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Identify and distinguish between tests of controls, substantive tests of transactions and substantive tests of balances.

Identify and understand when the auditor will undertake substantive audit procedures in response to specific assessed risks of material misstatement.

Understand how assertions relate to account balances

Understand how to select the most efficient and effective combination of audit procedures that allows them to achieve the audit objective

Aactive participation in an “audit team context” with professional group discussions

Co-operation with fellow students to produce a joint deliverable on time and to a high standard.

Tests of Controls, Substantive Tests of Transactions, and Substantive Tests of Balances

Samson Oil and Gas Limited is a listed company on Australian Stock Exchange founded in 1979 is being selected for the project. The company is the subsidiary of National Nominees Limited and holds more than fifty percent of shares in Kestrel Energy Incorporation. It has its registered office loacted in Australia and all the key decisions of the company are being taken therefrom. The company is primarily engaged in exploration of mineral oil and gas .

The nature and the industry in which the company deals in are briefed through the following four items as described –

Business Operations – This company is engaged in the extraction of oil and gas in a large scale production. The shares of the company are being actively traded in stock market. As per the results of the financial statements for the year ended 30thJune, 2017, the company has shown a substantial increment in the revenue as compared to previous year. However, it is observed that company has no such other source of income during the year except derivatives income. The company has disclosed net earnings of approximately $13 lacs from derivatives during the year. Despite being increase in the revenue, the profits of the company is being declined substantially. Thus it can be said that the business operations of the company are not being conducted under proper planning and observation and the key managerial persons are least concerned about the matter. On comparing with other companies operating in the same industry , the Samson Oil and Gas Limited are operating at a low level.

Investment and Investment Activities – Since the company is incurring losses in its previous years including the current year, it is not actively engaged in making investments. However, the company has acquired certain Oil and Gas Properties and furniture during the year. As observed from the financial statements of the company, the company had sold its old Oil and gas properties against the purchase of new ones. Further, the company does not own any intangible assets in its balance sheet. Due to excess of expenditure over revenue, the company is not engaged in any investment activities. Thus, the company is solely engaged in its primary activities and does not fetch any substantial other income from any other source including investment.

Financing and Financing Activities – The company has a substantial amount of finance cost as compared to other expenses. This cost is due to high amount of borrowings at a higher cost to operate the business and day to day activities of the business operations. After the analysis of the financial statements for 30thJune, 2017, it is observed that  finance cost is more than one fourth of the total expense is and is comparatively higher in both comparitive and absolute terms as compared to last year financial cost due to net increase in the short term borrowings of near about $75 lacs during the year. Further, the cash flow statement of the company shows that the company has raised money by way of issue of shares of an amount of $3198. The net cash flow from the financing activities of the company show a cash outflow of $1,10,88,016/- which includes a major repayment of borrowings amounting to $1,10,47,443./- Analysing the overall view it is concluded that the company is not financially stable and had shown a great downfall in the closing cash balance for the year ended 30th June, 2017 (Report, 2017)

Assessed Risks of Material Misstatement and Substantive Audit Procedures

Financial Reporting Practices – The reporting of financial statements involving comprehensive Income statement, Cash Flow statement, balance sheet and the statement of equity shareholder’s is the essential and fundamental practice to be followed by each and every enterprise engaged in a business or profession. The notes explaining the items in these above statements are also annexed to the financial report. Thus, it can be said that financial reporting is the formal statement of the entity’s financial position which is to be drafted in a structured manner to make it understandable and easy to communicate the matters recorded in it with the stakeholders and the other members and employees of the entity to discuss over it and make economic decisions for the improvement and growth of the company at a later and long term stage.

Analytical procedures are applied by the auditors of the organization to have an understanding of the business of the client in detail and the required changes in the business as an objective of identifying the potential risks associate with it and to further plan the other audit procedures to be applied keeping in mind the changes and the risks associated with it. Analytical procedures includes consideration of foreseeable items and comparison of financial information with prior period items, forecasts and considers for instance- gross profit margin against turnover. Analytical procedures are performed in the stages of Risk Assessment, Substantive procedures and final analytical procedures. Final analytical procedures are nothing but an overall view of the financial statements at the final stage of its presentation and preparation.

As per the question stated, the key ratios of the last three years for performing analytical procedures are briefly explained and described hereunder –

Ratio

Formula

As at 30th June, 2017

As at 30th June, 2016

As at 30th June, 2015

Description and Explanation

Working Capital Ratio

Current Assets / Current Liabilities

0.09

0.81

1.86 (Report, Samson Oil and Gas Limited, 2016)

This is also called current ratio which signifies the ability of the firm to repay its short term debts against its current assets. Higher the ratio, more is the ability of the firm to repay its debts from its liquid assets and is said to be more financially stable. Taking into account the past three years it is observed that the company is degrading every year signifying that the liabilities of the company are increasing at a higher speed as compared to increase in current asset. This is probably due to continuous substantial loss in the company for the past three years as analyzed . Thus an  analytical procedure is to be applied in this area to understand the base of such weakness in the company from the several past areas and proper recommendations shall also be provided to control such weakness.

Debt-Equity Ratio

Total Liabilities / Equity of Shareholders

8.54

8.20

1.48

This ratio is also known as Leverage Ratio. The debt-equity ratio means the weightage of debt over the equity of the firm. Higher the ratio, less is the stability of the firm because a firm with higher debt and lower equity has a higher market value . In our case the it signifies that the debt of the firm is 8.54 times higher than its equity which is worse in terms of financial terms since it signifies that the firm is largely dependent on the financing of the third party and is not stable financially. Further, the ratio has severely increased during the last two years as reflecting from its financial statements. Thus, the auditor has to apply analytical procedures in this area to get the knowledge of the basic loopholes and demand of such debt in the company.

Cash Flow coverage Ratio

Operating Cash Flow / Total Debt

(0.08)

0.03

0.13

This ratio refers to measure the ability of the company’s operating cash flow to meet its liabilities and other obligations of the entity. Higher the ratio, better is the ability of the firm to repay its liabilities and meet its obligations. In this case, it is viewed that the company again the company is being degrading in its ability to meet such liabilities against its cash flow from primary activities. Further, it is viewed that in the current year the ratio of the company has reached to negative value which is even doubts the going concern assumption of the entity. Not only the operating cash flow, but it is seen from the cash flow statement of the entity that the firm has a net cash outflow of $ 26.5 lacs which is most material to the financial statements and had a significant impact on such statement.

Acid Test Ratio

(Current Assets – Inventories) / Current Liabilities

0.08

0.79

1.86

It is also called Quick ratio. It is as similar as current ratio with the only difference that it does not include inventory since this ratio is under the believe that inventory is less liquid asset as compared to other assets. Further, an lyrical procedures are to be necessarily applied in this area to control the degradation of such ratio since it even may let the company to shut down if the company is unable to pay its short term liabilities. Thus, the company should think and assess on this matters to redevelop the company.

The materiality of the items in the financial statements is said to be material if the balances of such item is having a significant value as compared to other items and have a higher impact on the financial statements of the company both in monetary and non-monetary terms . In the given financial statement of 30thJune, 2017 the account balances of finance cost , derivative income and cost of sales are found to be most material as these items impact the income statement substantially and is an important oar of the comprehensive income statement. The cost of sales is 88% of revenue which is significantly high  as compared to other companies operating in the same industry. This may be either due to low sale price or high cost price. The cost of production may be high due to poor or inefficient use of resources or lack of knowledge in use of assets to extract the oil and gas or poor allocation of resources at the right place in the right time. As no discount is being booked in the statement of income it is clear from the fact that the cost of production of the company is too high to generate profits for the firm and the company is not operating below the break even. Further, the finance cost of the company is too high as the company has low shareholder base and market capitalization due to continuous losses in the past years. Other than this, the company apart from earning profits from its primary activities, it is generated profit from the derivative instrument in the current year (Board, 2015) Thus, these are the factors which gave rise to materiality of these items in the financial statements. The materiality of items helps the auditor in planning and preparing the audit procedures and the areas where the audit procedures are to be extended and to determine the nature, timing and extent of the audit procedures to be applied to obtain significant audit evidence to conclude an opinion over the financial statements of the company as prepared by the management.

Assertions and Their Relationship to Account Balances

Financial reporting  is the nothing but a medium through which the entities convey its financial position to the stakeholders and other investors. These financial statements affect the market price of the shares of the company which varies according to the profits and other considerations adopted and the economic decisions taken by the company and its key managerial persons. Thus due to this relevance, the financial statements should be free from any material mis-statement so as it does not mis guide any investors and its shareholders due to omission of any items which may affect the decision of the users based in such financial statements. Thus, to avoid such discrepancy, the auditors are required to identify the items which are material to the financial statements and apply extended audit procedures to such items so that it gives a true and fair view of the financial statements prepared. The materiality in Australia is governed by AASB 1031. This standard states that an item is considered as material if the omission or mis-statement or non-disclosure of such items impacts the accountability of those persons charged with governance and affects the decisions of the users based on such financial statements. The materiality not only considers the amount of the item but also considers certain factors which is qualitative in nature and not quantitative. For instance the retirement or death of the managing director of the company if not disclosed may impact the decision of the users since users have a trust on the skills and the determination of the MD of the company. On the other hand, the quantitative effect may be for instance event occurring after the balance sheet date but before the preparation of the financial statements which may have a significant effect on the financial statements and the materiality of such event may be determined solely through the quantitative value of the amount of loss/ gain. Thus, materiality plays a significant role in the audit of the financial statements by the auditor and the determination of the items affecting the financial statements.

However, as asked the different account balances being material including both the assets and liabilities which affects the financial statements as a whole are being explained and described hereunder –

Account Balances

Financial Report Assertions as required in point - 6

Audit work steps as required in point - 7

Assets

Oil and Gas Properties

Existence, Rights and Valuation are the financial assertion to the said account balance. This is classified under the non-current assets of the balance sheet where the possession of the asset is to shall be with the company along with all the rights and controls reserved with the entity. The valuation shall be properly accounted for such assets after considering the effect of depreciation and obsolescence’s.

The auditor in this respect shall follow a set of audit steps to satisfy himself about the existence, rights and the value accounted for the oil and gas properties. The auditor shall review the fixed asset register in which he shall determine the additions, deletions, depreciation and its rates to account for the correct valuation. Further, the auditor shall himself physically check the existence of the assets in the possession of the client. Lastly, he shall inspect the relevant documents of acquisition and invoices of transfer of such assets to verify the actual rights of the client on such property.

Trade Receivables

Existence and completeness define the accuracy of the trade receivables accounted in the books. The management should be clear that the receivables recorded in the books exist at the balance sheet date and is complete i.e. all the receivables which were supposed to be recorded are accounted for correctly.

The auditor to address the selected assertion shall enquiry into the fact by cross verifying the relevant documents of sales and its corresponding payments received. Apart from this the auditor shall also enquire from the third parties to confirm the balances of higher amount which have an major impact in the balance sheet. In addition to this procedures, the auditor shall verify the credit notes issued by the company and the reason behind the same is also to be recorded for future reference. Finally he should assure himself that all the receivables are being accounted for in the balance sheet as those recorded in the books.

Cash & Cash Equivalent

Right and existence are the key financial assertions to cash and its equivalent. The management shall ensure itself that the cash balance in hand with the management is that of the management only and the same is under the possession of the management at the end of the financial year.

The auditor shall extend its audit procedures in regard to verify the cash. The auditor shall  physically verify the cash in hand balance available with the management and reconcile it with the books. Further, he shall obtain bank reconciliation statement to compare the balance of bank with the bank statement and the books of the company. Additionally, the auditor shall vouch the cash vouchers of payments and receipts during the year to cross verify any mis-statements along with its authorization to issue such vouchers. Thus, by applying these procedures the auditor may address the related financial assertions associated with cash and cash equivalent.

Plant and Equipment

The financial assertion of this account balance is same as that of Oil and gas properties since both are recorded under Tangible fixed assets i.e. valuation, rights and existence. All the three assertions are to be effectively ensured by the management to have a true and fair view of the financial statements.

The auditor in this respect shall physically verify the plants and equipment’s and ensure the possession of the same with the management. Apart from this, the auditor shall recalculate the valuation of such plants to avoid any material mis-statement to occur in the financial statements. The auditor shall if required should check whether the same is under the proper working condition and is regularly in use for the purpose of claiming depreciation.

Oil Inventory

All the four financial assertions i.e. existence, valuation, right and completeness are required to be ensured to get free from any material mis-statement. The management in respect of inventories shall be assured that the inventory only belonging to the management shall be recorded whether kept at his own place or with third party. Secondly, the value shall be in accordance with the prescribed accounting standards.

The auditor in case of inventory shall be very careful as it forms a major part of the financial statements. Though in this case, the company does not hold large amount of inventory but then also it cannot be avoided from being material. In this regard the auditor shall after physically verifying the inventory shall ensure that the same is being valued as per relevant accounting standard . apart from this, the auditor shall vouch the purchase invoices carefully to cross check the closing inventory against the production and shall ensure that all the inventories in possession with the company is accounted for in the financial statements. Finally, the auditor shall differentiate the stock from the scrap and value them differently as per the accounting standard AASB 102 to avoid any mis interpretation. These audit steps covers all the financial assertions associated with the Inventories. (W., 1993)

Liabilities

Trade Payables

The financial assertions related to trade payables are existence and completeness. It should be mandatorily ensured that the payables accounted for in the financial statements are in existence at the balance sheet date and all the payables outstanding as on that date is included in the financial statements.

The auditor should ensure that the account balances are met with the financial assertions associated with it. It would lower the risk of the financial statements being materially mis-stated. To ensure this the auditor shall cross verify the high amount balances directly with vendor and check the invoices and other related documents to which such balances may be confirmed with the books maintained by the company.

Borrowings

Completeness and Obligations may be the correct financial assertion to borrowings to prevent any mis-statement in the financial statements. The management must assure that the borrowings included in the statement are the obligation of the management to repay and all the borrowings i.e. both general and specific is accounted for in the balance sheet (GOvernment, 2015)

The auditor in this respect shall ask for the borrowings statement with the management and review the receipts, payments, interest charged and paid during the year correctly and assure that all the borrowings in book is accounted in the financial statements and that the company has the obligation to pay the same within specified time period. Also the auditor shall ensure that all the related party borrowings are being disclosed in the financial statements.

Provisions

Completeness and Valuation are the key assertions to provisions. The provisions are the estimates made by the management on the basis of past experience. The estimates shall be valued and determined in a approximate manner close to the actual and shall be completely recorded in the books in respect if all items which require provisions to be made (Government, 2017)

The auditor in this respect shall review the estimates made by the management and if any discrepancy found, the auditor shall ask the management to revise its estimate and also give recommendations and basis of estimating the same. The auditor in respect of satisfying himself about the provisions should check the valuation of items in respect of which the provisions are made and its viability to make the provisions for that particular balances.

Derivative Instruments

The financial assertion to the derivative instrument is existence and valuation of the instrument. The management should be aware of the fact that the instrument is in the possession of the company and that its value has been accurately accounted for as per the lower of market price or cost of such derivative instrument.

The auditor in this respect shall thoroughly vouch the related documents of such instruments and its manner if acquisition and transfer and whether all the legal compliances and taxes associated with such instrument have been compiled with. Apart from this, the auditor shall verify the value to be recorded in the financial statements with the market value of such instrument as on the balance sheet date.

 Note : Only four liabilities are being considered as material since the balance sheet contains only the four items under the liability in the balance sheet.

References

Board, A. a. (2015). Auditing Standard ASA 320. Retrieved from https://www.auasb.gov.au/admin/file/content102/c3/Jun11_Compiled_ASA_320.pdf

GOvernment, A. (2015). AASB. Retrieved from https://www.aasb.gov.au/

Government, A. (2017). IFRS Adoption in Australia. Retrieved from https://www.aasb.gov.au/admin/file/content102/c3/IFRS_adoption_in_Australia_Sept_2009.pdf

Report, A. (2016). Samson Oil and Gas Limited. Retrieved from https://www.annualreports.com/HostedData/AnnualReports/PDF/AMEX_SSN_2017.pdf

Report, A. (2017). Samson Oil and Gas Limited. Retrieved from file:///C:/Users/com/Desktop/2016AnnualReport.pdf

W., R. (1993). The five assertions - a revisit. (categories of assertions about which auditors must collect adequate evidence to support financial statement items) (Auditing). Retrieved from https://archives.cpajournal.com/old/14038934.htm

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