Discuss About The Budget Pressure And Intentionality On Audit Supervisors.

Key business risks in Arena Reit

The following report is designed to gain an insight of auditing concepts in context to a company listed on ASX. The report aims to perform the required auditing steps and design a risk-based audit program in context of Arena Reit that owns, and manages specific real estate assets throughout Australia. For this purpose, the substantial tests of balances of the company’s assets and liabilities are performed using substantive approach. Moreover, the report discusses the key business risks, identifies the materiality of the items, and carries out analytical procedures over the last three years of Arena Reit, using ratios and metrics. Finally, a sampling plan is prepared for each material account to complete the audit process

Business risks refer to the factors that have ability to prevent a company from the achievement of its goals (Baatour et al., 2017). These factors, if not taken into consideration and managed timely, could result in business failure. Since Arena Reit is a real-estate company, its key business risks are divided into: location risks, operational policy risks, regulatory and external risks, and appearance risks. These risks are mentioned as below:

Development risks

• Ground acquisition risk
• Zoning plan risk
• Nuisance risk
• Financing risk
• Social unethical development risk
• Workspace design risk
• Temporary housing risk
• Tender risk
• Planning risk
• Development budget risk

Financial policy risks

• Solvability risk
• Liquidity risk
• Cost of capital risk
• Budget cut risk
• CRE budget risk
• Real estate investment risk
• Book value risk

  Operational & business policy risks

• Facility management risk
• Maintenance risk
• Real estate flexibility risk
• Office layout risk
• Health and safety risk
• Malfunctioning installation risk
• Occupancy rate risk
• Expansion profile risk

 Location risks

• Supplier risk
• Uptime of production facility risk
• Preferred location risk
• Accessibility risk
• Stakeholder risk

Appearance risks

• Maintenance risk
• Design risk

• Real estate data availability risk
• Terrorism risk
• Natural failure risk
• Contracts hazard
• Political and social unrest risk
• Property market risk
• Exchange rate risk
• Market risk
• Legal risk
• Technology development risk

As per the guidelines of International Accounting Standard (ISA) 315 auditors are need to gain proper knowledge of the Arena and its environment for purpose of evaluating the risks of substantial misstatement within its financial statements (Shariman et al., 2017). This would help the auditor to strengthen the importance of gaining a bird’s eye view of the business operations and related key risks by at the stage of audit planning.

Audit risk refers to the threat that the auditor may issue an unqualified audit view if the financial statements are extensively overstated or understated. This opinion could also be the result of the significant flaws in the internal controls of the company.

In this view, the auditor needs to apply the Audit Risk model while carrying out audit in Arena Reit. This model has three aspects called, Internal Risk (IR), Control Risk (CR), and Detection Risk (DR) (Anantharaman et al., 2016). The IR represents the vulnerability of a group of transactions or an account balance to the significant misstatement when there exist no related controls. On the CR refers to the risks which the internal control processes find unable to identify or prevent the material misstatements. DR signifies risk of auditor’s inability or failure to discover the major errors in the accounts that are not even captured by the related internal controls. The formula for determining the audit risk in Arena is:

AR = RMM*DR

AR = (IR*CR)*DR

DR= AR/ IR*CR 

Or

AR = IR*CR*DR

Let the planned audit risk for the accounts receivables of Arena be at 0.05.  Further, the assessment of inherent risk is at 0.80 while the control risk is at 0.60.  In order to find out the degree of detection risk for this accounts receivable balance, the above audit risk model would be used:

0.05 = 0.80*0.60*DR

0.05/DR = 0.80*0.60

0.05/DR = 0. 48

DR = 0.05/0.48

DR = 0.10

Result: From the equation of audit risk model, the detection risk or DR is determined at 0.10. This shows that detection risk is lower or minimum while the internal risk is higher or maximum, and the control risk is moderate or medium for the Arena Reit (Chan et al., 2018).  Since the internal risk rate is high in the company, it indicates that the accounting transactions of Arena Reit might be exposed to the aspects of external environment along with the internal environment within the organization, such as political & legal factors, and economic conditions. On the other hand, the key areas where deception is expected to arise due to weaker internal controls in the organization include:

• Payroll fraud
• Cash & other valuable assets
• Third party fraud
• Banking transactions

Therefore, while carrying out the audit program in Arena Reit, the auditor would require reviewing those types of risks and applying the procedures for addressing the inherent risks in the best possible way. Also, for this purpose, the auditor requires to employ relevant audit approach and policy in order to calculate the impact of frauds and errors on the financial statements, along with rectify these timely.

In accordance with the section 330 of International Accounting Standards, the auditor requires to perform analytical procedures (Miglani et al., 2015). Here, the analytical procedures for Arena Reit are performed as below, using the ratios and metrics for the three years’ financial statements of the firm:

Calculation of ratios:

From the above table, it can be analyzed that reasonable cost control has been maintained in Arenas regardless of the substantial rise in sales (Arena Reit, 2016). In order to test this, it is essential for the auditor compare operating costs to sales.

The above table shows that operating costs are low in comparison to revenue. It means the expenses might be understated by Arena, or the high sales might be the result of increased business (Arena Reit, 2017). Thus, it is important for the auditor to identify why this has happened. The common causes might be inefficient business operations or overstretched management. However, there might exist other implications too, which must be examined by the auditor.

Importance of determining business risks for auditing

It can be observed that the ROCE of Arena Reit has been decreased from the year 2016 in the year 2017. However, the ratio was higher in 2015. It indicates that the company might has stopped issuing more equity shares or borrowing loans (Arena Reit, 2017). However, the auditor is required to check all the assertions properly to see if there exists any misstatement in the financial statements.

Asset turnover ratio indicates the ability of a company to generate sales using all its assets efficiently. The above table tells that this ratio of Arena has been increasing for last three years thus showing how hard the company has worked on its assets (Arena Reit, 2016). However, the auditor needs to check all the assertions of the company related to this ratio so as to identify of there is any overstatement of sales or understatement of assets in the balance sheet.  

Current assets are used by a company to oblige its current liabilities. The current ratio shows how effectively the current assets are used by a company to pay off its debts (Arena Reit, 2016). If the ratio is less than 1, it creates worries as the company does not have sufficient assets to discharge debts. The above table shows that in 2016, Arena Reit’s current ratio was low and it substantially increased in 2017. Thus, the auditor needs to check all the assertions before making any conclusion.

The quick ratio is valuable to determine an entity’s liquidity position when the inventory reduces over time. This is because the discharging of current liabilities mainly depends on the cash and receivables (Arena Reit, 2016). This ratio of Arena Reit is good in 2017. However, in order to ensure the reliability, the auditor should analyze the business and comparatives of the company.

In auditing, substantive approach is proposed to provide evidence that the collected data of the auditor have accuracy, completeness and validity of financial statements of an organization. In this concern, the substantive approach in auditing is executed by the auditor to distinguish the material misstatement in the financial records. Under the substantive approach, different classes of testing the transactions, disclosures and account balances are included. The journal entries and different adjustment entries are in financial statement are examined by the auditor (Johnstone et al., 2013). Substantive approach can be used for both internal and external audit activities of Arena Reit. This approach is also called as vouching approach, as most of audit activities are performed by verifying and vouching documents. The substantive audit approach is useful for the companies in managing weak internal control over the financial records. The examples of substantive audit approach are bank confirmation, account receivable, observation of physical inventory, observe fixed assets, confirm account payable, confirm debts, analysis of liabilities, assets, expenses and revenue (Glover et al., 2014). In this concern, the substantive approach in audit works steps improves the reliability of the collected data during the audit procedure of an organization. The audit work steps for Arena Reit are discussed as below:

Application of the Audit Risk Model

Sampling refers to the application of an audit procedure by the auditor to below 100% of the items within a group of transactions or accounting balances for the purpose of analyzing some basic characteristic. In context of Arena Reit, the auditor should take following steps:

1. Defining the attributes of the population

Since repairs and maintenance is a risky expense account inherently, for the audit, the auditor would examine the accuracy level and categorization of assertions for repairs and maintenance (Rashidfarokhi et al., 2018). The accuracy can be verified if transactions are recorded properly in the correct accounts. At the final analysis, the auditor needs to confirm that these accounts are correct materially or do not contain any material misstatement.

1. Identifying the sample size

Despite the nature of the sampling method adopted, before determining the number of those transactions the auditor is required to sample, he has to reflect on the risk of mistaken acceptance, tolerable error, confidence level, and expected fraud.

1. Choosing the sample items

For example, there exist 4,000 records in a group of transactions of small-dollar. The auditor would divide 4,000 by 50 (the population size or sample size). It equals to 80, which would taken as interval number. Then after, the auditor would organize these records in some sort of order with the help of software or some other means to pick the starting point.

1. Carrying out audit procedures

After the selection of sample size and pulling of sample from the whole population of records, the auditor would need to carry out the appropriate audit procedure that could differ from one item to other (Hossain et al., 2017). For instance, the auditor could follow the transactions which arise in the repairs and maintenance account to the records from the books, such as the paid bill of lading.

1. Deriving at valid conclusions

The last step in sampling plan is to establish whether the account balance is considerably proper (Andon et al., 2015). If the overall misstatements do not go beyond the reviewed acceptance level, the auditor has the right to conclude that the account is not substantially misstated, and there is no requirement for expanding the sample in order to examine more records.

Conclusion

On the basis of above discussions, it can be concluded that auditing is essential for a company in order to provide a transparent picture of its operations to its stakeholders, including the society. The above analysis shows that Arena Reit is operating effectively in accordance to the principles and guidelines defined by the Australian Accounting Law and Australian Securities Exchange. Although there exist some variations in the figures of accounting items in the financial statements of the company over the last three years, the reasons for such variations seem to be valid. Also, the sampling plan made by the auditor for Arena Reit helps the auditor in determining the characteristics of each item along with the identification of any material misstatement.

References

Anantharaman, D., Pittman, J.A. and Wans, N. (2016) State liability regimes within the United States and auditor reporting, The Accounting Review, 91(6), pp.1545-1575.

Andon, P., Baxter, J. and Chua, W.F. (2015) Accounting for stakeholders and making accounting useful, Journal of Management Studies, 52(7), pp.986-1002.

Arena Reit (2016) Annual Report 2016. [Online]. Available at: https://www.arena.com.au/arena/media/docs/Reports/Arena-2016-AR-FINAL-Web-version.pdf (Accessed: 15^th September, 2018).

Arena Reit (2017) Annual Report 2017. [Online]. Available at: https://www.arena.com.au/arena/media/docs/Reports/Arena-2017-annual-report-Final-web.pdf (Accessed: 15^th September, 2018).

Baatour, K., Ben Othman, H. and Hussainey, K. (2017) The effect of multiple directorships on real and accrual-based earnings management: Evidence from Saudi listed firms, Accounting Research Journal, 30(4), pp.395-412.

Chan, D.Y., Chiu, V. and Vasarhelyi, M.A. eds., (2018) Continuous Auditing: Theory and Application. Australia:  Emerald Publishing Limited.

Cohen, J. R., Hoitash, U., Krishnamoorthy, G., and Wright, A. M. (2013) The effect of audit committee industry expertise on monitoring the financial reporting process, The Accounting Review, 89(1), pp. 243-273.

Glover, S. M., Prawitt, D. F., and Drake, M. S. (2014) Between a rock and a hard place: A path forward for using substantive analytical procedures in auditing large P&L accounts: Commentary and analysis, Auditing: A Journal of Practice & Theory, 34(3), pp. 161-179.

Hossain, S., Yazawa, K. and Monroe, G.S. (2017) The Relationship between Audit Team Composition, Audit Fees, and Quality, Auditing: A Journal of Practice & Theory, 36(3), pp.115-135.

Hyatt, T. A., and Taylor, M. H. (2013) The effects of time budget pressure and intentionality on audit supervisors’ response to audit staff false sign?off, International Journal of Auditing, 17(1), pp. 38-53.

Johnstone, K., Gramling, A., and Rittenberg, L. E. (2013) Auditing: a risk-based approach to conducting a quality audit. USA: Cengage learning.

Lenz, R., and Hahn, U. (2015) A synthesis of empirical internal audit effectiveness literature pointing to new research opportunities, Managerial Auditing Journal, 30(1), pp. 5-33.

Miglani, S., Ahmed, K. and Henry, D. (2015) Voluntary corporate governance structure and financial distress: evidence from Australia, Journal of Contemporary Accounting & Economics, 11(1), pp.18-30.

Rashidfarokhi, A., Toivonen, S. and Viitanen, K. (2018) Sustainability reporting in the Nordic real estate companies: empirical evidence from Finland, International Journal of Strategic Property Management, 22(1), pp.51-63.

Shariman, J., Nawawi, A., Salin, P. and Azlin, A.S. (2017) Public Sector Accountability-Evidence from the Auditor General’s Reports, Management & Accounting Review, 16(2).

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