Key Information

The bible for an auditor is the standards on the audit. These standards are followed by all professionals in the fraternity, and any deviation from the same can be acted against and may amount to a violation of the code of ethics of the profession. The Accounting Standards lay down the entire end to end policies that an auditor needs to follow while conducting an audit of the financial statements (Fazal, 2013). Now before taking up the audit assignment, it is imperative that the auditor should write to the previous/outgoing auditor to ensure that the audit engagement he is planning to take up is not detrimental to his professional accolades and achievements.

The audit plan shall include the undermentioned steps. The audit plan should be comprehensible, concise and foolproof. The plan shall include the following steps.

As an auditor, the first step towards accepting an audit engagement is to communicate with the outgoing auditor about the sanity of transactions of the company. Then the auditor prepares an engagement letter, enlisting his terms and conditions and gets the letter countersigned by the management of the company.  Thus, agreeing to the terms of the audit engagement as is propagated by the audit standard 210 is the foundation towards a healthy audit relationship (Baldwin, 2010). The auditor and the company discuss, communicate and come to an agreement upon the terms of the audit engagement, which both parties need to follow.

After the terms are agreed upon, and the auditor and the company are comfortable with the policies of each other, the agreement becomes valid. As per the directives of the standard on auditing 220, the auditor checks in details the quality control procedures already adopted by the company. While conducting the audit of the financial statements, the engagement partner is responsible for ascertaining that the nature and timing of audit policies should be clearly understood by the audit personnel and it is the duty of the engagement partner to keep a watch on the execution of the audit policies (Christensen, 2011). The quality control to be maintained during the execution of audit needs to be taken care by the engagement partner.

The audit documentation is described by standard 30. The audit plan should entail the format of working papers which the audit officials have to maintain, the degree of risk associated in case of loss of audit papers, and the ownership of the papers. The laws and policies governing the company need to be understood. A clear understanding needs to be developed. The company’s policy environment, nature of transactions and accounting policies need to be understood before starting the audit. First, comes a clear cut understanding of all the peripheral, primary and tertiary laws governing the company. The audit planning is a much later stage in an audit engagement. Once all the laws and rules are understood, and the auditor has a clear understanding of the same, and any material risk identified has been communicated with those charged with governance and the auditor is now sure that there is no fraud that he knows of or a possibility of misstatement, he can start the planning of the audit engagement (Gilbert et. al, 2005).

Reece Group Ltd

The various other standards need to be followed in making an effective audit plan. The given case is of Reece group is a group of companies dealing in supplying bathroom and plumbing products (Reece Group, 2016). The inherent risk associated with the business is already high because of the nature and volume of transactions. Also, the scale of operations of the company is high. The chances of material frauds, errors and misstatements are high. As an auditor, we cannot rely on the records maintained by the company or the internal audit conducted by the company (Hoffelder, 2012). Vigilance is needed.

The audit fees are declared and communicated via engagement letter. The engagement is taken up in good spirit and hence we can proceed with the audit planning.

Apart from using highly professional and technical skills, the basic audit techniques should be in place. The first step in the audit engagement will be questioning the employees. Asking questions can give a clear understanding of the pattern of business and the way it is conducted (Cappelleto, 2010). Then, allotting the audit staff to audit is an important decision to be taken. How many interns or no- skilled and semi-skilled personnel are to be delegated for doing the routine and simple activities, and how many skilled and technical people to be allocated is to be decided wisely. A good resource mix can prove to be very beneficial in conducting an effective audit.

The order of items of the audit is another important aspect of the audit. We can begin with cash and bank account audit and vouch for petty cash expenses (Hoffelder, 2012). Going by the trends, there is an increasing trend of cash and bank transactions. There is a high increase in cash and bank balances as compared to the previous year, and hence, we need to be vigilant in auditing of the same. The bank reconciliations have to be done with more care. The nature timing and extent of audit has to be increased for bank and cash transactions. This is because the company being Australia’s largest supplier of bathroom and plumbing products, hidden transactions can be highly fabricated and can be difficult to ascertain.

The year 2016 seems to be a good year for Reece group. There is an increase in receipts, payoffs, interest income. Finance costs have reduced. The dividend payout has also increased. The audit samples to be selected have to be increased in number from that of the previous year. The next step in the audit will be checking for receipts, payments, sales and constructions. Because of the high volume, manipulations in these are much possible. Purchase of raw materials, payment of wages to workers at construction sites, etc. needs to be checked. Licenses obtained from various government authorities, permits and quality control boards should be kept handy. Purchases to be checked more closely to ensure no substandard material, at an inflated price is purchased.

The assets and stocks account to be checked or closely to ensure stock in trade and assets are not mixed or interchanged to manipulate profit.

The rest of the plan can be enumerated by choosing five areas where there are risks of high and material misstatements.

Firstly, purchase of property, plant, and equipment is a material account which shall determine the nature timing and extent of the audit. Considering the scale at which the company operates, this high investment can be attributed to expansion activities because of which the property could have been purchased. The investment in the year 2015 was also high, and although there is not much difference in the value of investment this year, the investments will still be a risk prone area, where fraud, misstatement, and irregularity is possible. Physical verification of the assets so purchased or invested in is a very important activity (Kaplan, 2011). The land deeds, matched with bank statements, bills of plants and equipment purchased, requisition lists, new sites or showrooms opened, new franchise or expansion deals, need to be checked. Proper depreciation is being charged or not needs to be checked. Intercompany or Intra Company transfers to related parties needs to be checked too (Lapsley, 2012).

The materiality level of the investments is as follows:

Value of investments made during the year 2016= $65511000

Balance of total assets account at the end of 2016= $500035000

Materiality level= 0.025%

Thus materiality= $ (0.025%*500035000)

= $ 125008.75

Secondly, impairment of goodwill is another risk area. In the year 2015, there was no impairment of goodwill. In the year 2016, based on accounting estimates, there has been impairment in the goodwill of the company. The value in use of the cash-generating units of the company, the carrying amount of the Cash generating units and its recoverable amount, should be ascertained properly. The estimates used by the company to arrive at these numbers, the base of such estimates and feasibility have to be verified. A statement of goodwill clearly indicating the acquisition and impairment in goodwill can help keeping a check on the fluctuation in the value of goodwill (Livne, 2015).

Value of impairment of goodwill during the year 2016= $10901000

Balance of total intangible assets account at the end of 2016= $201392000

Materiality level= 0.025%

Thus materiality= $ (0.025%*201392000)

= $ 50348

Thirdly, the increase in income from non-continuing operations as compared to that in the year 2015 is almost 9.5 times. This is a clear significance that the company is drifting towards activities other than crucial business activities which are definitely not a good sign. The notes prove that the profit is from the sale of assets. The company where on one hand is purchasing property plant and equipment, it is also selling a huge portion of its assets (Manoharan, 2011). Thus, this can amount to material risk. Check can be kept on the same by adopting a check based approach on the same. The reason for the sale of property, investments and the income from such investments need to be monitored to ensure there is no embezzlement of funds.

Value of income from other sources during the year 2016= $15405000

Materiality level= 0.025%

Thus materiality= $ (0.025%*15405000)

= $ 3851.25

Fourthly, expenditure on philanthropist activities can turn out to be materially risky because this is one expense where funds can be embezzled with ease. The expenditure of $510000 is not huge as compared to the scale of operations of the company but is definitely high enough to be a potential risk factor. The areas of expenditure, receipts from the recipient organization of such donations, banks statement verification, the nature of expenses, any relation of these recipient organizations to the directors of the company, needs to be monitored to ensure that the funds are utilized for the right purpose (Merchant, 2012). Moreover, monitoring internal controls if any for these expenses is an efficient way to keep an eye on these expenditures.

Thus, the level of materiality can be computed as under:

Value of expenditure in philanthropist activities 2016= $510000

Materiality level= 0.025%

Thus materiality= $ (0.025%*510000)

= $ 127.5

Fifthly, all transactions with related parties are materially dangerous and can hamper the financial health of the company. Although in 2016, the transactions have been at arm’s length prices, but the company still owes money to the company in which directors are interested parties. For future audit plans, this area shall count as a material risk area and extra audit procedures have to be applied for ensuring that no foul play occurs in this area.

Goods purchased from an entity in which directors are interested parties= $ 4035427

Lease rentals paid to entities in which directors are interested parties= $ 1199552

Total value of transactions with entities in which directors have interest= $ 5234979

Materiality level= 0.025%

Thus materiality= $ (0.025%*5234979)

= $ 1308.75

Strong internal controls are needed in this area of expenditure since there are more chances of funds embezzlement as directors are directly involved in these transactions. The higher the level of authority involved in a transaction, the lesser are the chances of finding them out. Hence, even if strong internal controls are maintained, it is difficult to keep a track of these transactions deviating into personal benefits of the higher management (Parker et. al, 2011). More audit procedures have to be imposed, and a real time check has to be kept on the scale and validity of these transactions.

The above analytics are vital for the healthy running of the organization. Audit procedures and their efficiency determine the effectiveness of the entire audit engagement. It is important as it provides a road map to the engagement partner on how to go about auditing the company. Reece limited is a huge company with multiple showrooms and outlets. The nature of the business is a luxury as well as fittings. Bathroom fitting and plumbing works business is a fancy and increasing business in today’s business scenarios. Audit planning is needed even if the engagement is a small scale business. Planning the audit prior to starting the engagement is a practice that is being followed ever since the concept of audit came into place. It is all pervasive. Planning of audit helps the audit team to analyze the challenges that can possibly crop up in the audit during its course.

For Reece Group, the audit team should first of all select audit samples. Audit samples cannot just be transaction based. Samples are also location-based. Given the widely spread network of the business of Reece group, which location to choose, the order of preference, the nature of transactions to be audited for that particular location, and the duration of the audit. The location which is high revenue generating should be given more preference and time as compared to others (Reece Group, 2016). Also, the location where the revenue is less, but a number of transactions are high, also needs time. This is because more transactions can imply errors in accounting or failure in internal controls. Once all this is determined, allocating the right personnel for the job is another crucial element of audit planning.

The nature of audit also needs to be determined. Whether the audit procedures will be concomitant or a one-time activity is a very important decision in audit planning. Another important part of audit planning is to determine how much to rely on the internal auditors and how much to believe in the internal control measures of the organization. A discussion and review of the past performance of internal auditors can help the audit engagement partner analyze the nature timing and extent or audit risk procedures to be applied to work done by internal auditors (Cappelleto, 2010).

Embedding audit software modules into the system, or allocating personnel to the premises of the company, and the frequency of such audit is one more crucial decision in audit planning.

Firstly, Purchasing of properties and plants and equipment is the expansion decision of the entity. It is evident because the company is constantly increasing its volume. Where on one side it is purchasing property, on the other, it is also disposing of property and that too for profits. There has to be a check as to whether this practice is actually a business need or just another way of turning out funds from the company.

Secondly, a fair practice of imparting goodwill can be considered a no risk factor. But here we can see that the impairment was not done last year. It was done only in 2016. So was some considerable event that led to this impairment or was it a regular business activity has to be found out. Impairment of goodwill beyond normal business level is a potential threat to the company

Thirdly, the increasing income from non-regular activities is not a good sign as long as it doesn’t affect the regular operations of the entity. What needs to be monitored here is that whether these non-continuing activities are affecting the daily workings of the entity (Niemi & Sundgren, 2012).

Fourthly, philanthropy is one area which is prone to fund embezzlement. The company’s? social responsibility acceptance is fair. But there are chances that the management can divert money to their interested concerns in the name of philanthropy. Hence, due care is to be given.

Fifthly, a transaction with related parties or companies where the director is interested is one major risk prone area because of involvement of higher levels of management. There can be a turnaround of funds which can be unidentified by internal controls and internal audit findings as well.

Conclusion

The entire procedure listed above shall be guided by the principles of auditing standard 300, which enumerates the planning of an audit of the financial report. In the entire process of planning, the engagement partner and his team get to know the company and its environment. It becomes clear as to how prone the entity is to the material is- statements. Once the planning phase is over, the conclusions drawn from the planning is communicated to the management and those charged with governance. If the auditor is of the opinion that the risks so identified are high, the same shall be communicated to the management and they should take necessary actions. However, if there is no response from the management or the audit engagement partner is of the opinion that the engagement can be detrimental to his profession, he can disassociate himself with the engagement by giving prior notice about the same to the management (Roach, 2010). In order to be surer about the nature of risks and the level of materiality of risk, analytical procedures, and comparative approach should be followed by the auditor. These are all procedures guided by various standards on accounting which need to be followed by the engagement partner before and in the process of conducting any audit.

References

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Cappelleto, G. 2010, Challenges Facing Accounting Education in Australia, AFAANZ, Melbourne

Christensen, J. 2011, ‘Good analytical research,’ European Accounting Review, vol. 20, no. 1, pp. 41-51

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Gilbert, W. Joseph J & Terry J. E 2005, The Use of Control Self-Assessment by Independent Auditors, The CPA Journal, vol.3, pp. 66-92

Hoffelder, K 2012, New Audit Standard Encourages More Talking, Harvard Press.

Kaplan, R.S. 2011, Accounting scholarship that advances professional knowledge and practice, The Accounting Review, vol. 86, no. 2, pp.  367–383.

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Livne, G 2015, Threats to Auditor Independence and Possible Remedies, viewed 5 March 2017, https://www.financepractitioner.com/auditing-best-practice/threats-to-auditor-independence-and-possible-remedies?full.

Manoharan, T.N. 2011, Financial Statement Fraud and Corporate Governance,  The George Washington University.

Merchant, K. A. 2012, Making Management Accounting Research More Useful’, Pacific Accounting  Review, vol. 24, no. 3, pp. 1-34.

Messier, W & Emby, C 2005, Auditing & Assurance Services: A systematic approach, McGraw-Hill.

Niemi, L., & Sundgren, S 2012, ‘Are modified audit opinions related to the availability of credit? Evidence from Finnish SMEs’,  European Accounting Review, vol. 21, no. 4, pp. 767-796.

Parker, L, Guthrie, J & Linacre, S 2011, The relationship between academic accounting research and professional practice, Accounting, Auditing & Accountability Journal, vol. 24, no. 1, pp. 5-14.

Reece Group 2016, Reece Group Annual Report 2016, viewed 5 March 2017, https://www.reecegroup.com.au/assets/Uploads/F2016-Reece-Limited-Annual-Report.pdf

Roach, L 2010, Auditor Liability: Liability Limitation Agreements, Pearson.