The provided statements is not correct because of an inverse relationship between the level of audit risk and materiality. It means that the higher the level of materiality, the lower the audit risk and contrariwise. On the other hand, the lower the level of materiality, the higher the audit risk as a lower level of materiality implies that there is not enough room for error. This inverse relationship between audit risk and materiality is considered by the auditor when ascertaining the audit procedures’ timing, nature and extent.
The following discussion shows the 4 riskiest audit issues in the audit of ZNA Baking Ltd:
- As per Paragraph 521.4 A1 of APES 110, there might be the development of a familiarity, self-interest or intimidation threat to audit independence when the auditor’s immediate family member is employed in such a position of the audit client to apply significant influence over the financial performance, position or cash flows of the client (org.au 2022). In the provided case, the CEO of ZNA Baking Ltd is the brother-in-law of the auditor responsible for auditing the company. Hence, it should be considered as an audit issue because the auditor might lose objectivity and independence while auditing the financial statements of ZNA Baking Ltd because of his personal relationship with its CEO.
- As per the provided information, a new competitor of ZNA Baking Ltd has entered the market half-way through the financial year. This competitor may put more stress on the management of the client to generate the expected profit. As a result, the management might involve in fraudulent financial reporting to show an improved financial performance of the company. Hence, it is a key audit issue.
- The sales of ZNA Baking Ltd have declined because of the impact of COVID-19 as people are staying home and cooking. The decline in sales may lead to the issues like slow-moving of inventories or obsolete inventories which might overstate the inventory account. Hence, it is a key audit issue.
- The CEO jokes about some creative accounting practices to obtain equal bonus as the previous year raises a question about the honesty and integrity of the senior management of ZNA Baking Ltd. This is an audit issue since the CEO might cook the book to get the equal bonus.
The two main accounts affected are Sales account and Inventory account. The audit procedures and assertions are as follows:
Sales account is at risk because the management of ZNA Baking Ltd might overstate this account to increase profitability. Therefore, the relevant assertion that will be tested is accuracy as sales may not be recorded at correct amount to overstate it. The audit procedures are as follows:
- Tracing the records of products sold with the sales records in order to agree dates, customers, prices, quantities and amounts.
- Testing the mathematical accuracy of the sales transaction file (Almasria et al.2021).
Inventory account is affected because the decline in sales might result in overstatement of inventory due to slow-moving or obsolete inventory. Therefore, the assertion that will be tested is valuation and allocation. The audit procedures are as below:
- Sighting inventory at stock take so that obsolete or slow-moving inventories can be identified and assessed.
- Testing whether the inventories have been valued at the lower of cost and net realisable value (Saro, Keitany and Rop 2021).
- The incident of the CEO admitted to commit fraud and stole $400,000 over the last five years is an adjusting event as the conditions of this incident were there at the reporting period’s end (com 2022). He testing include:
- Considering whether changes need to be made in the financial statements;
- Discussing the matter with the management of Golden Golf Club; and
- Testing whether this issue creates any going concern issue for the client (auasb.gov.au 2022).
In addition, the auditor is needed to discuss with the management on how they are planning to amend the financial report by disclosing the incident. The auditor will also be involved in ascertaining whether the event is correctly reflected in the club’s financial report as per the applicable framework for financial reporting. If the financial statement is amended by the management, the auditor will be needed to perform additional audit procedures essential in the situation of the amendment.
- If it is indicated by the management of Golden Golf Club that the financial report will not be changed even though the auditor believes it needs to be changed, it is needed to issue a qualified or adverse opinion. Not changing the financial report would materiality misstatement the financial statements of Golden Golf Club. If the management agrees with the auditor and amend the financial statement by including the effect of this incident, there will be no need to modify the audit opinion.
- The accident of Norman Greg is a non-adjusting event because does not provide any evidence of any condition that existed at the financial reporting date (com 2022). Therefore, the testing include:
- Discussing the matter with the management of Golden Golf Club and if needed, those charged with governance;
- Carry out the required analytical procedures to assess the impact of this legal case on the financial statements of the club;
- As it a non-adjusting event, recommending the management to disclose the issue in the notes to the financial statements (auasb.gov.au 2022).
The auditor is also needed to assess the intention of the club’s management to address the issue by disclosing the same in the notes.
- If the management of Golden Golf Club disclose the issue and possible legal case details in the notes to the financial statements, it will be needed to issue an unmodified audit opinion. The auditor will be needed to include the detail of this case in the audit report in order to draw the attention of the users. If the management of the club shows no intention to disclose this information in the notes to the financial statements, then the auditor needs to amend its audit report by including an additional paragraph about the matter so that the users can have an understanding of it. In both of the cases, there is not any need to modify the audit report.
References
Almasria, N., Airout, R.M., Samara, A.I., Saadat, M. and Jrairah, T.S., 2021. The role of accounting information systems in enhancing the quality of external audit procedures. Journal of management Information and Decision Sciences, 24(7), pp.1-23.
Apesb.org.au. 2022. APES 110 Code of Ethics for Professional Accountants (including Independence Standards). Available at: https://apesb.org.au/uploads/home/02112018000152_APES_110_Restructured_Code_Nov_2018.pdf (Accessed: 19 April 2022).
Auasb.gov.au. 2022. Auditing Standard ASA 560 Subsequent Events. Available at: https://auasb.gov.au/media/jmootdwz/asa_560_12_21.pdf (Accessed: 19 April 2022).
https://www.accaglobal.com, A. 2022. Subsequent events | F8 Audit and Assurance | ACCA Qualification | Students | ACCA Global, Accaglobal.com. Available at: https://www.accaglobal.com/an/en/student/exam-support-resources/fundamentals-exams-study-resources/f8/technical-articles/subsequent-events.html (Accessed: 19 April 2022).
Saro, B., Keitany, P. and Rop, W., 2021. Inventory Audit and Supply Management: An Evidence of Inventory Control Practices. East African Journal of Business and Economics, 4(1), pp.85-92.
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