Describe about the Assessment of Audit Risk in respect to the company of Mathra Tool Inc.?
Auditing is the procedure of checking of all the accounts book and transactions whether it is stated in Financial Statement properly or not (Gramling, Rittenberg and Johnstone, 2010). It is the procedure of judging financial statements shown (Balance Sheet and Profit & Loss Account) with all the records of account and financial transaction whether it is correct or false.
Auditor risk refers to the risk that is identified by an auditor regarding financial statement. A wrong opinion regarding the financial statement is expressed by the Auditor. Audit risk consists of three risk such as Inherent risk, control risk and detection risk (Cosserat and Rodda, 2009).
Inherent risk arises due to error depending on such factors despite from the inefficiency of controls. Inherent risk will more where the business involves judgment and estimation with high degree or involves complex transaction. Control risk arises due to inefficiency in the operational activities from the side of business entity. Detection risk refers to the risk which is raised by the error or fraud in material misstatement in respect to financial statement (Leung, 2011).
The preliminary measurement of control risk is the procedure of appraising the usefulness of an organization’s accounting and in-house control system by preventing or detecting and improving the material misstatements (Moeller and Brink, 2009).
Mathra Tools Incorporation is a machinery tools producing company. It is reputed company in producing high quality of machine parts and it has grown into a $10 million-a-year business. The owner of the MTI is George Mathra. Thomas Smith appointed as auditor in charge in this company has identified several issues regarding the operation of the business.
This auditing plan includes the assessment of internal control risk and the judgment for detection risk. It also contains the description regarding the substantive procedures that could be conducted for the WIP inventory.
Assessment of Internal Control Risk
Preliminary assessment of risk measures and prevents the system of accounting and the internal controlling system of an organization regarding material misstatements (Pickett, 2010). The risk cannot be mitigated fully because there are certain inherent limitation in the system of accounting and controlling. The assessment of control risk is required when the in-house control systems of the organization are not useful and the accounting systems of the organization are not efficient (Pickett and Pickett, 2011). There are several techniques which can be used to document the information regarding the systems of accounting and internal control (Hargie and Tourish, 2009). A particular technique is selected for the judgment by the auditors. The techniques can be used by alone or together. The examples of techniques are narrative description, questionnaires, checklist and flowcharts (Reding, 2009). The outline and length of the documentation depend on the size and complexity of the business and kind of applied system in respect to accounting and internal control (Pickett, 2011). Tests of control are executed to find out the audit evidence regarding the usefulness to evaluate whether the business designed the systems correctly to prevent material misstatement and the effectiveness of internal operational activities over the period (Shim, 2011). There are several things are included in test of control. These are as follows:
1. Test of control involves checking of documents related with transaction and other activities to obtain the audit evidence that business has operated the internal control correctly or not (Louwers, 2011). Such as, it is verified that whether transaction is authorized or not.
2. It involves enquiry and observations regarding the internal controls which leave no audit trial such as finding out who really performs the all functions rather than who is supposed to perform.
Lastly, it includes the re-performance of internal control such as reconciliation of bank statement to see whether it was actually performed by the business correctly.
Business should adopt effective internal controls in the operation for preventing and detecting the occurrence of error and fraud (Beasley, 2009).
The fraud can be suspected under following situations:
If any paper is missing regarding financial transaction such as cheques, vouchers, invoices, etc.
If subsidiary books does not match with control account.
If there is huge difference in trial balance and it is very difficult to match the balance.
If variation of Gross Profit Ratio and Net Profit Ratio are high.
If there is mismatch between the balances according to the company and the verification of the balance by the parties.
If the stock according to the company’s record is not same with the stock physically counted.
If the client does not able to provide any satisfactory information.
If the some accounting figures have found overwriting
There are several steps through which errors can be detected. These are as follows:
1. Checking the balance of opening with the closing balance of last year.
2. Checking all the posting made in ledger accounts.
3. Checking the total balance of subsidiary books.
4. Verifying each and every carry forward.
5. Making confirm whether all ledger accounts are included or not.
6. Checking the total list of debtor and creditors match with the ledger accounts or not.
7. Comparing the different items of trial balance with the items of previous year.
8. Checking any differences including round figures such as $10000 is written as $1000.
9. Checking any misplacement of amounting figures such as 91 is written as 19.
10.Identifying any entry is leaved unposted from the actual books.
Duties need to perform by auditor are as follows:
1. Check up all the entire activity of financial operation.
2. Confirm all the receipts from the counterfoils or carbon copies or cash memos, sales report.
Confirm the register of salary and wages.
1. Verify the techniques used in stock valuation.
2. Examine the all registers, notes and challans related with inventory, inwards and outwards of goods and delivery, etc.
3. Compute different ratios which are required to identify the fraudulent activities and errors.
Examine the details the items which are not used.
Investigate the area where the problem is suspected.
Perform the audit process by applying sound skill and with care.
Do surprise visit in the organization to examine the accounts activities.
There is found several faults and errors in in-house control system of MTI though the company is using computerize system for the production of machinery tools. The equipment and machine are operated through computer.
The control risks relating to business operation of MTI are as follows:
1. The company has no licensed antivirus to protect the computerize system and there is no system expert.
2. There is no proper maintenance of networking system and it is maintained by only an owner of computer shop which located far from the office. So, there is no such expert to maintain the networking system all time. Only Mr. Lee is responsible for maintaining equipment, upgrading software and maintaining user security profiles on the network.
The staffs of the organization do not maintain the system related with user password. Two staffs use common password for making entry data of accounting transaction.
1. The backup is taken every end of the in tape cartridge. There are seven tape cartridges for taking for taking full set of backups for a week. But the cartridges are not kept safely and systematically.
2. There is no any protection used between office system and home system of the senior personnel. Home system can be used like as office system fully.
3. There is only one accounting staff that is responsible for all accounting activities. There is no other staff who can deal with accounts payable and cash disbursements.
Judgment for Detection risk
Detection arises due to applying of wrong procedures in auditing by the auditors to evaluate and find out the material misstatements in all activities of financial aspect (Taylor and Osborne, 2013). The total audit risk is the combination of control risk, inherent risk and detection risk. After assessing of control risk and inherent risk, the detection risk is assigned to solve and reduce the total audit risk. It is never possible to eliminate the detection risk fully because it is difficult to check each and every financial transaction completely (Beasley, 2009). But, the objective of audit is to reduce the detection risk as much as possible.
There are some elements of detection risk which are described below:
Using of wrong procedure in audit
The use of wrong procedure can increase the detection risk (Weirich, Churyk and Pearson, 2012). Such as, certain ratios are used to analyze the financial statement. But, the selection of ratio is very important. If the auditor choose wrong ratio (has no link with the objective of audit) in assessing the misstatement in financial activities, it can increase the detection risk.
Wrong interpretation of audit results
After auditing with correct procedure, if wrong interpretation is made from the results, it can increase the audit risk. Such as, it may be interpreted that the accounts payable is shown correctly but it is found a material misstatement in actual.
Selecting of wrong testing technique
Detection risk can be reduced by using of specific testing techniques for detecting the errors in financial transaction (Millichamp and Taylor, 2012). Such as, to confirm a particular sale occurred, it is not required to check the invoice whether is mathematically correct.
During the checking of accounts payable, it is seen that accounts payables are actually paid or not by making test the invoices. It may be the correct audit procedure for asserting the accounts payable which can helps to interpret the decision of no material misstatements in respect to accounts payable.
Sometimes, it is observed that there is involvement of several persons in maintaining financial transaction. Suppose an employee make process the payment and another employee does update the supplier’s file by marking the invoice as paid. Then the auditor may fail to test the separate duties of two employees. As a result, misinterpretation can be found and it can increase the detection risk.
Substantive Procedures for the WIP inventory
Substantive procedures have an important role in audit planning. The substantive procedures of WIP inventory are as follows:
1. The first procedure includes the observation of physical inventory of the company through using separate inventory observation program.
2. It is to be verified that the inventory held for another parties are not added in total inventory figure at the end of the year.
Whether the inventory held at another party location is added in inventory listing at the end of the year, it is to be confirmed.
It is to be obtained and agreed whether the listing of inventory is matched with general ledger or not.
The valuation methods are used by the owner which needs to discuss. Valuation may be regarding any change in machinery product, change in process of production system, accounting system applied, techniques applied to gather cost of inventory, etc.
Clerical accuracy is needed to check from the summary of physical inventory of the company.
Next process is to review of physical inventory listing and identification of each and every item related with raw-materials, WIP and finished good. Documentation is to be made from the selected items.
After reviewing of WIP, the costs are required to test. The nature of cost accounting system is to be determined such as system of job order and the process of cost system, checking of the quantities of raw material used and checking of labour charge used in production process, testing of overhead rate, etc. In case of WIP, it is required to test the pricing by calculating overall percentage complete in manufacturing process. It is need to evaluate the method used by the company for calculating the inventory.
1. It is to be checked whether the standard techniques are used to calculate the cost and find out the sales price.
2. It is to be determined what methods are used for inventory valuation especially when the actual cost exceeds the sales price.
3. It is to be examined whether finished goods required to written down after sold at the end of the year.
After calculation of ratios, it should compare with the previous year or with the industry whether there is any difference. (such as gross profit margin)
All the accounting figures such as raw material, inventory turnover and finished goods are required to compare with the last year or with the industry.
It is needed to evaluate the days of inventory with the past year or with industry standard.
Whether the standard cost of present year is different from the previous year, it is needed to compare taking into consideration of present conditions.
It is to be checked the listing of inventory to make sure that it has been appropriately classified from raw-materials to finished goods or not.
In the conclusion it can be said that control risk and detection risk should be reduced to reduce the total audit risk and the total audit risk cannot be removed due to existence of inherent risk. Audit planning is made to identify or detect the problems regarding of those risk and it is planned to perform the audit efficiently and timely. Audit plan is conducted at the time of beginning of audit process to develop the entire approach of audit focusing to the important areas. It can be said that audit plan is certain guideline which is to be followed in audit process.
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