Analysis of Audit Risks
The report is prepared to demonstrate the audit risks that are encountered by one of its long standing and significant audit clients of Miller Yates Howarth (MYH) that is Trunkey Creek wines (TCW). Such risks are generally attributable to the fraud activities or efforts conducted by the assessors or the auditors. Some of the areas of concerns for which the auditors have been asked to evaluate and analyze are investment, accounts receivable, property assets and marketing expenses. It is required by the auditor to plan the audit engagement by extracting the information by reviewing the system notes in the permanent file and pursuing a manual of new internal control for organization. Assessment of the audit risks related to specific accounts has been done by the computation of relevant ratios and thereafter outlining the steps that should be taken for reduction of such risks (Bell et al., 2015). The second part of report presents the analysis of effectiveness of internal control systems and identifying the measures of alleviating risks. Furthermore, the weakness of internal control system related to accounts payable and purchase accounts have been identified and evaluated in the report.
The first question seeks to give the explanation of the audit risks associated with the accounts of TCW by analyzing the ratios such as gearing ratio, solvency ratio, profitability ratio, liquidity ratio and efficiency ratios. It has been said that the financial assertions can be analyzed effectively by computation of relevant ratios that helps the assessors or auditors in understanding the financial performance or financial position of the organization. In the given case study, evaluation of accounts of Trunkey Creek wines is evaluated by the computation of relevant ratios associated with the accounts such as property assets, marketing expenses, investment and account receivables. The audit planning on the given case study indicates that the audit would be facing several material misstatements in the accounts while assessing. For this purpose, they have been entrusted with the responsibility of identification of such risks and accordingly recommending the mitigation steps for reduction of such risks. The important element of audit risk is intrinsic difficulty in detecting such risks because of nature of fraud (Iyer & Samociuk, 2016). However, the implementation of effective internal control would help in reduction in audit risk resulting from occurrence of fraud. It is required by auditor to exercise reasonable care and skills and maintaining professional skepticism while planning and conducting the audit. The analysis of several accounts of TCW has been depicted in the table below that depicts the audit risks and the mitigation strategies or the audit steps taken to reduce the occurrence of such risks.
Table depicting ratios:
|
Ratio |
Unaudited (2018) |
Audited (2017) |
Audited (2016) |
|
Return on equity |
10.80 |
17.5 |
15.2 |
|
Return on beef production assets |
1.67 |
-0.82 |
-3.45 |
|
Return on grapes and wine production assets |
12.2 |
14.5 |
16.2 |
|
Gross margin |
24.5 |
30 |
31.76 |
|
Net profit margin |
14.38 |
20.27 |
17.85 |
|
Marketing expense |
23.67 |
17.89 |
15.2 |
|
Days in inventory to wine |
367 |
423 |
53.24 |
|
Current ratio |
2.8 |
2.54 |
2.66 |
|
Quick ratio |
1.18 |
1.15 |
1.2 |
|
Debt to equity ratio |
0.54 |
0.63 |
0.67 |
|
Account |
Analysis |
Audit risk |
Audit steps to reduce risk |
|
Accounts receivables |
Accounts receivable is the amount that is by the clients or customers of TCW to company itself. The accounts receivables ratio is examined evaluated for the purpose of evaluating the financial condition of organization. It can be seen from the above table that the days in accounts receivable for wine and beef is recorded at 60.65 and 36 respectively. The total number of days of standard number of outstanding customer invoices is replicated by these numbers (Kend & Basioudis, 2017). However, it can be seen that in year, this value has reduced for wine and has increased for beef indicating that time taken to make the payment by debtors has increased in case of wine as against beef. |
It can be seen from the case study that marketing of predicts by TCW is done on the credit system. Hence, the system of credit attaches a considerable amount of risks on part of the payment made by the customers. It can be assessed that there exist a risk to completeness and this represents the risks of firms relating to its validity. The risk relating to completeness is that the accounts might not file documentation or rerecord the accounts in an appropriate manner. |
The accounts receivables whose numbers of days are increasing should be regularly viewed and the same should be discussed with the management. Any allowance for the provision of doubtful debt should not be done without the approval by upper level management (Fortvingler & Szívós, 2016). In addition to this, the process of credit approval should be reviewed. |
|
Investments |
The effectiveness of investment of organization can be evaluated by the computation of total number of times of interest that is earned ion any particular investment (Groomer & Murthy, 2018). It can be seen that the time earned interest of TCW has decline from 8.1 in year 2016 compared to 7.5 in year 2017. |
It is required by financers to make disburse the investment in a planned manner if the level of risks associated with the investment is high. The working capital of the company would be impacted by the amount of the risks associated with the investment made. |
It is required by the auditors to make the assessment about the investment made by TCW whether they are making any unusual investment that has reduced in the time interest earned. Investment should be monitored by the management as a part of their operation. |
|
Property assets |
The investment scenario of TCW can be assessed by the computation of ratios that identified the number of time that firms are earning in the amount of investment made by them. It can be seen from the table that there is increase in return generated on equity for the audited financial statements. In addition to this, the return on beef production of assets has improved. Furthermore, the return generated on the wine and grape production of assets has increased in year 2017 |
There can be risk related to the recording and registering the property assets and intricacy in the valuation of assets. The audit risks associated with property assets include the method used for charging depreciation and the depreciation amount that is recorded by the accountant and documented might not be appropriate (Aziz et al., 2015). There can be incorrect valuation of the assets and any incorrect recording which might be hidden complex structures. Furthermore, there can be incorrect calculation of losses and gain on the revaluation of assets. Evaluation and exploration of assets might be overstated which might lead to misrepresentation of data (Ge et al., 2017). |
It is required by the auditors to make the assessment of effectiveness and existence of client control. Depreciation should be analyzed for the economic activity and their consistency. There should be regularly reviewing of ledgers and journals of property assets. The clients should be asked about any assets that have been removed. For determining the existence of the property assets, auditor should review the documents of acquisition. |
|
Marketing expenses |
The marketing expense as a percentage of total expenses has increased from 15.2 in year 2016to 17.89 in years 2017. Such increase in the percentage is indicative of the fact that the amount of marketing expenses has increased in recent year. Since the activities of marketing can be dispersed across the organization |
There might not be adequate disclosures of the related party transactions and the data relating to such activities might be misrepresented for improving the scenario that would change the perception of stakeholders (Cohen et al., 2017). |
It is required by the auditors to make evaluation of all the marketing activities sand verify their recording in to the file. There should be analytical review of all the expenses related to marketing activities (Byrnes et al., 2018). |
Business risk is the risks that are associated with the fact that there would be negative fluctuation on the anticipated loss or profits attributable to any organization. There is numerous factors impact the business risks of an organization (Groomer & Murthy, 2018). It can be analyzed from the given case study that the earnings of TCW have been quite stable for considerable number of years. In addition to the audit risks that have been analyzed in the table above, the ability of TCW to meet its objectives might be threatened by various external and internal factors.
Evaluation of Internal Control System Effectiveness
Return on wine and grape production assets- The total amount of return generated on the beef and wine production assets has reduced on a consistent basis. It can be seen that the return on such items production has declined to 14.5 in year 2016 as against 16.2 in year 2015. Such fall in value depicts that the assets have not been utilized efficiently for the production (Abbott et al., 2016). Furthermore, such decline can be also attributable to several external factors.
Days in accounts receivable beef- It can be seen from the table that there is consistent increase in the total number of days related to accounts receivable of beef. The days in account receivable for beef has increased from 24 in year 2016 to 36 in year 2017 and the number of days has increased further to 57 in year 2018 which is indicative of the fact that the time taken by TCW to recover its amount owed from customers have increased significantly.
Debt to equity ratio- The figure of debt to equity ratio is improving indicating that the proportion of total amount of debt held by TCW in relation to the assets has reduced. Debt to equity ratio has reduced in year 2017 to 0.63 compared to 0.67 in year 2016. This fall in the figure is indicating that the financial leverage of TCW has declined and therefore the associated business risk has lowered.
Gross margin- The gross margin of TCW has declined in year 2016 from 31.76 to 30 in year 2017. Such decline would make it difficult for the firm to retain higher percentage in terms of sales. There is further decline in the value of gross margin which depicts that firm has the capacity of retaining higher in terms of sale percentage.
Time interest earned- The interest coverage ratio depicts the total amount of rime that is taken by organization to make the repayment of assets. From the figures, it can be seen that the interest coverage ratio is below than one which indicates that the operating activities of firms do not generate sufficient amount of cash to make the payments or to carry out other additional activities (Farooq & de Villiers, 2017). Such fall in earnings depicts that the cash earnings of TCW is low and has reduced year on year.
In this particular section, the potentially effective internal control system of TCW has been identified along with the test of control for each identified control systems. There are different components of internal control system of TCW which is influenced by the management of organization (Louwers et al., 2015). The following table below illustrates the identification of internal control system, test of control and risk alleviated.
|
Effective control |
Risk alleviated |
Test of control |
|
Computer ordering system |
This would help in generating adequate and complete accounting records without any missing of data. There is effective usage of password for gaining access to any program. All these have helped in mitigating the risks associated with fraud activities (Guenther et al., 2015). |
Auditors should observe the preparation of deposits and opening of mails by employee. A sample of resistance should be selected for tracing the recording of receipts and deposits made to the bank. In addition to this, the policy about depositing the cash receipts should be enquired about the auditors. |
|
Electronic invoice from suppliers |
Receiving of electronic invoice from suppliers would helps in avoiding risks related to errors, late payments and compliance that are faced with manual invoice generation. Such invoice helps in streamlining and management that store data in a cloud based hub. Electronic invoices are more efficient, simpler and convenient and help in reducing the errors and any acts of misrepresentation (Carson et al., 2016). |
A sample of sales invoices should be selected by auditors and the computation of such invoices should be performed again for checking the correct recording. |
|
Online approval of payment file by management accountants and uploading the same to the bank |
Such system would help in assuring the accuracy and completeness of accounting records and entry validation associated with such records. Management would be able to ensure that the control system is effective due to the employment of online platforms for making payment and it would help in reducing the fraud and theft activities on part of employees (Soh et al., 2015). |
There should be application control relating to standing data and transactions pertaining to computerized or online system of making payment. The control of applications should be recorded, ascertained and evaluated by the auditors so that it helps in determining the material misstatements risks related to the financial statements of clients (Boyle et al., 2015). |
|
Generation of service order and sending it automatically to service provider |
The generation of service order by the computer system would enable the timely arrival of receipts of such orders and sending it automatically to the service provider would help in avoiding the delay in providing service orders. It would help in ensuring that the information would be in line of expectations of clients as well as suppliers along with data compatibility from two or more field (Hardy, 2014). |
In order for auditors to ensure that the data input is accurate, there should be digit verification check by using a process of algorithm. The reference codes of service order which is generated internally should be formatted in a proper way. The updating of data files should be done in a timely manner (Kend & Basioudis, 2017). |
|
Restricting payment unless discrepancies are resolved |
If the payment would be made by TCW without checking for any discrepancies, this would lead implausible generation of cash that might lower the total amount of cash earnings. Resolving of discrepancies without making the payment would help in ensuring that there is not any unusual flow of cash and maintenance of good relation between production manager of wine and suppliers (Rahim & Idowu, 2015). |
It should be evaluated by the auditors that there are not any unnecessary payments made on payments made to the suppliers. |
|
Master file control |
The supplier master file of TCW contains all the information related to suppliers with each supplier having a unique code. Such master file would help in ensuring the standing data integrity contained in the file (Simnett et al., 2016). |
There should be stringent security controls that are exercised by the organization. In addition to this, auditors should make use of control totals and record counts. Adequate procedures should be established over the data amendment that should comprise of restricting the authority to the appropriate individual and segregation of duties appropriately (O’Grady et al., 2016). |
The last section discusses about the weakness in the internal control systems associated with the accounts payable and purchase account.
Purchase account:
|
Weakness |
Justification |
|
In relation to the purchase account of TCW, there can be overstocking if the purchase is not checked independently with the stocks against the requisition of purchase. There can be misrepresentation of purchase order if there is no proper accounting of the sequence of orders along with the cancellation orders in event of no actual occurrence of purchase (Vovchenko et al., 2017). |
In the absence of management accountant, there is no second person who will account for any discrepancy between delivery and order. There is possibility that the accountant might forget to compare between inspection report and receiving records which does not provide guarantee of recording the related items. |
|
There can be errors in receiving invoices such as errors incorporating the wrong mentioning of price and posting in ledgers. |
There can be error in basis of trail balance preparation and errors on part of suppliers in entering the price and volume of sales made. |
Accounts payable:
|
Weakness |
Justification |
|
Occurrence of errors in the control account |
Management accounts might not be involved in regular comparison of control and credit ledger accounts that could result in occurrence of errors as it go on without any detection. Moreover, there is no guarantee that all the items related to accounts payable have been received and accounted that could lead to understating of the ledger accounts of creditors (Chen et al., 2014). |
|
Material weakness in the accounts |
There are certain weaknesses in the account payable of TCW that can be material that is associated with the internal control system. |
Conclusion:
From the above facts and figures related to several accounts of TCW, it can be inferred that there are various audit risks associated that requires introduction of various auditing steps to reduce such risks. The financial conditions of TCW have been deteriorated in terms of return generated on grape and wine production assets along with net and gross profit margin generated. In addition to this, the appropriate audit measures for reducing the audit risks have been explained. There are some businesses risks associated with the operations of TCW that is more pronounced internally compared to external factors. The evaluation of effectiveness of internal control system of organization depicts that the newly implemented system has been designed in such a way that it helps in reducing the fraud and errors on part of employees.
Analysis of TCW’s Accounts Receivable, Investment, and Property Assets
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