Identify FIVE inherent risks for the audit of Bega Cheese. For each inherent risk, identify the account or accounts that may be affected.
With specific reference to Bega Cheese’s corporate governance arrangements, you need to assess the likelihood of the potential reliance that could be placed on the overall control environment. Your conclusion should be supported by at least FIVE factors.
Recently Bega Cheese acquired the Vegemite and other Kraft brands in a $460 million deal that takes it far from its roots as a cheese producer. How will this acquisition affect your 2017 audit plan for Bega Cheese? Your answer should be supported by at least
The main responsibility for the detection and prevention of fraud lies with those who are charged with governance and the management of the company. To understand the control environment it is essential for an auditor to consider the design which is already made by the company. The risk of fraud needs to be assessed in this case as per Section 316. The inadequacy of such kind of programs and controls may constitute a material weakness or a significant deficiency. A very good example can be given of a hotline process which is for employees to report on a confidential basis any known or suspected fraudulent activity. (ASX, 2017)
To understand the design and control of a company, auditor needs to consider the following five elements and how they have to be incorporated into the process of the company:
- There must be a commitment to compete. It has to be seen that how the management have considered the competence levels for every jobs assigned. They also need to see that how those levels translates into adequate skill and knowledge.
- Auditor needs to check the Human resource policies and practices. Policies needs to be checked should be like orientation, training, recruitment, promoting, counseling and compensating. For example, how did the management respond to the control deficiencies communicated in earlier periods?
- Auditors need to check the participation of those who are generally charged with governance. Factors which needs to be considered are independence from management, the stature and experience of managers, involvement and scrutiny of the activities of the members, information received, the degree to which difficult questions are raised and pursued with management and the interaction of the management with internal and external auditors.
- Management operating style and philosophy needs to be evaluated as well. Management approach towards managing business and taking risks needs to be evaluated, its attitude towards financial reporting and information processing and accounting functions.
- One more thing which needs to be checked is the how the authorities and responsibilities are assigned. How responsibility and authority for operating activities are assigned and how reporting relationships and authorization hierarchies are established.
- Organization structure needs to be seen. The framework within which the company’s activities for achieving objectives are planned, executed, controlled and reviewed needs to be checked. (Anon., 2017)
The plan for the year 2017 after the merger is discussed below:
- Due Diligence: whenever a merger happens, the most important aspect of the company is to have a complete check on the due diligence. In this case Bega Cheese had acquired another company named as Vegemite, so auditors need to completely check every details of the due diligence conducted by the company. If there were any shortcomings in the due diligence conducted by the company then it should be reported in the audit report.Auditors should also check that the price which was paid to acquire the company should not be overpriced or underpriced. If it was overpriced then auditors need to check the accounting and valuation of goodwill and if underpriced then profit has been accounted properly or not. (TechTarget, 2017)
- Post-Acquisition Integration: auditors need to authenticate the integration which happened between the two companies. Generally integration is very risky since it brings uncertainty for people who are already working with the company. Following activities need to be done:
- Need to play advisory role to the functions which carried out the integration.
- There must be a checklist prepared to actualize the expected value from the acquisition.
- There must be proper implementation and development of communication policy to inform the acquired company’s staff regarding procedures, risks and systems.
- Impact of new management: Part of the audit plan is to assess management’s knowledge of the business and the accounting for the business. Anytime the business changes or management changes, there is a learning curve. That learning means that they are doing it for the “first time” and so they may or may not get the accounting right. For example, Vegemite might have a pension plan rather than a 401(k), requiring extensive technical computations and disclosures.
- Product/Customer differences: Vegemite business features will be new. Bega’s management may not be familiar with the credit worthiness of the customers in the Vegemite segment so their estimate for bad debts may be more of a guess than their typical product line. Vegemite may have warranty issues that Bega’s management is unfamiliar or inexperience in accounting for, introducing new risk to the audit. It does not mean they are getting it wrong. It just means that more checking is needed in the audit plan during the first “learning” year.
- Impact of controls and prior audit history: Any large change, like an acquisition, introduces new inherent risks, such as inexperience in management, new customer credit worthiness, new employees, new systems and new products. An acquisition also poses new controls risks because controls are just unfamiliar (and might be well-designed and working or not). In an audit, both inherent risk and control risk impact the audit plan. When risks increase, the amount of audit work also increases to obtain evidence that all the transaction, especially from new systems and products, support all the audit assertions.
Hence the audit plan for the year 2017 would go on a complete change since there was a merger of two companies. The audit plan which had to be followed under this scenario was discussed above in detail.
In this case Bega Cheese and Blackmores had set up a joint-venture to supply infant formula and other nutritional foods to the consumers in Australia and China. But there were some drastic changes in China and the intense competition due to which the joint-venture did not go well as expected. Hence the share price of the company had fallen and due to this fall the audit plan for 2017 would also go on a change. Audit plan after such the drastic change is discussed below: (ASIC, 2017)
- Materiality: since there was a change in share price of the company the materiality aspect of the audit plan will get affected. Since the share price had fallen, its impact in the financial statement needs to be considered. There might be a change in the true and fair view of the financial statements. Materiality is the magnitude of risk of misstatement on the true and fair view of the financial statement. Because of this judgment of a person relying on the information must have changed owing to the omission. Materiality is the very important factor because the stakeholders decisions might get affected and can even cause financial loss to them. The impact would be on the following: (AASB, 2017)
- Collecting receivables
- Contract term modification
- Deferred tax assets recovery
- Debts should be classified due to restructuring
- Revenue recognition
- Audit Risk: audit risk is a risk where misstatements exists even after the audit is completed. The fall in the share price would definitely increase the need to detect and minimize audit risk which generally includes following risks:
- Control risk: controls implemented by the company would be not be sufficient.
- Detection risk:there are high chances that in such a situation omissions and misstatements would not get detected.
- Inherent risk:even after completing the audit there are chances that misstatements and omissions still exists in the financial statements.
- Asset Retirement Obligations: companies are bound to record asset retirement obligations, so auditors are held responsible to perform procedures which would help them to determine whether the obligations are properly disclosed and recorded in the financial statements. Since the economy of China had gone down, it would impact estimated amount to compute an ARO. Due to lower price, operators need to plug and abandon wells sooner. This would even reduce the expected flows used in the ARO estimate. (AASB, 2017)
- Nature of business: every country has different geographical operation and complexity. Now since there was already an issue in China, the audit plan for the company in that particular location would definitely go on a huge change. This would be required since the dependency on audit of the company increased. The main reason behind this was the poor financial performance and failure of the joint venture.
- Contract modifications: company would also consider to modify various contracts which were entered by them. These renegotiations would provide immediate or short term relief. Below mentioned points would highlight certain situations where contract modifications should be considered:
- Employment contracts needs to be served.
- To change the specified sales prices, purchaser contracts need to be renegotiated.
- Leases which were about to expire, should be extended so that drilling plans could be delayed.
- Going Concern assumption: now since the share price of the company had gone down, there are doubts regarding the going concern assumption opted by the company. Going concern assumption is opted in a situation where the company thinks that it will run in future for a long period of time. But in this case since the joint venture business did not took off, going concern assumption needs to be evaluated in accordance with the future projections and financial viability of the company to exist in the near future.
- Changes in Regulatory framework:there are chances that changes in the regulatory framework would have a major impact on the continuance of the operations of the company, mainly when it is doing business in a foreign location. It becomes important to give more attention in this aspect as given in this case. These changes seems to be the primary reason for the failure of the joint venture and the audit plan. Due to this financial statement of the company had also got impacted and it is not giving true and fair view picture of the company.
AASB, 2017. Proposed Auditing Standard ASA 320, Melbourne: Australian Government.
AASB, 2017. uasb.gov.au. [Online] Available at: https://www.auasb.gov.au/Pronouncements/Australian-Auditing-Standards.aspx[Accessed 18th April 2017].
Anon., 2017. investsmart.com.au. [Online] Available at: https://www.investsmart.com.au/shares/asx-bga/bega-cheese-limited[Accessed 18th April 2017].
ASIC, 2017. https://asic.gov.au. [Online] Available at: https://asic.gov.au/regulatory-resources/financial-reporting-and-audit/auditors/audit-quality-the-role-of-directors-and-audit-committees/[Accessed 18th April 2017].
ASX, 2017. asx.com. [Online] Available at: https://www.asx.com.au/asx/statistics/announcements.do?by=asxCode&asxCode=BGA&timeframe=D&period=M6[Accessed 18th April 2017].
Harrabin, 2017. analysysmason.com. [Online] Available at: https://www.analysysmason.com/About-Us/News/Newsletter/Post-acquisition-integration-Jul2014/[Accessed 18th April 2017].
TechTarget, 2017. whatis.techtarget.com. [Online] Available at: https://whatis.techtarget.com/definition/due-diligence
[Accessed 18th April 2017].
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