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ACC305 Auditing and Professional Practice
Auditing is a process under which a reasonable assurance is provided to the users of financial information of an entity that the financial statements are free from frauds, errors and material misstatements and also that the auditor has obtained sufficient and appropriate audit evidence that the financial information presents the true and fair view of the financial position of an entity. The process of an audit is a multistage process which includes planning, documentation, reporting and closure. The audit procedures include different types of audit tests undertaken by the auditor to obtain evidence such as test f controls, the test of details, substantive procedures and analytical procedures. This increases the reliability of the communication and quality of the financial reports. This report discusses the audit planning issues, audit planning document, audit procedures, audit risks and the connection between the communication of accounting information and auditing process.
Case study 1
(a) City Ltd, a property developer, has several major projects in progress in Brisbane's central business district. Due to a downturn in the commercial property sector and an abundance of city office space, no buyers have been secured for the projects.
The major auditing issues which are included in the planning document of property developer generally include testing of compliance with rules that relate to the real estate or property development services provided. City Ltd is a company having business in the real estate sector. The real estate sector is the industry which is highly influential by market forces. The business of City Ltd has been adversely affected due to a downturn in the commercial property sector and abundance of city office space. The audit issues, in this case, will relate to the audit of nature of business and transactions of City Ltd, nature of properties as to whether they are only commercial property or residential also, excessive rates charged from the clients and services provided in relation to the properties sold.
(b) Your client, Web Ltd, has recently purchased new computer software, which allows extensive management financial analysis and improved quality management reporting.
The audit issues that will be covered in the planning document for the purchase of new computer software include conducting substantive procedures to recognise the need for new computer software, verifying the invoice for the purchase of software, verifying the contract with the vendor and annual maintenance contract, whether the purchase has been made for excessive prices or not , the recording of purchase of software as assets in accordance with applicable financial and accounting framework physical verification of the software etc. The representation letter from the management of Web Ltd shall be obtained to justify the need of purchase of software allowing the extensive management financial analysis and improved quality management reporting to ensure the effectiveness of performance of business operations of the company. The licensing agreements shall also be verified for the purchase of software and compliance with legal and regulatory provisions and guidelines (Abbott, 2010).
(c) During the year Beauty Pty Ltd, a manufacturer of cosmetics and skincare products, established an overseas branch operating as a sales outlet. Inventory has been transferred from Australia to the new branch to reduce lead times to existing customers and to provide inventory for samples as part of an increased marketing effort.
Beauty Pty Ltd is a manufacturing company engaged in the operations of production of cosmetics and skincare products, therefore, the audit issues will cover the compliance of health and safety laws applicable on the manufacturing of cosmetic products to protect the health and safety of customers. The opening of an overseas branch will cover audit issues related to legal compliance procedures, government policies, FDI norms etc. the physical verification of inventory will be required to verify the inventory transferred to Australia. The physical verification of samples will have to be covered. The marketing policies of a company will have to be verified to check for the need of distribution of samples as part of increased marketing efforts of the company. The marketing plan can be verified. The internal control procedures of the company with regards to the new sales outlet will be covered to identify the audit risk (Hooper & Maskell, 2011).
Case Study 2
(a) What are the general issues related to deciding whether to use a test of controls approach or a substantive approach?
Test of controls – It is the audit procedure which relates o testing the internal controls implemented by the entity for its operations and reporting procedures. The test of controls by the auditor suggests the efficiency of operations since these controls are designed in such a way so as to ensure that the business functions and organizational procedures are performed smoothly and effectively. The test of controls helps in identifying the inherent and control risk.
Substantive approach – These are the audit procedures undertaken by the auditor to detect fraud or misstatement in the financial statements at the assertion level. This includes vouching and verification of each and every transaction in detail without relying on the information provided by the management
The general issues which relate to deciding about whether to use test of controls or substantive procedures during the audit include the auditor’s judgement of the materiality of transactions and tolerable error which define the impact of transactions on the financial statements. The effectiveness of internal controls is also an important issue which helps in deciding whether the testing of internal controls will be sufficient and appropriate evidence or the test of details will be required. The identification of the level of inherent risk, control risk and detection risk is also a major factor influencing the decision about audit procedures. Higher the inherent and control risk, higher will be the need to use substantive audit procedures (Gould, 2010).
(b) How do the risk assessments above relate to the choice of audit approach?
Inherent risk is the audit risk which prevails when the entity does not have internal controls in place for its operations whereas the control risk is the risk which arises when the internal controls are in place but they are not so effective to prevent or detect frauds and errors in the financial transactions. On the contrary, the detection risk is the risk which arises when the entity has strong internal controls in place and due to this there are lesser chances that the frauds and errors will be detected by the audit procedures. The above risk assessments directly affect the choice of audit approach in a way that higher the risk of inherent and control risk, higher will be the need for the test of controls and on the contrary higher the detection risk, higher will be the need of substantive audit procedures to be adopted and test of details to be conducted for each and every transaction. The level of risk defines the level of materiality and impact of this risk on the financial transactions and capability of internal control to detect and prevent frauds and errors. This directly affects the auditor’s judgement to decide the test of controls, the test of details, substantive procedures or analytical procedures under audit process. Thus, the risk assessments for each of the above-mentioned transactions which relate to disclosure of finance eased assets, measurement of depreciation expense, rights and obligations in relation to vehicles and valuation of vehicles will be used for different audit procedures for these transactions.
(c) If you adopted the approach set out in the planning summary, what audit procedures would you use for the accuracy and completeness of depreciation expense?
The depreciation expense is the amount which relates to wear and tear of fixed assets used in the business operations. The approach which is set out in the planning summary about the audit objective of measurement and completeness of depreciation expense is the use of the more significant test of controls with minimum substantive procedures at the balance sheet date. In this case, the inherent and control risk is low which means that the internal controls with regards to charging of depreciation on assets by the company are strong and effective but the detection risk is high due to such strong internal controls. Therefore in case of high detection risk, substantive procedures need to be adopted by the auditor including the test of details extensively since the chances that the frauds and errors will not be detected are very high. However, the approach set out in planning summary requires ore test of control rather than substantive details. The audit procedures which shall be adopted in accordance with this approach will require verifying the rate of charging depreciation, the period of depreciation expense, cost of fixed assets, recognition and disclosure of depreciation amount etc.
Case Study 3
Explain to Jim the connection between auditing and the communication of accounting information.
Financial reporting – It is the process of generation and presentation of reports about the financial information in the form of financial statements which is prepared in accordance with applicable accounting or financial reporting framework. The financial reporting is an essential process which is used by the organizations and corporates to communicate the relevant accounting information to the intended users of such information which includes the stakeholders and external parties. The preparation of financial statements is the function of management of an entity who are the authorised persons for the generation and presentation of financial information to the users in accordance with the applicable financial reporting framework. All the details of financial transactions are included in the financial statements for the purpose of accurate and effective financial reporting.
Auditing – It is the process undertaken to ensure that the financial reporting done through financial statements is free from frauds, errors and material misstatements and to provide an opinion to the users of financial information that the financial statements of the entity present a true and fair view of its financial position as on the date of preparation. This process is performed by the external party known as the auditor of the company who is independent and exercises his professional judgement and scepticism in obtaining sufficient and appropriate audit evidence that the financial statements of the company are free from frauds and errors. The process is an assurance and not the guarantee of the responsibility of preparation of financial statements is of the management of the company (Leung et al, 2015).
The connection or interrelationship between the communication of accounting information to the users and process of auditing is that the auditing is an element of the communication process of the accounting information. The financial reporting is done by the entities to make proper and effective communication of relevant and accurate accounting information to the users of such information. Auditing is the next stage of this financial reporting process which provides an assurance to the users about the reliability of the information contained in the financial statements through issuing an audit opinion. Thus an integrated amount of information is communicated to the users of financial information which comprise of details of accounting and financial information presented in a logical and sequential manner on one hand and a reasonable assurance that such information is error free and there are fewer chances of fraud and material misstatements. By this, the users get an idea about the reliability of the accounting information which contributes to their decision making for the financial transactions with the entity. The decisions of the stakeholders of the company including investors, suppliers, government, shareholders etc. depend on the financial information communicated to them about the business operations. Therefore, it is very important not only to communicate the relevant information to the users but also to assure them about the reliability of the information (Parker et al, 2011).
From the discussion and analysis of audit planning issues, audit procedures under various cases, audit risks including inherent, control and defection risk and their interrelationship and the connection of communication of accounting information and process of auditing, it can be concluded that the communication of relevant, reliable and accurate information to the users is very important for an entity an, therefore, the auditing process is an inseparable part of the financial reporting framework which applies to an entity and its operational procedures and financial transactions. However the financial reporting is the task undertaken by the internal parties including the management, the auditing is an activity of external auditor who is independent of the management functions.
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