Inventory Key Assertions
Audit Assertions are the various claims that the management of any company make with respect to the various elements of the financial statements making an opinion regarding various aspects that govern these elements. It is one of the best ways of making sure that books of the company are free from all kind of misappropriates (Mock, et al., 2018). It also helps in making claims whether there are any loopholes on part of the management in making sure that appropriate controls are in place.
It is the duty of the management to prepare the financial statements and it is the duty of the auditor to comment on the viability of the same. The audit assertions are mostly made on five characteristics that includes existence, valuation, completeness, rights and obligations, disclosures made. In the given assignment, there are two case studies that are related to two different companies to analyse the various assertions with respect to specific elements of the balance sheet.
Inventory Key Assertions
In the given case the company named Computing Solutions deals in various inventories with respect to computer related software goods. There are various aspects of their inventory that is stated in the case study and two key assertions that can be identified with respect to that includes:
- Disclosure –AASB 102 deals with valuation and disclosure of inventory and it is important that the management should comply with the same. It is important that all the important elements with respect to the financial statements that affect the company and its materiality level should be disclosed in the annual report of the company. This will help the company and its management to maintain a transparent approach, in the given case inventories are having an annual turnover of 5.2 times in 2017 and 3.8 times in 2018, this shows that there is a reduction in the overall movement of the inventory and the company needs to state that.
- It can also be seen that the company is making change in the accounting policy that deals with valuation of inventory, as the company has got a big tender and they are contemplating to value inventory at 10% less than the cost, but the general principle is that inventory should be valued at cost or Net realizable value whichever is lower(Lessambo, 2018). Thus, this is a change in the accounting policy and hence disclosure with respect to that should be made.
- Valuation – Valuation is an important audit assertion that companies need to check. Inventories should be valued at cost or net realizable value as per the respective accounting standards. Also, the treatment of wastage should be seen, normal wastage should not be included in cost valuation. But abnormal valuation should not be included. In case of Computing Solution, the companies are valuing their inventories at cost or NRV whichever is lower, but now they want to change the valuation made that would be at 10 percent less than the NRV. Also, there are chances that inventory might become obsolete as there are technological updates happening again and again, thus this makes valuation a key assertion with respect to Computing Solutions. The management needs to make sure that they are correct in this aspect(Fukukawa & Mock, 2011).
Substantive audit procedures
Substantive audit procedures are those procedures that helps the auditor is forming an opinion on the elements of the financial statement and making judgement whether they are valued correctly or not. In case of Computing Solutions, the substantive procedures can be used to make an opinion on the audit assertions described above-
- Disclosures – In case of disclosures, the auditors can apply test of controls to see whether the company has made relevant disclosures with respect to the respective accounting standards and whether there are any loopholes in that. They should check the notes of accounts to make an opinion with respect to disclosure of the inventory provision in the financial statements(Andiola, et al., 2018). Disclosures can also be checked by checking how the company has been performing in years prior to the relevant year and whether there are changes with respect to valuation or other key features. Like in this case the company is changing the valuation policy so the management should state it clearly in the annual report as it might be materially relevant.
- Valuation – With respect to valuation, the auditors can perform various substantive procedures that would include test of controls that includes vouching and valuation that means checking whether the value of the inventory ties to general ledger provided, whether the parties have provided proper bills(Axelsen, et al., 2017). The auditors should focus more on valuation of the closing inventory as there are chances that management can do under or over valuation in that.
- The auditors can also check the prevalent market rates and see whether the rate that the company has used for valuation is correct or not. In case of computing solutions, the auditors should see that valuation is correct and the inventories have not become obsolete, they must be updated. For the tender the company wants to value the asset at 10 percent less than cost, so the auditor should see whether this is allowed as per the relevant accounting policies and there are no misstatement involve in the same (Bailey, et al., 2017).
Communicating Key Audit Matters in the Auditor’s Report
As per ASA701, the auditors should all such matters which they feel are detrimental to the company and the stakeholders should be aware of that. They can ensure that such matters should be highlighted in different sections, they should also state all the different audit procedures that they have adopted in checking the appropriateness of the same. Key audit matters helps in making the audit report more transparent and are very helpful to the shareholders.
In case of the given company the computing solutions, the valuation of the inventories is a key audit matter as inventories are a big part of the financial statements, in 2018 they were valued at 22 percent of the total sales (Sirois, et al., 2018). Hence stating the same under key audit matter is very relevant. The auditor needs to provide the respective disclosures in their audit report under the KAM section-
- The overall valuation method adopted by the company, like in this case the company is valuing at 10 percent less than cost so that should be stated.
- The overall rights and obligations with respect to the inventories and whether proper agreements are there between all the related parties.
- The auditor should also state the various audit procedures that they have taken in valuation of the inventory provisioning and whether that is correct or not(Heminway, 2017).
All these highlighted points will draw the attention of the shareholders and make them aware whether the company is correct in their approach or not and if any change is needed then that should also be highlighted accordingly. The KAM should be stated as per the principles of ASA701. An extract from the annual report of JBH has been attached below highlighting the key audit matter stated by the auditor (Knechel & Salterio, 2016).
The auditor have stated the acquisition of the Good Buys as a key audit matter and that includes the overall valuation of the assets and the liabilities and the fair value of that the company has acquired. It also states the steps that the auditor has taken and that includes reviewing the sale agreement, testing the fair value of the assets and liabilities, checking the judgement made by the management etc.
Substantive Audit Procedures
Question 2 Key Assertions
The second case deals with Beautiful Hair Ltd. The company wants to acquire a small business named Shimmer Pty Ltd, as the product of Shimmer goes very well with the business of Beautiful Hair Ltd. The owner of Shimmer is the only person who has knowledge about how these products are made, thus the company is contemplating purchasing the intellectual product that is in the form of technical know-how from Shimmer Pvt Ltd, and now the company is contemplating recognition of the same as per AASB 3 (Bumgarner & Vasarhelyi, 2018). AASB 3 deals with valuation and recognition of intangible assets and the companies need to abide by it. In the given case two key assertions with respect to intangible assets are –
Completeness – It is important that all the accounting transactions with respect to any asset must be complete from part of the management and there should be closure to that. Completeness also refers to the fact that the asset must be properly recorded and reflected in the financial statements. In the given case there are intangible assets involved, and it is important that if Beauty Limited is taking such property from any individual they need to reflect it in their financials.
This is since this property is of great value to the company now and it is drawing revenue from the same. Thus, only if proper transactions are made and recorded in the financial statements, the asset can be correct and complete. Thus, Beautiful Ltd needs to reflect the technical know-how that it is acquiring from Shimmer Ltd and state the same in their annual report. The auditors should also see that the management is complying with the provision of AAS 3 when they are dealing with valuation of the assets and their disclosure (Rimmer, 2017).
Valuation – Valuation of the intangible asset is a very complex method and a lot of judgement is involved on part of the management based on which such valuation is done. The main rules that applies is with respect to the market value. It is important that companies can first identify the type of intangible asset that they are dealing in. Different companies have different methods by which they can value their assets, hence having a proactive approach is very important.
Calculation of few intangible assets like patent trademark is easy, as their value can be assign to the revenue that they can generate, but in some cases like technical know-how it is very difficult. Like in the case of Beauty Ltd, it is important that they should take help from valuation experts to make definite valuation of the property involved (Garon, 2018).
Substantive Audit Procedures
The auditors can adopt various substantive and analytical audit procedures to value the intangible assets. Few of such procedures in the given case are stated below-
Completeness – First and foremost it is important to have proper knowledge with respect to the asset and have proper background information related to that. The auditor also needs to have proper knowledge about AAS 3 to judge whether the transactions of the company is correct or not. The auditor can also take help from valuation experts and they can help in ascertaining the completeness of the asset involved for the company (Appelbaum, et al., 2018).
Communicating Key Audit Matters in the Auditor’s Report
Valuation – To determine whether the valuation of the asset is correct or not, the auditor should check what are the terms based on which the asset is being recognized by the company. The relevant areas based on which the company has valued the asset should be checked. There is a lot of judgement involved on part of the management therefore they need to make sure that there is no error (Mubako & O’Donnell, 2018). The auditor can also analyse the prevalent market rates and then value the asset. It can also take help from valuation experts who can provide inputs on how the asset can be best valued and what are the areas that auditors need to check accordingly for their own satisfaction.
Communicating Key Audit Matters in the Auditor’s Report
ASA 701, deals with reporting of the key audit matters in the auditor’s report. All such matters which the auditor feels are of utmost importance to the management of the company and for the stakeholders and can influence their decision regarding the company needs to state in the audit report. The auditor needs to highlight it differently and state the various audit procedures that they have adopted in valuation of the same. In case of Beautiful Ltd, there is a lot of judgement involved on part of the management and it is overall a very complex process (Segal, 2017).
Thus the need is that auditor should properly check all aspects of this intellectual property and then disclose the same in their audit report. It will help in making the shareholders aware about the various steps that the auditor has taken from his end in asserting that the asset is reflected true to its value. The various disclosures that the auditor should make-
- The method of valuation that Beautiful Ltd, has adopted and how relevant it is as per the market standards(Kangarluie & Aalizadeh, 2017).
- The overall compliance that the company has done with the relevant accounting standard AAS 3 and whether proper disclosures have been done as per that in the annual report.
- The overall procedures that the auditor has adopted should also be stated and it should also highlight the various steps that have been taken by the valuation experts in the opinion that they have shared(Kachelmeier, et al., 2018).
- The impairment with respect to the intangible asset should also be stated and highlighted by the company.
An extract from the annual report of JB HiFi has been stated below and an analysis of the key audit matter stated by the auditor is also given
In case of JBH the company has got cash generating units which are a form of intangible assets and the auditor has stated the same in their key audit matter. As per the report, the group was having impaired goodwill of $14.7 million and impaired plant and property of $1.1 million. The company has used the discounted cash flow method to value the asset. The auditor has adopted respective steps to check the management value-in-use model. The auditor has also checked the latest approved forecasting and historical accuracy as stated by the management. The auditor has also taken help from valuation experts.
References
Andiola, L., Lambert, T. & Lynch, E., 2018. Sprandel, Inc.: Electronic Workpapers, Audit Documentation, and Closing Review Notes in the Audit of Accounts Receivable. Issues in Accounting Education, 33(2), pp. 43-55.
Appelbaum, D., Kogan, A. & Vasarhelyi, M., 2018. Analytical procedures in external auditing: A comprehensive literature survey and framework for external audit analytics.. Journal of Accounting Literature, 40(1), pp. 83-101.
Axelsen, M., Green, P. & Ridley, G., 2017. Explaining the information systems auditor role in the public sector financial audit. International Journal of Accounting Information Systems, 24(1), pp. 15-31.
Bailey, C., Collins, D. & Abbott, L., 2017. The Impact of Enterprise Risk Management on the Audit Process: Evidence from Audit Fees and Audit Delay. Auditing: A Journal of Practice & Theory, 37(3), pp. 25-46.
Bumgarner, N. & Vasarhelyi, M., 2018. Continuous auditing—a new view.. Continuous Auditing: Theory and Application, 20(1), pp. 7-51.
Fukukawa, H. & Mock, T., 2011. Audit risk assessments using belief versus probability. Auditing: A Journal of Practice & Theory, 30(1), pp. 75-99.
Garon, J., 2018. Ownership of University Intellectual Property. Cardozo Arts & Ent. LJ, 36(1), p. 635.
Heminway, J., 2017. Shareholder Wealth Maximization as a Function of Statutes, Decisional Law, and Organic Documents. SSRN, pp. 1-35.
Kachelmeier, S., Schmidt, J. & Valentine, K., 2018. The disclaimer effect of disclosing critical audit matters in the auditor’s report. SSRN, 2(1), pp. 1-39.
Kangarluie, S. & Aalizadeh, A., 2017. ‘The expectation gap in auditing. Accounting, 3(1), pp. 19-22.
Knechel, W. & Salterio, S., 2016. Auditing:Assurance and Risk. fourth ed. New York: Routledge.
Lessambo, F., 2018. Audit Risks: Identification and Procedures. Auditing, Assurance Services, and Forensics, 3(1), pp. 183-202.
Mock, T. J., Ragothaman, S. C. & Srivastava, R. P., 2018. Using Evidential Reasoning Technology to Enhance the Audit Quality Assurance Inspection Process. Journal of Emerging Technologies in Accounting, 15(1), pp. 29-43.
Mubako, G. & O’Donnell, E., 2018. Effect of fraud risk assessments on auditor skepticism: Unintended consequences on evidence evaluation. International Journal of Auditing, 22(1), pp. 55-64.
Rimmer, M., 2017. The Trans-Pacific Partnership: Intellectual property, public health, and access to essential medicines.. Intellectual Property Journal, 29(2), p. 277.
Segal, M., 2017. ISA 701: Key Audit Matters-An exploration of the rationale and possible unintended consequences in a South African. Journal of Economic and Financial Sciences, 10(2), pp. 376-391.
Sirois, L., Bédard, J. & Bera, P., 2018. The informational value of key audit matters in the auditor’s report: evidence from an Eye-tracking study.. Accounting Horizons., 32(2), pp. 141-162.
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