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Auditing and Assurance Services: Advanced Computer Solutions Limited

ACC 707 Auditing and Assurance Services Individual Assignment

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.

Answer

ANSWER TO QUESTION NO- 1

Requirement (a)

After assessing the inventory recorded in the financial statement, there are following key assertion at risk have been identified. 

KEY ASSERTIONS AT RISK

The key assertions are checked by the organisation’s management that have the responsibility for preparation of financial statements. Ideally, accountant and auditors are indulged in identifying and evaluating the key assertions at risk. Each assertion related to assets is affirmed to exist in all the asset accounts by the management (Murphy, 2015). However, when audit is processed there are chances that certain account balances come into the knowledge of auditor, where some of these key assertions may lie at risk. These key assertions are found by the auditors at risk.

 The key assertions that are found at risk in the inventory account in the audit of Advanced Computer Solutions Limited are:

Key assertion at risk
Description
The reason why this assertion is at risk
  1. Valuation

The inventory valuation is done accurately and it is valued at lower of market value or cost of acquiring the inventory (Mock, & Fukukawa, 2015).  This is done to assess the value of the inventory recorded in the books of account of company. 
The company’s inventory that is present in the stock has increased significantly. This has been caused because of the returns from customers that have increased highly in the audited financial year. Besides, the sales have been less in this year which is shown by the lower inventory turnover. The lower inventory turnover has been recorded which is compared with the last year sales. Nonetheless, with the increasing stock turnover, stock holding in the books of account has been recorded. 
  1. Existence

The inventory items that have been valued to arrive at the balance sheet figure are present with the organisation. The existence of these items is real (Mallik, 2018). The existence test has been done to assess the real value recording and evaluating whether the inventory is in existence in real.

The existence of inventory items is seen at risk. Out of the total inventory that is held by the organisation, a lot has been shifted to warehouses that have been newly constructed regionally. There is scepticism that there are no warehouses and the inventory has been moved out of business. There might be no inventory existent against what mentioned. 


Requirement (b)

Substantive audit procedures 

When the auditor identifies any risk of material misstatement that might hit the key assertions, there is a need for the auditor to obtain evidence that is appropriate and sufficient enough. These evidences may be invoices and uncertain events which may be used to assess the true and fair view of the assets and liabilities recorded in the books of account of company. For this he performs certain procedures known as substantive audit procedures. The procedures that can be performed in the given situation are as follows:

substantive audit procedures
Performance
Cross checking inventory valuation
The valuation of the inventory must be checked. The physical count should be undertaken. On the basis of the number of items that have resulted in the count, the valuation must be done again. The lower of the current market price or the cost of purchase of goods must be applied to value the counted items (Knechel, & Salterio, 2016). This shall give the value of inventory held by the organisation. 
Checking inventory purchase, sale and storage
The receipts related to inventory purchase and all the invoices dealing with sale of goods must be inspected. This shall provide information related to the value at which inventory is purchased or sold. As well the volume of inventory purchased and sold could also be obtained. An inventory reconciliation statement could be prepared from the same (Chan, & Vasarhelyi, 2018).  This is done by assessing the inventory receipt and invoices. 


Requirement (c)

Key audit matters

Requirement

Every matter that is considered sceptical has to be tested by the auditor. There are certain areas that probe high risk to the whole organisation. Auditor is required to place high attention while auditing these areas as compared to the other less risky areas. These matters that are highly risky and are important to be resolved are also discussed with those charged with governance. The recent judgements in the field of auditing standards have brought a new requirement. Auditors are now required to disclose to the shareholders and other users of financial statements all those areas that are highly required to maintain transparency. These matters have to be reported under the name of key audit matters. This requirement is laid by ASA 701, communicating Key Audit Matters in Auditor’s report. The auditor is required to keep the investors and other users informed of all those matters that are significantly risky. These areas have asked the auditor to place a lot of his attention during the audit process and require placing proper audit procedures (Cordoş, & Fülöp, 2015).  However, auditors needs to assess the audit program and policies while implementing the audit program. 

The auditor refers and places these matters in the audit report for providing the shareholders with a better understanding about the financials. The intention is not to report a specific opinion on these matters. They constitute a part of overall audit report. The motive is just to make the shareholders aware of every aspect related to these matters. Nonetheless, auditors passes the disclaimer and audit opinion report after assessing the financial statement of company. 

Rationale behind key audit matters

A matter becomes a key audit matter as per ASA 701, only when the auditor of the financial statements considers so. This consideration is in the view of his professional knowledge and judgement. Every point of consideration in audit that is highly risky and is genuinely important for the members of the company to be aware of is mentioned in the key audit matter paragraph. The mentioning is done only when it is felt that the matter is highly significant (Sirois, Bédard, & Bera, 2018). 

Is inventory a key audit matter?

The above matter constitutes a high alert area. The inventory is not stored at a single place now. The location of inventory is disbursed in different areas. This has raised distrust over the existence confirmation. Further, there has been a fall in the sales resulting in lower turnover. All of these matters have Answer to question noed the valuation and existence. It is must for the investors to know about this. 

Disclosures

In the key audit Para, following disclosures are required:

The following matters have been identified which constituted high risk. Special attention from auditors has been exerted. However, no different opinion is expressed for these matters. 


Key audit matter:

Inventory has been found more in volume than previous financial year. However, doubts exist over the valuation. Further, there is a doubt over the presence of all the inventory items that are claimed to be present.

How the matter is addressed:

1. Inventory has been counted against the documents that evidence inventory sale and purchase.

2. Market value is sourced and comparison is made with the acquired value to obtain lower of both. Valuation of counted items is done with the resultant value.

3. Receipts of storage of inventory in the warehouses have been acquired to get proof of storage of inventory.

ANSWER TO QUESTION NO 2

Requirement (a)

KEY ASSERTIONS AT RISK

Key assertions are implied to be laid by management while preparation of financial statements. These key assertions relate to the correctness and accuracy regarding the existence, completeness, ownership and valuation of the assets. The main key assertions that significantly at risk are:

Key assertion at risk
Description
The reason why this assertion is at risk
Valuation
The property, plant and equipment have been valued appropriately. The depreciation rates are appropriate and impairment is followed wherever required (Colley, & Scott, 2018). 
Valuation is at big risk. The depreciation rates followed are not appropriate. Higher rates of depreciation were required to be used for depreciating assets, but lower rates have been used. This has resulted in reducing the accumulated depreciation. Overall, assets have been depreciated less than required. This has resulted in asset overvaluation. Chances are there that the plant might not be working even, but has shown as a working asset. Reconciliation statement could be prepared by using the invoices and changes in the cash statements (Chan, & Vasarhelyi, 2018).  This is done by assessing the receipt and invoices of the plants and machinery. 
Completeness
All the assets that make up the property, plant and equipment have been included while computing the level of the account balance. No assets that might have been included have excluded (Al Ameen, 2016).  This completeness has been used to assess the value of the recorded plants and machineries in the books of account. 
There are assets of the organisation that have been observed to be treated as expense of the audited period. Resultant all of them have been treated as a revenue expense. They were required to be capitalised but were not. Conversely, a few other expenses were originated in the organisation as revenue expense. However, The treatment of them has been done wrong. All of them were treated as capital expense and had been capitalised. This has created an image of assets falling in property, plant and equipment that does not exist in real terms.  Nonetheless, these are the main focus point of the auditors in the audit report. It helps in assessing whether the true and fair view of these assets is shown or not. 

Requirement (b)

SUBSTANTIVE AUDIT PROCEDURES

The substantive audit procedure is used to assess the risk and reduce the uncertainty or risk associated with the recorded assets and liabilities in the books of account. The audit procedures that could be performed by the auditor to grasp evidences that can reduce the uncertainty or the risk that is tied with the key assertions are as follows:

substantive audit procedures
Performance
Taking expert’s advice
A valuation expert must be called. The facts and circumstances of the case must be put forward the valuer. An independent property appraisal should be conducted by the valuer. He must be asked to value the property for the audited financial year (Glover, Taylor, & Wu, 2016). Through the report of the independent valuation expert, the accuracy of company’s valuation can be tested. Expert advice is taken in order to strengthen the fairness of the financial statement and evaluate whether the recorded assets comply with the domestic and international accounting standards. 
Inspecting asset documentation
The company have the documents that relates to the dealing that have been done for the assets. Some assets might have been purchased, other be leased and some have been taken on rent. All the assets that have been owned or leased, should be taken while valuation. The assets that are present in the organisation or factory of the company should be checked with the evidencing documents this shall confirm the inclusion of all the organisation’s assets for the purpose of preparation of financial statements (Appelbaum, Kogan, & Vasarhelyi, 2018). 

Requirement (c)

Key audit matters

Requirement

All the sceptical areas of audit are to be attended significantly by the auditor. All the risky areas are required to be devoted higher attention as compared to less risk zones. There is a need to communicate with those charged with governance for these matters. Auditors are now required to disclose to the shareholders and other users of financial statements all those areas that are required to maintain transparency and keep the users informed. These matters require placement under the Key Audit matters Para. This requirement is provided by ASA 701, communicating Key Audit Matters in Auditor’s report. The auditor is obliged to keep the investors and other users informed of all those matters that are significantly risky. Even when these matters are highly risky, they still form a part of the opinion that is made on the overall report. The auditor is not specifically opined for these matters (Segal, 2017).

Rationale behind key audit matters

The judgement that is inbuilt in a any auditor is of high importance when the decision is required to be made for deciding whether a matter has to be reported as key audit matter or not. When the circumstances of a case call an auditor to decide that the information is must to be extended to the users, a key audit matter is raised. It has to be material enough to make it definite to be disclosed to the users specifically (Kachelmeier, Schmidt, & Valentine, 2017).  The rationale behind the key audit matters is related to strengthen the true and fair view of the recorded assets in the books of account. 

Is property, plant & equipment a key audit matter?

Any investor looks upon the level of assets with which a firm or an organisation is geared up. This level is created by constituting all the property, plant and equipment. There is a lot scope of penetrating misstatements in this area to lure the investors. Hence the auditor, if notices any anomaly must work attentively to resolve in case of property, plant and equipment. In the current situation the risk revolves around depreciation rates and capitalisation, which directly affects the value and completeness of the components of property, plant & equipment. Hence it has to be constituted in the key audit matter. These property, plants and equipment’s are accompanied with the high capital and ideally shown at high price. These are the factors which attracts investors for the investment purpose. Auditors stands in the fiduciary position and works in the best interest of the stakeholders. They asses the value of the plant, equipment’s and assets values recorded in the book of accounts. After that on the basis of the accounting standards and market value, auditors shows the true and fair view of these assets in the best interest of the shareholders. 

Disclosures

There are several points which needs to be disclosed by the auditor in his audit report. In the key audit Para, following disclosures are required to be made. 

The following matters have been identified which constituted high risk. Special attention from auditors has been exerted. However, no different opinion is expressed for these matters. 

Key audit matter:

The assets that make up the property, plant & equipment are depreciated inaccurately. Lower rates have been observed. Further there are corrections required in the line of expense capitalisation.

How the matter is addressed:

1. Assets are checked individually with the documents that contains proof of their ownership and leasing. 

2. Independent valuation expert is appointed to value the assets for the purpose of audit.

3. Assets are counted in number to resolve the doubts that revolve around the completeness of the assets. Every asset is counted and is checked for the condition in which the organisation is operating them. It is recorded to check the true and fair view of the assets and liabilities. 

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