The report presents an analysis about M Ltd, a company which is specialized in the production and selling of wine. The company has recently been listed on the stock exchange which increases the responsibility of management to prepare unbiased and transparent financial statements that satisfies the needs of shareholders. The initial part of the report focuses on risk assessment strategies and bifurcates it into inherent, control and detection risk. Further, this part of the report also discusses that the allocation of resources will depends on the importance and complexity of business transactions.
The second part of the analysis provides a detailed knowledge about the audit plan and what strategies could be adopted by auditor to gather sufficient appropriate audit evidence. This segment also describes various audit procedures about the valuation and measurement of foreign currency and inventory valuation. At the end, the report provides a conclusion about the overall analysis.
In accordance with ASA 315 Identifying and Assessing the Risk of Material Misstatement through Understanding the Entity and its Environment, it is the responsibility of the auditor to appropriately address the overall audit risk through adopting appropriate audit procedures (AUASB, 2015). The Audit Risk can be bifurcated into inherent risk, control risk and detection risk.
Inherent risk is the risk of errors and omission in financial statements. It arises where there is high level of management judgment and estimations. One of the major risk in M Ltd is the valuation of stock; there is a significant stock in warehouse which is rejected by customers and its payment is still in dispute. The valuation of stock may require significant management estimation which increases the inherent risk. Further, the precedent auditor had also some disagreements with finance director regarding some accounting treatments, so the current auditor must contact the precedent auditor and obtain knowledge about any discrepancy in accounting treatment.
Control risk arises due to the failure of internal controls. It is the responsibility of those charged with governance to implement sound internal controls that prevent the chances of errors or fraud and encourage them to present unbiased and transparent financial information to shareholders. One of the major control risk in M Ltd is there is a lack of supervision. The managing director is involved in executing the operations whereas on the other hand, finance director oversees all the financial matters. In order to effectively implement internal controls, it is very important that there must be proper supervision and segregation of duties which reduces the risk of error and omission (IIA, 2008). The internal controls of M Ltd seem to be weak, so the auditor must focus on substantive procedures to gather sufficient appropriate audit evidence.
Detection risk arises where auditor fails to detect a material misstatement in financial statement. It arises where the auditor fails to apply appropriate audit procedure and the error or omission may not be detected in sampling. In order to avoid this risk, auditor must assure that sufficient competent and capable staff has been assigned to the client that can conduct an audit in an efficient manner.
ASA 300 Planning an Audit of Financial Statement requires the auditors to develop a comprehensive audit plan in order to gather sufficient appropriate audit evidence. The major purpose of the audit plan is to obtain an understanding of the entity and its environment so that appropriate audit procedures could be applied to generate a reasonable opinion on financial statements (AUASB, 2015). Further, it can also facilitate external auditors to understand what procedures have been applied by auditor to support the audit conclusion.
The first step in the audit plan is to obtain an understanding of the entity and how its operations are executed. It will help us to analyze the risk associated with entity and enable us to allocate sufficient resources to collect sufficient appropriate audit evidence (AUASB, 2015)
M Ltd operates a management incentive plan which is based on the profit of the company. The finance director is susceptible to get a bonus on the profit of the company so the auditor shall made a rebuttable presumption that there is a risk of material misstatement in financial statement. The auditor shall believe that the financial statements could be misstated to get finance director eligible for bonus. The auditor shall also exert strong emphasis on the valuation of inventory and foreign currency. Further, the auditor shall also consider the disagreement of finance director over accounting treatment in last year as well.
The auditor must obtain draft financial statements of current year and verify the opening balances from the audited financial statements. If there is any discrepancy in figures then the auditor must enquire it from management and if the figures are restated then the auditor shall apply appropriate audit procedure to assure that the restated figures does not materially misstate the financial statements (AUASB, 2013).
Test of controls is a strategy where the auditor itself process a transaction to determine whether the company has sufficient internal controls in place that can reduces the risk of material misstatement in financial statements. If the controls are week in the organization then the auditor performs substantive audit procedures to reduce the risk to an acceptable level. On the other hand, if the controls are strong in the organization then auditor mainly focus on analytical procedures to form an audit conclusion (IIA, 2008).
Balance audit program is basically a design of comprehensive audit procedure to gather direct audit evidence on the basis of various audit assertions. It facilitates the auditors in obtaining sufficient appropriate audit evidence and helps auditor in reaching reasonable conclusion. The controls of M Ltd seem weak so the organization shall balance the substantive and analytical procedures in providing a reasonable conclusion (AUASB, 2013).
The extent of the audit procedures will depend on the complexity of the entity and its environment and the implementation of internal controls in the organization. Areas which are of strategic importance will be allocated higher workforce and the areas of least importance will be allocated reasonable workforce.
Foreign currency business arises due to the changes in economic and political conditions in different countries. It increases the risk for auditors due to its subjective nature and raises difficulty for auditors in developing a suitable audit program that enable them to gather sufficient appropriate audit procedure (AUASB, 2013).
In order to reduce the foreign exchange rate risk, it is very important that the auditor shall verify the accuracy of foreign transaction through accounting records. Further, the auditor shall also obtain the daily foreign rates and compare it with processed transaction. The auditor shall also verify that the exchange gain or loss has appropriately been recognized in income statement in accordance with AASB 121 (AASB, 2015).
In manufacturing concern organizations, stock represents a substantial portion of an organization’s current assets. Further, it is of strategic importance because it has direct impact on the profitability of the organization. It is important that the organization shall appropriately record the stock in financial statement which is free from any material misstatement and enable shareholders to obtain unbiased and transparent information (AUASB, 2013).
The basic audit procedure for the stock valuation is that the auditor shall conduct a physical stock count and verify it with the stock list provided by the organization. If there is any variation in available stock and accounting records then enquire it from management and ensure that there is no material misstatement in financial statement. Further, the auditor shall also observe the physical condition of stock and assure that it is in saleable condition (AASB, 2015).
The second audit procedure for stock is to appropriately value the inventory in accordance with AASB 102.The inventory must be valued at the lower of cost and net realizable value. For the rejected bottles of vines by the foreign customer, the auditor must assure that the inventory has been recorded at the lower of cost and selling price less any less additional cost to become saleable to customer.
In order to develop an audit program, the auditor must obtain an understanding of the entity and its environment which would help them to form a reasonable opinion on the financial statements. The audit plan is bifurcated into general audit program and specific audit program. The general audit program shall focuses on industry analysis, test of controls and opening balance verification where as specific audit program shall focus on the development of specific audit procedures that helps to verify different audit assertions.
There is an inherent risk in M Ltd as the bonuses of finance directors are dependent on the profitability of the organization. Further, there was also disagreement of accounting treatment with precedent auditor which requires the application of sufficient resources to gather sufficient appropriate audit evidence. Additionally, it also requires the adoption of appropriate audit procedures for the valuation of stock and foreign currency.
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