Inventory And Recording Of Transactions And Depreciation Problems

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Question :

Trimester 3, 2018

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.


  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


  1. Identify and explain 
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Answer :


Executive summary

In this report, two companies have been considered which is advanced computer solutions limited and Green machine limited. These companies are facing problems regarding their financial statements. This report consists of the problems for both companies as well as audit procedures they can follow. Advanced computer solutions limited is facing inventory related problem that is a major problem. They are planning to conduct substantive audit procedure to reduce these problems. Checking of financial statements might help the company to solve their problems. Accounting standards have to be followed properly throughout the financial calculation to avoid mistake. On the other hand, Green machine limited is facing problems regarding recording of transactions and depreciation. This company is also planning to incorporate auditor procedure that might help them to mitigate these problems. Audit procedure helps to cross check all the rules and regulation followed during the preparation of financial statements, Therefore, these companies are taking up substantive audit procedure to enhance their organisational structure. Better organizational structure might help them to develop their business in the future. 


In this report, advanced computer solutions limited is providing their computer products at 10% below cost price. They need to consider all the risks that are related to inventory and conduct audit procedures to minimise loss. Substantive audit procedure has to be conducted for the identified risks of the company. Auditing standard ASA 701 has to be followed for conducting audit procedures. Green machine limited is a plant and equipment manufacturing company, which needs to identify accumulated depreciation and costs. Some problems occurred in relation to revenue and capital expenditure that needs to be addressed by conducting appropriate audit procedures.    

Question 1

a) Identification and explanation of two key elements of risks related to stock level 

Based on information provided by Advanced computer solution limited two key elements at risk related to stock level have been identified. These two risks are excess amount of inventory and value loss of inventories. 

Excess amount of inventory

From the viewpoint of Axelsen, Green and Ridley (2017), audit procedures conducted in this company has revealed that they are facing high level of returns that is due to software problems. These software problems are occurring due to usage of out of date software. The opinion of Azim (2015) has reflected that excess amount of inventory in the company is leading to increase in loss percentage. Inventory level of the company has to be managed properly as it can be seen inventory turnover has become lower compared to 2017. 

Value loss of inventory

Advanced computer solutions also need to provide proper valuation of inventories as the company is facing high level of return in recent days. Average rate of stock turnover was 5.4 times in the year 2017. In 2018, this has come down to 3.8 times that means that the company is not able to sell at satisfactory level. This ratio helps to display the number of times the company has sold or replace their products. Reduction in this ratio means the company is not performing well and audit has to be conducted for identification of weak areas. Providing provisions for returned items may prepare the company to face risks and mitigate huge loss. As researched by Bumgarner and Vasarhelyi (2018), proper inventory management has to be conducted within the company to reduce loss percentage. Selling of more computer products might help the company to increase their profit level. Updated version of software can also helps them to lower the amount of returned items. 

Identification of two key assertions at risk related to inventory

Figure 1: Identification of two key assertions at risk related to inventory

(Source: Byrnes et al. 2018)

b) Identification and description of two substantive audit procedures 

The company Advanced computer solutions limited is facing problems regarding inventory management and they are conducting audit procedures to mitigate those problems. The first risk they are facing is excess amount of inventory for which examination of documentations regarding inventory are needed. The second risk this company is facing is value loss of inventories that can be solved by examining transactions and accounting standards. As opined by Byrnes et al. (2018), audit procedure is a systematic procedure, which might help the company to manage their inventory levels by proper examination. These examinations include checking of transactions, accounting procedures, vouchers and documents. 

Examination of documentations regarding inventory

The company need to conduct substantive audit procedures that include examination of inventory documents. This helps the company to analyse their weak areas and they might be able to mitigate such loss. Examining inventory document might reveal the total number of product, which was planned to produce for the current year, and the sales target. As identified by Cannon

and Bedard (2016), auditor is able to provide information related to inventory to the director and manager of the company. Identifying weakness areas and production line can reveal the true picture and they can work on those areas. 

Examination of transactions and accounting standards

Auditor has to perform examination of accounting transactions and financial statements of the company. This can reveal true valuation of computer products to the managamers of the company. From the viewpoint of Carson, Fargher and Zhang (2016), cross checking of accounting standards and disclosure policy might help the auditor to understand loss of valuation of inventories. Accounting standards have to be followed properly in order to sustain development process and this substantive audit procedure can help to mitigate valuation problems. 

c) Requirements of ASA 701 Key Communicating Audit Matters

Requirement and rationale for ASA 701

Auditing standard is a key communicating audit matter in the auditor report. This helps to perform legislative procedures and strategic direction can be implemented within the organisation. Statutory independent committee of Australia issues these auditing standards. Main feature of theses auditing standards are laws and legislations. ASA 701 establishes and reflects explanatory matter of materiality and communication regarding key audit matters. These also help to integrate matters with the current trend of enhancements. The research of Cassell et al. (2016) has opined that listing of key matters of audit in the auditor’s report is mandatory for communication purpose. Assessment of areas that are at high risks should be assessed properly. This assessment includes management judgement and respective effects of recording transactions. This audit standard also enables auditors to decide whether to add key audit matter in their report or not. Determination of matters has to be communicated with the governance as they are supervising the whole matter. 

Rationale for determination of key audit matters

Advanced computer solutions limited is facing problems regarding their inventory management and this falls under the category of key audit matters. As suggested by Doxey et al. (2015), the structure of the company has determined evidence that reveals that these inventory management problems are key audit matters. This applies for determination of key audit matters and these matters should be communicated in auditor’s report. This helps to form standards and legislation for determining main audit purpose and creates necessary adjustments. As claimed by Eilifsen, Hamilton and Messier (2017), significance of this inventory related the auditor who conducts examinations judges matters. Qualitative and quantitative factors are considered while preparing these documents such as nature and effects of main subject matter, magnitudes and related interest of users. This helps to form legislations based on these factors and express these opinions in auditor report. These reports are correlated with financial reports to enhance the auditing process. 

Disclosure of key audit matters required under ASA 701

Communication of key audit matters is important for preparing financial reports. These reports should disclose audit procedures along with requires framework. Financial reporting is the main structure of the company that discloses all material factors. This helps to make fair presentation of all financial data along with substantive audit procedures. As suggested by Fakhfakh (2015), reference related to audit procedures should be included in the disclosure section. Financial report should include significant audit procedures and this comes under disclosure policy. Laws and regulations that have been followed for preparing audit report have to be disclosed to the public. Disclosure of communication between the auditor and governance might help the company to take proper financial decisions. These financial policies are based on disclosure factors and implemented in the organisation accordingly. Framework management of the financial report helps to perform task and material misstatement can be prevented. ASA 701 addresses issues that are concerned with adequacy and appropriateness of data. Disclosure policy is communicated with auditor for better preparation of financial statements. 

Question 2

a) Identification and explanation of two important elements at risk related to plant, property and equipment

Green machine limited has provided information regarding their plant, property and building. The research of Joe, Vandervelde and Wu (2017) has reflected that this information contains risks that are improper identification of capital and revenue expenditure and depreciation calculations.  

Improper identification of capital and revenue expenditure

Capital expenditure and revenue expenditure are very different in nature. Capital expenditure consists of expenses that do not occur at a regular basis. These area mainly yearly expenditures and revenue expenditure are recurring in nature. These expenses should not be miscalculated as this can hamper preparation of income statement. As analysed by Glover, Taylor and Wu (2016), previous year financial statements shows that some items, which were capital in nature, have been categorized under revenue expenditure. This has decreased the amount of profit and miscalculations occurred. Capital items were included in maintenance and repairs account that only consists of revenue expenditure. Therefore, this risk should be analysed properly in order to refrain from such mistake in the future. 

Risk regarding depreciation calculations

Another risk related to plant, property and equipments is error in depreciation. Depreciation is calculated based on reduction in value over the years. This depreciation comes under profit and loss statement of the company. From the viewpoint of Huggins, Simnett and Hargovan (2015), depreciation is charged on assets and it can be seen that some of the items has been charged with low amount of depreciation. This is increasing profit of the company and that is not showing actual amount of depreciation. Depreciation policy has been disclosed in the previous year financial statement. The company has identifies these two risks which can hamper the company's performance and they need to analysed their financial statements properly. 

b) Description and identification of two substantive audit procedures 

Green machine limited is facing some problems regarding plant, property and equipments and they are planning to conduct substantive audit procedures. The first risk this company is facing is misreporting of capital and revenue expenditure for which examination of financial statements are needed. Depreciation related risks are the second risk for which provision policy of the company needs to be revised. In addition to this, Kachelmeier, Schmidt and Valentine (2017), auditing might helps the company to tackle their finance related problems. 

Examination of financial statements 

Financial statement of the company has to be audited by the auditor in order to remove miscalculations. Financial statements reveal all record of transactions, profit and loss statements and related data. The auditor can examine this in order to rectify misreporting of transactions. As researched by Kowaleski, Mayhew and Tegeler (2018), rectification of theses financial statements can lead to accurate recording of transactions and show true value. Maintaining financial statements using appropriate procedures leads to health financial position of the company. 

Examination of provision policy

Green machine limited needs to improve their depreciation relate provision policy. Examination of these policies might help the company to identify true depreciable value of each plant, property and equipments. As proposed by Lee (2017), depreciation contributes to profit margin of the company and miscalculation of this can lead to reduction in the same. Substantive audit procedure might help the company to segregate their depreciation value among plant, equipment and property based on their weight. Depreciation needs to pay equally on straight-line basis and the company follows straight-line method. In this method, depreciation is charged equally in every year until the value of the item becomes zero. This company might eventually gain profit by conduction these audit procedures in their company. 

Description of two substantive audit procedures

Figure 2: Description of two substantive audit procedures

(Source: Nosworthy, 2015)

c) Requirements of ASA 701 Key matters of Audit in Auditor’s report

Requirements of ASA 701 (Key Matters of Audit) 

Auditing procedures mainly deals with standards and policies followed by auditors. This helps them to stay on track and follow audit procedure in a proper manager. Communication audit matters helps to disclose all the factors relating to audit report. The suggestion of Nosworthy (2015) has stated that enhancement of value of auditor’s report comes from auditing standards. This standard might help the company to provide accurate information. Understanding matter, which is intended for specific users, might be disclosed properly. This auditor’s report helps to perform tasks, which are more significant for the company. Reporting framework is based on these judgements given by the auditor. These reporting are needed for fair presentation of financial statements. Auditor can express their opinion for better presentation of these statements and management of the company might follow them accordingly. A specific circumstance requires managerial performance by the auditors and he can modify laws and regulations. The auditors for additional information also give separate opinions.

Rationale for determination of key audit matters

Risks of Green machine limited are key audit matter as it is hampering company's performance. From the viewpoint of Sethi, Martell and Demir (2017), misreporting of capital and revenue expenditure is affecting company's profit and they need to be aware of this fact. Conducting audit procedure within the company might helps to mitigate this problem. Financial audit might help the company to record their financial transactions is a proper manner. On the other hand, depreciation is fictitious assets that contribute to profit margin of the company. Depreciable value plays a vital role for the company and helps to determine proper valuation of plants, equipments and property. These provide accurate value that helps the company to measure their asset value. Therefore, these two risks are important for the organization that needs to be addressed properly. The comment of Sirois, Bédard and Bera (2018) has explained that auditing might helps the company to assess their valuation system and earn more profit in the future. 

Disclosures required in key matters of Audit in Auditor’s report

Certain disclosures are provided for conduction these audit procedures. Disclosure for adequacy of data might help the company to prepare appropriate financial statements. Gathering all information for providing justification to management board might help the company to make better decisions. Disclosure policy also helps to understand task and procedure that have taken place during the whole process. Recording of transactions, balance, reports and account information are maintained in the disclosure policy. Auditor’s assessment of risk materiality helps to perform accurate tasks. Risk assessment is based on certain control in financial statements such as inflow and outflow of cash. Obtaining this evidence helps the auditor to perform audit process which are more transparent in nature. They are able to provide information which area authentic and estimates future costs. As influenced by Soh and Martinov-Bennie (2015), critical accounting estimates and assumptions are placed at the disclosure section for better understanding. In order to reduce complexity within financial statements theses audit procedure along with disclosure are provided. This helps Green machine limited to proper financial statements appropriately. 


It can be recommended that Advanced computer solutions should perform their inventory management properly which might help them to achieve sales target. Conducting audit procedure might help the company to identify their weakness area and manage their inventory level. Valuation of each product needs to be done properly with time estimation in order to maintain their value. Production line also have be carefully analysed so there are least amount of inventory. Examining financial documents and accounting standards the company might be able to manage their stock level.

Green machine limited need to conduct audit procedure to check their financial statements. This might help them to record transaction properly. The company have to record transactions according to their nature that can help them to achieve desired results. The company is conducting audit procedure that intends to address depreciation problems. This can help the company to sustain development for a long time. 

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