Risks Associated with Property Plant and Equipment of Green Machine Ltd
Auditors can easily communicate key matters to the stakeholders through the audit report and this requirement is emphasized by ASA 701. However, it is also the management’s liability to oversee whether the exact scenario and affairs of the company have been reflected in their financials. Moreover, stakeholders can make appropriate decisions if the adopted communication measure is effective in nature. Disclosures should happen at the proper course of time because disclosures lead to transparency (Badolato, Donelson & Ege, 2014). It not only supports and helps the users of the financial statement but ensures a strong goodwill of the entire company. Further, it is vital to understand that the auditor must ensure decision making in an unbiased manner as it will led to independent decision making.
- Two prime assertions
Assertions are those claims that the management exerts during the presentation and preparation of financials. Therefore, if such claims are untrue, then the company can become liable to penal provisions and can lose their goodwill as well. From the given case, the software problems encountered by Advanced Computer Solutions Ltd has been highlighted that has generated further problems like secondary sales, increasing returns, and accumulation of stocks.
- Accurate valuation
Due to software issues prevailing in the system of Advanced Computer Solutions Ltd, there has been major deterioration of sales and increasing returns that has resulted in degradation of the company’s goodwill. Moreover, if reporting of cost is not greater than the actual cost, then accurate inventory valuation cannot be achieved (Baldwin, 2010). Further, if such cost is not greater than the NRV (net realizable value), such valuation must be achieved at the same NRV and not the costs. In addition, all costs must be rightfully aligned to their respective inventories and thereafter, the valuation must be undertaken at NRV if the costs are lower. The reason behind this can be to ensure that such valuation can assist in recording the exact amount realized from the sales and no untrue amounts are recorded (Niemi & Sundgren, 2012). Therefore, proper computation of cost is crucial in the given scenario as it generates immense amount of risk for such assertion. If the cost is computed in an effective manner it will lead to proper result and decision making.
- Completeness
In the given case, it is visible that the inventories of Advanced Computer Solutions have been transferred from a centralized area to different regional warehouses situated at different places. Therefore, there are chances that inventories at every area is taken due care of and the same is calculated properly. In addition, there can be stocks of other companies in such warehouses if the same are not under ownership scheme (Gajevszky, 2014). Hence, due care must be exerted to ensure that these scenarios are monitored effectively and inventory valuation is undertaken by including the company’s own costs and not of other companies. Overall, claims of ownership and completeness are totally complementary to each other.
Appropriate Audit Procedures to Mitigate Risks
The evidence that acts as a support of the assertions made by companies are signified as audit evidence. Besides, any procedure performed to accumulate these evidences is commonly known as substantive audit procedure. The procedures in relation to the above-mentioned risks are:
- Against inaccurate valuation
In order to tackle inaccurate valuation, procedures like thorough scrutiny of segments like overheads, nature of expenses, costs aligned to such overheads, human resource salaries and wages, etc can be performed that can play a role in minimizing wastage and scrap. Further, a thorough market evaluation can be also adopted to obtain a proper NRV in relation to inventory valuation.
- Against completeness
Substantive procedures like cut off assessment can be adopted to get rid of such risk wherein the auditors can determine a particular date outside of which any inclusion or exclusion from the warehouse shall not be considered. In addition, by being physically present at the site can also assist in supervising the entire process effectively, thereby ensuring completeness on a whole (Hoffelder, 2012). Further, cross-checking of books of accounts to ascertain discrepancies can be also done to make sure any risk does not exist.
The AUASB has framed the standard of ASA 701 that necessitates both listed and non-listed companies to communicate their key audit matters to the stakeholders through a proper audit report. The reason behind this can be attributed to the fact that communication of material matters can allow users to make proper decisions. However, it must be noted that the judgement of an auditor is crucial in this regard to ascertain what matter is considered material and what is not. The increasing level of inventories is a matter of serious concern in the given scenario and hence, must be duly communicated by the auditors (Matthew, 2015). This is because all the utilized analytical methods reflect that there has been an increment in the value of closing stock not due to increment in production but due to major issues in the software of the company resulting into secondary sales. Moreover, this can also affect the government tender that is a negative indicator (Coram et.. al, 2011). Nevertheless, the objective is to intimate the users that they must cross-check through other means and thereafter, take decisions based on the same. Since, propriety funds are associated in the given case, the same is material in nature and must be duly reported.
a. Two prime assertions
Assertions are based on preparation and presentation of financial statements and any false assertions can be troublesome for the company and therefore, there must be strict avoidance of the same. In relation to the given case, the prime matter for the company is its property, plant, and equipment (PPE) as the same is assumed to be a manufacturing company an PPE forms a major part of such company’s assets. Moreover, classification and valuation of these assets is equally important because financial outcomes can be altered to defraud the stakeholders (Coram et.. al, 2011). The risks related to the company are as follows:
- Classification
Conclusion
The assets of the company must be accurately classified so that users get a true and fair view of the financial outcomes. Further, all expenses must be appropriately aligned to their own heads so that there is no error in the financials. For instance, maintenance and repairs must be allocated to the revenue expense, fresh purchases must form part of block of assets, etc. Nonetheless, these classifications must be based on generally accepted accounting principles (GAAP). In the case of Green Machine, all its costs of past year are totally mixed up, which means that its revenue and capital expenses are interpreted inappropriately, thereby portraying a wrong picture of the overall accounts as the carrying values of PPE are either at inflated or degraded figures.
- Accuracy
Such assertion highlights the fact that proper computation of accounts has not been done and that may not gather an unqualified audit judgement on the auditors’ part. Besides, from the company’s management report, it is visible that the rate of depreciation has been considered very less that has paved a path for the destruction of correctness and fairness of books of accounts. Nonetheless, considering lesser depreciation rate can have the following outcomes namely exaggerated value of assets, increased financial figures, creation of additional liabilities like deferred taxes, etc (Asien, 2015). Hence, considering a lesser depreciation rate can affect the financial health of the company in the upcoming tenure that is a major risk factor.
As mentioned earlier, substantive audit procedures play a key role in gathering audit evidence to support the assertions or claims offered by companies. Further, these procedures can assist in identifying any false claims or assertions on the part of companies that can assist in preventing future problems.
- Against classification
In the given scenario, it is visible that errors persist in the past computations that necessitates due caution and care on the part of auditors towards the current year computation. Therefore, the entire audit team must scrutinize the past calculation and analyse the present year’s computation to arrive at appropriate figures. Nevertheless, the entire procedure is lengthy and time consuming in nature but the same must be undertaken to mitigate the risk of classification assertion (Arens et. al, 2013). Moreover, for such purpose, a unique team must be framed to check the capital assets and monitor any changes or additions in the documents related to the company’s PPE. In addition, proper care must be undertaken to advise the finance department so that such errors are not repeated in the future (Arens et. al, 2013).
- Against accuracy
This assertion is very relevant in this scenario because major errors can incur in the future owing to improper calculation, inappropriate judgements or estimates, and inaccurate valuation. In order to mitigate the issue of accuracy, all the assets of the company must be carefully supervised and checked and thereafter, their depreciation rate must be understood.
As mentioned earlier, ASA 701 is primarily related to an auditor’s judgement regarding whether a matter is of material nature or not. In relation to Green Machine, its fixed asset (PPE) forms a significant part of its total assets and therefore, errors associated with the same can be considered as a key audit matter. Further, these errors are not of minor nature that can be overlooked and proceeded further. Therefore, reporting of the same must be duly done.
Therefore, disclosure of errors, reasons behind the cause of such errors, actions taken in the current year to mitigate the past issue, etc must be done by the auditors in their report so that users can make efficient decisions based on the same.
Conclusion
It is very significant for companies to follow requisite accounting policies and standards to assist users in their decision-making processes. Further, auditors are also bound to oversee this entire process so that in the event of material issues, the same can be highlighted at the primary stages itself and major risks can be mitigated on a whole. Besides, companies can safeguard themselves from penal provisions if the advice of auditors are considered while preparing and presenting the financials. Nonetheless, this can assist in maximization of goodwill as well.
References
Arens, A. A, Best, P. J, Shailer, G. E. P & Loebbecke, J. K. (2013) Assurance Services and Ethics in Australia, 9th ed, Australia: Pearson.
Asien, E.N., (2015). Firms’ attributes determining auditors’ remuneration: empirical evidence from Nigeria. International Journal of Auditing Technology, 2(4), pp.297-315. Doi: https://doi.org/10.1504/IJAUDIT.2015.076440
Wright, M.K. & Charles, J. (2012). Auditor independence and internal information systems audit quality, Business Studies Journal. 4(2), 63-84.
Coram, P., Mock, T. J., Turner, J. & Gray, G. (2011). The communicative value of the auditor’s report. Australian Accounting Review 21(3): 235-252. Doi: https://doi.org/10.1111/j.1835-2561.2011.00140.x [Accessed 22 January 2019]
Hoffelder, K. (2012) New Audit Standard Encourages More Talking. Harvard Press.
Matthew, S. E. (2015) Does Internal Audit Function Quality Deter Management Misconduct?. The Accounting Review. [online]. 90(2), pp. 495-527. Available from https://doi.org/10.2308/accr-50871 [Accessed 22 January 2019]
Niemi, L., and Sundgren, S. (2012). Are modified audit opinions related to the availability of credit? Evidence from Finnish SMEs. European Accounting Review, 21(4), 767-796. https://doi.org/10.1080/09638180.2012.671465
Baldwin, S. (2010). Doing a content audit or inventory. Pearson Press.
Badolato, P.G., Donelson, D.C. and Ege, M., (2014). Audit committee financial expertise and earnings management: The role of status. Journal of Accounting and Economics. 58(2-3), pp.208-230. Available from: https://utexas.influuent.utsystem.edu/en/publications/audit-committee-financial-expertise-and-earnings-management-the-r [Accessed 20 September 2018]
Gajevszky, A. (2014)The Impact Of AuditorS Opinion On Earnings Management: Evidence From Romania. Network Intelligence Studies, 2(1), p.3. Available from: https://EconPapers.repec.org/RePEc:cmj:networ:y:2014:i:3:p:61-73 [Accessed 20 September 2018]
Geoffrey D. B., Joleen K., K. K.S., and David A. W. (2016) Attracting Applicants for In-House and Outsourced Internal Audit Positions: Views from External Auditors. Accounting Horizons. [online]. 30(1), p.143-156. DOI: https://doi.org/10.2308/acch-51309
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