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Audit and Assertion

Answer the given questions in detail based on audit and assertion

Answer

Auditing

Audit and assertion



Answer to question no-1

The audit and assurance method is adopted to strengthen the business transparency and strengthen the true and fair view of the financial statement of company. By using the audit and assurance program, auditors gives disclaimers on the books of account of company. In the given situation, the risks of material misstatements that revolve around the asset inventory are to be ascertained. The aim is to design the substantive procedure around the key assertions identified to make the chances of inventory being at risk lower.  The substantive procedure is used to evaluate the inventory check and identify the discrepancies in the recorded inventories. However, auditors follow proper assertion test and substantive procedure to determine the viability of the recorded inventories and other items in the books of account so that proper valuation and transparency could be maintained in the financial statements of company. 

Answer to question no-1 (a)

The two key assertions that are at risk in relation to inventory are specified as follows:

  1. Valuation: This key assertion suggests a risk that revolves around wrong valuation of inventory. There are high areas of risk in the situation provided which suggest that the management might have valued inventory wrongly (Yu, et. al 2016).  This is done to evaluate and assess the true value of the inventory of the organization. 

Reason: In the information that gets available, it is evident that in the year for which financials are audited, the inventory items that were sold have experienced a high return from the customers. This states that these returned items are also forming the inventory at end. In addition to this, in the year, the inventory turnover had been lesser than the previous year. It shows the changes in the inventory values which get changed year to year. This suggests that more inventories are stocked in the accounts as compared to past times. Further, the company has won a tender, wherein a large order is required to be supplied in the month of coming July. This large order would also be forming a part of inventory, and that would be sure to increase the inventory count and value as well. However, if the actual inventory analysis is observed, one thing that gets the catch is that, even when so much of instances show that more inventory is sure to be stocked in the audited financial year, but only 8% of sales rise in the inventory figure is observed as compared to previous financial year (Knechel, & Salterio, 2016). 

  1. Existence: There is a scepticism that the inventory which is shown in the books as the closing year figure does really exist or not. It shows that company may record the wrong information in the books of accounts related to the inventory. 

Reason: the inventory of the company has been observed to have moved from the central warehouse to 6 new warehouses in the audited financial year. There is a risk that the movement in not legit. Rather than transferring the inventory to the new warehouses, the same might have been absconded. Further, the audited financial year has shown a hike in the number of item return from the customers. These items may not have actually reached the company’s warehouses and could have been taken away in the process (Griffith, Hammersley, & Kadous, 2015). 

Answer to question no-1 (b)

There are several substantive audit test which could be used to assess the true and fair view of the assets and liabilities of the company. However, the substantive audit procedures that could be performed to reduce the risk concerning to the key assertions identified above is as follows:

  1. Valuation test:  It is analysed that the inventory is at the risk of wrong valuation due to the complicated recording of the inventory turnover. The inventory items would be tested randomly to check the appropriateness of value assigned. Company needs to follow proper inventory valuation methods to strengthen the true and fair view of the inventory. It is analysed that the invoices received from suppliers must be checked to evaluate the cost of purchase. In the inventory valuation, test, auditors needs to assess the books and market values of the inventory. It must be checked whether the rule of valuation of inventory at lower of market value or cost is followed or not. The direct labour, and overhead charges must be examined that have been charged to arrive at the value of finished goods inventory (Chan, & Vasarhelyi, 2018). 
  2. Physical existence examination: the inventory items must be checked to ensure whether they really exist. Physical count of inventory must be arranged so that the same can be attended. While physical counting the inventory, the condition of inventory must also be analysed. The warehouse locations must be visited surprisingly to check whether the inventory mentioned to be transferred is actually done or not. Separate confirmation might be obtained from these different warehouse owners confirming the inventory balance with them. The items that comprise higher value items must be given more consideration to (AICPA, 2018). This is done by assessing the documents and invoices of the company. 

Answer to question no-1 (C)

ASA 701, Communicating Key Audit Matters in the Auditor’s Report, requires every auditor who is auditing the financials of an organisation, to communicate in the audit report all the information which shall add to the transparency by providing additional information to the users. This is mandatory for the auditor to provide the significant information as key audit matter which shall aid the users in understanding the financial statements in a better manner. A better insight gets available to the users of the financial report when the key audit matter section is included. All the matters which are not a modification or qualification but are in every manner significant, gets highlighted. These key audit matter represent those areas of risk that have also been conversed by the auditor with those charged with governance. A high probability of risk of material misstatement revolves around these matters.  For each key audit matter that the auditor observes, he shall mention the reason or rationale that made him consider the same as a high risk area, as well as the way evidence was obtained to reduce the risk. 

The rationale to choose a key audit matter to be communicated depends upon the judgement of the auditor. The judgement relates to how significantly the auditor needs to be attentive to that particular matter. For anything that makes it difficult for the auditor to gather appropriate and sufficient audit evidence, the chances of material misstatement lingering arises (Carson, Fargher, & Zhang, 2016).  However, auditors stands in the fiduciary position to the shareholders and they needs to assess whether the recorded assets and liabilities are showing the transparent view or not. Auditors passes the disclaimer on the basis of the recorded assets. 

RATIONALE: 

In the given situation, inventory is supposed to be a key audit matter. The audit procedure is used to assess whether the recorded inventory is showing the true and fair views. The rationale behind the same is the high risk regarding the valuation and existence of inventory. It is analysed that inventory value may vary due to the increased add and less quantities in kept stock warehouse. Even when so much of inventory is stocked in business pursuing to higher customer returns and less inventory turnover, the value of same tends to lower if seen relative to past financial year.

DISCLOSURE: 

Key audit matters

These all given matters and items are the key audit matters and in order to strengthen the transparency of the true and fair view of these items recorded in the financial statement of company, proper audit procedures and methods needs to be followed. The matters that are specified below have not been provided any distinct opinion, but are the ones that have taken significant attention in audit process.

key audit matterHow our audit addressed the key audit matter
Inventory valuation:
The inventory size if looked seems more than the past financial years. But the value if compared seems relatively less as a percentage of sales. There is a need of audit attention in significant terms in valuation of inventory. 
The procedures performed include:
  • Checking of supplier invoices.
  • Cost sheet making apportionment of labour and overhead charges is checked.
  • The realisable value and the cost of inventory items on sample basis is checked to find whether inventory has been valued at lower of market value or cost.
Inventory existence:
The inventory is provided to have moved to six different warehouses from the central warehouse. The action has been taken for the first time and seeks significant attention in audit. 
The procedures performed include:
  • Arrangement of physical count of inventory at client’s place.
  • Distinct attention to high value inventory items.
  • Checking of invoices against which customer returns are received.


Answer to question no- 2

In the given case, the information about the entity’s property, plant and equipment is given. Based upon the information observed, the key assertions at risk and the substantive audit procedures required to settle the risks are discussed.

Answer to question no-2 (1) 

The key assertions at risk that relate to property, plant and equipment are provided as follows:

  1. Valuation: there is a high chance that the value which is reflected for the asset representing building, plant and machinery and fixtures, fittings and equipment is inappropriate. 

Reason: the entity’s management while preparing the financials had committed a mistake earlier in distinction of the expenditure that must be categorised as capital or revenue. Further, it appears that the rates of depreciation that have been used in charging depreciation are very low as compared to average (Warren Jr, Moffitt, & Byrnes, 2015). 

  1. Existence: it is to be checked that whether the assets that the company has reflected under the name of property, plant and equipment exist for real or not (Swart, 2018).

Reason: there had been a mistake of capitalizing the revenue expenses. This has created assets in the balance sheet. But no such assets exist if seen in real condition of the organisation. However, some assets that are capital assets have not been capitalised. This has reduced the overall asset existence of the property, plant and equipment head (Nyamai, 2018). 

Answer to question no-(2)

The substantive audit procedures that are required to be performed to reduce the risks related to the key assertions identified above are:

  1. Valuation check: the acquisition contract relating to the fixed assets must be checked. The acquisition value must be obtained from there. Using the depreciation rate provided by the management, the value that must exist today should be recalculated. This shall help in understanding whether management has correctly valued the property, plant and equipment. Management letter must be obtained for their agreement about the depreciation rates being reasonable. Overall check must be done into the asset useful live, and the depreciation rate being used (Eugene, et al. 2018).
  2. Physical check: the assets that are booked in the financial statements must be checked by the auditor to get evidence about their physical existence. The premises of organisation must be visited where the assets are kept and operated. Their operational condition must be checked to ensure whether the carrying value is appropriate or not. Any assets that might need discarding should be observed. Proper examination must be made whether the assets present are all required by the organisation or not. The asset checklist must be obtained from management as per the financial statements, and physically present assets must be looked for from that list. Any discrepancy observed must be consulted with management and audit procedures must be performed until sufficient evidence is obtained (Gu, Simunic, & Stein, 2017). 

Answer to question no-2 (3)

ASA 701, Communicating Key Audit Matters in the Auditor’s Report, requires every auditor who is auditing the financials of an organisation, to communicate in the audit report all the information which shall add to the transparency by providing additional information to the users. This is mandatory for the auditor to provide the significant information as key audit matter which shall aid the users in understanding the financial statements in a better manner. A better insight gets available to the users of the financial report when the key audit matter section is included. All the matters which are not a modification or qualification but are in every manner significant, gets highlighted. These key audit matter represent those areas of risk that have also been conversed by the auditor with those charged with governance. A high probability of risk of material misstatement revolves around these matters.  For each key audit matter that the auditor observes, he shall mention the reason or rationale that made him consider the same as a high risk area, as well as the way evidence was obtained to reduce the risk. 

The rationale to choose a key audit matter to be communicated depends upon the judgement of the auditor. The judgement relates to how significantly the auditor needs to be attentive to that particular matter. For anything that makes it difficult for the auditor to gather appropriate and sufficient audit evidence, the chances of material misstatement lingering arises (Shafiee Sardasht, & Rashedi,2018).

RATIONALE: the depreciation rates are significantly lower than that are charged in the industry. This shows that the assets might are overvalued. There had been wrong capitalisation technique. Some wrong capitalisations are done, while a few assets are not even capitalised (Jacobs, et al. 2015).

DISCLOSURE:

Key audit matter

The matters that are specified below have not been provided any distinct opinion, but are the ones that have taken significant attention in audit process.

key audit matterHow our audit addressed the key audit matter
Property, plant & equipment valuation:
High misstatement chances are observed in the valuation done. Improper capitalisation is followed (Knechel, & Salterio, 2016).
The procedures performed include:
  • Analysis of the acquisition contracts of the fixed assets.
  • Analysis of the current market value to gather the appropriateness of the carrying value.
  • Depreciation chart is checked and sample depreciation is computed for several items of property, plant and equipment to ascertain the correctness of carrying value reflected (Maksymov, Nelson, & Kinney Jr,. (2017).
Property, plant and equipment existence (Mock, & Fukukawa, 2015).
The depreciation is believed to be charged lower than what should be. This signifies that although the carrying value reflects presence of physical assets, but the same could be obsolete, not present or out of working condition (DeFond, & Lennox, 2017).
The procedures performed include:
  • Checking the physical existence of the assets that are shown in the balance sheet.
  • The operative condition of the physical assets is evaluated (Petherbridge, & Messier, 2016).


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