apply substantive audit procedures to reduce the risks of the business. The substantive audit procedures which can be undertaken by the auditor are listed below:

• Substantive Audit Process for First Risk: In the business of Advanced Computer Solutions, the assertion of completeness is considered to be a significant assertion and should be considered by the auditor. The auditor needs to carry out substantive audit procedures which includes physical verification of the inventory of the business and keep track of the inventory of the business (Kachelmeier, Schmidt and Valentine 2017). The accounting professional who is responsible for inventory management needs to appropriately maintain ledger accounts and ensure that the balances of inventory are properly maintained by the business.
• Substantive Audit Process for Second Risk: Accuracy can be determined as the effectiveness in the reporting process of the business. The auditor needs to apply substantive audit procedure which involves physical verification of the stocks of the business. The physical verification of inventory and also close scrutiny of the annual report of the business would enable the auditor to appropriately find the error of the business. The company has transported its inventory to six new locations which are warehouses of the business (Christensen, Glover and Wolfe 2014). The auditor needs to verify the inventory balances which is shown in the ledger accounts and also check confirmation the balances by adopting appropriate test of the business. The auditor would be required to separately test the balances of the inventory from the central warehouse and also separately from 6 warehouses of the business.

The information which can be obtained from the business of Green Machine Ltd shows that there are certain key assertions which is related to valuation of Property, plant and equipment. The Property, plant and equipment valuation can materially affect the financial reports of the business and the same are discussed below:

Valuation: The major assertion which can be identified from the reporting of Property, plant and Equipment is the valuation of the asset. The management of the company needs to appropriate value the non-current assets of the business considering the costs of the assets and also the depreciation which is chargeable on the assets of the business. The principles states that all disposals and additions which are made to the asset should be taken into account by the management (Czerney, Schmidt and Thompson 2014). In addition to this, the impairment indicators and even test need to be conducted in order to ensure that no impairment charges are applicable on the asset. The assertion further requires the disclosures to be appropriately represented.

Key Assertions for Risk Minimization

The information which is available for Green Machine Ltd shows that there are significant risks which is associated with the valuation of Property, Plant and Equipment as the rates which is charged for the purpose of depreciation is not appropriate and the same is considered to be lower than the standard rate. The lower depreciations charges which are made by the management of the company directly affect the profit and loss statement and reduces the capital expenditure of the business. This would overstate the profitability of the business and thereby brining in material changes in the financial statements. Therefore, the presence of all these aspects affect the business and makes the same risky in nature.

Accuracy: The overall accuracy of the valuation process of Property, Plant and Equipment is important. There is a responsibility on the management of the company to appropriate shows and disclose the asset in the financial statement of the business. In addition to this, the management needs to appropriate identify the revenue and capital expenditure of the business and ensure that the same are appropriately treated in the financial statement of the business. The management of Green Machine Ltd has made a mistake in identifying the revenue and capital expenditure of the business. This mistake has affected the financial statement of the business and thereby also appropriately represent the financial information of the business. The management of Green Machine Ltd has wrongly capitalized certain revenue expenditure of the business and on the other hand, certain capital expenses are included under the head of repair and maintenance in the profit and loss statement.

The substantive audit procedures which needs to be followed by the management of the company are necessary for maintaining the risks of the business (Duff et al. 2014). The risk minimization process which needs to be followed by the management of the company are listed below:

• Substantive Audit Process for First Risk: The information which is available for the business of Green Machine Ltd shows that the management of the company has charged lower rate of depreciation of the asset which has affected the financial statement of the business (Azim 2013). The auditor needs to consider the appropriate rate at which depreciation is to be charged by the management of the company and also the residual value of the asset of the business. In addition to this, the auditor also needs to check whether the any disposal or addition is made to the asset and whether appropriate accounting policies are followed by the management for measuring the asset and also the policy of replacing the asset. The auditor therefore needs to appropriately value the asset and then charge depreciation on the same which will then be recalculated for assessing the actual value of the asset of the business.
• Substantive Audit Process for Second Risk: The information which is available from the business, the company has made significant errors in identifying and treating the capital and revenue expenses of the business. This has significantly affected the financial statements of the business. The auditor needs to review the capitalization of expenses and also the expenses which are treated in profit and loss account. This is to be done by the auditor on order to ensure that the management has made correct treatment of expenses of the business and the same is appropriately shown in annual reports of the business. The auditor needs to ensure that the treatment of capital and revenue expenditure of the business are appropriately done by the management.

As per the provisions which is stated under ASA 701, Key Audit Matters are items which are represented in the financial reports which as per the judgment of the auditor is highly substantial. The auditor identifies the key audit matters of a business from the analysis of the financial statement of a business and the same is considered after appropriate audit procedure is followed.

As stated under ASA 701, the auditor needs to discuss the matters that requires special focus of the auditor of the business and the same is to be identified after having a discussion with those charged with governance of the business. The following matters are to be considered by the auditor of the business:

• The areas which are susceptible to higher risks of having material misstatement under ASA 315 needs to be considered by the auditor.
• The auditor is required to assess the financial statement and especially areas which require vital management decisions and estimation of accounting principles.
• The auditor needs to consider any event which can bring about uncertainty in the business and can impact the decision making process of the business (Vik and Walter 2017).

Substantive Audit Procedures for Risk Minimization

In addition to this, the auditor must also consider the events under paragraph 9 of the standard which can have influence on the financial statements of the business and such aspects can be considered as Key Audit Matter.

The discussion above shows the application of ASA 701 assist the auditor in identifying the key audit matters of the business from the financial statements of the business. However, there are some benefits which are associated with ASA 701 and the benefits of the same is listed below:

• The identification of KAM are done as per the principles stated in ASA 701 and the same helps in communication of between the auditors and those charged with governance (Carson, Fargher and Zhang 2016). This aspect would help in creating better governance and transparency in financial reporting.
• The principles which are covered under ASA 701 helps the auditor to identify the key areas of reporting. This can be help in contributing the overall quality of audit.
• The provisions which are covered in ASA 701 helps the auditor to determine the financial reporting framework and disclosing the key audit matters of the business. This can also help in improving the overall quality of audit of the business.

There are certain factors which affect the key audit matters of the business for both the companies which are Advanced Computer Solutions Ltd and Green Machine Ltd is stated below:

The key audit matters which are identified for Advanced Computer Solutions Ltd and the same is covered in ASA 701 due to the existence of certain reason. The primary reasons for risks is the inappropriate valuation of inventory which is shown in the financial reports. In addition to this there are also certain judgments from the management in the valuation of inventory which contribute to les transparency in the business (Knechel and Salterio 2016). Therefore, there is material misstatement in the financial reports of the business.

The information which is present about the company shows that the key audit matters of the business of Green Machine Ltd are associated with ASA 701 due to certain reasons. The main reason for the risks is the lower rate of depreciation which is charged by the business which results in difference in depreciation in the income statement and thereby lead to misrepresentation of financial position of the business (Huggins, Simnett and Hargovan 2015). The net profit of the business is also affected due to such reason and can show inappropriate value.

Another major fault which is identified from the reporting of the business is from wrong classification of revenue and capital expenditure of the business and this also affect the true and fair view of the financial statement. Thus it can be said that ineffective charging of depreciation and wrong classification of revenue and capital expenditure can create material misstatement. Therefore the primary reason is area of concern for the business.

According to ASA 701, the audit must mandatorily must recognize the key audit matters of the business as per the standard. The auditor is also required to consider the major disclosures of the business and also the reasons for key audit matters of the business. The auditor is also required to make disclosures relating to the substantive process of the audit and also addrss the key audit matters of the business.

Conclusion

The discussion above shows that key audit matters of the business and the same is covered in ASA 701 and the same is considered for the business of Advanced Computer Solution and Green Machine Ltd. The above discussion shows that the risks which are faced by the business are related to the key assertions of the business. The auditor needs to follow ASA 701 Key Audit Matters for identify the substantial matters of both the companies.

Reference

Azim, M.I., 2013. Independent Auditors Report: Australian Trends From 1996 to 2010. Journal of Modern Accounting and Auditing, 9(3), p.356.

Bédard, J., Gonthier-Besacier, N. and Schatt, A., 2014, January. Costs and benefits of reporting Key Audit Matters in the audit report: The French experience. InInternational Symposium on Audit Research. Available at: https://documents. escdijon. eu/pdf/cig2014/ACTESDUCOLLOQUE/BEDARD_GONTHIER_BESACIER_SCHATT. pdf.

Brasel, K., Doxey, M.M., Grenier, J.H. and Reffett, A., 2016. Risk disclosure preceding negative outcomes: The effects of reporting critical audit matters on judgments of auditor liability.The Accounting Review, 91(5), pp.1345-1362.

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.

Christensen, B.E., Glover, S.M. and Wolfe, C.J., 2014. Do critical audit matter paragraphs in the audit report change nonprofessional investors’ decision to invest?. Auditing: A Journal of Practice & Theory, 33(4), pp.71-93.

Czerney, K., Schmidt, J.J. and Thompson, A.M., 2014. Does auditor explanatory language in unqualified audit reports indicate increased financial misstatement risk?. The Accounting Review, 89(6), pp.2115-2149.

Duff, J., Walker, K., Edward, K.L., Williams, R. and Sutherland-Fraser, S., 2014. Incidence of perioperative inadvertent hypothermia and compliance with evidence-based recommendations at four Australian hospitals: A retrospective chart audit. ACORN: The Journal of Perioperative Nursing in Australia, 27(3), p.16.

Huggins, A., Simnett, R. and Hargovan, A., 2015. Integrated reporting and directors’ concerns about personal liability exposure: Law reform options. Company and Securities Law Journal, 33, pp.176-195.

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

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

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).