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Key Risks in Auditing

Complete the requirements of the Cloud 9 Case Study as appearing.

Sharon Gallagher, Josh Thomas and Jo Wadley are members of the audit firm W&S Partners. Sharon is the audit manager and Josh is the audit senior assisting the partner, Jo Wadley, evaluate the decision to accept the Cloud 9 Pty Ltd (Cloud 9) audit engagement for the year ended 31 December 2018. Background information about the company Is presented In the appendix to this text. In addition, Josh has 'discovered the following facts and has requested your help to document and assess the factors that affect the client acceptance decision.

• The Finance effector of Cloud 9, David Collier, is married to a distant relation of PS Nethercott, a partner In WM Partners' consulting department.

• The consulting department at W&S Partners has tendered for an IT Installation project at Cloud 9. The fees from this project, If the tender Is successful, would be twice the size of the audit fee.

• A survey of audit staff at W&S Partners has revealed that 30 per cent have purchased Cloud 9's products (basketball shoes or worlcboots) in the past.

• Four members of the IT department at W&S Partners have shares in retailers that sell Cloud 9's products. In each case, the shareholdings were disclosed on the firm's financial interests register and the size of the shareholding is deemed material under W&S Partners' ethical guidelines.

• An article in a newspaper published In the United States has claimed that Cloud 9 Inc. (Cloud 9's parent company) was secretly running 'third-world sweat shops'. The article alleged that shoes made by other wholly owned subsidiaries of Cloud 9 Inc. In China and Brazil were using illegal child labour In factories that did not meet local health and safety rules. Cloud 9 Inc. has vehemently disputed the accuracy of the article, suggesting it was planted by a rival company. Cloud 9 Inc. has Invited international advocacy groups to visit its factories at any time. 

Answer me tonowing questions based on the Information presented In the appendix to this text and lhat presented above and throughout chapters 1 and 2. Consider your answer to the case study questions in chapter 1 where relevant.

(a) Prepare a document that explains the impact, If any, of each piece of relevant information on your client acceptance decision for Cloud 8.

(b) List and explain any additional actions you would take before making your client acceptance recommendation to the partner, Jo Wadley, ki this case.

Understanding Financial Performance

(c) Assume the decision is made to accept Cloud B as a client. Prepare the client engagement letter. 

Complete the requirements of the Cloud 9 Case Study as appearing

(a) What is the current condition of the economy?

(b) Is the business affected by developments in other countries, foreign currency fluctuations or other global forces?

(c) If the industry is labour intensive, are there unusual or unique labour relations issues?

(d) How does the company's growth and overall financial performance compare with the industry, and what are the reasons for any significant differences?

(e) What Is the volume and type of transactions in the business?

(f) Are the client's operations centralised or decentralised?

(g) Is the client's business cyclical in nature or Influenced by seasonal fluctuations in the market?

(h) What is the susceptibility to fraud/theft? (Is the product something that can easily be stolen and has a sale market?

(i) What products does the client sell, and have there been significant changes with respect to: I. major products or brands? ii. selling strategies? sales/gross margin by product?

(j) Who are the client's major competitors, and what share of the market does each hold? N Is there significant differentiation between the client's and competitors' merchandise?

(k) What Is the effect on the client of potential new entrants Into the market? Are there any significant barriers to entering the market? 


(m) Is there a specific lifecycle for the product?

(n) Is the product dependent on trends or styles? Customer information

(o) Are there specific customers on whom the client is highly dependent?

(p) What is the overall profile of the client's customers? Have there been significant fluctuations in the client's customer base? Supplier information

(q) Who are the key suppliers?

(r) Are the materials subject to significant price movements or influenced by external market forces? Technological advances and the effect of the Internet

(s) How does the Industry use technology?

(t) What technological trends are impacting the industry? Laws and regulatory requirements

(u) Are the client's operations affected significantly by local or foreign legislation?

(v) What new laws and regulations recently enacted (or pending) may have significant effects on the company? 

Complete the requirements of the Cloud 9 Case Study as appearing

Using the 30 September 2016 trial balance (in the appendix to this text), calculate planning materiality and include the justification for the basis that you have used for your calculation. When you are answering the question, you should refer to the information presented for Cloud 9 in the appendix to this text and in the current and earlier chapters. You should also consider your answers to the case study questions in earlier chapters. 

Financial Ratios

Answer the following questions based on the Information presented for Cloud 9 in the appendix to this text and the current and earlier chapters. You should also consider your answers to the case study questions In earlier chapters. The trial balance for Cloud 9 as at September 2016 is included in the appendix. Note the following when analysing the company: The current and non-current assets and liabilities for 31 December 2015 are shown in the balance sheet. In the trial balance, non-current assets are Property, Plant and Equipment, and Deferred Tax. The non-current liabilities are Provisions $110744 (other Provisions are current liabilities), Interest Bearing Loans — Loan with Bank $850000 (the remainder of the balance of this account is a current liability), and Provision for Deferred Tax Liabilities $352 231. Where a ratio requires an average balance and the prior year is not available, use the current year only. Items of revenue and expense in the trial balance for September 2018 should be annualised where appropriate.

(a) Using analytical procedures and the Information provided in the appendix, perform an analysis of Cloud 9's financial position and its business risks. Discuss the ratios indicating a significant or an unexpected fluctuation.

(b) Which specific areas do you believe should receive special emphasis during your audit? Consider your discussion of the analytical procedures results as well as your preliminary estimate of materiality. Prepare a memorandum to Suzie Pickering outlining potential problem areas (that is, where possible material misstatements in the Milt:Idal report exist) and any other special concerns (for example, going concern). 

Complete the requirements of the Cloud 9 Case Study as appearing.

Based on your results from researching the client and its industry for the case study questions in earlier chapters, discuss the inherent risks in the audit of Cloud 9. Identify the associated financial accounts and assertions that would be affected and provide an assessment of 'high', 'medium' or 'low' In relation to the likelihood and materiality of the risk occurring. 

(a) Explain the procedures for engaging component auditors to perform the work on the inventory in China and the United States.

(b) Advise Suzie on engaging the derivatives expert. Discuss the qualities the expert must possess. What steps must Suzie perform? What should she tell the expert about the engagement? What must the expert provide to Suzie so that she can be sure she has sufficient appropriate evidence about the derivatives? Can the expert do all the work on derivatives, or must Suzie perform any other procedures? 

Key Risks in Auditing

a) From the case study, it is recognized that Sharon Gallagher, Josh Thomas, and Jo Wadley are associate members of an audit firm named W & S Partners. Sharon works as an audit manager, Josh is a senior auditor, and he helps the partners. Jo Wadley analyzes the decision of accepting the auditing task of Cloud 9 Pty Ltd for the year ending on 31st 2016. In this matter, Jo has investigated various things, and he discovered some facts that put him in a dilemma about the acceptance of the auditing task. The first fact is that the Finance Director of Cloud9, Mr. David Collier wife is a distant relative of PS Nethercott, who is a partner in the W & S Partners consulting section (Appannaiah, Reddy, & Putty, 2010). Moreover, as per the rule and regulation prescribed by the Board of Australian Audit and Assurance Service Providers and the codes of conduct to perform auditing task, the fact is against the code of conducts as it reduces the independence of the auditor, because of the relation with the auditor and the member or distant relation of the proposing firm for auditing. Hence, before accepting the offer from the Cloud9 Pty it must be considered that there should not be any relationship between the team members of auditing team and the proposed firm of auditing

The next fact is that the consulting section of W & S Partners has made tender for an IT installation project at Cloud9. For the fees of this project will be twice from the audit fees. Moreover, as per the auditing and assurance services code of conduct and the rule of AASB it is strictly prohibited that the auditing firm must not have any other interest in the client company and part from the auditing tasks the auditing firm cannot perform any other task within the clients' company (Bragg, 2013). Hence the W & S Partners consulting department must avoid any tender for the IT installation within the Cloud9 Pty Ltd as it can hinder the auditing process and the audit can be influenced and spoil the independence of the auditors.

The third fact reveals that 30% of Cloud9 products were procured in the past. Moreover, this particular information has not any impact on the auditing performance hence can be ignored.

The forth evidence revealed that four members of the IT section of W & S Partners have shares of the retailers that sell the product of Cloud9 (Britton, & Waterston, 2013). Moreover, in each case, the shareholder disclosed the firm's financial interest register. Besides this, shareholding is considered as material under W & S Partners ethical rule book or guidelines of the company. As per the code of conduct of auditing the W & S Partners cannot do the audit as four members of the IT section are shareholders of the retailer of Cloud9.

Understanding Financial Performance

The fifth fact about the company that takes places illustrates that the Cloud9 Company is running third world sweet shop and in Brazil and China the company’s subsidiary companies use illegal child labor (Dauber, 2005). However, this information will not influence the auditing tasks, but the bad reputation can effect on the reputation of W & S Partners.

b) The auditing team must keep distant from the PS Nethercott during the audit process, the IT tender by consulting department of W & S Partners must be withdrawn, and the four-member from the IT must not involve in the audit task. Hence, the independence of the auditors can be managed.

c) W & S Partners accept the offer of auditing in your company but in some condition that Cloud9 in any way will not influence the audit process directly or indirectly by engaging the links with W & S Partners (Horngren, 2013).

a) The current economic condition is in a better state by which the expansion of the business could be easily made.

b) The business is seemed to be not affected by the development in the foreign countries. But slight fluctuations in the economy are seen with the variation of the currencies.

c) The unique issues which are being identified as it is considered to be labor intensive are represented to be showing the management of the labor issues (Horngren, 2014).

d) With the comparison of the financial statement of the Cloud 9, it is being found that the financial structure has an appropriate stable position with illustrating the rising of the equity level and decrement of the debt level. The reason that can be provided is that the more surplus of the goods in the foreign countries increases the level of the equity of the Cloud 9 Pty Ltd.

e)The volume is dependent on the stock and the supplying of the stocks. It is depicted to be consisting of 75 % of the sales of the product in the wholesale market which itself illustrates that the volume is much more in amount.

f) The client's operations are centralized, and also it is showing the appropriate management of the risks involved in the business and the transactions (Kew, & Watson, 2012).

g)The cyclical business is being seen in the business nature, and also it is not influenced by the seasonal relations that are built by the business.

Financial Ratios

h)The general ledger fraud is being identified in this case of the susceptibility to the fraud or the theft. The fraud is being identified in the form of being stealing of the product which is being the major threat as it is identified in this case. For this reason, the company is undertaking various security measurements by using the computerized cc television cameras.

i) The client sell the athletic shoes in the market.

The changes in the products are undertaken by the company on the major products or the brands.

The strategies of selling are also identified to be changed by changing the promotional activities of attracting the customers (Krivogorsky, 2012).

The sales or the gross margin of the product is being depicted to be 4.95.

j) The main competitors of the Cloud 9 Pty Ltd are the other shoe companies of Australian market who are holding a large amount of share in the market of Australia

k) Yes, there is a difference between the client and the competitor’s merchandise. The competitors are holding the Australian market with being their home market, but the client is operating from the US to capture the market of Australia.

l) As the market of Australia is being targeted, there lies a huge threat of the competitive entry into the market since Australia is an open market (Libby, Libby, & Short, 2014).

m) Yes, there is a specific life cycle of the product.

n) Yes, the production of the product is depicted to be dependent on the styles and the trends.

o) Yes, there is a specific customer on whom the client is highly dependent that is the China show industry from who the client is buying the product.

p) The profit of the client is depicted to be increasing as per the financial statements are included and examined (Parker, Guthrie, & Milne, 2008).

No, there is no fluctuation in the base of the client and the customer.

q) The key supplier is the China Shoe industry who is supplying the product to the client.

r)  No, the products supplied by the client do not seem to be affecting the significant changes as it is being influenced by the external market.

s) The industry is seemed to be using the advanced technologies for the purpose of keeping track on the stocks and also the enhancement of the business environment can be easily made.

Inherent Risk

t) The trends that are impacting the industry are the development of the competitive environment where the competitors are launching a variety of the products.

u) Yes, the client’s operations are affected by the local and the foreign legislations.

v) The importing and the exporting taxation laws are depicted to be affecting the business, and also it is affecting the company (Powers, & Needles, 2012).

1)The planning materiality helps the accountants and auditors to use their professional judgment to provide a fair and true representation of the financial statements. The materiality planning is made to decrease the risk of misstatements in the financial statements. It provides significant information to the stakeholders in making investment decisions. The base is selected for the examination of the profit of the company. For the profit organization, revenue or asset is used as the based for the estimation of the materiality level. It helps the auditors to present true and fair view of the financial statements (Ricchiute, 2006). The material percentage shows the materiality, and it is fixed as per the requirement. The setting of planning materiality at lower level increases the quantity and quality of the financial statements.

Materiality level = 0.5% * of total assets

                               = 0.5% * 30875612

                                = 154378.06

The auditors provide significant information to the stakeholders and determined the materiality level of the company.   

2)a)

Debt to equity (2015) =total debt/total equity

  = 16172369/14703243

                                         = 1.09

Current ratio (2015) = Current assets/current liabilities

                         = 25110129/14833563

                         = 1.69

Profit margin (2015) = Profit/sales revenue

    = 2999839/60572216

= 0.049

The financial ratios help to determine and evaluate the financial performance of an organization. The profitability ratio shows the profit margin of the company. The profit margin of the company is good. The liquidity ratio shows the debt level of the company. The debt to equity ratio shows that the debt level of the company is not so high (Schroeder, Clark, & Cathey, 2011). The debt level is low which means the risk is low. The current ratio of the company shows the ability to pay the due amounts to the creditors. The current ratio of the company is one which means that the company would be able to pay the due amounts. The financial position of the company is good.

b)To:

From:

Subject: Risk of material misstatement

The accountants and auditors should be very focused during the preparation of the financial statements. The risk of materiality materially can be there in significant accounts such as sales revenue, account receivable, cash, account payable, inventory and expenses. The changes in the values of this account can lead to the increase or decrease in the value of the company. The increase or decrease in sales revenue means profitability will be affected (Singleton, & Bologna, 2006). The increase or decrease in the account receivable, cash and inventory mean current assets will be affected. The increase or decrease in cash payable means current liabilities will be affected. The increase and decrease in the expenses mean the income statement is affected. The accountants and auditors should focus on audit risk model to decrease the risk of the material misstatement.

The inherent risk is the probability of error as well as an omission in the financial statements because of failure of the control. In financial audit, inherent risk or intrinsic risk occurs when the transactions are complicated the situation needs a high degree of decision or judgement regarding the financial report. There are many reasons for that the inherent risk occurred in the financial reports such as lack of experience and efficiency of the auditors, which hinder them to detect any risk from the auditing task (Waterston, 2006). Tiredness and lethargy of the accountants also make them mistakes as the accounting and auditing task related with monotonous calculation, hence the probability of mistake and omission increase.          

The inherent risk arises within an organization due to the material misstatement. The risk analysis clearly shows that the company has medium risk level. The debt level is low, but there can be material misstatement in the significant accounts of the financial statements.  The financial accounts that can be at the risk of misstatement are sales revenue, account receivable, cash, account payable, inventory and expenses (Weil, 2017). The changes in the value of the accounts mean changes in the financial position of the company.

References

Appannaiah, H., Reddy, P., & Putty, R. (2010). Financial accounting. Mumbai [India]: Himalaya Pub. House.

Bragg, S. (2013). Accounting best practices, seventh edition. Hoboken, N.J.: John Wiley & Sons.

Britton, A., & Waterston, C. (2013). Financial accounting. Harlow: Financial Times Prentice Hall.

Dauber, N. (2005). 2006 Auditing standards. Canada: Thomson.

Horngren, C. (2013). Financial accounting. Frenchs Forest, N.S.W.: Pearson Australia Group.

Horngren, C. (2014). Accounting. Toronto: Pearson Canada.

Kew, J., & Watson, A. (2012). Financial accounting. Cape Town: Oxford University Press.

Krivogorsky, V. Law, corporate governance, and accounting.

Libby, R., Libby, P., & Short, D. (2014). Financial accounting. Maidenhead: McGraw-Hill Education.

Parker, L., Guthrie, J., & Milne, M. (2008). Accounting, auditing & accountability journal. [Bradford, England]: Emerald.

Powers, M., & Needles, B. (2012). Financial accounting. [Mason]: South-Western, Cengage Learning.

Ricchiute, D. (2006). Auditing. Mason, Ohio: South-Western/Thomson Learning.

Schroeder, R., Clark, M., & Cathey, J. (2011). Financial accounting theory and analysis. Hoboken, NJ: Wiley.

Singleton, T., & Bologna, J. (2006). Fraud auditing and forensic accounting. Hoboken, N.J.: Wiley.

Waterston, C. (2006). Financial Accounting. Pearson Education UK.

Weil, R. (2017). Financial accounting. [Place of publication not identified]: Cengage Learning.

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