Using the analytical procedures that are part of the case and any further analytical procedures you deem appropriate, identify what you believe to be significant differences from your expectations, and then discuss the audit implications of those differences. Report your results in the table below. Use the student resources posted online labeled Analytical Procedures as a guide - this is the example that developed and analyzed the financial statements of New Technologies, Inc. Feel free to add rows to the table as needed.
Part A - 1. Results of Analytical Procedures
Significant Difference
Audit Implications:
Identify the assertion(s) and related account balance(s) that is (are) are likely to be misstated.
Make preliminary decisions about the type of audit procedures to be performed, the timing of audit procedures, and the extent of audit procedures.
Explain the logical connections between the significant differences you noted and the audit decisions you made as a result.
Investments in associates have increased by 52% during the year.
It is possible that Investment in associates is over stated, the auditors have to perform audit procedures to verify (Existence, completeness and valuation) of this investment.
This can be done by detailed review of the investment documents, since in this case the investment and its valuation would have been carried out by an independent professional, the auditors will also have make judgement as to which level the work of an independent value of investments can relied upon. Qualification, experience, scope of work, assumptions by the value will have to be taken into account
For new investments its vital for the auditors to verify its Existence, completeness and valuation) Given the fact there was a huge increase in investments this year, this is an area the auditor is bound to verify and perform detailed testing on.
The company's Property plant and Equipment has increased by 43%. ( might be over stated)
Given the company has acquired a large number of Property plant and equipment, the auditors will have to verify the (Existence and Valuation) of these assets using substantive procedures.
As substantive procedure the auditors will have to Physically (observe) the fixed asset. A confirmation of their valuation will be needed by reviewing the purchase documents of the asset.
The auditors will have to detail testing for verification, which is necessary given the fact the company is undergoing rapid expansion, which may lead of chances of over stating its assets. Auditors need to exercise due diligence.
For fixed assets acquisitions it is vital that they are verified using substantive audit procedures, since they represent a big portion of assets of the company their existence and valuation both needs to verify. .
Increase in intangible assets by 76% (might be over stated)
Given the fact that the company went through an acquisition of a small competitor "Discount Computer and Electrical". The company acquired some Goodwill as well.
The auditors will need to check the (Valuation) of the Goodwill since the company had recently faced rumours about being a target of a takeover.
Auditors will need to test Goodwill for impairment. For this the auditors will have to analyse the goodwill working and assumptions taken into account by the management to calculate this goodwill.
Another intangible asset increased is the inventory management software, auditors will have to review the purchase documents of this software and verify its (existence).
All intangible assets are required to undergo an impairment test annually.
The auditors have to ascertain that the management went through such a test, and the results represent a true and fair picture of its intangibles.
Over all liabilities have increased by 28%, Accounts payable show an increase of 35% while the cost of sales has increased by 27%
There is a possibility that cost of sales have been understated, since the increase in accounts payable generally comes with a corresponding increase in cost of sales.
The auditors will need to verify all components of cost of sales using analytical procedures to test its (Completeness).(Inventory and its existence can be verified during stock counts)
Auditors will also have verified what other liabilities comprise and what resulted in an increase. Analytical Procedures in this area may be sufficient since the % of change is big however overall value to other liabilities may give auditors an option of relying on analytical procedures only rather than test of details.
An increase in account payables has been linked to cost of sales since these two items are interlinked and result in increase or decrease on the change of the other component.
Part A - 2. Part 5 of the audit planning meeting memo asks you to identify audit issues related to the following areas:
(a): Revenue:
Generally;
Specifically related to:
Sale of Goods;
Selling Franchises;
Provision of Consumer Finance; and
(b) Other audit areas / concerns that have come to your attention.
Using the following table format (1) identify important inherent risks that you see, (2) identify the account(s) and related assertion(s) that are likely to be misstated and make preliminary decisions about the type of audit procedures to be performed, the timing of audit procedures, and the extent of audit procedures, and (3) explain the logical connections between the inherent risks that you noted and your subsequent decisions about the nature, timing, and extent of audit procedures. Feel free to add rows to the table as needed.
Part A - 2a(i). Identification of Audit Issues - Revenue Generally
Inherent Risks Identified
Audit Implications:
Identify the accounts(s) and related assertion(s) that are likely to be misstated, and make preliminary decisions about the type of audit procedures to be performed, the timing of audit procedures, and the extent of audit procedures.
Explain the logical connections between the inherent risk you noted and the audit decisions you made as a result.
30 day return policy and considering to increase this period (may lead to over statement of revenue)
The company has set up a 30 day return policy for all sort of its sales i.e. electrical goods, furniture, computers, bedding etc. which seems very lucrative provided the fact that they want to increase this term further more. In order to verify the completeness and occurrence of the sales transactions. The auditor will need to perform substantive procedures in order to verify revenue to an acceptable level. This may have to be performed using vouching method.
There is a strong chance that this 30 days return policy has increased the sales for time, but later returned as well, which have not been recorded as the income statement doesn't show a line item as "sales return". Given such a lucrative return policy, it's very unlikely that customers didn't avail this offer.
Part A - 2a(ii). Identification of Audit Issues - Sale of Goods:
Inherent Risks Identified
Audit Implications:
Identify the accounts(s) and related assertion(s) that are likely to be misstated, and make preliminary decisions about the type of audit procedures to be performed, the timing of audit procedures, and the extent of audit procedures.
Explain the logical connections between the inherent risk you noted and the audit decisions you made as a result.
Revenue (and related accounts receivable) is recorded when title passes, which is generally when goods are delivered. However Occasionally customers request that the company hold onto some of the products after the sale date and ship on request. This may result in an inherent risk to the revenue recognition. This may result in revenue being under stated.
As a result of the requests made by customers for holding on to the goods may conflict with the revenue recognition of the company. This may understate the overall revenue. Auditor will need to go through the whole documentation from the receipt of order till delivery of goods on a sample basis to verify revenue has been recognized on the correct point of time i.e. passage of the tile of goods. As mentioned such instances are very low, therefore the overall impact of such instances on Financial statements may be tolerable and only sample based testing of few transactions may be sufficient to verify occurrence assertion.
Inherent risk of improper revenue recognition comes with the request of customers to the company to hold on to products after sale and company accepting such requests.
Since the matter has been brought to the attention of auditors, it is vital that at least low level of testing in performed in relation to such requests from customers.
Part A - 2a(ii). Identification of Audit Issues - Franchise Revenue:
Inherent Risks Identified
Audit Implications:
Identify the accounts(s) and related assertion(s) that are likely to be misstated, and make preliminary decisions about the type of audit procedures to be performed, the timing of audit procedures, and the extent of audit procedures.
Explain the logical connections between the inherent risk you noted and the audit decisions you made as a result
Franchise sales are made on "buy back provisions with deferred payment terms"
The terms in which franchise revenue is earned and recognized creates a major audit risk of revenue being over stated.
This creates a situation where the sales is only for the time being and will have to be bought back after year end. The auditor will need to review the contracts involving these terms and conclude the % of such sales in the overall franchise revenue, if the % of such sales is more than our materiality level a further substantive procedure i.e recalculation of income, may be needed, auditors need to verify the valuation the existence of such sales.
Buy back options often boost the sales for the time being, auditors need to keep this point into consideration while performing their audit.
Part A - 2a(ii). Identification of Audit Issues - Provision of Consumer Finance
Inherent Risks Identified
Audit Implications:
Identify the accounts(s) and related assertion(s) that are likely to be misstated, and make preliminary decisions about the type of audit procedures to be performed, the timing of audit procedures, and the extent of audit procedures.
Explain the logical connections between the inherent risk you noted and the audit decisions you made as a result.
No provision against Consumer Finance
With the current downturn in economy and rumors about the company's going concern, the company has managed to show results not consistent with the notes by the CFO and auditor. The company offers consumer finance and other advances without generating any allowances for such uncollectable accounts. As per the management historically they haven't suffered any uncollectable accounts therefore they haven't provided. The auditor needs to ascertain this assumption made by the management regarding uncollectable. Account advances have to be compared with the amounts returned in order to verify assertion of valuation under this case.
It is observed that management avoids to provide allowance for uncollectable in order to maintain a good image in front of the investors and show positive picture on the balance sheet. Auditor needs to show his professional judgment in this area.
Part A - 2b. Other Audit Areas/Concerns That Have Come To Your Attention
Other Audit Areas/Concerns That Have Come To Your Attention
Inherent Risks Identified
Audit Implications:
Identify the accounts(s) and related assertion(s) that are likely to be misstated, and make preliminary decisions about the type of audit procedures to be performed, the timing of audit procedures, and the extent of audit procedures.
Explain the logical connections between the inherent risk you noted and the audit decisions you made as a result.
Company's pay scale combination (lower base pay and generous incentive for performance.
This is an audit risk which may lead to sales being over stated, since around 45% of pay of employees depends on the sales made every month, this creates a great risk towards sales being manipulated.
The auditors therefore will need to verify the salary expenses and sales using test of details method, to verify the (Accuracy assertion).
Pay scales which are dependent on the performance tends to motivate the employees to perform, however in some cases it also creates room for manipulation of data, auditors need to take these practical aspects into account during their audit procedures.
Timing and procedure of stock counts
It is noted in the notes of the predecessor auditor about issues regarding the stock counts and cut off dates, plus a request has also been made by the CFO to let him know about stock count before it is scheduled.
These two important facts makes vital for the auditors to plan a detailed stock count for this client, which may include counting of not only large number of stocks , but observing their quality as well.
Auditors have to verify the (Existence , completeness and valuation assertion for stock).
The auditors will also need to hire local auditors or send staff from the current team for stock count in australia and new Zealand.
The fact that the company has only recently implemented the new customized inventory management software system is also required to take into account by auditors.
Stock count for trading business is one of the key audit procedures, combined with the facts given by previous auditors, the auditor needs to make the stock count for first year detailed.
The assessment of fair value is based on an internal assessment approved by the Board, which may engage independent, qualified values to assist in the valuation process. (Independence threat)
Work of independent valuer being reviewed and approved by the board makes the role and judgment of the independent valuer being compromised. There is a threat of independence on the role of the valuer and therefore on his work the auditors will use during their audit process. The auditor may have to request a new independent valuer's work in relation to Investment properties to place reliance on his work.
Independence threat of another valuer may have impact on his work, therefore re-valuation might be needed here.
Over/ Understatement / In appropriate disclosure of Investment Property
This is one of the major inherent risks to the financial statements. Investment properties are categorised as a separate asset on the face of statement of financial position. As per the requirements of GAAP, an investment property is required to be valued at their open market value. The movements in market value are taken to the statement of total recognised gains and losses (investment revaluation reserve). Investment properties. There is an inherent risk that the investment properties are not valued correctly, leading to a risk to Valuation assertion. There is also a risk to the disclosure assertion, as an entity having investment property is required to present the following items separately on the face of the financial statements related to investment property investments:
(a) rental income
(b) rental expenses
(c) fair value of investment properties
(d) Debt.
Given the inherent risk of the line items above, the intensity of this inherent risk may lead to auditors performing substantive audit procedures, which may include verification of the valuation and of investment property. Also since due to guidelines of GAAP in relation to Investment properties, there is also a risk of noncompliance and may lead to extensive audit procedures to verify disclosure and presentation assertion.
The suggested audit procedure to be performed in relation to Investment property is
Verification of Existence and valuation of Investment property via substantive procedure like visiting the property and obtaining a valuation certificate to verify the value of the land.
Check compliance with GAAP in relation to presentation and disclosure.
Given the fact that due to the aggressive expansion program and some of the personnel in key control positions were marginally qualified for their responsibilities, this leads to auditors choosing extensive procedures, since the reliability of information ( since its coming from people not fit for the job) is considered low in this case.
Over/Understatement of the foreign currency translation reserve (FCTR)
There is an inherent risk of over and understatement of FCTR. Since the company has corporate stores located in Australia, New Zealand, Singapore and Malaysia all of which are reporting in their functional currencies and translated at weighted average exchange rates for the period. This is an activity involving the financial statements translating from currency into another and than creating reserve for foreign currency translation. An error in the translation of currency may lead to over / understatement of the FCTR and therefore mispresentation of overall financial statements, leading to a risk to the valuation assertion. Preliminarily the auditor can verify the financial statement's valuation into local currency on a sample basis, and make a decision whether to go ahead with an extensive audit procedure or a limited one based on the sample testing.
Currencies and their rates fluctuate on a daily basis during the current economic situation all over the world. Therefore there is a great inherited risk of misstatement of valuation in this scenario. To overcome which recalculation on a sample basis has been suggested.
Part A - 3. Identify three other documents you would review in order to obtain an understanding of the client's operations & assist with audit planning
1.Contracts copies of Malaysian Investment properties:
Auditors will need to obtain a copy of these contracts, to ascertain what legal implications the client may be facing as a result to Criminal Code Act 1995.
2. Copies of Franchise documents
Auditors will need to obtain copies of the agreements and deeds of client's franchise in Australia and New Zealand.
3. Agreement and Memorandums:
The auditors can gain an understanding about the client and its operations by reviewing the company's Articles of Association and Memorandum of Association. They will guide the auditors about the combination of capital of the client and stake holders involved. Further, company's lease agreements, sale agreements, land documents, sales policy, return policy etc. can also help auditors gain primarily extensive knowledge of client and way of doing business.
Marking criteria:
