Auditing And Assurance Services: Understanding A Client And Risk Of Misstated Accounts Essay.

Discuss about the Auditing and Assurance Services. There are mainly two method of auditing i.e. internal auditing and external auditing. In the internal auditing, an audit department is established within the organization and the audit report is prepared by that internal auditing department only.

Key Information

Auditing is a process which can be defined as conducting inspection of financial statements of a company. Auditor is a person who conducts the process of auditing. There are mainly two method of auditing i.e. internal auditing and external auditing. In the internal auditing, an audit department is established within the organization and the audit report is prepared by that internal auditing department only. On the other hand, company contacts an external audit firm for the auditing purpose is known as external auditing. In the assignment topics which are being discussed are- significance or importance of understanding a client for auditing purpose, accounts of particular business organization which are exposed to risk because of the materials misstated. Set of materiality in addition to assessment of the risk of misstated accounts is also being enclosed in the assignment.There are number of risks which can harm the business activities or overall business. Therefore it is crucial for the business entity to detect the frauds or errors which can cause risk and harm the business of the company. In the assignment the risk which cannot be controlled through the management or the risk which cannot be detected by the auditor are also discussed.

In order to develop the auditing plan or while planning an audit, the first measure that has to be kept in mind is to gain the knowledge about the business environment of the client and of the business process followed by client. In the context of Australian Auditing Standard, it is required to know about the entity, checking the risk taking ability and the business environment is to be checked by the auditor. Also, it is necessary to do detailed analysis of these points undertaken. In Australia, there are many telecommunication service providers. The only thing that has to be done is to establish and develop different network towers in the particular area. These are required so that the functions such as designing, develop the program and them installation could be easily done. The way in which Service stream limited functions, has been defined in the following information. This is explained on the basis of three different levels, that is:

The business operation of the service stream limited is being carried on in Australia. In order to conduct the maintenance of services and building customer relationship with other customers are the things provided by the service stream limited. Building, designing, maintenance and installation are the services in terms of business operation that are provided by the service stream limited. Mobile communication, fixed line communication and water quadrant are inclusions of primary business carried on by service stream limited. They have their functional structure as of now is, six directors in the leading board members of the directors in context of the board forum (materiality thresholds).The major clients of Service stream limited in Australia are in sector of telecommunication service that is based on the network and other provider providing the services in retail network. The major thing that has been audited is that the service stream limited is not engaged or do not do any of the internal transaction. So basically we can say that they are not included in any of the operation conducted in other foreign countries. As a result, if we look at the capital structure of Service stream limited, there is no financial leverage figured out. Rather than this as per the financial reports, Service stream limited has improved excellently in the past two years in terms of financial performance. As the report shows, the net profits of the company have improved from $ 19,983,000 in 2016 from 11,720,000 in 2015 (Bryan, Rafferty, and Wigan, 2017).

Significance of Understanding a Client for Auditing Purposes

At industrial level:

In Australia, the services providing industry is one of the largest. In the Australia industrial sector, there are many competitors of Service stream limited. As a result, they need to deal with tough competition in the market. In Australia, the requirement of telecommunication has increased to 98%. Therefore, it needs to be managed in a whole proper manner. In making this better, more efficient resources are required to fulfill the need of the client or the customers. For this, the Australia government also supports service industry. Based on this many legal rules are to be followed and kept in regulation in context of being major service providers in Australia (Fülbier, et al 2017).

At economical level:

The level of economy of this industry has a greater effect on the business operations done at economic level. By the continuing rate of interest, the assessment of the economic level of any business organization can be done. Other factors such as financial structure and inflation rate supports in the assessment. In the service industry, the resources are comparatively less. And hence, they need more internal assets in comparison to outside loans. Service stream limited has the same structure, they has invested more in the internal funds for their business dealings (Mary & Wendy, 2011).

The materiality mechanism can be described as the procedure that is used to identify and analyze the factors relating to finance by an auditor of the business organization. This concept of materiality is often used to check at each and every step of audit that is performing the functions and planning. This is done by an auditor in order to decide and so on improve the financial management so that a limit is created. The concept of materiality is based on the importance of other financial statement that shall be analyzed and identified further. Furthermore, the following decision the auditing procedure is to be applied, that is to decide that the substantial process is to be applied or not. Another option is to perform the detailed analysis procedure so that important information behind it and other relating evidence can be decided. When we talk in context of Service stream limited, many accounts can be taken in use of material misstatement and so as to continue the remaining procedure of auditing to be analyzed further. As per the information, there are five accounts that Service stream limited that has been taken in use after identifying the business environment and its entity (Juma’h,  2009).

Five significant accounts of Service Stream Limited, most at risk of being materially misstated are as follows-

The most significant account for the Service Stream Limited is the sales account , it is the account in which material misstatement or the fraudulent activities could occur. There are three major resources from which the revenues of the Service Stream Limited could be received these resources are revenue from the contraction contract, revenue from the contracts which provides the services to the customers and various other sources of the revenues. Among all the selected sources there are two sources which are at the high risk in which material misstatement could occur and these two sources are contract services or the revenues generated from the contracts that are made to provide the services. Reason for the risk in these sources is that in these revenues are received from the customers because there is high volatility in the transactions of the contract services (Newman et al., 2001). On the other hand it is also being evaluated that the revenue recognition in the construction contract is a critical process which includes consideration of various elements. There are various stages of completion that are included in the construction contract some stages are total contract revenue and cost, approval of the customer in relation with the contract completion and the activities date in which the completion of the contract is being determined. Hence it could be evaluated that the sales accounts are at the level of significant risk which could be materially misstated.

Accounts at Risk of Being Materially Misstated

Cash equivalent and cash are known as the financial resources which are used in carrying out the business activities of business organizations. These are also known as liquidity of the business organization which is generally used to make certain payments or repayments of present obligations. Significant increase in the cash as well as cash equivalents of Service Stream Limited, in last year can be seen in comparison to other preceding period. As in year 2015, the cash and cash equivalent of Service Stream Limited was recorded as $ 14,756,000, however in year 2016 it was recorded as $ 41,086,000. This shows, Service Stream Limited`s significant increase in cash and cash equivalent. In context to misstatement, cash account is the easiest to approach in order to make alteration or misstatement as per the interests of entity. For that reason significant increase in cash and cash equivalent of Service Stream Limited displays the misuse of cash resources or risk of material misstatement.  

Through the analysis of financial statement of company i.e. Service Stream Limited, it is being analysed that significant amount of investment is covered by the intangible assets. Huge capital investment into intangible asset was done by Service Stream Limited`s management under the head of non – current assets. In the former years, goodwill was also being allocated in the subsidiaries of Service Stream Limited, by its management. From the accounting notes of Service Stream Limited in addition to the intangible account`s analysis it is concluded that goodwill amount shall be considered as material aspect while performing and planning materiality. In future, estimation of cash flow would be done by considering the carrying amount of goodwill. Estimations regarding flow of cash are determined through anticipation of management as well as opinion given by the external experts. It is not easy to predict the future as the happening of events in future are uncertain, so in context to calculation of goodwill, it is requisite that management shall estimate the flow of cash in future. As a result there is predictability for misstatement of materialin context to intangible assets` amountalso more predominantly in the goodwill account.

The revenue accrued is the revenue that has been basically earned by the help of the business organizations but actually they have not been billed by the business organizations yet. The revenue is somehow earned by the business organization and the bill to the customers or clients is not given. It can be inferred that, all the transactions have been completed in the physical in context of business operations of the Service Stream limited by the client is not actually billed yet (Nishant, Goh, and Kitchen, 2016).  Therefore, the transactions have been done by Service Stream limited, so that probably the material misstatement can be done. As a result, for this mechanism is performed the customers are charged for this but the certainty is not recoverable. These are the things that have been covered under the accrued revenue. In the context of Service stream limited, the revenue recognition is done. The accrued revenue procedure includes the provision of payment claims by the Service stream limited by the client to whom the services has been provided (Houston,Peters, and Pratt, 2009).

Industrial Level and Economic Level Impact on Service Stream Limited

The two different set of accounts which are at the significant risk of the material misstatement in relation with the Service Stream Limited are the debtors and creditors account. The accounts which include all the receivables in near future and ar5e included in the current assets of the business are the debtors. On the other hand creditors represents the accounts in which payments are to be made or the current obligation of the business are included. In the Service Stream Limited it could be analysed that debtors and creditors have a higher rate of involvement in the financial statements.

The auditor must consider to plan for setting the materiality prior to start the financial statement`s audit of business entity. For that reason level of materiality should be set at preliminary level earlier at the time when the process of auditing is being planned. Planning of materiality can be defined as the process which is used to determine the level of threshold or materiality. Limit of threshold can be set in both terms i.e. in percentage or in dollar amount. In order to set the level of materiality, auditor requisites to decide a base and which can be decided from various factors such as- profit earned before tax and interest, net income, current obligation level, current asset, gross profit as well as many other factors can also be decided as a base to set the level of materiality (Edgley & Atkins, 2015). In Service Stream Limited’s case, the base decided to set the materiality level is the business operations of the company related to volatility of transactions, business operations level and nature of transactions. Analysis of business environment of Service Stream Limited is done by considering the macro and micro level and the financial performance of the company is also analysed to decide the materiality level (Kalelkar, 2017). The level of material which is decided is stated below:

In terms of percentage (%) - All through the performance of audit, the materiality which shall be applied should be 2.50 % of earnings before depreciation, interest and tax.

In terms of Dollar ($) –By considering the amount of transactions done in dollar, as a base the level of materiality is set as $ 895,000.

This level of materiality defines beyond the limit of materiality level,as auditing of the transactions shall be done by considering the level of materiality $ 895,000 or i2.5 % of earnings before depreciation, interest and tax. Or we can say that, the analytical or substantive procedure of audit shall be executed on each transaction beyond the set level of materiality.

The term audit risk can be described as an assimilation of three different risk associated with audit process of business organization. The risk which are presented in business organization`s audit are- decision risk, control risk and inherent risk. In order to evaluate the risk present in internal control system or in the financial statement of a particular business organization, audit risk model can be used (Bigus, 2014). Assessment of risk associated with audit comprehends exploration of all accounts identified in the course of audit which are exposed with risk of being materially misstated.

Control risk: This type of risk can be described as the inability of the management in controlling (assessing and preventing) the errors and frauds in certain activities or operations of business.

• Inherent risk: The risk which is caused due to the external environmental factors of business to the business organization is known as inherent risk. This types of risk is also beyond the control of business organization`s management. Inherent risk cab be found in the financial statement as errors or risk of material frauds (Johnstone et al., 2013).
• Control risk: This type of risk cannot be easily identified and prevented by the auditor as well; it can also be found in the business organization`s financial statements (Handsworth, 2012).
• Detection risk is the risk which states that auditor will not be able to identify and prevent frauds or errors in the financial statements of the business organisation. 

(Singleton & Singleton, 2011)

Conclusion

Auditing is crucial for each and every organization as the risks can be detected and prevented through the auditing process. It is being concluded from the assignment that auditing provides benefits to the business organizations, as through proper auditing, financial statements can be checked and the errors while recording the financial transaction can be detected. Auditing is not only important for the business organizations but also for the stakeholders as the information disclosed through the audit report of the business organization is determined by the stakeholders such as investors to make decision regarding investments. Some of the risks associated with the business are- inherent risk, control risk etc. These risk can arise due to misstatement of material. It is also concluded that, auditor or the auditor firm shall maintain a good relationship with the business entity and this relationship can be formed by the auditor through understanding the business entity.

References

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