Introduction to Audit Assertions
Audit assertions are the management estimates and judgements and treatment of various accounting items in respect to various elements and sections of the financial statements of the entity. It is the responsibility of the management of the company to prepare the books of accounts of the entity and to place and implement the relevant internal controls in place for the same. This is one of the way to ensure that the accounts of the entity are free from errors, omissions and material misstatements. Also, the responsibility can be fixed on the management of the company. The auditor can verify the same and then based on the professional judgement, can opt to rely on the same while doing the audit or opt for applying additional audit procedures to get sufficient and appropriate audit evidences for the audit (Andiola, et al., 2018). The assertions are mainly categorised into 5 major categories namely the completeness in recording of transaction, the existence of the asset or liability (substance over form), rights and obligations in respect of asset or liability, valuation of the asset and finally the disclosures to be made in respect of something. The two below mentioned case studies discusses the audit assertions, the audit procedures to be employed and finally the key audit matters to be disclosed in that regards (Appelbaum, et al., 2018).
Question 1: Inventory
The given case is on Computing solutions which deals with the computer related inventory and the auditor has few of the observation while doing the audit for June 2018. Some of the audit assertions in this regard are as follows:
- Disclosure: As per the relevant Australian accounting standards all the critical and significant information which may affect the decision making of any user should be disclosed clearly in the financial statements in a manner which is understandable to the user. The company should comply with the same and disclose all the material information. In the given case, the company’s inventory turnover ratio has decreased from 5.2 times in 2017 to 3.8 times in 2018 which clearly shows that the inventory movement has gone down drastically, also the company has moved the stocks and the existing inventories from the central warehouse to the six regional warehouses which might have an impact on the indirect supply chain costs and therefore the same should be disclosed(Axelsen, et al., 2017). Finally, it is a standard that the inventories should be valued at cost or net realizable value, whichever is lower but in the given the company is altering the inventory valuation process by valuing it at 10% lower than the cost to meet the major tender received from the large government department. This is one of the major changes in the policy of the company and therefore the same should be disclosed in the financial statements. All this is required to be transparent with the relevant stakeholders and therefore it needs to be seen if the company has met the same (Bailey, et al., 2017).
- Valuation: Valuation is one of the complex areas where a lot of judgements and estimates are involved. Some companies even take the help of the valuation experts in valuing the inventory of the company. As per the accounting standards, the inventory must be valued at net realizable value or the cost, whichever is lower(Bumgarner & Vasarhelyi, 2018). Besides, that, it also needs to be checked what is the treatment of wastage being done by the company and how are they treating abnormal things. In the given case, the computing solutions has valued the material at 10% less the net realizable value. There is always a risk that the material or the inventory might become obsolete in case of the technological improvements in the industry and therefore the company and the management must take care of this aspect of valuation (Fukukawa & Mock, 2011).
Key Audit Assertions
The substantive audit procedure may be defined as the procedures being employed by the auditors in the conduction of the audit and it includes vouching of income and expenses and verification of the asset and liabilities (Garon, 2018). Based on this checking only, further analytical procedures to be employed by auditor is being determined which forms the basis of the overall audit opinion. In the given case, the audit assertion to be employed for audit of Computing solutions has been mentioned below:
- Disclosures: With regards to the disclosures in the annual financial statements of the company, the auditors should first check the test of controls as to whether the relevant, necessary and the compulsory disclosures have been shown in the notes on accounts in the financial statements. The same should adhere to the provisions of the law and the Australian Accounting Standards. Furthermore, with respect to inventory, the company should be disclosing the inventory valuation method, the provisioning norms followed by the company and what is the bifurcation of the raw material, work in progress and the finished goods(Heminway, 2017). In case the company has changed the valuation policy, then the same should be disclosed along with the reason and effect of the change, which is applicable for the given company.
- Valuation: With respect to valuation of the inventory, the auditor should be made aware of the estimates and judgements being used by the entity during the valuation as it is a subjective concept and can vary from company to company. The auditor should first be employing vouching and verification to ensure that the purchases is properly supported by the bills and the invoices and there are no chances of errors and omission in this. The value of the inventory should be matching with the ledger books and the auditor should also be taking the help of the expert on valuation being used. It should be checked if the management has undervalued or overvalued the stock and if the taken the correct rates for discounting and valuation and should be in line with the market rates. The auditor here should also be checking if the inventory has become obsolete and the same should be provided in the books or not(Sirois, et al., 2018). Since, in the given case, the management is valuing the inventory at cost price les 110%, it should be checked by auditors if the same will not result in material misstatements and is allowed by the accounting standards (Segal, 2017).
Communication of Key Audit Matters in the Auditor’s Report
The communication of Key Audit Matters in the Auditor’s Report is compulsory as per ASA 701 and they should be reporting all the important, critical and significant matters relating to the company is this section which can prove to be material from the perspective of decision making (Rimmer, 2017). It is very helpful for the decision makers as it shows what all were the important key audit matters and what was the audit procedures being applied to check on the same. In the given case of Computing solutions, inventory has been regarded as one of the key audit matters as the same constituted 22% of the overall sales in 2018 and 18% of overall sales in 2017. It is the extent of materiality due to which it should be reported as KAM and the disclosures in regard of the same should be:
- The rights and obligations with respect to the inventory in hand and whether proper contractual agreement is in place with all the vendors and the related parties.
- What is the valuation method being used by the company for each of the components of inventory – raw materials, work in progress and the finished goods
- Whether there is any material change in the policy with respect to inventory – reason and impact of the same(Mock, et al., 2018).
- What are additional audit procedures being employed by company for inventory checking and provisioning and if the same is sufficient and appropriate.
All these points will increase the transparency of the financial statements and will help in several decision-making measures.
Question 2: Intangible Assets
This case study deals with the client named Beautiful Hair Ltd, whose audit is being done by the audit senior from Howard and Associates. As per the given case, the company is planning to acquire one of the small businesses named Shimmer Pty Ltd as the product of Shimmer is unique and it goes well with the business model of Beautiful Hair. The company has therefore approached a regional bank for arranging the funds (Lessambo, 2018). One critical point here is that the owner of Shimmer is the only person who knows the formula of the product and the same has been well documented and the company Beautiful Hair is contemplating to buy this as technical knowhow in the form of intellectual property and will be recognising the same as per AASB 3 – Intangibles: Recognition and Valuation. The audit assertions in this regard are as follows:
- Completeness: Recording of the complete transaction of accounts in the financial statements is one of the basic requirements which needs to be ensured. IT needs to be checked if the company has recorded all the aspects of the transaction in the books and it is reflecting all the important points about the same. The intangible assets forms one of the most significant portions of the asset side of the balance sheet and it needs to be verified as to what is the purchase consideration for purchase of technical know-how by Beautiful Hair Ltd from Shimmer(Kachelmeier, et al., 2018).
- Valuation: Valuation of the intangible asset is a very difficult process and there are many provisions and assumptions that are involved in it. The first major valuation technique is that valuation is done based on the market value. For every company there are different kinds of intangible assets and different methods that they follow. In case of these kind of asset it is very difficult to align the asset with the revenue that they generate and hence valuation becomes very difficult. In case of Beauty Ltd, they want to buy a technical know-how from Shimmer Ltd and that is a complex process and for that they need to undertake help from valuation experts who can guide them accordingly(Kangarluie & Aalizadeh, 2017).
Substantive Audit Procedures
There are few audit procedures that the auditor need to undertake to form an opinion on the validation of the above points with respect to intangible assets. These are-
Completeness – To check completeness, the auditor needs to have proper knowledge regarding the asset and the different types of provisions that are applicable to it. It also need to understand AAS3 to know whether the asset has been correctly reported in the financial statements or not. They can also take help from various valuation experts who can help them in forming the required opinion (Knechel & Salterio, 2016).
Valuation – To determine whether the value of the asset is correct or not, the auditor should check the basis on which the company is recognizing the asset in its financial statement. There are lot of assumptions involved on part of the management so they need to understand that proper valuation is done or not and proper internal controls are in place or not. It is also necessary to check whether proper agreement is there in case of assets that are not self-generated (Mubako & O'Donnell, 2018). All the important market rates should be checked and based on that valuation should be done. It is important to check whether the assets are proper valued and what are the areas that the auditors need to check for his self-satisfaction.
Communicating Key Audit Matters in the Auditor’s Report
ASA 701 deals with communication of key audit matters that the auditor needs to do and make necessary disclosure in the books of account. It helps in making the investors aware about the areas in which there can be a possible chance of risk and the auditor has checked those areas and framed an opinion. In case of the given asset the following disclosures need to do –
- The method of valuation that Beauty Ltd has taken into consideration and the relevant market standards that the company has applied for the asset.
- The company has complied with the relevant auditing and accounting standards as per the AAS3 and have given relevant disclosure in their books of account.
- The auditor will specify the various steps that have been undertaken for the valuation of the assets and the opinion of the valuation experts should also be stated.
- The KAM will also include the key audit procedures that the auditor has undertaken for the valuation of these assets.
- In case there is any impairment cost then same should also be calculated and stated in the annual report(Bumgarner & Vasarhelyi, 2018).
An extract from the JB HiFi company has been taken to form an opinion on how auditors have disclosed the KAM in their audit report
In the given company, the company is having various cash generating units that are part of their key audit matter and same has been stated in their annual report under the KAM. In the given financial year, the company is having impaired goodwill of $14.7 million and impaired plant and property of $1.1 million. The company has adopted the method of discounted cash flow to value the goodwill. The auditor has adopted various steps to check the company’s value-in-use model and has also checked the historical accuracy of the asset that they have provided. The auditor has also taken help from valuation experts and that have also been stated.
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