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Audit Function and Key Assertion Risks

ACC 707 Auditing and Assurance Services

 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: 

(i) The best-selling computer presentation package has been experiencing a high level of returns owing to suspected software problems 

(ii) Based on closing inventory, inventory turned over an average of 5.4 times in 2017 and 3.8 times in 2018 

(iii) Advanced Computer Solutions moved its inventory from a central warehouse to six new regional warehouses in March 2018 

(iv) Inventory on hand at end of year represented 26 per cent of sales in 2018 and 18 per cent of sales in 2017 

(v) 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

(a) Identify and explain the two key assertions at risk in relation to inventory (b) Identify and describe two substantive audit procedures that you could perform in response to each risk identified above 

(c) 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 som 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 01 depreciation rates within categories and there has been concern that the rates applied to son. 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 

(a) Identify and explain the two key assertions at risk in relation to property, plant and equipment 

(b) Identify and describe two substantive audit procedures that you could perform in respont to each risk identified above 

(c) 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 kE 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 to 2,500 words (assignment in excess of 2,500 words will be penalized). Minimum of 8 academic references is required.

Answer

Audit Function

Question 1

Audit is the procedure which is used to strengthen the transparency of the financial statement of company. Any audit function can be performed in a proper manner only by laying a proper plan for an audit. The audit program is used to assess the revealed information and evaluating whether the financial statement of company is showing the true and fair view of the asset.  This plan comprises of identifying the key assertions that are at risk, the substantive procedures that could be performed to reduce down the risks and the overall communication of the identified risks and audit procedures to the users of report.  In this case, substantive test could be used to identify the risk associated with the process and assets check. 

(a) Key assertions at risk

These assertion test is implemented to evaluate the true and fair view of the assets in the books of account of company. In this case, in order to evaluate the inventory values and assessing the assertion at risk, valuation and right and obligation assertion test is followed.  The key assertions that have been identified in the organisation which relate to the inventories of the entity are: 

Assertion
Description and justification
Valuation
This assertion represents that all the items that relate to inventory are precise completely and the amount that is represented in financial statements relating to inventory is valued properly (Cassell, Myers, & Seidel, 2015).  However, amount shown in the books of account for the inventory is closing stock. The inventory valuation is done by using the assertion test. 
For the given organisation inventory when analysed is observed to be valued improperly. The conditions that existed in financial year 2018 represented that the organisation must have stocked higher volume of inventory. This is owing to decline in inventory churn in the year, increasing sales returns from customers, and for the preparation for new orders. But the actual valuation of inventory has not risen to cope up with the rising stocks.
Rights & obligations
This assertion represents that the organisation is completely allowed and authorised to incorporate the inventory items in its functioning (Mock, & Fukukawa, 2015). 
This assertion is completely at risk because of the strange movement that is observed in the inventory storage location. However, inventory order quantity is set to proper flow of inventory in warehouse.  Usually all the items of inventory are stored at central warehouse of the organisation. But the financial year 2018 has showed a different pattern. This involves the transfer that has been affected in the inventory items from a central warehouse to six new warehouses that are made operational regionally. The right and obligation is followed to give proper transfer of the inventory in the storage. 

(b) Substantive audit procedures that can help 

The substantive audit procedure is used to evaluate the stock counts in the books of account and evaluating whether inventory and other items are evaluated. The substantive procedures that can be adopted in response to resolve the risks that revolve around advanced computer solutions’ inventory are:

Substantive audit procedures
Description
Stock count
The inventory items that are stocked in the warehouse of the organisation must be counted. This count should be organised by the management as per the directions of the auditor. This should be repeated for the items that are present in the regional warehouses. By using this method the auditor shall get an idea about how accurate the items are disclosed by management. As well the valuation could be reconciled by applying the rate, i.e. lower of net market value or the acquisition cost, upon the overall stock items (Baah, & Fogarty, 2016). 
Inspection of invoices and confirmations
To get the confirmation in relation to the rights and obligations regarding the organisation’s inventory, the invoices that relate to the purchase of the stock items must be checked for certain sample items of inventory. For the inventory items that are located at places other than client’s central warehouse, a confirmation must be asked for from the warehouse owners. The good receipts from warehouse owners should also be asked for and checked. For the items that are released on the basis of consignment must be checked for ownership confirmation (Fang, Lobo, Zhang, & Zhao, 2018). However, while auditing the process, there is need to make the inspection of the invoices and other bills to evaluate the true value of the inventory recorded in the books of account. 

(c) Key audit matters

The current standards demand the auditors to provide such an audit report to the users that are enhanced in terms of its overall quality. By enhancement the communication part is to be proved. This improvement can be observed when the audit reports tend to be more transparent and understandable to the users. For making the audit reports much relevant and informative for the users, there is a need to provide in the audit report more information highlighting certain specific areas of audit. Through the introduction of ASA 701, Communicating Key Audit Matters in the Auditor’s Report, there is a need for the auditors to highlight in the audit report certain matters which according to then have been of highest significance and importance (Warren Jr, Moffitt, & Byrnes, 2015). This will be used to strengthen the transparency and evaluating whether all the financial information shown by company is reflecting the true and fair view of the assets and liabilities.  The requirement is not just of mentioning the matter, but to signify why the matter has been that important. The way the auditors have addressed the matter has also to be mentioned in the report (da Silva, & Dantas, 2018). These key audit matters are used to assess the quality of the financial statement and passing disclaimers in the audit report. In this case, valuation of the inventory and application of the financial statements of company have been taken into consideration. 

The foremost requirement that makes a matter a key audit matter is the way the same is decided according to the judgement of the auditor. These matters are selected among the things that are communicated to the management of the company and have at the same time called for significant attention from the auditors. In these areas the risk that material misstatement is present is higher. These areas make up those aspects that comprised highest risk (Sirois, Bédard, & Bera, 2018). 

Is current matter has rationale for being a key audit matter

The inventory is naturally an important and risk Center area for any organisation. It is analysed that value of the inventory and assets values changed with increased quantities of the inventory in the books of account. Many unusual patterns are observed in inventory, which have required greater effort and attention from the auditor. Further these are important to be disclosed to the shareholders and other users. This disclosure is required to make then get a clear and transparent idea about what is happening inside the organisation. Through this the insight of how audit is preceded in this part shall also get available to the users (Cordoş, & Fülöp, 2015). 

Disclosures

The key audit matters that have been represented below are not provided with a separate opinion than the overall report. They are the matters that have required attention significantly from the audit team. The audit report is given as disclaimer to showcase whether company has complied with the applicable rules and regulation in the books of account. 

Key audit matter and the way it is addressed by the audit team
The key assertions that have been identified in the organisation which relate to the inventories of the entity. 
Risk around inventory valuation and ownership rights:
Unusual and irregular inventory shipments from the company’s original warehouse have been observed.  Therefore, order to reduce the risk associated with the inventory recording process in organization, auditors needs to assess the invoices and shipment numbers. Six regional warehouses are created and inventory is moved to them. Inventory turnover has reduced significantly over the past financial year. Even when the inventory is stocked in the organisation, the valuation of the same is doubtful.
Steps taken to address the issues
  • Conducting a re-count of the inventory items of the organisation to analyse the correctness of inventory valuation.
  • Giving special attention to the inventory items that are considered risky because of high value attached to them.
  • Obtaining written confirmation from the warehouse owners regarding the receipt of inventory by them.
  • The confirmation regarding the inventory condition should also be obtained. 
  • The written slips in relation to the inventory must be checked to get the actual price at which inventory had been purchased. This shall help in identifying whether the management has been correct in its valuation techniques or not.
  • Therefore, by following the above give process, auditors could easily evaluate transparency of the recorded inventory in the books of account. 


Question 2

(a) Key assertion risks

The key assertions that have been identified in the organisation which relate to the property, plant and equipment of the entity are:

Key assertion
Description and justification
Valuation 
The key assertion relating to value states that the management has valued all the assets comprised as a part of property, plant and equipment correctly.
In the given case there is a risk in relation to correct valuation because the depreciation rate that have been chosen for the assets that are held by the organisation tends to be on the lower side. Whereas if the actual assets are to be depreciated, a higher depreciation in the depreciation rate bracket is to be used.  Further, the way capitalisation of expenses is done is also absurd. There is no proper procedure that is being followed.
Existence
This assertion states that the assets that are mentioned in the balance sheet of the organisation are existent in the real business of entity (May, 2015). 
The given organisation is depreciating assets for a longer duration that they should have been by charging a low depreciation rate. This means that the assets that are still charged depreciation upon are not even in a condition to operate now. Further for all those expenses that have been capitalised wrongly, there is no respective capital asset in existence.

(b) Substantive audit procedures that can help

The substantive procedures that can be adopted in response to resolve the risks that revolve around advanced computer solutions’ property, plant and equipment are: This substantive procedure is used to strengthen the property and plants true values and identifying the risk associated with the recorded assets. 

Substantive audit procedures
Description
Inspection of physical assets
The property, plant and equipment that belong to the organisation and are represented in the financials must be inspected personally by the auditor. The inspection must be done by visiting the entity’s location where assets are held and inspecting the same for analysing the physical condition in which they are present. It should be checked whether the assets are still in an operative state or not. The asset list that is present in the financial statements must also be checked with all the assets that are present in the organisation. This shall help in finding the wrong capitalisations done by the management (Tucker, Hockridge, Sawyer Jr, & Petty, 2016). 
Inspection of documents
The written documents that evidence the purchase or leasing of any property, plant or equipment should be checked. Through the inspection of these documents the value that is attached to these assets at the original place can be arrived. Through the original value of the assets a computation could be made into arriving the current value at which the asset must be valued. This shall help to understand whether the company has done valuation in correct line.


(c) Key audit matters

The current standards demand the auditors to provide such an audit report to the users that are enhanced in terms of its overall quality. By enhancement the communication part is to be proved. This improvement can be observed when the audit reports tend to be more transparent and understandable to the users. For making the audit reports much relevant and informative for the users, there is a need to provide in the audit report more information highlighting certain specific areas of audit. Through the introduction of ASA 701, Communicating Key Audit Matters in the Auditor’s Report, there is a need for the auditors to highlight in the audit report certain matters which according to then have been of highest significance and importance. The requirement is not just of mentioning the matter, but to signify why the matter has been that important. The way the auditors have addressed the matter has also to be mentioned in the report (Bédard, Coram, Espahbodi, & Mock, 2016). 

The foremost requirement that makes a matter a key audit matter is the way the same is decided according to the judgement of the auditor. These matters are selected among the things that are communicated to the management of the company and have at the same time called for significant attention from the auditors. In these areas the risk that material misstatement is present is higher. These areas make up those aspects that comprised highest risk.

Is current matter has rationale for being a key audit matter

The property, plant and equipment are highly looked for by the investors while making any investment decision. These tell how strong a company is in its financial footing. Any kind of problem that persists within this asset slot has an intensity to hamper the whole financials. The above identified issues are highly risky and if not known to the investors would keep the investors in void. The key audit matter are selected on the basis of the materiality of the work statement and assessment of the recorded invoices. 

Disclosures

The key audit matters that have been represented below are not provided with a separate opinion than the overall report. They are the matters that have required attention significantly from the audit team.

Key audit matter and the way it is addressed by the audit team
Risk around property, plant & equipment valuation and existence:
Lower depreciation rates are being observed. Lack of knowledge on management side to differentiate revenue and capital expenditure is seen. 
Steps taken to address the issues
  • The assets are being inspected on one on one basis. This has helped to observe the actual condition in which they are used and returns produced by them.
  • Written representations have been obtained from management regarding the solving of any glitch relating to capitalisation of wrong expenses. 
  • Purchase agreement that is present with the organisation is checked. This checking shall help the auditor in determining the value of the assets. Through this value the depreciation rates can be checked, i.e. if they are actually lower or are correct. This is done by computing the current value of the assets using the depreciation rates that management has used. 


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