Audit Assertions and Key Audit Matters

The prime responsibility of the auditors can be found in the examination as well as analysis of the financial statements of the companies in order to ensure the fact that there is not any material misstatements in them as a result of errors and frauds; and the key stakeholders of the companies use the report of the auditors to verify the fairness and truthfulness of the company’s financial statements (Bédard and Courteau 2015). At the time of the development of these financial statements and reports, the managements of the audit clients use certain assertions. Audit assertions are the implicit or explicit claims along with certain representations that the managements of the clients make for the preparation of financial statements concerning its appropriateness of various financial statements elements and disclosures. Managements of the companies use different audit assertions for inventory, property, plant and equipment and others; such as accuracy, valuation, cut off, completeness, existence, occurrence and others (Knechel and Salterio 2016). At the time of auditing the clients’ financial statements, it is essential for the auditors to consider examining these audit assertions with the aim to verify the truthfulness of the used judgements and assumptions by the managements for the preparation of financial statements. After that, they need to determine the Key Audit Matters in case the risks have significance in auditing (Louwers et al. 2015). This report sheds light on the used assertion of the given companies from the perspective of an auditor for the determination of key audit matters.

a.Accuracy/Valuation

At the time to test this audit assertion, the two significant matter faced by the auditors are to provide the necessary assurance on the correctness of all the values and figures of physical inventory count and to provide assurance on the aspect that correct amount of inventory has come as cost of goods sold in the income statements from the balance sheet (Stagg et al. 2018). For these reasons, accuracy or valuation of inventory needs to be tested by the auditors. The case study of Advanced Computer Solutions shows that the inventories of the company are transferred to six new regional warehouses and this incident can lead to the miscalculation in the physical inventory count which can reduce the inventory turnover in 2018. In addition, issues in software can cause error in the inventory valuation process (Ma 2016). These reasons states that this assertion is at risk.

Cut Off

Risks Involved in Audit Assertions

It is needed for the managements of the audit clients to ensure proper recording of the values of inventory in the correct accounting period when they take place. Considering examination of the shipping and receiving documents of inventory is a crucial aspect as it assists in cut off of inventory (Bumgarner and Vasarhelyi 2018). Hence, the companies cannot record the value of inventory of past year in the accounting book of the present year. However, this aspect can be seen in case of Advanced Computer Solution as the inventory of the year 2018 consists of the sales of both 2018 and 2017. This event is the proof that there is an error or errors in the recording of inventory in the correct year’s accounting books. It can also be happened that the problem in software might lead to this issue or any staff is responsible for the same (Kharisova and Kozlova 2014). Hence, it is evident that this assertion is at risk. 

For addressing this risk, the main audit procedure is the methodical surveillance of every aspect of the physical inventory count procedure of Advanced Computer Solutions (Glover, Prawitt and Drake 2014). Certain initiatives that the auditor needs to take are conversing about the strengths and weaknesses of internal control related to inventory, verifying the tags made for the inventory count and to be present when the inventory counts process is on progress. Moreover, the inventories need to be examines in all the warehouses. Lastly, the auditor needs to test the judgments and assumptions of the management along with their compliance with the required accounting standards (Glover, Prawitt and Drake 2014).

Substantive Audit Procedure 2: For the examination of cut offs, the substantive audit procedure will be the verification of all the notes for goods received and goods supplied so that the reporting date can be identified (Byrnes et al. 2018). After that, the auditor needs to undertake examining whether the inventory moved slowly or there was any irrational adjustments in them. Moreover, the auditor need to verify whether the company has provided any stop order in receiving the inventories in the warehouses as these aspects together can create the issue of inventory cut offs (Byrnes et al. 2018).

As per Section 7 of ASA 701, the objectives of the auditors are the ascertainment of the key audit matters, formulation of the key audit matters based on them and disclose as well as communicate them in the auditor’s report (auasb.gov.au 2019).

Substantive Audit Procedures to Address Risks

According to the definition of Key Audit Matters in Section 8 of ASA 701, these are the issues or matters that are important to the auditors to audit the financial reports of the clients; and they need to be selected from the discussion with the governance team (auasb.gov.au 2019).

According to Section 9 of ASA 701, the auditors are required to consider three specific requirements in determining the key audit matters; they are the parts in the financial statements with the higher risk of material misstatements in accordance with ASA 315, the judgements as well as accounting estimates used by the management of clients that are in uncertainty and the impact of the significant transactions or issues on auditing that occurred during the accounting period (auasb.gov.au 2019).

According to Section 10 of ASA 701, key audit matters need to be determined by the auditors after the consideration of the significant events and their impact on auditing (auasb.gov.au 2019).

Rationales for Determination

• The presence of errors in inventory valuation can be considered as significant area in the financial statements having higher risk of material misstatements.
• The presence of errors in inventory valuation indicates that there may be some uncertainties in the used judgments and accounting estimates used by the management for the inventory valuation.
• The occurrence of significant events can be seen that is the transfer of inventories in six different warehouses from the central warehouse that can have impact on the process of inventory count and valuation (Kachelmeier, Schmidt and Valentine 2017).

Disclosure of Key Audit Matters

Why Significant	How Audit Addressed the Key Audit Mattes
Transfer of inventory on March 2018 The company has recently transferred their huge inventory base from one central warehouse to six different warehouses and the physical inventory count process can be impacted with this incident. In addition, inventory valuation includes significant judgment and accounting estimated of the management that are significant for the audit.	The undertaken audit procedures are: – Methodical surveillance of every aspect of the physical inventory count procedure – Conversing about the strengths and weaknesses of internal control related to inventory – Verifying the tags made for the inventory count – Observe when the inventory counts process is on progress – Test the judgments and assumptions of the management along with their compliance with the required accounting standards -Testing the inventories in all warehouses
Inclusion of previous year’s sales in the inventory of 2018 The inventory of 2018 consists of the sales of 2018 and 2017 that indicates the presence of error. In addition, involvement of significant management’s judgements and accounting estimates are there. These can have material impacts.	The undertaken audit procedures are: – Verification of all the notes for goods received and goods supplied so that the reporting date can be identified – Examining whether the inventory moved slowly or there was any irrational adjustments in them – Verify whether the company has provided any stop order in receiving the inventories in the warehouses

a.Accuracy: The use of this particular assertion demands the commitment of the companies to accurately record all the transactions related to property, plant and equipment. It means the companies need to ensure the appropriate classification and distinction of all the expenses related to the property, plant and equipment (Peytcheva 2013). The case study of Green Machine Ltd shows the inaccurate distinction of the revenue and capital expenditures by the company. Certain revenue expenses are capitalized and certain capital expenditures are showed as revenue expenses in the income statements. Thus, it is clear from this aspect that there is error in the classification of major expenses related to property, plant and equipment in the company which can create material effects on the company’s financial statements (Omer, Sharp and Wang 2018). For this reason, this assertion is at risk.

Valuation: This particular assertion demands the commitment of the audit clients that they will record all the assets, liabilities and equity at their cost value after the deduction of accumulated depreciation; and thus, they must apply the correct rate of depreciation. This is an essential requirement for the companies (Mock and Fukukawa 2015). As per the case study of Green Machine Ltd, the rates of depreciation charged on property, plant and equipment are too low and this aspect can lead to the incorrect valuation of property, plant and equipment. Apart from this, application of the low depreciation rate can create different in operating expenses of the company which can ultimately leads to the misstatements of company’s net profit. In the presence of all these reasons, this assertion can be considered at risk (Bowlin, Hobson and Piercey 2015). 

b.Substantive Audit Procedure 1: In the part of substantive audit procedures, the auditor of Green Machine Ltd must review the policies and procedures of the company for the determination of the capital and revenue expenditures related to property, plant and equipment (Kuenkaikaew and Vasarhelyi 2013). In order to do this, it is needed for the auditor to collect the list of property, plant and equipment and must ensure verifying the fact that the company has complied with the necessary accounting regulation and standards related to the expense of property, plant and equipment (Kuenkaikaew and Vasarhelyi 2013).

Substantive Audit Procedure 2: In this part of the substantive audit procedure, it is essential for the auditor of the company to review the deprecation policies of the company along with reviewing the judgments and accounting estimated used by the management (Pizzini, Lin and Ziegenfuss 2014). After that, the auditor needs to consider recalculating the rate of depreciation after analyzing the property, plant and equipment’s residual value and any gain or loss from the sale of them. In this process, comparison of the ratios of depreciation needs to be done. In this process, the auditor will be able to recalculate the revised rates of depreciation along with the revised depreciation expenses (Pizzini, Lin and Ziegenfuss 2014).

c.ASA 701 Communicating the Key Audit Matters

According to Section 7 of ASA 701, the auditor’s objectives are the determination of the key audit matters, development of appropriate audit opinion based on them and reveal as well as converse them in the report of the auditor (legislation.gov.au 2019).

As per the description of Key Audit Matters in Section 8 of ASA 701, they are the issues or substances that are significant to the auditors to audit the financial reports of the clients; and they need to be selected from the conversation with the governance authorities of the companies (legislation.gov.au 2019).

As per Section 9 of ASA 701, the auditors must take into account three specific requirements for the determination of the key audit matters; they are the regions in the financial statements with the superior risk of material misstatements according to the standards of ASA 315, the judgements and accounting estimates utilized by the management of clients that are in doubt and the impact of the significant transactions or issues on auditing that took place during the accounting period (legislation.gov.au 2019). 

According to Section 10 of ASA 701, the auditors are needed to determine the key audit matters after taking into account the significant events and their impact on auditing (legislation.gov.au 2019).

The inappropriateness in the distinction of capital and revenue expenses along with the incorrect valuation of depreciation are the areas in the financial statements of Green Machine Ltd containing greater material misstatements risks.

The involvement of the management’s significant judgements and accounting estimates can be seen in these areas that are not certain as doubts are there in them (Simnett and Huggins 2014).
 

There are two significant transactions and errors; they are the wring division of expenses and application of low depreciation rates that have significant impact on the company’s audit.

Why Significant	How Audit Addressed the Key Audit Mattes
Incorrect distinction between the capital and revenue expenditures The company has done wrong distinction between the capital and revenue expense that can create material effects on the financial statements and it involves judgement and accounting estimates of the management which are crucial for the auditing.	The undertaken audit procedures are: – Review the policies and procedures of the company for the determination of the capital and revenue expenditures related to property, plant and equipment – Collect the list of property, plant and equipment for verification – Ensure verifying the fact that the company has complied with the necessary accounting regulation and standards
Appliance of Low Depreciation Rates for Property, Plant and Equipment Low rate of depreciations have been applied in property, plant and equipment that can create material impact on the company’s financial statements. In addition, the management has used certain accounting estimates and judgments which are important for the audit of the company.	The undertaken audit procedures are: – Review the deprecation policies of the company – Reviewing the judgments and accounting estimated used by the management – Recalculating the rate of depreciation after analyzing the property, plant and equipment’s residual value and any gain or loss from the sale of them

Conclusion

It can be seen from the above discussion that the key assertions at risk for Advanced Computer Solutions are accuracy/valuation and cut off; and the key assertions at risk for Green Machine Ltd are accuracy and valuation. It can be seen from the discussion part of the report that the auditors are needed to take into account the assertions at risk at the time to plan the substantive audit procedures as these procedures must be able to minimize the risks. ASA 701 provides the auditors with the necessary guidelines and principles for the determination of the key audit matters. The above discussion shows the responsibility of both the auditors of the companies to effectively communicate and disclose the key audit matters in the respective section of the audit report. Hence, it is the obligation on the auditors to adhere to the standards of ASA 701 for determining the key audit matters. 

References

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