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Steps to consider before an Audit

Discuss about the Business Activity for Bio Sustainable Feeds Ltd.

The study is on an Australian based bioresearch firm named Bio-sustainable Feeds (BSF) Ltd. The company listed on the Australian Stock Exchange. The company has been engaged in sustainable aquaculture for past two decades. One of its research based on plant-based feeds collapsed. This research had costed the company a whopping 360 million AUD dollars. The high value species failed to thrive. It was targeted that the plant based fish feed were converting 10 kg of low value fish into 1 kg high value fish. However, the actual conversion rate of fish-based species was that 30 kg of low value fish converted into 1 kg of high value fish, which was 3 times lesser than expected. In addition, the dying rate of fishes was much lower in case of plant based (Rust et. al, 2011). There was nearly double growing rate. In addition, the matured fishes were 60% smaller than those developed from fish based techniques (CBC, 2016).

Environmentalists as bad challenged the above-mentioned issue. They consider that growing luxury species at the cost of human quality food crops is not good (Piedrahita, 2003). It is just as bad as diverting low value fishes into a production process where it benefit the rich and affects the poor, with increased risks of malnutrition and starvation also to some extent (Dan, 2005). So in order to abide by environmental laws and benefits, BSF Ltd began the research of bacteria to produce fish feeds from wood chips, sugarcane residue, or recaptured methane gas. This research was to some extent useful. BSF had already spent 160 million AU dollars towards research, and the 200 million AU dollars, towards development proposed to be spent by it in bringing it to the market. BSF Ltd awarded a grant of 500 million AU dollars from Commonwealth Scientific and Industrial Research Organisation (CSIRO, Federal Government of Australia) on the condition that it will be spending at least 100 million AU dollars per year on alternative aqua culture feeds (Rust et. al, 2011). BSF received the grant amount in 2013 and has since then spent 500 million AU dollars on research and proposes to spend another 200 million AU dollars in development over the next two years, dedicated towards develop an alternative aquaculture from the research done till date by it (Lothe, 2013). The net value of the patent shall be 700 million AU dollars if sold in two years or 200 million AU dollars per year if produced and sold.

Before an audit, it is the auditor’s responsibility to analyze all the pros and cons of the audit assignment. The nature of audit assignment, the risks involved with taking up the assignment, the benefits, the responsibilities attached to it, all have to be analyzed before deciding on whether to take up the assignment or not. There are a number of things to keep in mind before agreeing to take up an audit assignment. When an assignment for audit comes to n auditor, the first thing he should check is at least his previous three years of accounts and compliances. Whether the company has strong compliance, diligent in its responsibilities towards its stakeholders, the management should speak to the previous auditor if any. In case of BSF also, the auditor should be doing the same (Griffiths, 2005). Understanding the nature of business is another crucial activity. The auditor should do extensive study and research n the nature of the business of the client and all the statutory rules, regulations, laws and by-laws applicable to it. He should be aware of the regulations that bind the company. The auditor of BSF Ltd should try to gain full knowledge of all the laws and by-laws governing the company and its regulations, which is the prerequisite of any audit (Lothe, 2013). The auditor must request the company to provide its compliances and accounts for the last three years immediately before the present year. This means that the auditor should have a strong compliance check on the documents and then provide the decision otherwise misleading information projected. This will create a strong imbalance that will affect the smooth conduct. After obtaining the same, an auditor must briefly check them in order to assess whether the particular company has been really effective and diligent in fulfilling its duties for the betterment of its stakeholders like investors, stakeholders, creditors etc any environmental impact of the business assessed (Ruhnke & Lubitzsch, 2010). All the regulations studied to know if the company is engaged in any kind of activity that can disrupt human lives, flora, or fauna (Fazal, 2013). The auditors of BSF Ltd should analyze whether the activities of the company are highly disruptive to the environment. Environment issues are a cause of major debate and in this regard, the auditor must lay special emphasis. In addition, when a company receives special grants and benefits from an organization, it is its moral duty to use the money for only the purpose for which the grant has been received (CBC, 2016). Therefore, the auditor should check the fair play of activities of the company. This helps the company to attain prosperity through legal means and implies compliance has been done diligently.

Computation of Audit risk (formula)

A business activity is synonymous to risk. Each business is vulnerable to risk and competition in the current scenario. However, management of risk is well settle if the management is strong and have the capacity to avert the risks. Curtailing the risk is important as it leads to long- term benefits.  Even after careful planning, some risks are inherent. An inherent risk is the risk associated with the business be it any kind of business. It is inherent in nature and that the business has to deal with it. It is a common phenomenon and therefore needs to be tackle effectively. It is the risk of taking up the idea of doing any form of business and going about the idea and developing it into reality and executing the idea. An inherent risk is present b it any kind of business. Control risk are the risks of a business which cannot be mitigated even by taking due diligence. Elimination cannot be done completely due the inherent risks of the type of business (Ruhnke & Lubitzsch, 2010). These risks occur because client’s system fails to prevent. Detection risk is the risk which cannot be detected even after due care is taken. If the inherent risk of the business 90%, it is highly probable that the company is involved in high level of speculator activities and certainty is low (Roach, 2010). In this scenario, the auditor can take up the assignment but needs to be extra careful about it. The control risk being 5%, there are chances that there will be fewer loopholes in the internal controls of the management. The detection risks being 80% imply that even after taking due care, there will be high level of risk which will remain undetected. The reason behind such failure is the prevalence of inherent risks in the business. These risks signify the loopholes in the proper management of the company in preventing risks (Ruhnke & Lubitzsch, 2010).

Audit Risk= Inherent Risk*Control Risk* Detection Risk
Therefore, Audit Risk for BSF Ltd. = 0.9 * 0.05 *0.8  = .036 that is acceptable. Therefore, the auditor can take up the audit of BSF Ltd.

Inclusion in the Audit Program

The audit program of BSF Ltd. should contain both general and specific items that shall ensure an overall coverage of the audit. The general plan should be on facts such as understanding business nature, laws that governs the company and type of business. Moreover, emphasis requires on associates delegated for the audit, the level of knowledge of the associate so delegated, the minimum level of care to require taking care of the activities, the details of the working of the company (Bowlin, 2011). The specific plans should be the environmental laws that govern the activities of the company, the amount of grant used and its ways of using the grant. Care is required that the grant is use for the purpose for the main purpose.
Journal Entries of the R&D transaction

Inclusion in the Audit Program

The research and development expenditure of the company capitalized only up to the time the company does not commence its operations. Passing of the journal entries done in such a way that the amount is capitalized only to the time the company has commenced its operations. Thus, the whole of the research expenses of 160 million AU dollars charged to the cost of patent. In addition, if the company completes it development expenses before commencement of business it can charge the whole of 200 million AU dollars to its patent cost. However, if it commences business before or in between its developments, it will be able to charge only that portion of the development costs to the patent that it incurs before the commencement. Since the grant awarded to the company is of capital nature, it is charge against the capital expenses charged to the patent cost (Messier, 2005).

Payment

R&D A/C Dr. 500

To, Bank A/C 500

Capitalization

Patent A/C Dr. 500

To, R&D A/C 500

Every year back up of expense is not present, the consideration done for entire 2015.

Start of the process of amortization from 2015 end because the research, as well as expense done and patent capitalized.

5 years patent cost amortization = 500 million/ 5 = $ 100 million each for 5 years.

Amortization

Patent (Amortization) Ac Dr 100

To, patent Ac 100

The company’s aquaculture activities are undoubtedly towards increasing the quality of marine produce and size and quality of fish. However, there has been an objection from the environmentalists in this regards. The objection was that the diverting of human-quality food crops into high value luxury crops is bad (Asche, 2008). They condemn that it is as bad as diverting low-value fish into the risk of malnutrition and starvation. Thus, BSF began finding more environment friendly ways of producing bacteria to produce fish feeds from wood chips, sugarcane residue, or recaptured methane gas (from dumps, sewage, food
processing plants). The research was not initially based on socially and environment friendly ways. However, after objections and accusations from environmentalists, the company sought alternative ways and this was not even an established way of research. They had simply sought to different ways. So signing off a report as being socially and environment friendly based on the contentions of the management of BSF Ltd is not correct (William, 2013). As an auditor, the approval should not be provided because a research should be based on the contentions that have not been challenged.

If the audit report is signed, there will be an emphasis of matter paragraph that will state that although the company was carrying on activities which was not socially and environmentally appreciated, and was objected, condemned and compounded by many industrialists, the company resorted to alternative ways of aqua culture which are more environment and society friendly (Eilifsen et. al, 2001). Thus, the statement of audit is given after giving proper disclosures about the same. Although, getting organizational grants is sufficient to vouch that the alternative activities are definitely not degradable to the environment, but because there has been serious allegation, an emphasis of matter paragraph is always desirable and important to be fair to the users of the audit report and stakeholders.

Patent of BSF Ltd.’s research is not booked. The patent procurement completes after all research and development activities complete. Hence contending in the prospectus that the company has exclusive rights over the bacteria based feeds technology is complete misstatements (Klinger, 2012). This is one of the misleading information contained in the report and sends a wrong signal to the stakeholders. This statement should not appear in the prospectus, as this would amount to misrepresentation of facts. The market value of patent is estimated but not determined. In addition, statements of this kind in the annual report reduce the prospect of the company. A prospectus is a window of the company to the outside world. It is the most important introductory document. The investors and other stakeholders take their investment decisions based on the prospectus only. An investor can peer in the company with the help of the available annual report. It is like an introduction of the company to the world. Any contention made in the prospects ought to be weighing in the truth balance and only if it is valid enough, it should be mention in the prospectus. If the  management still wants such a statement to be made in the prospectus knowing it to be false simply to attract public attention and goodwill, the auditor should either express his unwillingness to agree to the same or detach himself from the audit engagement of such a company as agreeing to the same would affect his credibility. He should never agree to be associated with a company that puts false contentions in audit reports, prospectuses, or any public document for that matter. It will amount not only to his moral and ethical violation but will also attract professional disrepute and penal actions. Agreeing to a fact and providing a correct judgement on such a prospectus is misleading in nature s it leads to duping of the public.

Conclusion

An auditor must evaluate the advantages and disadvantages of an audit process prior to taking it. In other words, he or she must assess the risks associated with the audit assignment, nature of the assignment, duties affixed to it etc prior to deciding whether such assignment is considered or not. These are very essential requirements and if an auditor neglects any of these, then ultimately all the negative consequences must be borne by him only (Fazal, 2013). Prior to the audit assignment, there are various things that an auditor must keep in mind The detection risk stands at 80% which implies that the company has exercised due care but still it has high exposure to unidentified risks. The control risk of BSF also stands at 5% that clearly indicate the presence of fewer loopholes in the company’s internal management. Hence, a weakness persists in the internal management and this needs to be sort in a quick span of time.  From the above report, it is clear that proper emphasis given to the auditing part because that determines the genuine nature of the project. The assertion of BSF Ltd in the prospectus is wrong and hence, the auditors should have avoided it. The statements should be sign when it contains a true and fair view and needs independent objective of the auditor.

References

Asche, F 2008,  ‘Farming the Sea’,  Marine Resource Economics vol. 23, no. 4, pp. 527–547

Bowlin, K 2011, ‘Risk-Based Auditing, Strategic Prompts, and Auditor Sensitivity to the Strategic Risk of Fraud’, The Accounting Review, vol. 86, no. 4, pp. 1231–1253

CBC 2016, Shift to plant based fish feed could hurt health environment,  CBC news technology and science, viewed 9 September 2016, https://www.cbc.ca/news/technology/aquaculture-feed-1.3262922

Dan F. F 2005,  Feeds for the future: the importance of better broodstock and larval nutrition in successful aquaculture, viewed 8 September 2016,  https://www.aquafeed.com/read-article.php?id=681

Eilifsen, A; Knechel, W. Robert; W, P 2001, Application of the Business Risk Audit Model: A Field Study’, Accounting Horizons, vol. 15, no. 3, pp. 193-207

Fazal, H 2013, What is Intimidation threat in auditing?, viewed 8 September 2016, https://pakaccountants.com/what-is-intimidation-threat-in-auditing/.

Griffiths, P 2005, Risk-based auditing, Aldershot: Gower

Klinger, D. H  2012,  Moving beyond the fished or farmed dichotomy, Marine Policy.

Piedrahita, R.H 2003, ‘Reducing the potential environmental impacts of tank aquaculture effluents through intensification and recirculation’,  Aquaculture  vol. 226, pp. 35-44.

Roach, L 2010, Auditor Liability: Liability Limitation Agreements, Pearson.

Ruhnke, K & Lubitzsch, K 2010, ‘Determinants of the Maximum Level of Assurance for Various Assurance Services’,  International Journal of Auditing, vol. 14, no. 3, pp. 233-255.

Rust, M., Barrows, F., Hardy, R., Lazur, A., Naughten, K., & Silverstein, J 2011, The Future of Aquafeeds, NOAA/USDA Alternative Feeds Initiative, viewed 9 September 2016 https://www.nmfs.noaa.gov/aquaculture/docs/feeds/the_future_of_aquafeeds_final.pdf.

William M 2013, Freshwater Aquaculture, Echo Point Books & Media, LLC.

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