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Inherent Risk Factors at Financial Report Level

Discuss about the Auditing and Assurance Services for Principles and Practice.

The probability of misstatement in financial reports depends on the level of various risks, associated with the financial and non-financial aspects of the organizations. Proper audit process helps the organizations to minimize those risk factors and to exhibit true and fair financial position and performance of the business. Still, it has been noticed that there are some factors, which cannot be controlled by the auditing processes.

In audit term, the risks of any error or omission in the financial statement, caused by such uncontrollable factors, are referred as inherent risks. Inherent risks mainly rise due to higher level of complexity in the financial statement and involvement of financial estimation or assumptions (Miller et al. 2012).

From the financial statements of One.Tel, it is quite clear that in the year 2000, the company has performed very poorly. However, it is very unlikely that the poor performances have not affected the financial position of the company very much. Rather, the balance sheet of the company exhibits that the financial position of the company in 2000 was better than that of previous year. From such disparity in the financial statements, it can be stated that there are some inherent risk factors, associated with the financial statement.

Financial reports are the final outcomes of all the business activities and financial transactions of an organization. Therefore, it reflects all the errors or omissions, caused by the various inherent risks, associated with the business activities. There are several factors, which are responsible for increasing the inherent risk level (Abraham and Shrives 2014).

Effectiveness of marketing plan is one of such inherent risk factors. The income statement and cash flow statement of One.Tel reflect that the company has failed to generate sufficient amount of income from the basic operating activities. It may been caused by ineffective marketing plans. Marketing plans are made for attracting more customers and increasing the income or profit of the organization. The plans are made on the basis of consumer behavior analysis and future market prediction. The effectiveness of the marketing plan, is , therefore, depends on the accuracy of the behavior analysis and market prediction. If the management fails to analyze the nature of the consumers properly, then it would not be able to prepare an effective plan, which can attract more customers. Moreover, the market prediction is very complex and involves various economic, political and social aspects. In reality, it is not possible to cover all the aspects. However, for a sound marketing plan, it is very necessary to cover the aspects, which are closely related to the nature of the business and product. If any necessary aspect is not considered properly for the marketing plan, then the plan cannot be considered as effective. As, it is not possible for an auditor to control the effectiveness of the marketing plan, the factor increases the inherent risk level very significantly at the financial report level (Beasley et al. 2012).

Identifiable Inherent Risk Factors during Strategic Business Risk Assessment

Change of consumers’ preferences is another inherent risk factor, which can affect the financial statement. It has been observed in the telecom industry, that the customers often change their network service providers for obtaining lucrative schemes and offers. Therefore, through attractive marketing and advertisement campaigns, the telecom companies may attract many consumers for certain offers, but face great challenge to retain the consumers for longer period. Such fast changes of consumers preference affects the sales of the company over the periods and alters the financial outcomes of different financial periods (Bratten et al. 2013).

The labors and staffs may also raise the inherent risk level high at the financial reporting level. Such risk level is much higher in the companies, where the total workforce includes higher numbers of new and inexperienced employees. The productivity level of any organization is very much relied on the efficiency level of the employees. The efficiency level of the employees uses to depend on the experience, training and dedication of the employees. The new employees may not provide high quality services or optimum output due to inexperience. Moreover, the existing or older employees may also fail to provide the output at desired level for various reasons. The company may introduce such employment policy, which would create negative impact on employees. In the peak seasons or in pressure, the employees require additional motivation. In absence of the proper motivation from higher management, the employees may not perform as desired. Moreover, if the company adopts any new technology or system, the management should improve the skills of the employees accordingly. Apart from that, the company should arrange training programs for the employees to update their skill & knowledge, so that they can provide better service to the company (Arens et al. 2012).

There are various risk factors, which can be identified during strategic business risk assessment. Through various risk assessment processes and the sensitivity analysis, management can assess the risk levels, associated with the factors.

The operational and other business planning is one of such factors. The management can identify the various risks associated with the new business plans by analyzing the plan for alternative circumstances (Baxter et al. 2013).

Market condition is another factor, which can affect the financial reporting of the company. The company can assess the various risks, associated with future changes in the market by proper market research and analysis.

Economic condition of the nation can also increase the risk level. It risk, associated with the national and global economy, by observing the change in the economical factors and analyzing the various economic data periodically.

Inherent Risk Factors associated with Accounting Balance

The business organizations may also suffers greatly due to change in government policies. Therefore, by analyzing the changes in the government structure and declarations from governments’ end, the company can assess the risk factors, associated with any new government policy (Sadgrove 2016).

Inherent risk arises on account of the particularity of the entities activities, nature of account, environment and its operation. The history of errors and the characteristics of management are perceived to be the major determinants of the inherent risks. The errors affecting the financial statements of the entity that is the risk factors associated with the accounting balance and the detection of such inherent risks would help in the risk assessment. The accounts of balance suffer from various inherent risk factors and the assessment of such risk would help the auditors and contribute to the increased risk assessment (Cohen et al. 2014).

The factors that need to be considered are that the accounts balance is considered of many high volume transactions that are non routine in nature. Some of the adjustments that are made in the accounts of balances do not exist in the ordinary routine process of the business. There are many complex transactions that are made in the accounts of balances. The auditor needs to assess the risks involved in auditing the account balance by considering the inherent risk factors (Messier 2016).


Some of the inherent risk to be assessed is based on the factors are that the financial reporting that actually depicts the result are different from the real projection. This is so because there are some financial transactions which need to be treated sing the complex calculation and when the simple calculation is incorporated then it can be misstated. The company, which is not in a stable financial situation, such company intended to meet certain covenants has greater incentive to misstate financial information and this is inherently. Suppose, a company has wrongly presented its financial data or if there is any discrepancies in the accounts in the previous year and so, is inherently likely to present in the same form. Such factors are mainly considered by the auditor to assess the inherent risk (Kunz et al. 2014). 

The inherent risk at the financial statement affects the potential outcomes and the operations of business. When the auditor is assessing the inherent risk, the factors affecting the judgment and the subjectivity of the financial statements are considered. The factors considered is the integrity and competence of the management and the preliminary interview that is held with the management. The auditor based the assessment whether there are any transactions that are unusual with the significant party or the outsiders (Porter et al. 2014). The history of the company regarding the estimates of the meeting analysts or there is any expectation of the growth earning. This can be explained with the help of an example say, the former CFO of any company was held liable for engaging in the fraud concerning the securities. He was engaged in a scheme that was intended to backdate the “stock option grants”. The fraud was mainly attributed to the integrity of the management. The inaccuracy of the financial reporting was mainly attributed to the failure of the accountant to maintain the accurate accounting record (Crous et al. 2012).

Going concern can referred as those organizations, which are expected to continue its business operation for infinite period and will not liquidate in the coming future. The business organizations, which are enlisted as companies, are regarded as going concern under statutory guidelines. Still, many companies discontinue its operations during the course of period (Harrison and Wicks 2013).

Therefore, the users of financial statements analyze the different financial statements to measure the organization’s capability for continuing the operation in future. Mainly three aspects of the organization are analyzed to measure the continuity prospect of the organization – liquidity, solvency and profitability (Carson et al. 2012).

Liquidity aspect describes the liquid asset position of the company. It helps to ascertain whether the company can cover its current liabilities by its current assets. In other words, it depict whether the company has sufficient working capital to operate the normal business activities. If the company does not have the adequate liquid assets then it may lead to liquidity insolvency and the company may have to discontinue its basic operational activities. Current ratios are the most widely used tools to measure the liquidity aspect of any organization. The current ratios of One.Tel for 2000 and 1999 are shown below:

Solvency aspect is used to measure the overall financial strength of the company. It describes whether the company owns enough assets to pay off all its liabilities. It also helps to understand the capital structure of the company. Debt to Equity ratio, Equity ratio and debt ratio are three ratios, which measure the solvency aspect of any organization (Horngren 2013). The three ratios of One.Tel for 2000 and 1999 are given as follows:


The profitability aspect narrates the financial performance of the company in terms of profit or loss. Any business organization operates for earning profit. Profitability aspect describes whether the company has performed effectively and has earned adequate profit. If the company cannot earn adequate profit then it cannot operate properly in the future due to insufficiency of funds. Return on Assets, return on equity and return on capital employed are some of the common profitability ratios. Theses ration of One.Tel are shown in the following graph:

The financial statements of One.Tel and the graphs, shown above describes that the current ratio has reduced over the years. However, still the current ratio is above 1.5, which states that the company has enough current assets to cover its current liabilities. The solvency ratios have improved over the period due to reduction of total liabilities and increase of total assets and total equity (Kaplan and Atkinson 2015).

The only matter of concern is the profitability ratio. In 2000, the company has incurred huge loss, which has led all the return to negative. Moreover, from the cash flow statement, it can be concluded that the company has also failed generate enough cash revenue to meet all the operational expenses. It has caused shortage of cash funds and the company has continued its operation from the retained earnings and additional capital funding by issuing new shares.

It can be concluded that though the company is suffering from net loss and shortage of funds, it has adequate assets to cover the liabilities and losses. Therefore, One.Tel can be considered medium going concern.

References:

Abraham, S. and Shrives, P.J., 2014. Improving the relevance of risk factor disclosure in corporate annual reports. The British accounting review, 46(1), pp.91-107

Arens, A.A., Elder, R.J. and Beasley, M.S., 2012. Auditing and assurance services: an integrated approach. Prentice Hall.

Baxter, R., Bedard, J.C., Hoitash, R. and Yezegel, A., 2013. Enterprise risk management program quality: Determinants, value relevance, and the financial crisis. Contemporary Accounting Research, 30(4), pp.1264-1295

Beasley, M., Elder, R. and Arens, A., 2012. Auditing and assurance services.

Bratten, B., Gaynor, L.M., McDaniel, L., Montague, N.R. and Sierra, G.E., 2013. The audit of fair values and other estimates: The effects of underlying environmental, task, and auditor-specific factors. Auditing: A Journal of Practice & Theory, 32(sp1), pp.7-44

Carson, E., Fargher, N.L., Geiger, M.A., Lennox, C.S., Raghunandan, K. and Willekens, M., 2012. Audit reporting for going-concern uncertainty: A research synthesis. Auditing: A Journal of Practice & Theory, 32(sp1), pp.353-384

Cohen, J.R., Krishnamoorthy, G. and Wright, A., 2014. Enterprise risk management and the financial reporting process: the experiences of audit committee members, CFOs, and external auditors. CFOs, and External Auditors (May 30, 2014)

Crous, C., Lamprecht, J., Eilifsen, A., Messier, W., Glover, S. and Douglas, P., 2012. Auditing and Assurance Services. Berkshire: McGraw-Hill.

Harrison, J.S. and Wicks, A.C., 2013. Stakeholder theory, value, and firm performance. Business ethics quarterly, 23(01), pp.97-124

Horngren, C.T., Sundem, G.L., Schatzberg, J.O. and Burgstahler, D., 2013. Introduction to management accounting. Pearson Higher Ed

Kaplan, R.S. and Atkinson, A.A., 2015. Advanced management accounting. PHI Learning.

Kunz, R., Josset, D., Scholtz, H., Motholo, V., Graeme, O.R., Penning, G. and Rudman, R., 2014. Auditing & Assurance: Principles & Practice.

Messier Jr, W., 2016. Auditing & assurance services: A systematic approach. McGraw-Hill Higher Education.

Miller, T.C., Cipriano, M. and Ramsay, R.J., 2012. Do auditors assess inherent risk as if there are no controls?. Managerial Auditing Journal, 27(5), pp.448-461

Porter, B., Simon, J. and Hatherly, D., 2014. Principles of external auditing. John Wiley & Sons.

Sadgrove, K., 2016. The complete guide to business risk management. Routledge.

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