Legal and other considerations for auditing ECO Chemical Limited
Auditing is one of the most important function for an organization. Auditing is a regulatory requirements for a public organization and a closely held private organization that has crossed the level of sales set by audit regulatory authority in a particular country. The audit helps in identifying inefficiencies in operational and financial aspect of business. Hence it can be said that audit is essential for overall development of a company. This reports is prepared from perspective of an auditor to conduct an effective and efficient audit engagement. In this report audit will be conducted on Eco Chemical Limited (ECL) that is engaged in manufacturing of chemical products in Australia (William Jr, Glover and Prawitt, 2018). The operation of ECL are spread all over the Australia with their headquarters in Queensland. Chemical manufacturing industry in Australia is /highly competitive and the two types of products manufactured by ECL i.e. “Type X” and “Type Y” get heavy competitive from domestic as well as imported products. This report is divided into three sections that represents different aspects of audit to be conducted. The first part is related to preliminary investigation and audit planning in respected of audit activities to be conducted in the process. Second part is specifically related to audit and evaluation of purchasing and payment system of the company. At last, third part is related to case study provided in relation to ECL.
There are some factors that should be considered by auditors just after being appointed as auditor and before commencing the audit. Some of such factors that should be considered in case of ECL are as follows-
- Laws and regulations applicable on the organization- First and foremost an auditor should evaluate all legislatures and other regulation that are applicable on an organization. This will enable the auditor to plan their audit. For example, environmental laws are applicable on the company as it is manufacturing chemical products that can have significant impact on environment (Arens, Elder and Beasley, 2013). Hence in cases an auditor should make plans including the rules and regulations that should be followed by ECL in relation to protection of environment.
- Business environment- auditor of the company should also evaluate the external as well as internal environment in which the business organization is working. This helps auditor of the company to evaluate the key areas which are critical to business and requires additional audit procedures for evaluation.
- Communication with previous auditor- The newly appointed auditor should communicate with the predecessor auditor before accepting the terms and conditions of an audit. This communication can be oral or written. The new auditor is not required to disclose any confidential information that he/ she has acquired from the predecessor auditor during the course of this audit (Hayes, Gortemaker and Wallage, 2015). An auditor should consider the possibility that there might be some disagreements between previous auditor and management of the organization. The ideas presented by previous auditor in respect to such disagreement should not affect the decision of auditor in accepting or rejecting the appointment as auditor.
- Resolution to remove previous auditor and appointment of new auditor- It is also duty of an auditor to check that all the compliances in relation of appointment and retirement of an auditor are properly complied by management and shareholders. Hence in this case, incoming auditor should assess whether notice of non-reappointment was given to the retiring auditor. In addition to that the retiring auditor has also rights to be given an opportunity of being heard in the general meeting in which resolution to dismiss auditor is to be passed (DeFond and Zhang, 2014). Auditor should also ensure that special resolution is passed by shareholders in general meeting in respect to appointment of new auditor and non-reappointment of old auditor.
- Special skills and expertise requirement- It is an ethical duty of an auditor to see that they have all expertise and skills that are essential for effective and efficient audit of an organization. Auditor should evaluate that whether company require some special skill for completion of audit procedure. If such skill is required then auditor should consult other partners of audit firm or hire some expert in such area (Eilifsen et.al, 2013).
- Conflict of interest- All provisions in respect to related party transactions and conflict of interest with the organization should be properly followed by an auditor. An audit should evaluate that he/ she personally or together with its partner/relative should not a business or personal interest in the organization.
Some of the major risk areas that will be addressed in audit for the year ending 30th June 2018 are as follows-
- Production estimation- The manufacturing for a business organization is dependent on the sales estimated by sale and marketing department on the basis of their past year sales. The process of sales estimation becomes more important in highly competitive market as in such market there are various product that can replace products manufactured by a particular organization. In case of ECL, the product that have become obsolete can be used in manufacturing process. In this case company will lose 70% of the value of their products as only .30 cents on 1 dollar are realizable on these products (Kapoor, 2017). This can be considered as risk on profit generation capacity of ECL.
- Accounting functions- The accounting function mechanism adopted by the company is centralized that means that all major accounting books are prepared at the head office. It is not a very efficient method of accounting as head office of the company has to collect record of each sales office on daily basis. The more efficient method would be that each and every branch prepare their own books of accounts and they can be transferred to head office at the end of financial year. The head office can consolidate the financial statements of all branches at the end of financial year (Griffiths, 2016). This would be a better method as it would reduce the errors in financial accounting and books of accounts.
- Contradiction with environmental law- one of the biggest factor of risk in audit of ECL would be the recent chemical spill in the river from one of the manufacturing units of the company. Investigation is currently being conducted and result of the investigation can result in penalty or legal consequences for the company. It is also reported by the media that top level management of the company (Lam, 2014). This could result in expulsion of these members from the company. These violations can also result in revocation of license to manufacture that will put a halt on business operations.
- Stock stealing- This is another case that happened during the financial year that should be included in financial statements of the company. As an aftereffect of this case, various local managers has resigned from their position which will require appointment of new managers. This will disrupt the operations of these local stores and their profitability would also be affected. The financial impact of this stock stolen from small warehouses of clients will also be evaluated (McNeil, Frey and Embrechts, 2015)
- New bank loan- the repayment in relation to bank loan is also dependent on break even sales of the company. Chemical manufacturing market is highly competitive and there are high chances that company could not achieve its break even sales in any particular financial year. In such case company would not be able to pay interest and principal amount of such loan and it would result in acquisition of assets of company by the bank. This should be evaluated properly in audit process and its impact would be material for existence of company.
Strengths-
- Following a particular path for any business activity can be very effective for getting positive results. Following set policies and procedures helps in making employees of the company relatable to the business operation and new employee can join at any time in such organizations. Same concept is adopted by ECL for purchase and payment system adopted for stock management. This will helps management to identify any errors in set system if the company easily and rectify the mistake with less financial repercussions.
- Another strength of this system is that specific jobs are given in purchase and payment system to different employees rather than giving all powers to a single employee. This management technique is also called as segregation of duties. This is a very effective method that is adopted by ECL as number of reports given to employees by their subordinates are high that makes evaluating the status of each activity very easy. The chances of fraud and misappropriation of funds by a particular employee also becomes very less (Vasarhelyi and Halper, 2018). Current problem of stock stealing can be managed with the help of this system.
- The level of stock reorder decided by the company is also very effective. This stock reorder level will help management to maintain the demand of products in the market. The industry in which ECL is working is very competitive and if such demand is not fulfilled by ECL then the customer will move over to other company. This preferential change on pa1rt of customer will result in loss of revenue and customer for the company.
Weaknesses-
- Lack of documentation- As per the details given in relation to purchasing of stock, it was mentioned that the order for stock reorder is given on telephone and no written document is produced in this regard. A mark is made in stock register which is not sufficient for effective stock management system.
- Inefficiency of warehouse assistants- Biggest mistake done in the purchasing and payment system is that quantity of stock delivered by supplier is not physically checked by warehouse assistants and directly put into the system. There is a probability that stock recorded in books off accounts are higher than actual stock in business which would ultimately result in exaggeration of overall profits made by the company (Knechel and Salterio, 2016). There are various decisions that are made on basis of these profits and exaggerated profits will also affect such decisions.
- Policies and procedures- a flow chart should be prepared by the auditor in respect to all activities undertaken by management in this process. On the basis of his/her experience, auditor should asses the viability and effectiveness of overall process. Auditor should also check the approval documents to see whether this policies and procedures are followed on every occasion or not.
- There are always some types of controls that are implemented when segregation of duty is adopted by management. For example in cash handling by banks, keys to the vault are given to two different people. Auditor should check whether any of such controls is implemented by the company or not. Auditor can also conduct a surprise check on payment procedure adopted by the company (Gay and Simnett, 2005).
- Stock register can be checked by the auditor to determine the level of stock at the time reorder is made by stock manager. This will help auditor to map out any inconsistencies that are followed in the process of stock reorder.
- Document not maintained by stock manager while ordering stock can result in double order to supplier. Lack of documentation always creates a level of confusion that can result in repetition of work and loss of time and money. This can be managed by making an invoice order at the time of stock reorder (Rezaee et.al, 2018).
- Inefficiency on part of warehouse assistants can be managed by supervision and giving training to these employees. The actual stock in the warehouse and stock recorded in books of accounts will not be equal if quantity of incoming stock is not verified by the manager.
After a detailed investigation in relation to purchase and payment transactions it was identified that there were certain aspects system that prone to risk and material misstatements. Hence auditor of the company has decided to implement additional audit techniques to ascertain accuracy of these data (Crosson and Needles, 2013). CAAT analysis is used to further investigate the transactions recorded by the organization in relation to purchase and payment in relation to stock management. These are various CAAT software that can be used to analyze such data and in this case Active data for excel has been used by the Auditor.
Summary investigation report
- Purchase transaction
During the accounting period under consideration, there were 220 invoices that were issues regarding purchases made from suppliers of the raw material. After CAAT analysis it was identified that only 29 transaction out of 220 transactions accounted for 65.89% of the total value of purchases made during the financial. This should not have been the case as per the current stock reorder system of the company. As per stock reorder system, 3 months stock was purchased before the current stock lying in the inventory was consumed.
Major risk areas to be addressed in the audit
It this system was properly followed then the amount of invoices for each transaction would have been approximately equal to each other. There might be some instances where the amount of purchases would have been higher but discrepancy identified in CAAT analysis is very high. It is a clear indication that the stock reorder system was not properly followed. There might be repetition of some of the order as proper documentation was not made for reorder made to supplier (Maher, Stickney, and Weil, 2012).
This data was also divided into two categories i.e. transaction with invoice value greater than 1000 and transaction with invoice value lower than 1000. This stratification shows that 122 transactions accounts for 14% of the total value of purchases and other 98 transactions accounts for 86% of total value of purchases. The company should give more focus to these later 98 transactions (Chen and Simchi-Levi, 2012). There should be separate payment system in relation to these suppliers as the value of raw material supplier by them is way higher as compared to other 122 transactions. Separate purchase agreements should be prepared with these suppliers.
ECL can demand for higher discount rate from these suppliers and even small percentage of discount from these supplier can result in huge cash saving for the company. Getting higher discount rates from other 122 suppliers would not be possible as in that case company would not have much bargaining power. In addition to that time taken for payment in relation to credit purchase should also be extended through new agreement. This is a very common strategy that is used by business organization as such a huge amount can be paid after the amount is realized from sales made by the company in market (Laudon and Laudon, 2016). If company is paying these suppliers before sales are made though other sources then it would result in loss of interest income which they could have earned if such amount was not used for payment to suppliers.
Standard deviation of purchase transactions is 6135 which is very high and it can be said that each transaction is scattered from Mean purchase invoice amount. This is in contrary with the stock order policy used by the management. The main objective of following a fixed reorder policy is to bring a uniformity in amount and procedure followed for stock management (Wild, 2017).
- Suppliers payment
The CAAT analysis has identifies the Top five postal coded from which the raw material is acquired by the company. One of the most important expense in relation to acquiring raw material is transportation expense. With the help of proper management of postal codes this cost can be reduces by the company. The CAAT analysis gas identified top 5 postal codes and management can arrange the time of delivery in such a manner that all of supplies from these postal codes can be acquired at the same time (Bauer et.al, 2012). This will reduce the cost of transposition as all supplies can be collected at the same time. Transportation cost is an indirect expense and it does not add any value to company. Hence it would be best to apply cost reduction methods to reduce this cost.
Strengths and weaknesses of the purchases and payments system
Conclusion
Each and every aspect of aspect of business is very important for effective management and operation of business. Auditing is very important for all the stakeholders involved in the business. It helps in identification of internal deficiencies in business management and through such evaluation management can take precautionary measured to cure such deficiency. In this report various aspects of Eco Chemicals Limited (ECL) has been evaluated. Auditor of the company has identified various deficiencies and risk areas in ECL. Auditor has also provided certain recommendations that could help management of the company in solving the problems arising from these deficiencies. In addition to that the key legal consideration are also discussed that an auditor has should consider before accepting an audit engagement. Stock purchasing and payment system of the company is also discussed in detail. Stock management is very important branch of business especially in a manufacturing company. After an audit investigation it was identified that there are various aspects of stock management that are at high risk. In this investigation strengths and weaknesses of stock management was identified with their impact on financial and operational aspect of business. In the last section of this report, auditor of the company has applied CAAT analysis methods to procure additional audit evidence to check accuracy and authenticity of transactions recorded in relation to purchase and payment to suppliers. IT can be said that auditor of the company has properly performed his functions to give true and fair review on financial statements.
References
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Crosson, S.V. and Needles, B.E., 2013. Managerial accounting. Cengage Learning.
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Rezaee, Z., Sharbatoghlie, A., Elam, R. and McMickle, P.L., 2018. Continuous auditing: Building automated auditing capability. In Continuous Auditing: Theory and Application (pp. 169-190). Emerald Publishing Limited.
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