Auditing Assignment: Audit Planning To Determine Risk Assessments
The questions to be answered in this auditing assignment are;
Week 7 - Question One
Mermaid Beach Hotel Ltd (Mermaid Hotel) operates a seaside hotel on the Sunshine Coast, providing accommodation, bar and restaurant facilities for tourists. Casual and part-time wages are a major expense item, particularly during summer, when up to an additional 30 staff members are employed. In order to keep track of casual and part-time wages, Mermaid Hotel’s operations manager prepares a weekly roster (using Excel) showing:
- employee name
- employment position (e.g. bar staff)
- days and hours rostered for the week
- hourly rate
- any additional amounts to be paid (e.g. meal allowances).
Each employee’s immediate supervisor is required to sign a hard copy of the Excel roster spreadsheet on a daily basis as evidence that the hours were worked as rostered. Any discrepancies (e.g. additional hours) are recorded on a separate payroll adjustment form (PAF) and co-signed by the employee. The Excel roster spreadsheet plus any PAFs are forwarded to the payroll officer at the end of the week and used as the basis for that week’s casual and part-time employee payroll. Last year, you still placed reliance on controls over casual and part-time wages, despite finding some breakdowns in controls, as you were able to obtain sufficient appropriate audit evidence that the controls were operating effectively. Assume that you have decided it is appropriate to test internal controls over the relevant payroll transactions.
Required: Briefly outline how the information provided above would affect the nature, timing and extent of tests of controls.
Week 8 - Question Two
You are the audit manager at Price & Coopers a medium-sized audit firm undertaking the audit for the year ended 30 June 2018 of Sera Ve Tech Ltd, an electronic component manufacturer located in Sydney. During the planning stage of the audit you discovered that one of Sera Ve Tech Ltd’s major suppliers went bankrupt one month ago, causing major product shortages. To overcome the problem, James Marshall, the husband of the finance director, Norita James, provided electronic components to Sera Ve Tech Ltd through his private company. There is no formal agreement in place with James Marshall, however, the goods are being provided at competitive prices. You are concerned about the electronic components that James Marshall, company is supplying, because his products are new to the market and you have heard some of Sera Ve Tech Ltd’s staff complaining that they are of poor quality.
The board has informed you that although sales have been strong this year, Sera Ve Tech Ltd has suffered significant cash flow problems because a major debtor, Merrinda Ltd, is experiencing financial difficulties. As a result, Merrinda Ltd is taking well over 120 days to pay outstanding amounts, despite Merrinda Ltd’s terms of trade being payment within 30 days. Merrinda Ltd makes up 40 per cent of Sera Ve Tech Ltd’s sales and the board has been reluctant to take any action that might adversely affect those sales. As a result, Sera Ve Tech Ltd has had to increase its dependency on its line of credit, and this has caused it to temporarily breach the debt to equity ratio required in its loan covenant with Commonwealth Bank Ltd.
- Identify two (2) key account balances at risk of material misstatement.
- For each account balance identify the key assertion at risk.
- Explain why the account balance and assertion are at risk.
- Describe one (1) substantive test of detail that you would undertake for each account to address the assertion and risk identified.
Week 9 - Question Three:
Axel Heckman is the engagement partner for the financial report audit of Sturfolks Equipment Ltd for the year ended 30 June 2018. The following material events or transactions have come to Axel’s attention before he is scheduled to issue his report on 31 August 2018:
- On 14 July 2018, Sturfolks Equipment settled and paid a personal injury claim of a former employee as a result of an accident that occurred in March 2017. The company has not previously recorded a liability for the claim.
- On 17 July 2018, Sturfolks Equipment agreed to purchase for cash the outstanding shares of Recreational Equipment Ltd. This acquisition is likely to double the sales volume of Sturfolks Equipment.
- On 20 July 2018, the directors became aware of broken glass found in their pre-packaged sandpits. This product had only been on sale for two weeks and had been purchased directly from the manufacturer, NSWPIT Ltd, an unrelated company in Thailand, one week prior to being introduced to the public.
- On 3 August 2018, a plant owned by Sturfolks Equipment was damaged in a flood, resulting in an uninsured loss of inventory.
Required: For each of the above events or transactions, identify audit procedures that should have brought the item to the auditor’s attention, and determine the treatment required in the financial report for the year ended 30 June 2018.
Week 10 - Question Four
What are key audit matters? How do these affect the format of the audit report?
Explain the effect of the misstatement on the auditor’s report and the audit opinion in each scenario stated below:
- You have completed the audit of Saibal Resort Ltd (Saibal Resort) for the year ended 30 June 2015. The audit partner suggested that the value of properties on the West Coast were overstated by $16 million, a figure which was twice the level of materiality set for the audit. As a result of discussions with the audit committee, the CEO of Saibal Resort agreed to revise the valuations downward by $10 million. All other issues were resolved to the satisfaction of the audit partner, resulting in an overall misstatement of the financial report of $6 million.
The audit partner is now considering the effect of the misstatement on the auditor’s report.
- Jason King Ltd is a building contractor with a varying workload. In order to compensate for the irregularity of its contracted building projects, Jason King also purchases large vacant blocks of land that it later subdivides for the construction of houses and units. Jason King then sells these on its own account. Your analysis strongly suggests that the apportionment of costs to houses and units sold has been kept low to boost profits. In your opinion, this has resulted in the overvaluation of the unsold properties. The directors of the company do not agree and hold to their view that the stock of properties is correctly valued.
Week 11 - Question Five
The following information relating to Tedy Brown’s operations has been identified:
Tedy Brown has an accounts receivable insurance policy that allows the company to claim for bad debts of up to $50 000 per annum. The amount covered under the policy has remained the same since 2012 (when the accounts receivable balance averaged $2 000 000). Since 2012, the average accounts receivable balance has increased to $3 800 000.
Tedy Brown sales representatives are entitled to commission on sales above quarterly targets. Any commission earned is required to be paid in the month following the quarter. In the year ended 30 June 2015, on two occasions, the commissions were paid three months following the quarter.
There were numerous occasions during the year where major debtors, representing 40 per cent of gross revenues, settled their accounts 45 days after the due date. These debtors have been longstanding and reliable customers.
Tedy Brown does not enter into foreign exchange contracts to fix its exposure to foreign currency movements, as it has never previously suffered significant foreign currency losses. During the year ended 30 June 2015, Tedy Brown incurred foreign exchange losses representing 10 per cent of net profit before income tax.
- Identify which two (2) items are primarily relevant only to the head of internal audit. Justify your answer.
- Identify which two (2) items are significant and direct concerns for both the external auditor and the head of internal audit. Justify your answer
The research on auditing assignment signifies that the test of control is the sort of audit process executed to assess the existing internal control mechanism of the organisation, says Mermaid Beach Hotel Ltd. The phenomenon is undertaken to see whether the internal control system of the establishment is working properly to safeguard its business interest from the plausible risk of a material misstatement by properly identifying those. Internal control intends to identify the loopholes of the organisation and adopt measures to control such matters (Messier & Schmidt, 2018). So the test of controls would be effective in reducing the essential work of the business through its proper exercise.
The implication of the test of control lies in reducing the substantive audit process based on the internal control system of Mermaid Beach Hotel. The business proposition of the establishment takes into effect the implementation of the internal control system for identifying the aspects of material misstatement (Boiral, et al., 2019). For instance, the payroll adjustment form (PAF) is maintained well by the managers and monitored by the payroll manager to accommodate the weekly roster of the part-time and casual staff. The test of control is also implicative in sourcing additional audit evidence in support of reducing substantive audit procedures for Mermaid Beach Hotel(Ulrich & Blouch, 2018). Say the Excel file maintained by the establishment would be used to properly assess the PAF in lieu of the hours delivered by the casual and part-time workers for serving the organisation.
The nature of the test of control could be elaborated in the following manner –
Through inquiry, the auditor has the opportunity to counter-check the information by seeking clarification from the payroll manager, asking the staff about their roster mechanism. But there are risks like the personnel might conceal the truth from the auditor misleading the process.
Observation is to go thoroughly to the process conducted by the Mermaid BeachHotel. The auditors would perform the test of control by going thoroughly with the PAF to see the roster has been carried out properly (Hay, et al., 2017). It leads to the meticulous performance of the internal controller o the notion that they are under strict observation.
Inspection stands as the verification of the supporting records associated with the internal control process(Moroney, et al., 2017). It is to check and verify the PAF ensuring that the roster is well maintained by the managers at the Mermaid Beach Hotel and verified by the payroll manager. Though it is a physically intriguing task but is effective than inquiry or observation. It would be better to run a sample check on the matter than reviewing the entire thing.
Re-performance is considered as a reliable measure wherein the auditor repeats the exercise on the insistence of the client, say preparing the roster again to establish its genuineness.
The test of control is suitable for the organisation is to be conducted within the audit period to evaluate the risks that the organisation is vulnerable to.
Key account balances owing to material misstatement risk
For the Sydney based electronic component manufacturer, Sera Ve Tech Ltd a sort of material misstatement risk has erupted as one of its suppliers went bankrupt. To fill the gap, another supplier, James Marshall came into the picture who incidentally is the husband of the company’s Financial Director, Norita James. The materials supplied by the new suppliers are alleged of poor qualities despite charging competitive market prices for such products declining quality of the materials produced by the company.
Another aspect of material misstatement risk could be stated as one of the debtors of Sera, Merrinda Ltd which constitutes 40% of its sales facing certain financial difficulties. The debtor is defaulting on its usual payment term of 30 days extending unto 120 days. The non-payment of debts is forcing the company to depend on its line of credit affecting the existing capital structure.
- Key assertion at risk
The risk of a material misstatement could be categorised as inherent and control risks. The inherent risk in the business scope of Sera could be stated when there is a probability of the risk owing to the business approach of Sera. The element of inherent risk is based on judgement due to the non-expertise of the new supplier, James Marshall (Aven, 2016). The supplier is delivering poor quality affecting the quality of the electronic component manufactured by the client company.
Sera are also countering control risk out of a lack of effective accounting practise in the organisation. The main debtor of the company, Merrinda Ltd is defaulting on its credit term of 30 days often extending to 120 days. So it strives for a greater risk as the organisation is not able to contain the debtors due to relaxation of its credit term for its major debtors.
- Account balance and assertion at risk
The business scenario of Sera having a completely new supplier sets for account balance and assertions at risk. It presents for assertions related to transactions based on its occurrence as the supplier, James Marshall has no legal agreement with the company to supply the materials (Diouf & Boiral, 2017). Though he came into the scene to fill the void left by one of its suppliers, it strives for regulatory compliance as it led to the entry of an unauthorised supplier as he was related to the Financial Director of the company. Again, the issue with the debtor strives for valuation assertion as the risk of default is on a higher state frequently missing the payment deadline constituting substantial business.
- Substantive test of detail
In such a scenario, it calls for substantive tests for Sera for pointing out the risk of material misstatement at the assertion level. The substantive analytical procedure would be suitable for the purpose by working out the significant receivable ratios, comparing such figures with the industry, and regression analysis to get clarity on the picture(Moroney, et al., 2017). Such a test would be helpful in specifying the risk that the business is subjected to and enable it to work out specified measures to come out of it.
- The settlement of the personal injury claim of a former staff of Sturfolks Equipment Ltd is subjected to occurrence testing (Boiral, et al., 2019). This sort of audit procedure tends to evaluate whether there has been an incident of such kind as the company does not have any historical record of fulfilling the claim of former staff. In such a scenario, the auditor – Axel Heckman could resort to an inspection of the fact for ensuring the accuracy of the financial statement as ended on 30th June, 2018. So to satisfy the inquisitiveness of the auditor, he could resort to the study of the documents related to the matter and inspect such documents ensuring its validity.
- The aspect of stock purchase of Recreational Equipment Ltd by Sturfolks Equipment through cash is subjected to valuation testing. It is because such sort of acquisition is supposed to multiply the sales volume of the organisation facilitating a change in valuation of Sturfolks(Messier & Schmidt, 2018).The valuation testing undertaken by Axel would reveal the fact whether the organisation has been able to encase the benefits of such acquisition. For this purpose, the auditor would resort to confirmation to check the state of the financial statements of the current year whether the financial position of the company has improved owing to such acquisitions.
- The issue of broken glass in the pre-packaged sandpits as sourced from the Thailand based manufacturer, NSWPIT Ltd is subjected to existence testing. This is to ensure whether there is the existence of any such supplier, say NSWPIT which as per the estimate of Sturfolks is unrelated to its business segment. So inspection stands to be the plausible solution in this regard which could be carried out by going through the documents of the negotiation and agreements between the company and its supplier (Weston, et al., 2018). Axel would go through the terms and conditions of the deal to understand whether the company was in a position to charge the supplier owing to damaged and poor quality of items.
- The event of damages due to flood in the warehouse of Sturfolks which led to damage of inventories, the uninsured ones would undergo the existence testing. This kind of audit procedure is suitable to understand whether there was any sort of inventories held with the company(Almeida, et al., 2017).The inventories were not insured leaving little scope for its claim on account of flooding. So in such a situation, it would be effective for the auditor to run an inquiry on the aspects whether there were any such inventories held with the organisation. If there were any such thing, the auditor would try to understand why such assets were not insured. It runs the risk of material misstatement might be to inflate the assets as a part of window dressing of the balance sheet.
Key audit matters (KAM) are conceived by the International Auditing and Assurance Standards Board (IAASB) to address the challenges set by the stakeholders for having greater transparency and clarity on the audit reports. So, KAM is the element in accordance with the professional judgement of the auditor which stands as an important piece of information for auditing the financial statements(Legislation.gov.au, 2015).These are the substances that are taken from the aspects communicated with those responsible to maintain the governance issues.
The auditor while determining KAM takes into account the avenues of higher risks related to material misstatement or noteworthy risks as per the legislation of ISA 315. It requires an effective judgement of the auditor in lieu of financial statements in the stride of accounting estimates having a higher level of uncertainty (Groomer & Murthy, 2018). It is also concerned with the audit of important facts and happenings that take place during the audit period. The relevance of KAM in the audit report would lead to effective disclosure of the facts as deemed significant for auditing and evaluate its treatment while auditing. The audit report needs to be kept in mind while drafting the KAM in accordance with the auditing and accounting knowledge (Boiral, et al., 2019). In this respect, proper communication of the KAM to conduct the auditing process effectively and communicating the various aspects of KAM seems to be very effective. So, proper communication of KAM holds the key to form an opinion on the financial statements of the organisation to present the financials effectively for its fair presentation.
- The scenario depicted for Saibal Resort overstating its value by $16 million stands the materiality risk in terms of its valuation. A material misstatement is significant as it strives to inspire the decision of the users of financial statements (Hay, et al., 2017). Greater the misstatement as in this case owing to over-valuation of the firm by $6 million, the damage is also to a bigger extent. So the auditor has to document about writing-off this over-stated valuation of the company (Legislation.gov.au, 2015). Accordingly, the auditor would source related documents of the establishment related to its valuation and prevailing market to justify the stance and mention the vivid details in the audit report.
- As per the legislation of ISA 450, the scenario depicted for the building contractor, Jason King Ltd is an instance of judgemental misstatement. It is due to the differences that take place between the management of the company and the auditor regarding the valuation and the accounting estimates concerning it (Groomer & Murthy, 2018). It is an instance wherein the fair value of the non-current assets like the unsold properties were not properly accounted leading to its overvaluation. The auditor ought to reassess the materiality aspect of the resources to determine its financial implications (Aven, 2016). Accordingly, the auditor would cite the misstatements owing to regulatory compliances that lead to a change in its earnings trend like lower the costs apportionment for showing a higher profitability.
The head of the internal audit of Tedy Brown ought to be concerned about how the sales commission was disbursed in the company. There was the norm to pay the sales commission above the achievement of quarterly sales target in the month following the quarter. But for the quarter ended in June 2015 there was disbursal of frequent commissions. It is an error on part of the accounts department subjected to lose internal control prevalent in the organisation (Chiu, et al., 2019). As per the norms, sales commission were to be disbursed for the June quarter once in July but there were repetitive disbursals. So it is the responsibility of the internal controller to look into the matter and implement a strong mechanism so that it does not become repetitive.
Another aspect of Tedy Brown that needs the urgent attention of the internal audit team is that of the late receivables, say settlement after 45 days of the due date. It is seen that a long-term business partner of the company has turned it into a practice to settle their debts after a considerable time after the due date. It is the ineffectiveness of the internal control system to put the debtor in line and negotiate with him for active settlement of dues within the due date (Boiral, et al., 2019). The debtor comprise 40% of the gross revenue of Tedy brown, so it becomes necessary to facilitate effective negotiation and trade discounts to have the settlement duly ensuring its revenue timely reducing the risks.
The aspect of the non-settlement of dues by the debtor is a significant concern for both the internal audit department and the external auditor as well. It is because for the internal audit team it is the matter of losing control of its debtors as their repeated reminder on the payment might not have any effect on the debtor to pay off the dues timely. Again for the external auditor, it reveals the poor negotiation and an inefficient collection department (Groomer & Murthy, 2018). Such abrupt collection makes it difficult for the external auditor to assess its financial position and the bad debts to be written on non-payment of such dues leading to an ambiguous situation.
Tedy Brown has grown its business with the due passage of time but not its accounts receivable insurance policy having an annual coverage of $50,000. Since 2012, the average accounts receivable for the company was around $3,800,000 not enough to cover its outstanding dues. So it is the failure of the internal auditor to bring it to the attention of the management for updating the coverage and make provision for collection the dues timely (Diouf & Boiral, 2017). Again for the external auditor, it presents a scenario to have his opinion on the lack of efficiency and competence of the management regarding the matter.
Almeida, H., Hankins, K. & Williams, R., 2017. Risk management with supply contracts. The Review of Financial Studies, 30(12), pp. 4179-4215.
Aven, T., 2016. Risk assessment and risk management: Review of recent advances on their foundation. European Journal of Operational Research, 253(1), pp. 1-13.
Boiral, O., Heras-Saizarbitoria, I. & Brotherton, M., 2019. Assessing and improving the quality of sustainability reports: The auditors’ perspective. Journal of Business Ethics, 155(3), pp. 703-721.
Chiu, T., Brown-Liburd, H. & Vasarhelyi, M., 2019. Performing Tests of Internal Controls Using Process Mining: What Could Go Wrong?. The CPA Journal, 89(6), pp. 54-57.
Diouf, D. & Boiral, O., 2017. The quality of sustainability reports and impression management: A stakeholder perspective. Auditing assignment Accounting, Auditing & Accountability Journal, 30(3), pp. 643-667.
Groomer, S. & Murthy, U., 2018. Continuous Auditing of Database Applications: An Embedded Audit Module Approach1. In: Continuous auditing. New Yok: Emerald Publishing Limited, pp. 22-41.
Hay, D., Stewart, J. & Redmayne, N. B., 2017. The Role of Auditing in Corporate Governance in Australia and New Zealand: A Research Synthesis. Australian Accounting Review, 27(4), pp. 457-479.
Legislation.gov.au, 2015. ASA 701 - Communicating Key Audit Matters in the Independent Auditor’s Report - December 2015. [Online]
Available at: https://www.legislation.gov.au/Details/F2015L02016/Explanatory%20Statement/Text
Messier, W. & Schmidt, M., 2018. Offsetting misstatements: the effect of misstatement distribution, quantitative materiality, and client pressure on auditors’ judgments. Accounting review, 93(4), pp. 335-357.
Moroney, R., Campbell, F. & Hamilton, J., 2017. Auditing: A Practical Approach. Australia ed. Sydney: John Wiley & Sons Limited.
Ulrich, T. & Blouch, W., 2018. CPA PRACTITIONERS'FEEDBACK ON AUDITING CURRICULUM. Journal of Business and Accounting, 11(1), pp. 68-81.
Weston, H., Conklin, T. A. & Drobnis, K., 2018. Assessing and re-setting culture in enterprise risk management. Assurances et Gestion Des Risques, 85(1/2), pp. 131-166.