Case of Advanced Computer Solutions Limited

Auditing is the process of examining as well as inspecting the financial reports and financial accounts of the business organizations with the aim to ensure the fact that they are free from material misstatements (Louwers et al. 2015). At the time to conduct the audit, it is needed for the auditors for the review of the used assertions by the management for the preparation and presentation of financial reports. Audit assertions are the unspoken or obvious claims that the managements of the companies use in the process of financial reporting. The risks in the management assertion can become so severe that they can create material impact in the financial statements. For this reason, the responsibility of the auditors lie in examination of these assertions in order to find any risk in them (Knechel and Salterio 2016). In Australia, it is needed for the auditors to follow the guiding principles and regulations of ASA 701 Communicating Key Audit Matters in the Independent Auditor’s Report as it shows the procedures to the auditors to deal with the assertion risks so that they can be reported in the auditor’s report. The objective of this report is to analyse different dimensions of assertion risks and key audit matters from the two provided situations.

It can be seen from the provided information about Advanced Computer Solutions Limited (Advanced Computer Solutions) that there are two management assertions at risk and they are discussed below:

Completeness: Completeness is an important assertion in order to value the business inventories. As per this assertion, the managements of the companies are required to keep record of all the transactions for the valuation of inventory in the financial reports. Hence, inventory understatement can lead assertion risk (Titera 2013). For example, there can be risk of assertion when the responsible personnel do not keep record of inventory in spite of their purchase. Ineffective or weak internal control can contribute to this risk of assertion. The provided information of Advanced Computer Solutions states the inventory in hand of the company in 2018 includes 26 per cent sales in 2018 and 18 per cent sales in 2017. The responsible personnel must involve in inappropriate valuation of inventory that led to the inclusion of sales of the last year in the current year. This aspect contributes towards the incomplete accounting treatment of inventory of Advanced Computer Solutions.

Accuracy: For the purpose of the valuation of business inventory, accuracy is another important assertion that the managements of the firms make. This assertion plays a crucial part in the identification of inappropriateness and errors in the process to manage inventory. This assertion puts the obligation on the responsible personnel to ensure the correct calculation and count of the physical inventory so that this accurate inventory value can flow to the relevant financial statements (Bumgarner and Vasarhelyi 2018). It can be seen from the provided information of Advanced Computer Solutions that the company was involved in moving their inventory to six new regional warehouses from a central warehouse in March 2018. There is a high possibility of the occurrence of mathematical errors in the inventory counting process at the time to move the inventory; and the presence of this error in inventory valuation can contribute towards the reduction in inventory turnover of 3.8 in 2018 from 5.4 in 2017. Thus, these are the reasons for considering this as a vital audit assertion risk for Advanced Computer Solutions.

Key Assertions at Risk

It can be seen from the above that both completeness and accuracy are the assertions that are on risk in Advanced Computer Solutions. Now, it is needed for the auditor to apply the necessary substantive audit procedures to minimize these risks. These are shown below:

Substantive Audit Procedures for First Risk: Completeness is the first assertion that is on risk in Advanced Computer Solutions. For addressing this risk, the required substantive audit procedure that the auditor is needed to perform is the reconciliation of the physical inventory count with the ledger accounts (Chan and Vasarhelyi 2018). Under this process, the main responsibility of the auditor will be to trace the value of the inventory obtained from physical count of inventory. The main reason behind the use of this substantive audit procedure is the verification of the fact that the responsible personnel has carried forward the inventory balance in the proper manner.  

Substantive Audit Procedures for Second Risk: Accuracy is the next assertion on risk for Advanced Computer Solutions. With the aim to address this risk of assertion, there is a need for the auditor for performing the substantive audit procedure to observe the process of physical inventory counting. In this process of substantive audit technique, the auditor will discuss about the process to count inventory to the responsible personnel; thorough observation of the inventory counting procedure and sample inventory testing with the aim to find any error present in them (Mock and Turner 2013). According to the provided information about Advanced Computer Solutions, the company has moved their inventory in six locations and the auditor is responsible to test the inventory in all of those locations. Apart from this, the auditor is also needed to test the confirmation for the inventories from the central warehouse of Advanced Computer Solutions so that any errors can be recognized.

It can be seen from the provided information of Green Machine Ltd that there are certain assertions related to the valuation of Property, Plant and Equipment (PPE) that can create material impact on the financial statements. These are discussed below.

Valuation: One major assertion related to PPE is Valuation. The principles of this valuation state that the managements of the companies are needed to correctly state their non-current assets at cost value less depreciation; they record the additions and disposals on the correct manner; and they need to take into confederation the review of impairment indicators, impairment or test. It implies that all the financial information is disclosed fairly and at appropriate amount (da Silva and Dantas 2018). According to the provided information about Green Machine Ltd, there has been major concern about the fact that some of the applied rates of depreciation are not appropriate as they are too low. Low depreciation rates of PPE can decrease the operating expenses of the company in large scale that can lead to the material misstatements in the financial statements. Thus, in the presence of all of these aspects, it can be said that this assertion is at risk.

Substantive Audit Procedures

Accuracy: In the valuation of PPE, another major assertion is Accuracy. According to the principles of this assertion, it is the obligation on the managements of the companies to record the amounts and other data related to PPE transactions and events in the correct manner and method. In addition, the managements of the companies need to make the correct distinguish between the capital and revenue expenditure (Lessambo 2018). It can be seen from the provided information of Green Machine Ltd that the management has made an error to distinguish between capital and revenue expenditure. They have capitalized certain items when they should be revenue expenses; and they have included certain capital items in repair and maintenance in the income statement. For this reason, this particular assertion is at risk in Green Machine Ltd.

After the identification of these audit assertions at risk, it is needed for the auditor to apply the required substantive audit procedures to minimize them. They are discussed below:

Substantive Audit Procedures for First Risk: It can be seen from the above discussion that the management of Green Machine Ltd has applied low depreciation rate on PPE. Thus, as the part of the substantive audit procedure, the auditor is needed to consider the evaluation of the depletion rates in certain terms; like in term of lifetime of the PPE, residual amount of the assets, gains or losses on disposal, consistency of the company with the required accounting policies for the application of depreciation and the policy for replacement. After that, it is needed for the auditor to conduct the comparison of the ratios of depreciation of PPE. At the same time, the auditor is needed to recalculate the value of depreciation with the revised rate of depreciation with the aim to obtain the value (AICPA 2017).

Substantive Audit Procedures for Second Risk: The above discussion indicates towards the fact that the management of Green Machine Ltd has made major error in the classification of capital and revenue expenditures. As a part of the required substantive audit procedures, thee auditor of Green Machine Ltd is needed to conduct the review of the capitalization process of the expenses. More specifically, it will be required for the auditor to review the expenses like labour expenses, material expenses, overhead costs, operating expenses and others as it will help them in identifying the expenses that have been classified in incorrect basis. Apart from this, the auditor is needed to review the fact that whether the company has complied with the principles to review the expenses (Cannon and Bedard 2016).

As per ASA 701, it is the objectives of the auditors for the determination of key audit matters by developing an opinion on the financial statements and to communicate these matters in the auditor’s report with description (auasb.gov.au 2018).

As per ASA 701, KAM are the matters that, in the judgment of the auditors, were most substantial in the audit of the financial statements in the current period. The auditors select the KAMs from communicated matters with the governance personnel (Vik and Walter 2017).

Case of Green Machine Ltd

According to the principles of ASA 701, the auditors shall define the matters that need important attention in the audit process after discussion with the personnel responsible for governance. In this process, the auditors are needed to consider the following aspects:

• The auditors are needed to consider the areas with higher measured risks of material misstatements as per the standards of ASA 315 (Azim 2013).
• It is needed to consider the crucial auditor judgment related to the aspects of financial statements involving crucial management judgment that includes important accounting estimates that the auditors have identified for having uncertainty.
• The auditors are also needed to consider the effects of significant events and judgments on the audit operations (Tarr and Mack 2013).

Apart from this, it is needed for the auditors to determine the events or aspects as per paragraph 9 of this auditing standard having impact on the financial statements of the companies so that they can be considered as KAM (Brunelli 2018).

It can be seen from the above discussion that the standards are regulations of ASA 701 helps the auditors in the identification as well as communication of the KAMs in the financial statements of the companies. Now, it needs to be mentioned that there are certain benefits of ASA 701 and they are discussed below:

• The principles and standards of ASA 701 encourages in the better communication of KAMS between the auditors and the personnel charged with governance. This particular aspect creates transparency along with better governance in the process of financial reporting (Kachelmeier, Schmidt and Valentine 2017).
• The standards and principles of ASA 701 assist the auditors to put focus on the areas of audit that require the most cautious audit judgments. This aspect contributes towards the increase in audit quality.
• The principles and standards of ASA 701 provide the preparers with the incentives for revising financial reporting and disclosure in the areas of KAM. This particular aspect contributes towards the increased quality of financial reporting (Sirois, Bédard and Bera 2018).

There are certain reasons that lead to the selection of KAM in both of the companies and these reasons are discussed below:

In case of Advanced Compute Solution, the identified assertion risks are the KAMs as per ASA 701 in the presence of certain reasons. The first reason is that these risks related to the inventory valuation of the company can contribute towards the material misstatements in the financial reports as it has the ability to wrongly misinterpret the financial situation of the company. Secondly, the involvement of certain management judgments can be seen in the process of inventory valuation that consist of high uncertainty along with less transparency. It can also lead to the material misstatements in the financial statements (Backof, Bowlin and Goodson 2017).

The same aspect can be seen in case of Green Machine Ltd as there are KAMs as per ASA 701 in the presence of certain reasons. As per the first reason, charging too low rate of depreciation on PPE can create big difference in the depreciation expenses of the company for that specific period and this value can impact on the profit that can lead to the material misstatements in the financial statements of Green Machine Ltd. As per the second reason, error in the classification of capital and revenue expenses can create major difference in profit of the company for that particular year. This aspect can lead to the material misstatements in the financial statements of Green Machine Ltd. On the overall basis, it can create material misstatements in the overall financial position. These are the reasons for considering them as KAMs (Chambers and Odar 2015).

As per ASA 701, the auditor is needed to identify the KAMs and also needed to disclose these KAMs as per the regulations of ASA 701. The auditors of both of these companies are needed to consider two aspects for the disclosure of KAMs. First, it is needed for the auditors to consider the disclosure of the major events or reasons that have made them as KAMs. In a nutshell, the rationales behind the selection of these KAMs need to be disclosed (auasb.gov.au 2018). Second, it is required for the auditors to make the necessary disclosures of substantive audit procedures that they have applied for addressing these KAMs. In a nutshell, they are needed to disclose information about the substantive audit procedures for the KAMs (Sultana et al. 2015).

Key Assertions at Risk

Conclusion

It can be observed from the above discussion that KAMs are major parts in the audit process due to the fact that they can create material impact on the financial statements of the companies. As per the above discussion, the major assertions at risk for Advanced Computer Solution are completeness and accuracy. On the other hand, the major assertions at risk for Green Machine Ltd are valuation and accuracy. The above discussion also points out that the decision of auditors for the adoption of substantive audit procedures largely depends on the nature of audit assertions at risk. It can be observed from the above that the auditors are needed to follow the regulations and principles of ASA 701 Key Audit Matters for the identification and well as disclosure of the KAMs.

References

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