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Audit and Assurance of Advanced Computer Solutions Limited

Question 1

While assessing the risk of material misstatement and determining the appropriate response with regard to the inventory of Advanced Computer Solutions Limited (Advanced Computer Solutions) for the 30 June 2018 audit, you become aware of the following information:

  1. The best-selling computer presentation package has been experiencing a high level of returns owing to suspected software problems
  2. Based on closing inventory, inventory turned over an average of 5.4 times in 2017 and 3.8 times in 2018
  3. Advanced Computer Solutions moved its inventory from a central warehouse to six new regional warehouses in March 2018
  4. Inventory on hand at end of year represented 26 per cent of sales in 2018 and 18 per cent of sales in 2017
  5. Advanced Computer Solutions has recently won a tender to supply a large government department with various products. In order to win the tender and prevent competitors from gaining a foothold in the public sector market, Computing Solutions agreed to supply the items at 10 per cent below their cost price. The first shipment is due to be delivered to the government department in the middle of July 2018.

REQUIRED

  1. Identify and explain the two key assertions at risk in relation to inventory
  2. Identify and describe two substantive audit procedures that you could perform in response to each risk identified above
  3. Explain the requirement of ASA 701 Communicating Key Audit Matters in the Auditor’s Report and the rationale for this auditing standard. Determine if the above matters are key audit matters, providing full rationale for the determination. If it is determined that they are Key Audit Matters, provide the disclosures which are required in Key Audit Matters Section of the Auditor’s report as required under ASA 701.


Question 2

You are the auditor of Green Machine Ltd, a manufacturer. You have obtained a summary of the property, plant and equipment for the year ended 30 June 2018, which identifies cost and accumulated depreciation brought forward, additions and disposals in the year and depreciation charges.

A review of the management letter from the previous year’s audit shows that there were some problems in relation to making a distinction between capital and revenue expenditure; some items were capitalized when they should have been expensed and other capital items were included in repairs and maintenance in the income statement.

Another risk identified from prior years relates to depreciation calculations: there is a range of depreciation rates within categories and there has been concern that the rates applied to some assets have been too low. The depreciation policy disclosed in the financial report shows:

  • Building: 2  4% straight line
  • Plant and machinery: 5  10% straight line
  • Fixtures fittings and equipment: 5  20% straight line

REQUIRED

  1. Identify and explain the two key assertions at risk in relation to property, plant and equipment
  2. Identify and describe two substantive audit procedures that you could perform in response to each risk identified above
  3. Explain the requirement of ASA 701 Communicating Key Audit Matters in the Auditor’s Report and the rationale for this auditing standard. Determine if the above matters are key audit matters, providing full rationale for the determination. If it is determined that they are Key Audit Matters, provide the disclosures which are required in Key Audit Matters Section of the Auditor’s report as required under ASA 701.

Requirement: Using reference materials available on the internet, research the topic and prepare a report, fully referenced and up 

Answer

Audit and assurance

Introduction 

This report is accompanied with the key assertions which are at risk and evaluating the substantial procedure test. The audit and assurance is used to assess the transparency of the financial statement of company. Ideally, audit procedure is used to assess discrepancies in financial statement and evaluating the whether recorded assets and liabilities are showing the misstatement in the books of accounts of company. The key audit matters which are disclosed in the books of accounts are those which may be accompanied with the misstatements and discrepancies due to the lack of invoices and supporting materials. In the starting of this report, key assertions that are at risk have been analysed. Afterward, substantial test have been evaluated. In the end of this report, key audit report related to inventory recorded in books of accounts of company have been analysed. 

ANSWER TO QUESTION 1

(a) Key assertions that are required at risk

Every business that has public listing is required to issue its financials in the public portal. When these financials are prepared, they are issued with certain key assertions that are affirmed by management. However, when these financials are audited, the auditors are responsible to test the accuracy tied with these assertions. In the given organisation, Advanced Computer Solution Limited, the audit is carried on, which has laid several key assertions that are falling under risk area. The two of them are mentioned as follows:

KEY ASSERTIONCompletenessValuation
DESCRIPTIONThis assertion implies the affirmation from management side that they have taken into account every inventory item that exist in stock while arriving at the inventory figure which is highlighted in the financial statements (Chan, Chiu, & Vasarhelyi, 2018).Inventory is valued by the management as per the prescribed accounting policies and standards. Valuation is done at lower of cost or net value in market (Conrod, & Cumby, 2016). 
JUSTIFICATION
The prescribed key assertion falls in the risk area because of the high probability that lies around wrong stock count. Wrong counting is indicated by the inventory movement which is locked in the audited financial statements. There is a notable shift in the stock from the central warehouse of the organisation to different regionally located warehouses. It might be possible that the inventory which is transferred to the warehouses is not taken while doing the stock count.

Inventory valuation is showing risky pattern. The turnover observed in case of inventory has fallen in the audited financial year. This indicates high stock of inventory lying unsold with organisation. Apart from this, the customer returns on account of defect have also risen. All this has made stocks to rise. But the valuation is not par with the rise.

(b) Substantive audit procedures

The substantive audit procedures are used to assess the accuracy of the valuation of the inventory and other items in the books of account of company. To help in resolving the risk that is existent around the key assertions in relation in inventory, some audit procedures are required to be performed. Two major procedures that can be adopted in the case discussed are:

SUBSTANTIVE AUDIT PROCEDUREScrutiny of stock itemsChecking the mathematical accuracy of valuation
DESCRIPTION
By scrutiny it means physically examining the stock items. The stock items that are present in the central as well as regional warehouses should be examined in proper presence of the auditor. Different considerations should be placed while counting the stock depending upon the value of the items that are being counted. This shall perform dual function. First, the actual count of them items shall be visible. Secondly, the value attached could be identified, in terms of their current market value (Knechel, & Salterio, 2016).

The value of the inventory should be recalculated by using the inputs that are gathered above. The inventory volume should be multiplied by the rates prescribed. The rate must be chosen from the lower of market value identified or the cost at which inventory was purchased. The cost is made available from the purchase documents belonging to different slots of inventory items (Mayes Jr, Landes, & Hasty, 2018). 

(C) Key audit matters

Requirement

The key audit matters are those items which are at high risk and may result reflection of the misstatements in the recorded items in the books of account of company. When the financial statements are audited, the audit opinion is communicated to the users of financial statements through the help of audit report. This report earlier was not much detailed. Due to fewer details, the opinion was limited in terms of information that is provided to the shareholders and rest of the users. The auditing standards and pronouncements are improving day by day. The improvements are done by keeping in mind the need which the users of report have regarding information in an understandable form. ASA 701, Communicating Key Audit Matters in Auditor’s Report has filled the bridge. It is now possible for the users to get informed about the areas that are of specific importance in the overall financial statements. The auditors now have the duty to keep the users completely transparent. A key audit matter Para is required to be inserted, whenever certain audit matters are of such importance that requires the auditor to devote significant attention. In such case it becomes compulsory to mention such matters in the Key Audit Matter Para (Cordoş, & Fülöp, 2015). 

Rationale

There is no specified and particular rationale that must exist to make any matter a part of key audit matter Para. The auditor’s skills on his professional judgement play the most vital role while making a decision regarding the Key audit matters. The important requirement is that, the matters that are reported under the Key Audit Matter Para are chosen from the communications that auditor have with those Charged with Governance. The auditor through the inclusion of key audit matter does not intend to offer separate judgements or opinions. An Umbrella opinion is expressed on overall financial statements. It is just to make the understanding of the users based upon transparent disclosures and detailed information (Sirois, Bédard, & Bera, 2018). 

Does current situation makes a key audit matter

Inventory is the basis of revenue making by any organisation. Apart from revenue, the financial position is also affected by the figure of inventory that business holds. Any valuation defect in inventory can bring upon a change in overall financial statements. It is important and material for the users of financial statements to have complete information that can affect their decision. Even if not effect, but could provide a better understanding. 

Disclosures

These key audit matters are laid down with an outlook to raise transparency that the users of audit report can have for the financial statements. The overall opinion is final for the financial statements as a whole. There has been no separate thought expressed.

Key audit matter observedAddressing the key audit matter
The audit results have shown the valuation and existence are highly risk centric areas. Irregular transfers are seen for stock items. The sales have reduced. 
  • Inventory count is done to help in obtaining right volume of inventory.
  • Re calculation of value that must be attached to inventory is done. 
  • Inventory items that define the purchase price are inspected and obtained in Xerox form.

ANSWER TO QUESTION 2

(a) Key assertions that are observed at risk

Property, plant and equipment of Green Machine Ltd., are suspected to be the risky areas because of certain observations that are made during the audit. These risk areas relate to the key assertions that have been forwarded by the management. These key assertions are as follows:

KEY ASSERTIONRights & obligationsValuation
DESCRIPTIONThis affirmation suggests that the assets that have been reflected in the books of accounts are under the ownership of the organisation. These can be deployed in the business as per requirements (Griffith, Nolder, & Petty, 2018). The management affirms the fact that the assets that they have shown in the financial statements have been accurately valued and capitalised (Cannon, & Bedard, 2016).
JUSTIFICATIONWrong asses have been created in the organisation. This is because of fault that is observed in the capitalisation that management has done. The expenses which are done to earn income are treated as capital expenditure. Following this treatment they have been capitalised. In real there is no asset creation. And hence, there is doubt over the ownership of other mentioned assets also.Valuation done is observed to be inappropriate. This is because of wrong assumptions made in business. The most appealing example of wrong assumption is the depreciation rates. The asset categories demand higher depreciation rates. But business has employed lower rates of depreciation. Secondly, the faults in capitalisation of expenses have also hampered the overall valuation. 

(b) Substantive audit procedure

To bring confirmation regarding the valuation and rights attached to the assets mentioned in property, plant and equipment, the following audit procedures may be entertained. They might help in obtaining a clarity as well as appropriate and sufficient audit evidence. 

SUBSTANTIVE AUDIT PROCEDUREQuestioning accountant and obtaining confirmationConfirming the asset list with physically existent assets
DESCRIPTIONThe accountant who is responsible for preparation of the financial accounts must be questioned. The technique used to identify the assets to be capitalised must be analysed. A confirmation must be obtained from account that he believes that the capitalisation done is not wrong. The expenses capitalised are actually the ones that are incurred for capital expenditure. Xerox of Written evidences in form of purchase agreements could also be obtained as additional proof from the accountant (Abbott, Daugherty, Parker, & Peters, 2016).The asset list that is extended by management must be taken as a base document. This list represents the assets that have been considered while doing the valuation. Through the help if this list, the assets must be cross confirmed. The location where assets are present must be visited. The assets that are present in the organisation must be appraised against the list. Any asset which is missing or additional shall be identified (Lev, 2018).

(C) Key audit matters

Requirement

When the financial statements are audited, the audit opinion is communicated to the users of financial statements through the help of audit report. This report earlier was not much detailed. Due to fewer details, the opinion was limited in terms of information that is provided to the shareholders and rest of the users. The auditing standards and pronouncements are improving day by day. The improvements are done by keeping in mind the need which the users of report have regarding information in an understandable form. ASA 701, Communicating Key Audit Matters in Auditor’s Report has filled the bridge. It is now possible for the users to get informed about the areas that are of specific importance in the overall financial statements. The auditors now have the duty to keep the users completely transparent. A key audit matter Para is required to be inserted, whenever certain audit matters are of such importance that requires the auditor to devote significant attention. In such case it becomes compulsory to mention such matters in the Key Audit Matter Para (Pinto, & Morais, 2018).  The auditor through the inclusion of key audit matter does not intend to offer separate judgements or opinions but focus on strengthen the fairness of the recorded financial data of company and strengthen the transparency of the financial statement of company. 

Rationale

The rational of selecting the key audit matters are considered which may result to failure of showcase the true and fair of the financial statement of the company. There is no specified and particular rationale that must exist to make any matter a part of key audit matter Para. The auditor’s skills on his professional judgement play the most vital role while making a decision regarding the Key audit matters. The important requirement is that, the matters that are reported under the Key Audit Matter Para are chosen from the communications that auditor have with Those Charged with Governance. The auditor through the inclusion of key audit matter does not intend to offer separate judgements or opinions. An Umbrella opinion is expressed on overall financial statements. It is just to make the understanding of the users based upon transparent disclosures and detailed information (Kachelmeier, Schmidt, & Valentine, 2017). 

Does current situation makes a key audit matter

Property, plant and equipment make up most of the company’s owned accounts. It is the property which is under the ownership of company. Through these assets the company is able to attract potential investors. However, the existing investors and users are also interested largely in the status of property, plant and equipment of an organisation. They have a right to know whether the areas of property, plant & equipment are completely able to be relied upon. The matters that are reflected upon audit of the given financial statements suggest that the company’s property, plant & equipment comprise high risk. The assumptions used are not accurate. They are definitely to be included in the key audit matter section. However, proper impairment test as per the IAS 136 is assessed by auditors to evaluate the impairment loss and carrying value of these recorded assets. 

Disclosures

These key audit matters are laid down with an outlook to raise transparency that the users of audit report can have for the financial statements. The overall opinion is final for the financial statements as a whole. There has been no separate thought expressed.

Key audit matter observedAddressing the key audit matter
Lower depreciation rates are applied to arrive at the figure of current value of assets. There is a mistake which is done by the accountant while capitalising assets as per initial observation. 
  • Accountant who had prepared the financial statements has been questioned regarding the accuracy of capitalisation.
  • Confirmation is obtained in written form regarding the accuracy of capitalisation.
  • Verification of physical property is done.
  • The asset list is cross confirmed with the actual assets that are present.

Conclusion 

After assessing all the financial details and transparency of the books of account, it is inferred that auditor stands in the fiduciary position towards the shareholders of company. He needs to assess whether company has been reflecting the true and fair view of liabilities and assets recorded in the books of account of company. Now in the end, it could be inferred that inventory may vary its value due to the changes in internal and external factors. Therefore, it is considered as imperative audit matter for the auditors. Auditors by assessing the invoices, supply materials and stocks in the inventory and warehouse assess the true value of the recorded stocks in the company. It helps in discrepancies in the recorded stocks and help in strengthen the transparency in the stock value of the company. All the stocks recorded in the financial statements reflect the closing value and shown at market value to trengthen the true value of these recorded asset. 

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