Purpose of assignment
Purpose of assignment
The purpose of the assignment is to build your skill to research and explore specific aspect(s) of auditing and assurance as a group, and prepare and submit written work in academically acceptable format linking your KNOWLEDGE of auditing standards, corporate law and auditing guidelines and ethical standards to the world of corporate auditing for an Australian Listed company.
This is a two-part assignment. In Part A of this assignment, you are required to carry out a risk assessment of Xero Limited, a company listed on Australian Stock Exchange, and prepare a plan for audit of this financial report audit engagement for the year ending 31 March 2020. You have worked as the manager of this engagement for the past five years. You are now asked to present written response on three key segments of the audit plan primarily based on the audited financial report of the company for the year ending 31 March 2019 and other publicly available information on the (a) five key facts about the company, its management and governance, (b) analytical review of company’s performance and financial position, and (c) discussing five main matters that are required to be addressed for planning the audit for the year ending 31 March 2020.
In Part B you are required to submit a research essay on the effectiveness and efficiency of the current regulation of company audit in Australia and around the world. It appears that the future of auditing and auditors are set to be significantly revised and rewritten.
You are the audit manager of Ernst & Young, Chartered Accountants, Wellington for the past 5 years. Your engagement partner asked you to carry out a risk analysis and audit plan of Xero Limited for the year ending 31 March 2020. The engagement partner called you in his office on 1 June 2019 and asked you to complete the following preliminary planning tasks and report to him on 30 June 2019:
You are therefore required to prepare a written report
(i) Explaining four key facts about the company that highlight company’s business and audit risks for financial report audit of the year ending 31 March 2020
(ii) critically reviewing company’s history on four main aspects of performance and financial position for financial report audit of the year ending 31 March 2020
(iii) discussing four main matters that are required to be addressed for planning the for financial report audit of the year ending 31 March 2020
Regulation of company audit has attracted many media headlines for wrong reasons. The auditors and regulators have drawn significant challenges and criticisms in recent years around the world, especially for audit services provided to large listed public interest entities. Some auditing scholars believe that there is hardly a future for financial report auditing unless auditing, auditing profession and its regulation and quality is significantly overhauled.
You are therefore required to prepare a written research essay
(i) discussing four key regulatory failures in the audit of large corporations listed on stock exchange
(ii) discussing four recommendations of regulatory reform to ensure proper conduct of large public interest entities and its management and governance.
It is the responsibility of the auditors to assess the business risks and other key aspects of financial performance and position of the clients in order to identify the areas that require further audit investigation; and this whole assessment is a key part of audit planning. The main aim of this report is to undertake the audit planning of Xero Limited for 2020 audit by taking into consideration the relevant aspects in 2019 audited financial statements. The first part assesses the business risks and audit risks of Xero Limited, the second part reviews the four main aspects of the financial performance and position and the last part assesses the matters need to be addressed in audit planning.
- Xero Limited has to face major competition in the market and this needs the company to ensure developing and delivering innovative products and services to the customers for gaining competitive advantage (xero.com 2020). This increased competition needs to be considered as a business risk for Xero Limited as it can be a barrier for the company to achieve its goals and objectives. This competition can affect the accounts such as sales, inventory, accounts receivable of the company (Sadgrove 2016).
- As mentioned by Xero Limited, access to talent is a crucial aspect for the business success of the company and the company needs to more talented employees to work for it across the globe (xero.com 2020). This aspect always develop the business risk of not having adequate number of talented employees within the organization to perform the jobs and this can affect the company’s ability to achieve the goals and objectives. This can lead to risk of material misstatements in the financial statements of the firm.
- Xero Limited has to face the foreign currency risk where the cash flows of the company are negatively affected by the changes in foreign currency exchange rate (xero.com 2020). This particular business risk can lead to the development of inherent audit risks in the area of proper accounting treatment of exchange gains and losses. Moreover, this business risk can also contribute to the development of inherent audit risk related to the accounting treatment of financial derivatives (Ghosh and Tang 2015).
- It can be seen from the 2019 annual report of Xero Limited that the company has used many accounting estimates and judgments for the accounting treatment of some of the key items of income statements and balance sheet; such as inventories, financial derivatives, financial instruments and others (xero.com 2020). These accounting assumptions and estimates are full of assumption uncertainties which can lead to the development of audit risk of material misstatements (Chou 2015).
- 2019 Annual report of Xero Limited shows a key 36% increase in total operating revenue of the company from $406,659,000 in 2018 to $552,819,000 in 2019. Increase in this revenue includes 35% increase in subscription revenue and 62% increase in other operating revenue (xero.com 2020). In the presence of many business risks disclosed by the company, increase in sales revenue indicates towards the possible overstatement in sales revenue as an attempt to improve the overall financial performance (Munteanu 2015).
- As per 2019 annual report of Xero Limited, gross profit of the company has increased by 39% that is from $331,310,000 in 2018 to $461,904,000 in 2019 (xero.com 2020). It can also be seen that cost of revenue of the company has increased by 21% from $75,349,000 in 2018 to $90,915,000 in 2019. Therefore, even in the presence of increase in cost of revenue of Xero Limited, gross profit has increase by large margin in the same year (Saha, Bose and Mahanti 2016).
- Statement of financial position trend shows that total assets of Xero Limited have been increased significantly from 2017 to 2019; that is $335,870,000 in 2017, $350,616,000 in 2018 and $970,318,000 in 2019 (xero.com 2020). The main reason for this increase in the increase in some of the crucial asset items such as short-term deposits, trade and other receivables, derivative assets, property, plant and equipment, intangible assets and others.
- Alike total assets, total liabilities of Xero Limited have increased significantly over the last three years; that is $96,540,000 in 2017, $109,532,000 in 2018 and $617,009,000 in 2019 (xero.com 2020). One major reason for the increase in total assets is the increase in lease liabilities due to the adoption of new lease accounting standard of AASB 16 Leaseswhich requires recording right-of-use assets and lease liabilities in the statement of financial position (Lundin et al. 2015).
- Xero Limited has mentioned under business results in 2019 annual report that gross margin percentage has increases by 2.1pp from 81.5% to 83.6% (xero.com 2020). Even if increase in gross margin is a positive aspect for the financial performance of Xero Limited, it also an indicator that total sales revenue of the company might be overstated through entering fictitious sales in the absence of a corresponding cost of revenue entry. Therefore, investigation of this area needs to be considered in audit planning of Xero Limited (Rodgers, Mubako and Hall 2017).
- It can be seen from the portion of business results in Xero Limited’s 2019 annual report that the percentage of net loss of operating revenue has decreased from -6.1% to -4.9% which is an increase of 1.2pp; and decrease in net loss percentage is a positive aspect for the financial performance of Xero Limited (xero.com 2020). However, it also indicates towards the possibility that sales revenue might be overstated when operating and other expense might be understated intentionally in order to reduce net loss. Therefore, investigating occurrence, completeness, accuracy and cut off assertion of expenses need to be considered in the audit planning of the company (Camilleri 2018).
- Trade and other receivable of Xero Limited has continuously increased from 2017 to 2019 which is supported by the increase in sales revenue. Thus, there is a fair possibility that the value of trade and other receivables has been overstated in order to support the increase in sales revenue. Therefore, addressing the existence assertion of trade and other receivables need to be considered in audit planning.
- It can be seen that the amount of term debts in Xero Limited in 2019 is $357,731,000 which was nil in the previous year (xero.com 2020). This puts the obligation on the auditor to address the occurrence and existence assertions related to term debts in long-term liabilities in the audit planning phase of Xero Limited (Pritama, Supriana and Torong 2018).
It can be seen from the above discussion that business risks which hinder the ability of a company to achieve its goals and objectives can lead to the development of audit risk of material misstatement in financial statements. Moreover, the auditors are needed to assess the historical movement in the values of major financial performance and position item for assessing the presence of any issues in them which need to be addressed in the audit planning of 2020 of Xero Limited. Consideration of these aspects lead to the completion of a quality audit.
In this report, we are mainly going to discuss about the failure of regulatory framework that ultimately leads to big scandals and big loss for the top listed companies all over the world.
In this part, we are going to discuss about specific regulatory audit failures that arisen in various leading listed companies all over the world. It is an evident fact that generally audit regulatory failures arises when the auditor deviates from the specified professional standards and present the opinion in such a manner relating to the audit report that it represent false information.
Enron scandal is one of the largest accounting scandal of all time. The company was one of the leading company in US based energy, commodities, and Service Company however, the company was able to convince its investors that it is performing well in the market but it was not the real business scenario for the company. The regulatory authorities failed to identify the loopholes in the company and thus, it results to failure of the company. The company was using MTM method of accounting that is mark to market accounting that deals with recording of assets at fair market value (Corporate Finance Institute, 2020). However, fair values are hard to determine, the company was unable to explain its stakeholders, and it is seen that actual cash flow that reflected from company assets was less that cash flows that were initially reported to Securities and Exchange Commission. Even the regulatory authorities were unable to identify the Special Purpose Entities (SPEs) that the company had set up to hide its losses. Most of the SPEs did not exist and were only represented on papers.
Part A: Risk Assessment and Audit Plan of Xero Limited
WorldCom tends to be one of the biggest accounting scandal in US history. The company was in news after an internal audit resulted to improper accounting of more than $3.8 billion in expenses over the last five quarters (Cbsnews.com, 2020). The business reflected that accounting irregularities consisted of expenses, capital expenditure inflated its cash flows, and if exact audit has been done the financial report of 2001 and first quarter of, 2002 would have shown net loss.
Satyam fraud in India was a corporate scandal affecting India based company in 2009. The chairperson of the company confessed that the company reflected falsification in its accounts. In 7 January 2009, the chairperson of the company confessed to inflating cash and bank balances of the business (The Financial Express, 2020). The company chairperson in an interview claimed that the company is having cash balance of Rs 4,000 crore and it might raise further to Rs 15,000-20,000 crore. SEBI found PWC guilty for the fraud and banned the network entities of PWC from issuing any audit certificates to any listed company in India for two years.
Vivendi faced accounting scandal and Andersen audited the company. The shares of the company fell by a third and it reported that the business tried to flatter its 2001 accounts by almost Euro 1bn. It has been reported that the company instructed its auditor Anderson to book the transaction in such a manner that it reflects profitable situation for the company (Accountancy Age, 2020). However, after conducting various meeting with the regulators the real scenario was revealed.
An effective audit recommendation mainly refers to providing suggestion for correcting various issues and addresses various causes of the issues. Ensuring audit quality is extremely vital for all business organization as investors generally rely on audit report and according to audit findings; they make their further business decisions. The quality of financial report is one of the significant factor in business as audit reports are mainly prepared to inform the markets and investors about the financial performance and position of the company. There must be proper audit procedure so that large public interest entities can reflect true and fair position and condition of its management and governance.
The company needs to conduct effective quality reviews of audits. Findings proper audit evidence to form an opinion on financial report.
It is essential to identify the root cause of findings from the quality reviews and audit inspections. Even after identifying any loopholes in the entire system, development and implementation of action plan must be present to address various findings and ensuring that proper remedies are undertaken by the organization that results to profitable situation.
Part B: Research Essay on Audit Regulation
Reviewing the entire employee structure is extremely essential and to ensure that they are properly resourced to undertake increasingly complex audit into future.
Before heading towards conducting the audit procedures, the company needs to ensure the sustainability of reviewers. Reviewers needs to be independent, must conduct the audit procedures with all the regulatory frameworks, and specifies rules and regulations as per the audit framework. The reviewer must have adequate skill and expertise to identify loopholes in the accounting system and must try to evaluate each aspect of the business that comes under the framework of the audit rules and regulations.
Each findings identified and addressed must promote audit quality and must reflect true and fair representation of the financial report as investors mainly rely on audit report to make any further decision regarding investment opportunities.
Lastly, the report concludes that because of various regulatory complications and inappropriate audit procedures leads to accounting scandals that ultimately results in shutdown of the companies. There are various types of issues that has been discussed, which reflects that because of failure of regulatory authority there has been scandals that arises in the big listed companies.
Accountancy Age, 2020. Now Vivendi Rocked By Accounting Scandal - Accountancy Age. [online] Accountancy Age. Available at: <https://www.accountancyage.com/2002/07/02/now-vivendi-rocked-by-accounting-scandal/> [Accessed 8 May 2020].
Camilleri, M.A., 2018. Strategic planning and the marketing effectiveness audit. In Travel marketing, tourism economics and the airline product (pp. 117-135). Springer, Cham.
Cbsnews.com, 2020. World-Class Scandal At Worldcom. [online] Cbsnews.com. Available at: <https://www.cbsnews.com/news/world-class-scandal-at-worldcom/> [Accessed 8 May 2020].
Chou, D.C., 2015. Cloud computing risk and audit issues. Computer Standards & Interfaces, 42, pp.137-142.
Corporate Finance Institute, 2020. Enron Scandal - Overview, Role Of MTM, Agency Conflicts. [online] Corporate Finance Institute. Available at: <https://corporatefinanceinstitute.com/resources/knowledge/other/enron-scandal/> [Accessed 8 May 2020].
Ghosh, A.A. and Tang, C., 2015. Auditor resignation and risk factors. Accounting Horizons, Forthcoming.
Lundin, A., Hallgren, M., Balliu, N. and Forsell, Y., 2015. The use of alcohol use disorders identification test (AUDIT) in detecting alcohol use disorder and risk drinking in the general population: validation of AUDIT using schedules for clinical assessment in neuropsychiatry. Alcoholism: Clinical and Experimental Research, 39(1), pp.158-165.
Munteanu, C.C., 2015. Audit Risk Assessment in the Light of Current European Regulations. Acta Universitatis Danubius. Œconomica, 11(3), pp.94-105.
Pritama, Y., Supriana, T. and Torong, Z.B., 2018, January. The Factors of The Infuence on Audit Quality at The Inspectorate General of Ministry of Environment and Foresty. In 1st Economics and Business International Conference 2017 (EBIC 2017). Atlantis Press.
Rodgers, W., Mubako, G.N. and Hall, L., 2017. Knowledge management: The effect of knowledge transfer on professional skepticism in audit engagement planning. Computers in Human Behavior, 70, pp.564-574.
Sadgrove, K., 2016. The complete guide to business risk management. Routledge.
Saha, P., Bose, I. and Mahanti, A., 2016. A knowledge based scheme for risk assessment in loan processing by banks. Decision Support Systems, 84, pp.78-88.
The Financial Express, 2020. What Was Satyam Scam Which Toppled India’S Fourth Largest IT Company From The Top Slots. [online] The Financial Express. Available at: <https://www.financialexpress.com/industry/what-was-satyam-scam-which-toppled-indias-fourth-largest-it-company-from-the-top-slots/1010389/> [Accessed 8 May 2020].
Xero.com. 2020. 2019 Annual Report. [online] Available at: https://www.xero.com/content/dam/xero/pdf/about-us/xero-limited-annual-report-fy19.pdf [Accessed 8 May 2020].
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