Risks And Audit Procedures For Inventory And Intellectual Property Assets, Essay.

Question 1

Question 1

While assessing the risk of material misstatement and determining the appropriate response with regard to the inventory of Computing Solutions Limited (Computing Solutions) for the 30 June 2018 audit, you become aware of the following information:

(i) The best-selling computer presentation package has been experiencing a high level of returns owing to suspected software problems
(ii) Based on closing inventory, inventory turned over an average of 5.2 times in 2017 and 3.8 times in 2018
(iii) Computing Solutions moved its inventory from a central warehouse to six new regional warehouses in March 2017
(iv) Inventory on hand at end of year represented 22 per cent of sales in 2018 and 18 per cent of sales in 2014
(v) Computing Solutions has recently won a tender to supply a large government department with various products. In order to win the tender and prevent competitors from gaining a foothold in the public sector market, Computing Solutions agreed to supply the items at 10 per cent below their cost price. The first shipment is due to be delivered to the government department in the middle of July 2018.

Required

(a) Identify and explain the two key assertions at risk in relation to inventory
(b) Identify and describe two substantive audit procedures that you could perform in response to each risk identified above
(c) Explain the requirement of ASA 701 Communicating Key Audit Matters in the Auditor’s Report and the rationale for this auditing standard. Determine if the above matters are key audit matters, providing full rationale for the determination. If it is determined that they are Key Audit Matters, provide the disclosures which are required in Key Audit Matters Section of the Auditor’s report as required under ASA 701.

Question 2

You are the auditor of Green Machine Ltd, a manufacturer. You have obtained a summary of the property, plant and equipment for the year ended 30 June 2018, which identifies cost and accumulated depreciation brought forward, additions and disposals in the year and depreciation charges.

A review of the management letter from the previous year’s audit shows that there were some problems in relation to making a distinction between capital and revenue expenditure; some items were capitalized when they should have been expensed and other capital items were included in repairs and maintenance in the income statement.

Another risk identified from prior years relates to depreciation calculations: there is a range of depreciation rates within categories and there has been concern that the rates applied to some assets have been too low. The depreciation policy disclosed in the financial report shows:

• Building: 2 – 4% straight line
• Plant and machinery: 5 – 10% straight line
• Fixtures fittings and equipment: 5 – 20% straight line

Required

(a) Identify and explain the two key assertions most at risk in relation to the intellectual property intangible asset
(b) Identify and describe a substantive audit procedure that you could perform in response to each risk identified above
(c) Explain the requirement of ASA 701 Communicating Key Audit Matters in the Auditor’s Report and the rationale for this auditing standard. Determine if the above matters are key audit matters, providing full rationale for the determination. If it is determined that they are Key Audit Matters, provide the disclosures which are required in Key Audit Matters Section of the Auditor’s report as required under ASA 701.

Audit is referred as the process with the help of which the responsibility is dependent on the auditors relating to the implementation of logical methods in recognizing the material misstatements in the financial statements (Knechel and Salterio 2016). The auditors are accountable for keeping note of the time taken for performing the auditing work in an organization by using the assertion for preparing the financial reports. These assertions are treated as implicit or explicit claims by the management to develop and represent the financial statements.

Under certain situations the auditors have to respond to the risks assertion based on the material misstatement. The auditors are under the obligation of investigating the assertion to determine whether they are having any significant risk. The auditors while performing are required to adhere with the specific assertions and guidelines to determine the risks involved in material misstatement. The current report is based on assessing the risks involved in the audit and implementing the required audit procedures for appropriate disclosure.

Significant declarations at risk related to inventory:

The current scenario of Advanced Computer Solutions states that the auditor can recognize the two main risks assertion which is based on completeness and accuracy. The rationale for the risks is given below;

Completeness:

Inventory valuation is vital for any business. On the basis of the audit requirements, the management are under obligation of maintaining the economic records associated to inventory valuations (Mladenovic, Martinov-Bennie and Bell 2017). Besides this, incomplete information would lead to understatement of inventory. In the current case there is a risks of material misstatement given the responsible authorities fails to correctly link the information after purchase. This may result in risk of internal control. The case study represents that Advanced Computer Solutions recorded 18% sales with 26% sales of inventory in 2018. This represents that there is a chance of incorrect valuation of contributing the sales in 2017. Therefore, there is a significant risk related to the company.

Accuracy:

The procedure of performing inventory valuation is vital for the management of the business to maintain the accuracy in financial reports. Because of such concerns, the business is in the position of detecting the inappropriate techniques or errors made while valuing inventory (Kamaruddin et al. 2017). The management of every business is responsible for performing the physical count of inventory and recording it in the financial reports. This becomes for the auditors in obtaining the right knowledge because of shifting the warehouse to six new locations. The assertion associated to accuracy is helpful in recognizing the appropriate person that are accountable for recognizing the errors while performing the physical count of inventory at the declined rate of 3.8 in 2018 to the rate of 5.4 in 2017. Therefore, these combinations would help the auditors in performing all the different rationale which would permit the auditor in considering the particular risks assertion for the specified company.

Question 2

Practical audit procedures for each identified risk:

The auditors are required to perform the audit procedure for assessing risks. Similarly, in case of Advanced Computer Solutions Ltd it is evidently noticed that the auditor has identified the assertions relating to risks (Payne, Corey and Raiborn 2018). The current assessment of Advance Computer Solutions states that accurate substantive audit process would help in performing the physical count of inventory. This would enable the procedural inspection of the overall procedure. This would enable the auditors to take the process for discussing the staff responsibility that are responsible for conducting the inventory count as well as recognize the weakness in the procedure following the close observation of the sample testing of the stock errors. The company has published the data on March 2018 where it has shifted its six central warehouse in all its six locations to match with the physical count of inventory.

Furthermore, a risk assertion is noticed relating to completeness. This process helps in controlling the risks that must be performed by the auditors by indulging in the audit procedure to determine the results of physical count of inventory against its values in the books of accounts (Dunn and Sainty 2019). The auditors are responsible for recognizing the values of stock that is obtained from the physical inventory count against the probable errors. On implementing the audit procedure, the auditor would be able to acquire the information that would offer accurate inventory valuation.

Necessity of ASA 701 Communicating Key Audit Matters:

The auditors must communicate the significant audit matters under ASA 701. These standards are helpful for the auditors in numerous manners. The guidelines of ASA 701 permit the auditors in maintaining the effective communication channel with the stakeholders and government groups relating to the KAM discussion (Chaplin 2017). This would help in promoting the transparency and of financial reporting and would also improve the overall scope of the auditors that requires paying additional attention relating to the quality of audit. It is also necessary to adhere with the ASA 701 for the preparation of the financial reports. This would help in improving the quality of auditing and introducing improved understanding of the monetary reports.

In context of ASA 701, important risks assertion for the organizations is referred with reference to the Key Audit Matters based on the different reasons. Primarily, the existence of material misstatement may create an effect on the risks that may impact the financial position and effectiveness of the business (Kumar and Sharma 2015). This would additionally effect the stakeholder’s transparency relating to the judgement for management of the inventory valuation that may result in material misstatement. The key audit matters would help in supporting the above stated discussions.

Documentations relevant with ASA 701:

As per ASA 701, the auditors can recognize the key audit matters that must be disclosed in right way (Chaplin 2017). In context of the Advanced Computer Solutions sufficient justifications forms necessary in selecting the key audit matters that would enable the business in proceeding further with the substance of auditing and publishing the findings of the audit report.

Noteworthy considerations at risk associated to PPE:

As per the given study risk assertions of the auditor for Green Machine Limited are listed as follows:

Accuracy:

The companies need to carry out the relevant valuation for PPE. This will require the management for improving the amounts related to PPE transaction shown in the books of company. In addition to this, the company needs to also maintain the appropriate record for revenue and capital expenditures. The analysis of the information pertaining to the case may be depicted as per maintaining separate record pertaining to the expenditures (Pincham et al. 2016). The management of the organization is depicted to be at fault for capitalising the revenue expenses and at the same time integrating the repairs as per maintenance in the income statement. The important assertions at risk due to this are listed as follows:

Valuation:

In general, the organizations need to proceed with the valuation of PPE as per recording this value after deduction and disclosure pertaining to PPE. The guideline of such an assertion at Green Machine Limited shall be able to record the cost valuation of PPE as per charging depreciation with the deduction and disclosure pertaining to impairment and sales considered with the PPE. The inclusion of such factor will be mandatory for the organizations in disclosing the organizations for PPE standing in a fair and precise manner. As per the given case the lower depreciation will be charged on the value of PPE which will be inappropriate. Due to the lower date of depreciation, there will be a significant impact on the financial report related to the business entities (Berisha and Berisha 2016).

Practical audit procedures for each identified risk:

It is the auditor’s responsibility for conducting substantive and accurate process of audit for the individual risk areas for Green Machine Limited. The previous assessment of the company has identified that the company is not able to maintain a distinct record for capital expenditure nor revenue expenditure. Due to this, the role of the auditors may be considered by proceeding with a methodical reviewing of the organizations for capitalising the future expenses. It is also important for the auditor in better understanding of the various types of the expense which were improperly capitalised. It can be also discerned that the organization has not implemented the relevant procedure for policy of the organization to replace the economic life assessment of the assets (Ashour, Sukoharsono and Ghofar 2015).

Need for audit procedures for each identified risk:

The guideline for ASA 701 are stated pertaining to the auditors in order to assess various KAM which will be helpful in forming a relevant audit opinion pertaining to the financial statement. The procedure of ASA 701 has defined the issues which are essential for making relevant assertion in the financial statement of the company to form a judgement of the auditor. This is important for the auditor in declaring the important KAM pertaining to governance. The understanding of ASA 701 specifies the different aspects of KAM. This standard makes it essential for the companies in declaring the KAM which are to be depicted by the governance team (Heenetigala et al. 2016).

A clear understanding of the ASA 701 guideline is considered for ascertaining the KAM. This standard has made it mandatory for the corporations to consider the areas of higher risk and material misstatement as specified in the ASA 315. Moreover, the auditors are needed to review the critical judgement for the developing and anticipating the contingencies (Al?Shaer and Zaman 2018).

The case for Green Machine Limited, the detection of the risk assessment is important for depicting the essential matters audit which are in compliance with ASA 701 for several reasons. Firstly, the operating expenses for green machine may be affected due to depreciation of expense. This inaccuracy may increase profitability of the organization at the same time increasing scope of risk pertaining to material misstatement in the financial report. The given situation as identified possible deterioration in the audit report as a result of capital and revenue expenditures which may be having a negative impact on the profit of the firm (Ge, Simnett and Zhou 2017).

The statements given by Green Machine has suggested that the auditors are having the liability for detection of the KAM which shall be able to ensure appropriate disclosure of the financial statements. Furthermore, the consideration of this process has been further mentioned as per ASA 701. The auditor is responsible for fetching the necessary information which are significant for ensuring relevant disclosure of information which is followed as relevant process of audit thereby ensuring that the risk assertions are under control (Soh and Martinov-Bennie 2015).   

Conclusion 

The main risk assertion for Computer solutions is considered with completeness. This process helps in controlling the risks that must be performed by the auditors by indulging in the audit procedure to determine the results of physical count of inventory against its values in the books of accounts. The guidelines of ASA 701 permit the auditors in maintaining the effective communication channel with the stakeholders and government groups relating to the KAM discussion. It needs to be further concluded that the existence of material misstatement may create an effect on the risks that may impact the financial position and effectiveness of the business. The case for Green Machine Limited has ascertained the risk assertion as per accuracy and valuation. The companies need to carry out the relevant valuation for PPE. This will require the management for improving the amounts related to PPE transaction shown in the books of company. As per the given case the lower depreciation will be charged on the value of PPE which will be inappropriate. Due to the lower date of depreciation, there will be a significant impact on the financial report related to the business entities.

References

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