Accuracy or Valuation

Auditing is considered as the process to examine as well as insect the financial statements of the business organizations with the aim to find any kind of material misstatements in them that can hamper the decision making process of the key stakeholders (Simnett, Carson and Vanstraelen 2016). At the time of the preparation of the financial statements and reports, the managements of the audit clients utilize certain unspoken and unambiguous claims and these claims are called the Audit Assertions. It is needed for the auditors of the companies to take into consideration the analysis as well as examination of these audit assertions as there are many instances where the auditors have found errors or other issues in the used audit assertions (Burton et al. 2014). In case the auditors find any kind of issue in the assertions, they need to declare that particular assertion or assertions at risk. Then, with the aim to minimize this risk in audit assertions, the auditors are required to perform the suitable substantive audit procedures. At the same time, it is on the auditors to decide whether these issues can be considered as Key Audit Matters or not. In case they are Key Audit Matters, the auditors are needed to ensure the proper communication of them with description in the audit report so that the key stakeholders become aware of them (Simnett, Carson and Vanstraelen 2016). The aim of this report is to consider the analysis of the audit assertions related to inventory and property, plant and equipment for the companies in the provided case studies.

This assertion ensures that there is not any error in the inventory transactions. At the time to deal with this assertion, it is needed for the auditor to ensure the physical inventory figures are accurate and to ensure the flow of appropriate inventory to the income statement as cost of goods sold from the balance sheet (Titera 2013). In case of Advanced Computer Solutions, there was movement in inventory to six different warehouses on March 2018. For this reason, physical inventory count of the company can be wrong as there can be error in the inventory counting process. In addition, the suspected problem in software could be a barrier in the correct inventory flow to the income statement from the balance sheet of the company. These reasons lead to this particular assertion at risk (Kharisova and Kozlova 2014).

The use of this particular assertion ensures the correct reporting of the inventory values in the correct accounting books. Hence, the need for the auditors is to undertake examining the inventory shipping and receiving documents for ensuring the correct register of inventory movement (Knechel and Salterio 2016). For example, the companies cannot record the goods received of the last year in the current year’s book. According to the case of Advanced Computer Solutions, 18 per cent sales of 2017 are included in the inventory for the year 2018. By applying the principles of cut off assertion, it can be said that failure of the company in properly calculates the inventory contributed towards the inclusion of 2017 sales in the inventory of 2018. At the same time, it could also be happened due to the issues in software (Finkbeiner 2014). Hence, the auditors of Advanced Computer Solutions can consider this assertion at risk.

Cut Off

In response to the first assertion at risk, it is needed for the auditor of Advanced Computer Solutions to thoroughly observe the physical inventory counting process of the client (Feng et al. 2014). While doing this, the auditor need to discuss the methodical physical inventory count process with the responsible staffs in order to be familiar with the process; to scrutinize the process when they are being conducted; to examine the physical count of inventory to outline the inventory amounts in the company’s book; and to examine the tags of inventory. Apart from this, the auditor is needed to undertake the inventory tests in all the recently moved warehouses while it is needed for him to tally the results with the inventory confirmation from the central warehouse (Feng et al. 2014). Lastly, it is needed for the auditor of Advanced Computer Solutions to test the cost calculation process of inventory and ensure the fact that the company has complied with the required accounting standards for inventory calculation.

The auditor is needed to carefully conduct the cut off related tests as this risk can lead to major issue in inventory computation for the company. The need for the auditor is the examination of the notes of goods received in warehouses and goods delivered to suppliers (Elder et al. 2013). Analytical procedures need to be conducted to find any unreasonable incidents in inventory transactions that can cause inventory slow moving and abnormally high or low amount of inventory in the warehouses. As the inventory of the company has been moved to six different warehouses from a central one, the auditor needs to scrutinize the presence of any stop in receiving the inventory from the central warehouse at the time of physical inventory counting process. This needs to be done for the identification of needless items in the inventory with the aim to exclude them from the inventory counting process (Elder et al. 2013). 

As per ASA 701, the auditors are needed to follow the following requirements:

1. They are needed to determine the Key Audit Matters while considering the assessment of the areas of material misstatement, significant judgments of the client’s management and the effects of significant incidents on audit (auasb.gov.au 2019).
2. After that, they are needed to ensure the proper communication of the key audit matter in the auditor’s report (auasb.gov.au 2019).
3. The auditors are needed to communicate these with the staffs charged with governance.
4. They are needed to effectively document these key audit matters (auasb.gov.au 2019).

  According to the ruling of ASA 701, error in the calculation of inventory of Advanced Computer Solutions can lead to the material misstatements as it can majorly affect the liquidity as well as efficiency position of the company. After that, the inventory valuation process involves the judgment and assumptions of the management in the areas of coat calculation and physical inventory count; and there can be uncertainty in them. Lastly, the movement of inventory to the six warehouses along with the issues in the software can be considered as significant events having effects on audit. For these reasons, this risk can be considered as Key Audit Matter as per ASA 701 (Draft 2013).

The analysis of this assertion assists the auditors to tackle any error that took place during the transactions of property, plant and equipment. Hence, the need for the auditors is to analyze the procedures in which the company has classified the depreciation, repair expenses and impairment (Hall 2015). In case of Green Machine Ltd, there are certain mistakes in the distinction between capital and revenue expenses. The company has recorded certain revenue expenses as capital expenses and done the inclusion of certain capital expenses in repair and maintenance. It indicates towards the failure of the company in correctly classifying the property, plant and equipment related expenses and these aspects can lead to this particular audit assertion at risk (Mock and Fukukawa 2015).

Response to Risks

With the assistance of the analysis of this assertion, the auditors become sure about the fact that whether the clients have correctly recorded the values of their property, plant and equipment in the correct accounting books (Houmes, Foley and Cebula 2013). Hence, the client needs to report the property, plant and equipment at cost less accumulated depreciation where depreciation is a crucial part and the company needs to utilize the effective depreciation rate. In case of Green Machine Ltd, too lower rate of depreciation has been charged on the property, plant and equipment. This wrong application of depreciation rate leads to the reduced operating expenses that overstate the net profit. In addition, in the presence of wrong application of the depreciation rate leads to the incorrect reporting of the value of property, plant and equipment in the accounting books (DiGabriele 2016). In the presence of all these aspects, it can be said that this particular assertion is at risk.

It can be noted from the above discussion that Green Machine Ltd has certain issues in the distinction between the revenue and capital expenditures. For the auditor, the substantive audit procedure is to ensure the review of the capital and revenue expenses of the company (Chi et al. 2017). More specifically, the auditor needs to undertake reviewing the capital and revenue expenses related to property, plant and equipment after acquiring the list of property, plant and equipment. Apart from this, it is needed for the auditors to review the capital expenditure policies of Green Machine Ltd. The undertaking of all these substantive audit procedures will assist the auditor of Green Machine Ltd to recognize the revenue expenses which are wrongly capitalized and the capital expenditure which have been wrongly added in the repair and maintenance of property, plant and equipment (Chi et al. 2017).

In case of the next assertion at risk related to property, plant and equipment, it is needed for the auditor of the company to investigate the position of property, plant and equipment in relation to depreciation expenses. The need for the auditor is to identify unnecessary and dismantled property, plant and equipment that need to be removed from the list (O’Donnell et al. 2015). Most importantly, the auditor needs to undertake the recalculation of the depreciation related to property, plant and equipment. It demands the testing of depreciation in relation to the property, plant and equipment’s residual value and loss or profit from the sales of property, plant and equipment.  Comparison of ratios of depreciation needs to be done in this stage. The auditor must test the adherence of Green Machine Ltd with the needed policies and standards of depreciation. All these procedures will assist the auditor to recalculate the actual rate of depreciation so that they can charge it against the property, plant and equipment for obtaining the actual depreciation expenditures (O’Donnell et al. 2015). 

It is needed for the auditor to comply with the below requirements of ASA 701 while dealing with the Key Audit Matters:

1. Determination of the key audit matters is the first requirement by considering the risk of material misstatements, judgement of the auditors and significant events (auasb.gov.au 2019).
2. Communication of the derived key audit matters is another major requirement as per ASA 701where these matters need to be disclosed in Auditor’s Report (auasb.gov.au 2019).
3. Communicating the key audit matters with the governance department is another major requirement (auasb.gov.au 2019).
4. The auditors need to ensure the documentation of key audit matters as per ASA 701.

While complying with the standards of ASA 701, it can be seen that the application of low rate of depreciation along with the incorrect classification of expenditures can affect the expenses while misstating the company’s profit and can lead to material misstatements. Hence, the application of low depreciation rate and incorrect classification of expenses includes uncertain judgements and assumption of the management. Lastly, these aspects can be considered as significant events that have significant effects on the audit process of the company. For these reasons, this risk can be considered as Key Audit Matters as per ASA 701 (Simnett and Huggins 2014).

ASA 701 Requirements

Conclusion

At the time of the determination of the key audit matters, it is needed for the auditors to consider the analysis of the used management assertion in the preparation of the financial statements. As per the above discussion, the assertions at risk for Advanced Computer Solution are accuracy or valuation and cut off. In case of Green Machine Ltd, the assertions at risk are accuracy in the distinction between the capital and revenue expenses and correct valuation of the depreciation on property, plant and equipment. It can be understood from the above that the selection of the substantive audit procedures wholly depends on the types of audit assertions at risk. In addition, the auditors are needed to take into consideration the adherence to the requirement of ASA 701 at the time to determine the key audit matters.

References

Auasb.gov.au. 2019. [online] Available at: https://www.auasb.gov.au/admin/file/content102/c3/ASA_701_2015.pdf [Accessed 18 Jan. 2019].

Auasb.gov.au. 2019. ASA 701 . [online] Available at: https://www.auasb.gov.au/Pronouncements/Australian-Auditing-Standards/ASA-701-2015.aspx [Accessed 18 Jan. 2019].

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