Key Assertions at Risk
Auditing is regarded as the procedures of examining as well as inspecting the financial statements of the business entities in order to detect the material misstatement in the financial reports, if any. While conducting the audit operations, the auditors are responsible to take into account the assertions made by the management while preparing different financial statements (Eilifsen, et al., 2013). Audit assertions are considered as the implicit or explicit claims as well as representations made by the management of the companies while preparing and presenting the financial statements related to the appropriateness of financial elements and disclosures. In case the auditors find any key audit assertion risks, they are needed to conduct appropriate substantive audit procedures for the identified risks. In this process, the standards of ASA 701 Communicating Key Audit Matters play an essential role for the auditors as it provides the auditors with the guiding principles to deal with the key audit matters in the companies. The main aim of this report is to analyze and evaluate two provided situations in order to find any assertion related risks so that appropriate actions can be taken to minimize them.
According to the provided information about Computing Solutions, it can be observed that there are two management aspersions of inventory valuation that can be at risks; they are Completeness and Accuracy. They are discussed below:
Completeness: This is considered as a major assertion for the valuation of inventory and this assertion states that it is needed for the management of the companies to record all the transaction related to inventory in the financial statements. It needs to be mentioned that understatement is a major risk in inventory management. One example of this risk can be that the company purchases inventory but the employees have not recorded them in the inventory account. One major reason for this risk can be weak internal control in the management of inventory (Titera, 2013). According to the provided information, the inventory in hand of Computing Solutions at the end of the year represents 22 percent sales in 2018 and 18 percent sales in 2014. It indicates towards wrong accounting treatment of inventory when the inventory of 2018 includes the inventory of 2014. It indicates towards the fact that the employees of Computing Solutions may misappropriate the inventory. It can also be observed from the fact that there can be incompleteness in the financial treatment of the inventory of the business (Kharisova and Kozlova, 2014).
Substantive Audit Procedures
Accuracy: Accuracy is regarded as another major assertion made by the management of the companies for the accounting treatment of business inventory. At the same time, this assertion helps the companies in spotting any kind of error in the process of inventory management. The big issue under this assertion is to make it sure that the company’s physical inventory amounts are accurate and this accurate inventory flows from the balance sheet of the company to income statement in the form of cost of goods sold (Kharisova and Kozlova, 2014). According to the provide information in the case, the management of Computing Solutions moved their close inventory of business from a central warehouse to six new regional warehouse in March 2017. At the time of moving or after the time of moving, there can be huge possibility of errors in the mathematical counting of the inventory and it may contribute towards the reduction in the inventory turnover from 5.2 in 2017 to 3.8 times in 2018. It can be considered as a major risk of audit assertion of Computing Solutions (Titera, 2013).
The above discussing shows the presence of two major audit assertion risks in Computing Solutions; they are risk of completeness and accuracy. After the identification of the assertions, the auditors are responsible to perform substantive audit procedures for each of the risks identified above; they are discussed below:
The first risk is related to the accuracy of inventory management in Computing Solutions. In order to address this issue, the auditor of Computing Solutions is needed to perform the substantive audit process of reconciling the inventory count to the general ledger (Chan and Vasarhelyi, 2018). In this process, the auditors will be responsible for tracing the valuation complied from the physical inventory count to the general ledger of the company. The main reason for this procedure is to verify that that the counted balance of inventory has been carried forward in the accounting records of the company.
The next risk is related to the accuracy of the inventory management of the company. In order to address this assertion risk, the auditor of Computing Solutions needs to perform the substantive audit procedure of observing the physical inventory count of the company (Groomer and Murthy, 2018). Under this procedure, the auditor will involve himself/herself in the discussion about the inventory counting procedures, observing the procedures to count, testing some of the inventories so that any kind of errors in the inventory count can be traced. The provided situation states that Computing Solutions has multiple inventory storage locations and thus, the auditor is needed to test the inventory in those locations in the presence of significant amount of inventory. In addition, the auditors can also ask for confirmation of the inventories from the central warehouse of Computing Solutions in order to find the errors.
Requirement of ASA 701 Communicating Key Audit Matters in the Auditor’s Report
It has been mentioned earlier that ASA 701 Communicating Key Audit Matters is an essential document for the auditors as it provides the auditors with all the requirements to consider while assessing the assertion risks. It needs to be mentioned that ASA 701 puts the obligation on the auditors to consider four requirements while assessing the assertion risks (Xu, et al., 2013). The first requirement is the determination of the key audit matters of the client where the auditors are needed to take into account the areas of risks and material misstatements. The second requirement is the communication of the determined key audit matters where the auditors are responsible for describing the key audit matters with the help of required subheadings. The third requirement is to communicate the key audit matters with the staffs accountable and responsible for governance. The last requirement is the documentation where the auditors are needed to make the documentarian of the key audit matters in the annual report with the used rationales and procedures. These are the major requirements of ASA 701 (Auditing Standard ASA 701 Communicating Key Audit Matters in the Independent Auditor’s Report, 2018).
It needs to be mentioned that the above discussed matters are the key audit matters due to the presence of some rationales as per ASA 701. First, the above considered matters related to inventory valuation can lead to material misstatements in the financial statements as it can wrongly present the financial standing of Computing Solutions to the investors (Tarr and Mack, 2013). At the same time, the inventory valuation process of Computing Solutions involves the use of judgment by the management having high uncertainty and lack of transparency that can have material effect on the financial statements of the organization (Sirois, Bédard and Bera, 2018). In the presence of these reasons, these issues can be considered as key audit matters.
After the identification as well as resolve of the key audit matters, it is needed for the auditors to make a disclosure of this information in the section named Key Audit Matters. At the time of the disclosure, the auditors are needed to disclose two aspects. First, the auditor is needed to disclose why he/she has considered these matters as significant matters in the audit process; it implies that they are needed to provide the rationales behind these. After that, the auditors are needed to disclose the information about how he/she has addressed these key audit matters; it implies that they are needed to provide information about the performed substantial audit procedures to address these issues (Brasel, et al., 2016).
From the provided information of Beautiful Hair Limited (Beautiful Hair), it can be seen that there are two major management assertion at risk related to the intellectual property of secret ingredients for formula and they are discussed below:
Ownership: It can be considered as a major assertion for the business of Beautiful Hair for the valuation of their intellectual property of secret formula. The main aim behind the use of this assertion is to test the fact that whether the company has the lawful claim to the intellectual property on the company balance sheet. In case of Beautiful Hair, it can be seen that the intellectual property related to formula of the secret ingredients has the potential to be both valuable asset and material for the financial statements of the company. Thus, the lack of ownership of this intellectual property can lead to audit risk in the company (Bumgarner and Vasarhelyi, 2018).
Occurrence: It is regarded as another major assertion used by the management of the company and the main aim behind the use of this assertion is to test whether the transaction related to the intellectual property has actually taken place or not. It can be observed from the provide information of Beautiful Hair that the management of the company has recognized the secret formula of the ingredient as an impactful intellectual property of the company. Thus, in the presence of this reason, wrong occurrence of the deal of intellectual property can pose threat for the audit procedures of Beautiful Hair (Mock and Fukukawa, 2015).
After the identification of the above audit assertions in threat, it is needed for the auditor of Beautiful Hair to identify and perform substantive audit procedures to minimize these risks; they are discussed below:
For the first risk related to the assertion of ownership, the auditors of Beautiful Hair is needed to involve himself/herself in the inspection of the title document of the intangible asset of secret formula in order to make it confirm that all the title documents are in the name of Beautiful Hair. Title documents include title deed and registration of the intellectual property. In the absence of title document as proof, the documents related to possession can be used. These documents are the evident that the company has acquired that particular intellectual property. The absence of these documents indicates that Beautiful Hair does not have any right on this intellectual property (Kogan, et al., 2014).
The second risk is related to the occurrence of the transaction related to the intellectual property of secret ingredients. In order to test this particular assertion, the auditor is needed to involve himself/herself in the process to verify the fact that whether the acquisition of the intellectual property from Shimmers Ltd has been taken place or not at the time of the acquisition. The auditor is needed to do this with the help of the inspection of the documents raised at the time of the acquisition of the transaction for the intellectual property (Cannon and Bedard, 2016). For example, the occurrence of the acquisition related transaction of Beautiful Hair’s intellectual property can be verified with the inspection of all the documents related to the transaction.
The standards of ASA 701 Communicating Key Audit Matters put the obligation on the auditors to comply with four major requirements at the time of the assessment of the management assertion of the companies (Carson, Fargher and Zhang, 2016). The first requirement puts the obligation on the auditors to determine the key audit matters of the business after considering all the aspects related to the risk of material misstatements of the financial statements. The second requirement puts the obligation on the auditors to communicate these key audit matters with their professional judgment. The third requirement states that the auditors are needed to communicate these key audit matters with the employees responsible for governance and internal control. The last requirement puts the obligation on the auditors to make the documentation of all the identified and determined key audit matters in the auditor’s report (Auditing Standard ASA 701 Communicating Key Audit Matters in the Independent Auditor’s Report, 2018).
It needs to be mentioned that the assertion risk related to the intellectual property of Beautiful Hair for secret ingredients is key audit matters as it is valuable asset of the company and it has material effects on the financial statements. There will be major difference in the financial position of Beautiful Hair in case the company does not report it in the balance sheet (Christensen, Glover and Wolfe, 2014).
It is the responsibility of the directors of Beautiful Hair to disclose the rationale why the assertion risks are considered material in the auditor’s report (Azim, 2013). After this, it is the obligation on the auditor of Beautiful Hair to disclose the adopted substantive measures that they have performed for the minimization of these audit risks related to the assertion of the acquisition of intellectual property (Backof, Bowlin and Goodson, 2017).
Conclusion and Recommendations
The above discussion indicates towards the fact that the audit assertions have large role to play in the companies for both the management and the auditors; and it is the prime responsibility of the auditors to inspect these used assertions in order to make sure that there is not any high risk involved with them. From the above discussion, it can be observed that different kinds of management assertions are involved in the valuation of inventory and intellectual property. For example, completeness and accuracy assertions are related to the inventory valuation. The study shows the determining the assertion risk is not enough if they are not addressed with effective substantive audit procedures. It can be seen from the above discussion that the auditors have used different substantive audit procedures to address these risks; like physical cunt of the inventory, inspection of the accusation documents and others. The study also shows that the auditors are needed to communicate these key audit matter related all details in the audit report as per the obligation of ASA 701.
References
ASA 701. 2018. Auditing Standard ASA 701 Communicating Key Audit Matters In The Independent Auditor’S Report. [online] Available at: <https://www.auasb.gov.au/admin/file/content102/c3/ASA_701_2015.pdf> [Accessed 27 August 2018].
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