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Extreme Estimation Uncertainty And Audit Assurance System

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Question:

Discuss about the Extreme Estimation Uncertainty and Audit Assurance System.
 
 

Answer:

Introduction:

The risk associated with the audit engagement is assessed for measuring all the risks that are probable for the auditor if he accepts the engagement with a specific client. The engagement related risks are the risk of financial harm that may arise to the audit firm caused by the specific client. Before acceptance of an engagement, the auditor must find out the risk that is involved with the acceptance of the engagement and the continuity procedure susceptible from the client. While assessing the risk, the auditor must use his personal judgement and experience to measure the probability and impact of the risk. Through using the professional approach while assessing the risk, it is considered as the auditor has a questionable mind and is able to make important analysis for the facts related to audit (Uechi et al. 2015). Further the auditor must assess the risk associated with the financial records of the client as this is the most crucial segment and involves high level of risk. In the given circumstances, it is notified that MGC Ltd. Has already borrowed a large amount of loan from Westpak Bank and the bank has already put restriction on further borrowing of the company. It is clear from the circumstances that the company is experiencing financial risk and the auditor must look into the matter before acceptance of the engagement letter. Further, the auditor must contact the previous auditor to confirm whether any other risk involved with the engagement of the company’s audit. Moreover, the auditor before acceptance must ask few questions related to the client’s business whatever he feels necessary. He may ask for the previous year’s reports given by the auditors, and the communication with the creditors, investors and lenders. These will assist the auditor to get clear idea about the client’s business and assessing the risk (Serban and Mladin 2014).

Major financial ratio analysis

Ratio

Results

Industry average

2016

2015

2014

2016

2015

2014

Current Ratio

1.60

1.43

1.41

2.01

2.03

2.11

Quick ratio

0.34

0.31

0.33

1.15

1.01

1.1

Debt to equity ratio

2.78

1.94

1.54

0.65

0.52

0.49

Times interest earned

2.97

1.90

9.33

4

5

6

Average collection period

39.40

33.52

25.82

32

31

30

Average payment period

102.59

91.00

104.35

30

22

22

Days to sell inventory

233.39

187.00

188.57

50

48

46

Gross profit margin

20.59

14%

21%

24

25

30

Net profit margin

2%

1%

4%

6

7.5

9.2

 It is analysed from the above ratios that the areas which require specific attention are:

  • Days to sell inventory – while comparing with the industry average, it is identified that the company is not efficient in selling their inventories. The current asset of the company includes a large portion for inventories. The company must assess their product demand appropriately so that there is no overstock of inventories (Christensen, Glover and Wood 2013).
  • Quick ratio – the company does not have sufficient current asset in form of account receivable and cash. As this area is susceptible to material misstatement and fraud, the auditors must pay special attention to this regard. He shall check the vouchers, purchase ledger, sales voucher to assess the amount of receivables and cash.
  • Average period of payment – the company’s average period of payment is comparatively higher than the industry average. The reason that led the company in this situation is that the amount of unpaid payments is much higher. The auditors shall thoroughly check that whether the company does not have sufficient surplus fund to pay-off the obligations or they are not taking corrective measure for paying off the dues (Blay et al. 2014).
 

Strategies of audit for the engagement:

At the primary level, that is while planning for the audit, the auditor shall prepare the overall strategies that mean how the audit will be carried out. The strategy is very crucial as it will assist in reducing the overall risk of the audit procedure. Further, the strategies are required for performing the audit in a smooth manner. The strategy shall be prepared before initiating the audit process. The strategy also assists in analysing the availability of resources and their scarcity that will have to face by the auditor during the audit process (Legoria, Melendrez and Reynolds 2013). The following must be included while planning the audit strategy:

  • Analysis of the resources that are available and the way in which that shall be used
  • Analysing the level of materiality
  • Estimation of primary risk and whether it can be mitigated through internal control system
  • Analysis of the conceptual framework of the company regarding preparation of the financial statements (Eilifsen, Hamilton and Messier 2017).
 

Reference:

Blay, A.D., Notbohm, M., Schelleman, C. and Valencia, A., 2014. Audit quality effects of an individual audit engagement partner signature mandate. International Journal of Auditing, 18(3), pp.172-192.

Christensen, B.E., Glover, S.M. and Wood, D.A., 2013. Extreme estimation uncertainty and audit assurance. Current Issues in Auditing, 7(1), pp.P36-P42.

Eilifsen, A., Hamilton, E.L. and Messier Jr, W.F., 2017. The Importance of Quantifying Uncertainty: Examining the Effect of Audit Materiality and Sensitivity Analysis Disclosures on Investors’ Judgments and Decisions.

Legoria, J., Melendrez, K.D. and Reynolds, J.K., 2013. Qualitative audit material

Serban, C. and Mladin, F., 2014. IMPORTANCE IN PLANNING AN AUDIT OF FINANCIAL STATEMENTS. Anale. Seria ?tiin?e Economice. Timi?oara, (XX), pp.231-235.

Uechi, L., Akutsu, T., Stanley, H.E., Marcus, A.J. and Kenett, D.Y., 2015. Sector dominance ratio analysis of financial markets. Physica A: Statistical Mechanics and its Applications, 421, pp.488-509.

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