Identifying Potential Audit Risks and Audit Steps
An effort is being made through this report to ensure that all the financial and non-financial information received in respect of the given company is objectively analysed. Through the results obtained by the analysis conducted, an effort will be made to determine the weaknesses that are prevalent in the internal control of the company. Subsequent to the identification of the weaknesses, an effort is made to determine the audit procedure to objectively identify the steps that will alleviate the risks of material misstatement in the financial statement of the company (William Jr, Glover & Prawitt, 2016).
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Account |
Analysis |
Audit risk |
Audit steps to reduce risk |
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Plantand equipment |
From the information that has been given for consideration, it is observed that there has been significant amount of obsolescence on the part of the company’s plant and equipment. The reason being that, the requirement of the industry has changed substantially over the period of last 18 months (Wang, Li & Li, 2015). The new demand is for computer-aided machinery. This substantial shift of requirement of the industry has affected the plant and machinery requirement of the company significantly. The company will have to replace the majority percentage of its stock with latest machinery. Failing to do so will cost the company its client and its future viability of operations. After going through the warehouse of the company, it is observed that the stock of plant and equipment as kept and manged by the company is lying idle. This shows that the equipment present in the stock of the company has lost their power or ability to generate any sort of revenue or profit for the company. The investment of the company on these assets has become useless. In addition to this, the depreciation of the machinery including the method used for recognising the same has to be reviewed by the company to ensure that the depreciation due to obsolescence is duel accounted for by the company. |
There is several audit risk that are involved in respect of the review of the company’s financial statements. Some of them include non-financial factors like the obsolescence of the equipment used by the company. The reduction in the growth of the market etc. Someof the key audit risks present in the project involve the concept of depreciation. The reason being that the policy adopted for recognising depreciation at the time of acquisition of the machinery might have changed over the period due to the change of the circumstances in the business environment of the company. Another significant aspect corresponding to this account includes the valuation of the impact of the circumstances on the recoverable amount of the property, plant and equipment. |
Some of the steps that can be taken up by the auditor to minimise the risks include physical verification of the assets. This will enable the auditor to determine the usabilityof the asset in the near future. Taking the advice of an expert for determining the correctamountof depreciation that must be charged byte company for the same. |
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Machinery finance liabilities |
In the present case, the company has taken immense loan to finance the latest equipment. The machinery originally purchased was financed by way of loans too. This has led to immense finance liabilities in respect of the assets (Waldman & Jensen, 2016). The same has to be met by the company by utilising the revenue generation capability of the assets by the company. |
The audit risks that are involved in reviewing these include overlooking of the present revenue generation capability of the assets of the company. The auditor might also fail to objectively factor in the impact of the reduction in the market in which the company operates. This is because reduction of the market of the company will reduce its cash flow and thus affect the repayment of the finance liabilities the company has incurred in respect of the assets. |
There are several methods or steps that can be taken up by the auditor to minimise the risks this include: a) Going through obligation that the company has incurred in respect of the assets very objectively. The terms of repayment along with the period must be studied. b) Assessing the revenue generation capacity of the present assets of the company. c) Estimating the future revenues of the company while factoring in the |
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Accounts receivables |
The account receivable so the company have been –paying late payments to the company. This has increased the days in receivablesof the company above the industry average. |
There is a huge risk that the amount shown by the company as receivables become will become bad debt. The reason being the substantial time taken up by the debtors. |
The auditor must ask for debtor aging sheet from the management that will contain the details of the debtors and the delay they have shown in repayment. |
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Lease Income |
The company has been showing less lease income in the unaudited statements. There is also no relevant data available for the lease income in respect of the industry average. |
There is a substantial risk in respect of audit as there is no parameter against which the income can be measured.The auditor must take the suggestions from the experts of the field regarding the sufficiency of the lease income earned by the company. |
It is of utmost importance that the business risks faced by the company are properly discussed because their respective implication affects the business in a multitude of ways. The business risk is needed to be understood by the auditor in order to determine the areas of the company’s financial statements that are most likely to contain material misstatements (Stewart & Shamdasani, 2014). This will increase the effectiveness and the efficiency of the audit procedures applied by him.
Some of the business risks that are mentioned in the additional information are as follows:
- The demand for the equipment owned by the company has decreased substantially and there has been an increase in the demand for the computer operated machinery in the market. This has rendered the costly old equipment’sof the company useless and incapable of generating revenue in the future.
- Due to the rising demand for the new machineries, the company had to increase its borrowings for the purposeof acquiring tis new machineries.
- There had been huge fluctuations in the metal market and it had effected the operations of the company in the following manner:
- The gold market has dropped around 24.95% since 2012.
- Iron ore market has dropped around 43.78% since the year 2012.
- Due to increase in the demand of the new machinery, the company had to take huge borrowings and thus it will have to bear higher financial obligations.
- Along with the requirement of the new machineries, the company is facing the requirement of new employees who are trained and skilled in operating these machineries. As the workers of these machineries need to be more trained, they will command higher salaries. This will increase the employee cost of the company substantially.
The confirmation of the business risks identified in the additional information can be found in the ratio analysis because of the following reasons:
- The Return on Assets earned by the company is below the industry average.
- The company is earning a reduced amount of Return on Equity corresponding to the industry average.
- The profit margin of the company is less than the industry average.
Some of the business risks that can be identified from the ratio analysis are as follows:
- The difference between the audited and the unaudited financial ratios is substantially high. This suggests that the company has been involving in many either intentional or unintentional errors while reporting its annual results.
- The days in account receivable of the company is significantly higher than that of the industry average that suggests that the company is incurring additional opportunity loss due to blocking of funds (Rezaee et al., 2018).
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Control |
Risk Alleviated |
Test of Control |
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Inventory control system: Under this system, the company can utilise the services of information technology to maintain a log boom that will automatically inform the company regarding the status of the inventory or the time period for which it has not been used (Chan & Vasarhelyi, 2018).
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The risk of non-factoring relevant non-financial information for the planning of the business will be alleviated. The company will be able to factor in the obsolescence of its inventory to determine the depreciation that must be provided for it. It will also inform the company regarding the possible future acquisitions to be made by the company (Collins, 2017). |
The company should enter into the system the details of the entire inventory present with it at present. This will ensure that the company reports the obsolescence of the same to the company. If it is reported, it is assured that the system is working properly (DeFond & Zhang, 2014). |
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Receivables management softwares: Under this, the company can make us of software that contains the details of the entire debtors of the company. It will automatically inform the debtors when the payment will be due from them. Simultaneously the person concerned with the management of the receivables will be informed regarding the collection of the dues from the debtors on time (Alles, Kogan & Vasarhelyi, 2018). |
Risk of bad debt will be alleviated: If the system is implemented by the company, it will ensure that the company is bake to reduce its days in accounts receivables and it will substantially reduce the risk of bad debts. |
The present debtors are paying the company in a delayed time. Hence, immediate application of the system should inform the management regarding the debtors who are making defaults in respect of among the payments on time. |
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Use of effective and efficient accounting softwares: Presently the gap between the audited and the unaudited results of the company is immense. This suggests that the personnel’sof the company are failing to make the records of the company properly according to the statutory guidelines. Hence, there is an immediate requirement for its correction. |
This will alleviate the risk of faulty accounting recording and treatment. This will improve the efficiency of the auditor too as he will be able to focus on key performance indicators of the company rather than getting diverted with small but numerous errors in the financial statements of the company. |
The accounting software must be equipped with all the latest amendments that have been brought about by the statute recently. |
Some of the weaknesses that the company experiences in the internal control of its contract payroll are as follows:
- The entry of the employee details by the payroll clerk is made using a hard copy containing various sortsso details of the employee. The company must make sure that it should maintain the soft copy of the details as well. The same should be attached with the employee details in the system (Hayes, Wallage & Gortemaker, 2014). As the clerk may claim to lose the hard copy.
- The timing of the work hours are manually recorded and entered by the employee. It is not possible for the contract’s manager to monitor each employee if his or her numbers are significant (Freeman et al., 2017).
- The entire system is automatic. In case of failure to change the amendments in the regulatory requirements like that of the tax rate etc., the entire system along with the corresponding information will give misleading results.
- The bank log in details must not be present with the accountant. At least it must not grant him the ability of processing of payments. This may result in manipulation of funds by him.
- The calculation of the regular payments and the payments regarding the superannuation and other funds must be separate. As it will eliminate the risk of faulty methods being used by the company for computation of the same. It will increase the transference of the method employed by the company (Hargie, 2016).
Conclusion
After conducting the detailed analysis of the various aspects of the company, it was found that there is substantial business risk present in the operations of the business. This includes the obsolescence of the equipment of the company and the shrinking market. In addition to this, it was seen that there were several weaknesses in the internal control of the company. Those can be alleviated by optimal utilisation of the softwares by the company.
References
Alles, M. G., Kogan, A., & Vasarhelyi, M. A. (2018). Putting continuous auditing theory into practice: Lessons from two pilot implementations. In Continuous Auditing: Theory and Application (pp. 247-270). Emerald Publishing Limited.
Chan, D. Y., & Vasarhelyi, M. A. (2018). Innovation and practice of continuous auditing. In Continuous Auditing: Theory and Application (pp. 271-283). Emerald Publishing Limited.
Collins, H. (2017). Creative research: the theory and practice of research for the creative industries. Bloomsbury Publishing.
DeFond, M., & Zhang, J. (2014). A review of archival auditing research. Journal of Accounting and Economics, 58(2-3), 275-326.
Freeman, R. J., Shoulders, C. D., McSwain, D. N., & Scott, R. B. (2017). Governmental and nonprofit accounting. Pearson.
Hargie, O. (2016). Skilled interpersonal communication: Research, theory and practice. Routledge.
Hayes, R., Wallage, P., & Gortemaker, H. (2014). Principles of auditing: an introduction to international standards on auditing. Pearson Higher Ed.
Rezaee, Z., Sharbatoghlie, A., Elam, R., & McMickle, P. L. (2018). Continuous auditing: Building automated auditing capability. In Continuous Auditing: Theory and Application (pp. 169-190). Emerald Publishing Limited.
Stewart, D. W., & Shamdasani, P. N. (2014). Focus groups: Theory and practice (Vol. 20). Sage publications.
Waldman, D., & Jensen, E. (2016). Industrial organization: theory and practice. Routledge.
Wang, B., Li, B., & Li, H. (2015). Panda: Public auditing for shared data with efficient user revocation in the cloud. IEEE Transactions on services computing, 8(1), 92-106.
William Jr, M., Glover, S., & Prawitt, D. (2016). Auditing and assurance services: A systematic approach. McGraw-Hill Education.
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